Saturday, May 17, 2008

It is time to break this relationship

This chart is more than just a colourful pattern bouncing across your computer screen. It tracks house prices and household spending; the pivotal relationship that dominates the UK economy.

As the chart above amply illustrates, it is extraordinary how closely these variables move together. These indicators are the economic equivalent of synchronised swimming. When real house prices increase, spending follows. When house prices fall, spending dives down with it. Consumption spending accounts for about 70 percent of GDP, which in turn determines employment and income growth. Therefore, it's not hard to see why policymakers are obsessed with maintaining high and growing house prices.

It is, however, an unhealthy relationship. The recent period of sustained housing inflation enticed people into thinking that they were becoming wealthier. When they should have been saving, they began spending and borrowing. Through home equity loans or credit cards, the housing market was a great facilitator, which encouraged people to the sticky swamp of personal indebtedness.

Like a lot of nasty, compulsive relationships, it is difficult to see a way out. Nevertheless, there are a couple of steps that will allow our consumption spending patterns to break loose of our obsession with housing. We need to liberalise planning regulations, introduced a tax on land, and regulate the real estate and financial sectors industry more effectively.

The Bank of England should also explicitly target house price inflation. Like regular inflation, rising house prices occur when central banks reduce interest rates and commercial banks extend too much credit.

All these measures are perfectly reasonable and feasible, which will significantly reduce the probability of future housing bubbles. All that is needed is the political will to carry them out.


  1. Up and down, up and down, no more boom and bust, up and down, up and down, no more boom and bust....

  2. I was with you right up until your remedy, Alice.

    I've nothing against the idea of land taxes or less restrictive planning regulation, and competent regulation of real-estate and financial services. That all misses the point, however.

    The issue is securitisation. Look back over history at the biggest booms and you will see three factors:

    1. Monopolies or effective monopolies.
    2. Paper based contracts sold to investors in such volume that they dominate the money supply.
    3. Unregulated non-transparent trade in aforementioned contracts.

    This is exactly what we saw with the Mississippi Bubble; the South Seas Bubble; the Asian debt Bubble and, now, Asset backed securities and the noughty debt-bubble. It is as if we've learned nothing from history.

  3. Maybe all we can do is exploit your understanding. Changing the pattern of the economy may be a project for King Canute.

  4. Yes we need a land tax to stop speculation in real estate. We sooner we can get this enforced with a corresponding reduction in taxes on labour the quicker the monumental pile of debt we have acquired can be dealt with. As a nation I think we can do slightly better than turning our country into a land lottery.


  5. please! no new taxes!

  6. We do need a revision to the current planning system. Planning approval for new build takes forever, and leads ultimately to a lack of housing stock.

    We also need a reduction in stamp duty thresholds in order to give first time buyers a chance of getting a foot on the property market.

    A reduction in interest rates would help re-build confidence in the housing market.

    I am not sure about the land tax - don't we already have one with SDLT?

  7. gobsmacked,

    Oh go on, just one more,


  8. I oppose messing about with the tax system (in the short term, at the very least.) I can see the merits of a land-tax, but believe that it would take at least 20 years to adequately define - and that any attempt to rush through a land tax would end in absolute disaster. BMH... Yes, SDLT is a land tax... but it pales into insignificance compared to income tax, for example - or even NI. I firmly believe that abandoning these land taxes (or even relaxing them) would be a very big mistake. I think it unlikely that this will happen in the short to medium term, however, as we're heading for recession and the national debt is spectacularly large.

    The issue, essentially, has been market manipulation. The people buying houses have not been setting their absolute prices, only their relative prices. We have seen a false market in house prices for the best part of a decade - at least. The people settling the overall prices have been the financiers of mortgage originators. Securitized debt is relatively new (compared with the notion of bank debt per se.) and is essentially unregulated. Traded behind closed doors, this has lead to a spectacular bubble - which we are privileged to see burst. Politicians have either been corrupt and complicit - or too stupid to notice that government fiscal and monetary policy has been subverted. Unregulated securitisation has debased most world currencies.

    The game now is to predict the consequences and time scales. To my mind, the collapse of securitisation might well be the most significant global economic event in history.

  9. Asteve, I am with you on this one. Successive governments mess around with the tax system. We need lower taxes not new ones.

  10. Agreed, asteve.

    One of the things coming out of "Manias Panics and Crashes" is how much bubbles have in common. Add in a fourth point - that bubbles require things to be bought on margin - and I'm right with you.

    All bubbles require people to spend wealth they don't have. You do that by entering into promises to transfer future wealth, in exchange for credit. For example the tulip bubble in Holland relied on a margin-less futures market.

    I'd love to see OTCs forced onto an exchange and for margin requirements to be in place. At the moment JPMorgan is the unofficial exchange but that's going to end badly.


  11. Gordon Brown will try every trick in the book and more besides to perpetuate house price inflation.
    If he fails to do this, then his miracle economy will be shown up for what it really is - a mirage.
    I am sure that he WILL fail and that will be the end of this menace for good.
    Glad that HE will be at the helm when the wheels finally fall off rather than someone else.
    Sad to think that the once Great Britain is reliant on fickle house price inflation for it's "wealth" !