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About booms and busts


The most recent Absa House Price Index indicates that nominal house prices have now been contracting for three months year on year. The latest figure shows a decline of 5% since April 2011. As a result, house prices are in real terms moving closer to their long-run trendline, aided by high building-cost inflation (which is now much higher than consumer inflation). Lucky South Africa, your bubble is deflating; not bursting!

South Africa’s market could have been in a much worse state.

In the USA, Robert J. Shiller, renowned for what he and Greenspan had coined “irrational exuberance”, quite rationally predicted in 2006 that the bubble would burst (The Economist, 22 April 2006). And so it did. Shiller now believes that it would take at least a generation, and maybe even two, to recover (Reuters, 24 April 2012). Granted, this latest opinion seems a bit extreme, but it should not be rejected out of hand because it is probably based on the Japanese experience after 1989. In that year, an extraordinary real estate bubble in Japan burst, and more than two decades later there is still no recovery in sight ─ in spite of huge monetary expansion (“quantitative easing”) and zero or near-zero interest rates. In fact, the Japanese can be called the inventors of quantitative easing. So, perish the thought, Shiller could be right again.

In well-behaved, stable Netherlands, with inflation at a modest 2,3% today, house prices have declined by a noteworthy 12% since the outbreak of the credit crisis in 2008 (ABN AMRO, 29 February 2012). In fact, in March of this year, house prices were 5% lower than a year earlier, and in April the number of sales (churn) had declined by 19% year on year. It seems the end is not in sight.

Like the examples above, deflating house prices are now a feature of most developed countries, including all Anglo-Saxon ones. What these nations seem to have in common is hangover economies after the intoxicating cheap-credit consumer boom of the previous decade. Let us, completely unscientifically, check this theory by considering the two major contrarian economies, Germany and China.

Germany’s economy has so far given the European crisis a narrow miss. In terms of our theory, a lukewarm economy would lead to a tepid house market. Thus, rather unsurprisingly, in the first quarter of 2012, German house prices grew, in tandem with the weak economy, at a modest rate of 2,6% ─ a trend evident since 2010 (Verband Deutscher Pfandbriefbanken or vdp). In comparison, the inflation rate in Germany is 2,1%, meaning there is not much real growth. However, it needs to be said that the German house market on average hadn’t experienced the wild exuberance of large parts of the world in the run-up to the Great Recession. If it had, the house market here might also have been deflating, in spite of an economy that is not contracting (yet).

Now consider China, which has been in a once-in-500-year structural boom. Here prices have grown by a mind-boggling 90% since the start of 2009, but had reached a peak in the third quarter of 2011 (Knight Frank, “China Residential Market Watch: Q1 2012”). Since then, the Chinese government has implemented regulations to cool the market, and this has had the effect of orderly deflating prices by 6% (The Globe and Mail, 18 May 2012). Nevertheless, Forbes magazine (1 March 2012) claims property prices in China are still overvalued by 10% to 25%. Thus it seems that the government is managing an orderly deflation of prices; that is, there is no rout. However, Nouriel Roubini’s EconoMonitor states the number of transactions in the house market was 17,5% lower (year on year) in the first quarter of this year (Business Day, 22 May 2012). Add to this news the first straws in the wind that the Chinese economy is cooling significantly, and one shouldn’t be overly sanguine about prospects for this locomotive economy. A bursting of the house bubble is not out of the question.

Of course one cannot reach a conclusion on this sparse and biased selection of countries, and the superficiality of the above narrative. But, combined with other evidence we have, these examples are not inconsistent with the notion that the major driver of house prices on the demand side is economic growth. Bubbles, needless to say, accentuate this relationship quite dramatically. And how is a bubble created? The expectation psychology is created by an extended boom period (“this time it is different”) – but that is a different story.

A last thought: what comes first, a real estate bubble that bursts or the economic malaise? This needs to be investigated, but suffice it to say here that the two mutually reinforce one another.

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