A central dysfunction: house price inflation, stagnant economy

[Published at Pearls & Irritations, 7 Nov]

The problem with the housing bubble is not a shortage of housing, the problem is an excess of money. The solution is to restrict the amounts banks can loan. The solution is a credit squeeze. But it would have to be done carefully and the government would have to be willing to spend.

The housing market is rebounding. It is through the slump. The downturn is over and the market is making gains. So say the media reports, written by the property industry. Rising house prices are good.

Except they’re a disaster for everyone else.

In my small town, Sydney property money is spilling into the local market and pricing people out of their homes. Older women and single mums are homeless, couch surfing, taking anything the local community can find for them. Across the country young people can’t afford a house anything like the one their parents bought.

At the same time, the economy is stagnant. The Reserve Bank is begging the Government to spend some money, because near-zero interest rates can no longer do the heavy lifting to stimulate the economy. The Federal Government refuses, because it is stuck in its simplistic obsession with balancing the budget, cheered on by the government-hating libertarian media.

The Reserve Bank is caught in a hopeless dilemma. It lowers interest rates to stimulate the economy, and instead stimulates the housing market. If it raises interest rates it risks tipping the economy into actual recession, not just a per capita recession, and that risks popping the housing market bubble and bringing on a major downturn.

Why does economic management seem to be so hard these days? It is little remembered or remarked that in the postwar decades Australian GDP growth averaged above 5% per annum, unemployment averaged 1.3%, inflation was a moderate 3.3% and average wage earners could afford to buy their home. Why can’t we do that again?

We probably can, but we might have to regulate the banks. If that sounds wicked and leftist, then Bob Menzies was a pinko lefty because he imposed credit squeezes when the economy was ‘overheating’. But we don’t do that any more, it’s against our religion. Insead we rely solely on the wet-lettuce weapon of interest rates.

Banks are free to loan as much as their minimal duty of care suggests to them. As property prices rise, they can loan more. That allows property prices to be bid even higher, feeding a spiral. Economists used to be very alert to wage-price spirals, until employee rights were crushed, but many remain oblivious to house-price spirals, also known as property bubbles. In case anyone still disputes the existence of a bubble, house prices are two or three times higher than they used to be, relative to GDP or average incomes.

Australia has one of the highest ratios of private debt to GDP in the world and it is mostly household mortgage debt. This is dangerous because if the bubble bursts the money supply will shrink and bring down the whole economy. When that happened in the US it triggered the Global Financial Crisis.

All of this was pointed out some time ago by economist Steve Keen. He is widely disparaged because he unwisely tried to predict when the housing bubble would burst. Predicting the timing of a collapse is nearly impossible, even when the potential is obvious. Keen did not count on governments’ zeal in keeping the bubble inflated.

So here we are with a severely distorted, anaemic and precarious economy. The economic managers either deny there’s a problem or are unwilling to do anything about it, either because they’re afraid to disturb it, they don’t know what to do, or the remedy is against their religion.

The problem is not a shortage of housing, the problem is an excess of money.

The central problem is that bank deregulation allowed banks to loan more, which allowed asset-price inflation to take off. Money is channeled into unproductive property speculation rather than into productive investment.

The solution is to restrict the amounts banks can loan. The solution is a credit squeeze. The best solution would be to restrain credit for purchasing existing assets but not for investment in productive activities – activities like hiring people to make useful stuff. With two levers to work, the Reserve Bank would have some hope of effective action.

The trouble is the economy is now so precarious there would be a risk of triggering a crash. That’s the trouble with unregulated, unstable markets, their feedback dynamic can suddenly reverse, switching from an accelerating boom to an even faster bust. Mainstream economists have nothing to say about unstable markets because their theories exclude instability to keep the maths more manageable and their delusions unscathed.

A carefully coordinated slowing of property credit combined with government spending that could be rapidly ramped up might pull off the balancing act. Something like what Rudd and Swan pulled off during the GFC.

In the medium term it might be necessary to allow some general inflation so other prices and wages catch up and rebalance the economy. That could cause a bit of pain for the propertied class, but they’ve had it pretty good for a long time and mostly they would not be thrown out of their houses, as is happening to the unpropertied now. As always, an alert and willing government (hard to imagine, I know) could be ready to help out any hardship cases.

Leave a Reply

Your email address will not be published. Required fields are marked *