Wednesday, 4 December 2013

Life "Sans Gaz"

The great and the good of the economics world have been debating the possibility of growth without bubbles.  Larry Summers and other commentators have proposed that the dynamic growth enjoyed by the West between 1994 and 2008 was due to a stream of bubbles (dotcom, the euro, the credit boom and commodities) that kept growth rates artificially high.  Without a stream of future bubbles the developed world may not be able to grow at a rate that improves living standards.  Fortunately human being are well adapted to bubble recognition  (it occurs when the capital gain an investor expects over time is much greater than the potential change in interest rates in that same time period) and once one person has spotted a bubble we all dive in!
Stripping out these instances of temporary and unsustainable exuberance we are left will a pretty anemic performance in global GDP growth.  The inability to grow without market bubbles providing the fuel to the global engine has been coined secular stagnation – low growth, high debts, falling prices and high unemployment.
Here's to the next bubble
Before we all throw in the towel,  it's possible that the champagne that has been on ice for five years is about to pop its cork in a shower of new bubbles – the housing market is building up a head of steam in a number of key markets – parts of the US, the UK, Germany and parts of Scandinavia. In other markets there is still a considerable over hang in supply (Spain, Ireland, Greece and parts of the US) and the pain that investors and lenders have been through ought be burned into their collective consciousness.

Given these recent events, should we be surprised that housing markets have bounced back so strongly after the market failures of 2008-9?  This current market exuberance has got Central Bankers worried. In the UK where the bubble is very well developed Mark Carney has turned off the tap of credit support (Funding for Lending scheme) that banks have been using to make loans into the UK property market.  It will be interesting to see whether choking off this avenue of credit will be successful or whether the UK housing market will find new ways to grow.

The financial press has been deeply negative on the recent turn around in housing markets complaining that the recovery is being driven by property speculation rather than investment in manufacturing or some more worthwhile activity.  But should we be surprised that recovery is starting in the housing market?  Real interest rates have been negative for 5 years and this has created a problem for middle income families, where do they put their savings.  The threshold for equity investments has risen appreciably over the last 20 years and more standard saving devices offer meagre returns so where else to turn but the tried and “trusted” bricks and mortar option?  The economic cycle is driven largely by swings in consumer demand and we should be thankful that consumers are releasing saving (or taking on debt) to invest in the housing market rather than leaving they money dormant in bank accounts.

If you had to pick a catalyst for growth, the property market may not be such a bad place for us to start, buying houses or moving house will provide broadly based support for the economy:  obviously consumer spending will rise as home owners kit out their new homes, the construction industry will benefit as demand for new homes improve, this feeds to manufacturing as new houses and household improvements require manufactured materials and finally financial services will benefit through the new mortgage and insurance products that are required.  All of this is supported by long term borrowing that should be affordable for consumers and prudent for the lenders.
There are obvious dangers if the improvement in the housing market doesn’t pull through into the wider economy as a lopsided boom in property would be difficult to handle if the rest of the economy is struggling with high employment. In this scenario the interest rate that would be appropriate for the property sector would be quite different from rate that would be appropriate to the wider economy. Lowering interest rates for the wider economy would create a more dangerous housing bubble, while raising rates will bankrupt more people and businesses in a distressed debt situation.

At the moment a housing boom is welcome in the UK and if this turns into a more broadly based recover – perfect!  If the property boom does not filter down then the government will need some new regulatory tools to supress new mortgage demand, without raising interest rates generally.  Historically efforts to increase supply have failed dismally, so it looks like stricter limits on bank lending to this market might have to be extended until we find another bubble more interesting than housing!

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