Monday, 30 June 2014

What on earth is going on in Bulgaria?

At Forbes:

Things move quickly in Bulgaria. Less than a month ago, the IMF gave Bulgaria's banking system a clean bill of health, saying it was "stable and liquid, with banks' non-performing loans buffered by provisions and significant capital, as well as a positive net foreign asset position". But yesterday, the President of Bulgaria was forced to issue a statement reassuring people that their money was safe after a week of bank runs. And the EU has now granted Bulgaria an emergency line of credit to support its banking system.

So what on earth went wrong? Find out here.

Sunday, 29 June 2014

Of interest rates and deficits

(I was tempted to call this post "Sumner's Here" but thought that might be a bit too FT Alphaville.)

Recently, the American economist Scott Sumner visited the UK, among other things giving a presentation at the Adam Smith Institute and interviews on the BBC's Today programme and Newsnight. Sadly I missed these events, but fortunately he has written about what he saw.

He notes that all the talk in the UK is about raising interest rates. Indeed it is, and I am one of a rapidly diminishing number of voices who urge caution: premature interest rate rises in a fragile economy with high levels of household indebtedness could kill off the nascent recovery. The UK economy needs to be strong enough to support reduction in the fiscal deficit before interest rates start to rise. On this, Sumner and I seem to be in agreement:
Since 2008, the UK has run extremely large budget deficits, bigger than the US as a share of GDP. Everyone agrees these are too large, and need to be reduced. But Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument (although I have doubts due to monetary offset), but the implication is that if the recovery ever becomes so strong that you need to raise rates, then clearly the first place to tighten is fiscal policy, and policymakers should only raise rates when the budget deficit has returned to the optimal level based on the classical principles of public finance.  Britain is obviously far from that point.
But sadly that's where the agreement ends. Quite apart from the fact that not everyone agrees that the UK's fiscal deficit is too large, I think it is very evident that loose monetary policy cannot offset fiscal austerity. Admittedly, the combination of tight monetary policy with fiscal austerity - as in the Eurozone - is far worse, but most economists agree that the UK's fiscal austerity in 2010-12 did derail its recovery despite the Bank of England's monetary offset. The reason for this is likely to be the regressive nature of QE and fiscal austerity, both of which disproportionately affect poorer people - who are also those with the highest marginal propensity to consume. Supporting asset prices for the rich does not have the same effect on AD as increasing benefits and cutting taxes for the poor. The UK government has now started to do the last of these, and lo! there is recovery. What a pity it took three years for them to realise that monetary and fiscal policies need to complement each other rather than being antagonistic.

Sumner argues that tightening should start on the fiscal side, not the monetary side. As I've said, I don't disagree with this. Where I disagree, though, is in his notion that the UK government should introduce further austerity to reduce the fiscal deficit, and failing that, that interest rates should rise sooner rather than later:
Given the refusal of fiscal policymakers to speed up the austerity process, the BoE may need to raise rates in 6 months to a year.  That’s monetary offset, and it is quite appropriate.  The real problem in Britain is government spending, which is still too high.  (Or if you are a left-winger, the real problem is that taxes are too low.)
The fiscal deficit is usually quoted as a percentage of gdp. Currently, the UK's fiscal deficit is about 5.8% of gdp, well above the Maastricht treaty limit of 3% of gdp. Not that the EU is about to put the UK in a fiscal vice: the UK has only ever promised to "endeavour" to keep within Maastricht limits, and it famously refused to sign the fiscal compact. The EU has no means of applying fiscal sanctions to the semi-detached UK without causing further diplomatic problems. And despite all the rhetoric, the EU does not wish to lose the UK. Despite the UK's excessive deficit, the tone of the European Semester review of the UK's finances was decidedly gentle. The UK is under no EU pressure to speed up deficit reduction.

If gdp increases, the fiscal deficit/gdp ratio falls without any cuts in public spending. But the absolute fiscal deficit in a recovering economy should also fall naturally. This is because of increased tax revenues due to the nominal gdp increase, coupled with reduced benefit claims as more people enter work and wages start to rise. The ONS reports that the UK's fiscal deficit is indeed falling, though at a glacial pace: the public sector net borrowing requirement for May 2014 was £8.1bn lower than in May 2013 (yes, I know, that's tiny - a fall of less than 1%).

Once the recovery is well established, the Keynesians that Sumner criticises would agree that spending cuts and tax rises may be appropriate to restore budget balance. But is the UK recovery well established? There are differing views on this. Some say it is all smoke and mirrors engineered by direct support to the housing market from a Chancellor determined to win next year's election. Others say it is real, but very early days yet. For me, the recovery is good in parts: there does seem to be more energy in the economy, and improving employment figures are welcome, but the external deficit (which for me is a much more important indicator than the fiscal deficit) is too large - mainly because half the UK's exports go to the depressed Eurozone - and wages are stagnant.

This last is in my view the principal reason why the fiscal deficit is not falling as much as might be expected from reasonably strong nominal gdp growth. Government receipts are very disappointing for a recovering economy:

If this recovery were well established we should be expecting higher receipts. There may be any number of reasons why receipts are disappointing, but flat wage growth seems a likely culprit to me. ONS reports that tax receipts in May 2014 were up 0.4% year-on-year for Income and Wealth, which is actually a real fall in government revenue and substantially below increases in other categories, notably VAT (up 4.9%) and stamp duty on property transactions (up an astonishing 28.2%). These tax receipt figures suggest that this recovery is driven primarily by the housing market and, to a lesser extent, by consumer spending, neither of which is matched by an increase in nominal incomes. I haven't looked up the debt figures, but it is obvious that both consumer and mortgage debt must be rising. Unless nominal incomes start to rise and/or the external deficit starts to fall, this recovery cannot possibly be sustainable. Fiscal austerity at the moment would be madness - and so would interest rate rises.

So I can't agree with those who would like to see interest rates rise soon. And I can't agree with Sumner about increasing fiscal austerity, either. Doing nothing seems a good strategy to me. Impatience is a bad characteristic in both politicians and economists.

Austria falls out with Bavaria over zombie banks

 There’s a nice little storm brewing in the Eurozone core. Reuters reports that the German province of Bavaria is considering legal action against Austria. And it is seeking support for its action not only from the German federal government, but also from the EU.

The background to this is the failure and nationalization of the Austrian bank Hypo Alpe Adria (HAA) in December 2009. HAA was bought by the Austrian state from the Bavaria-based Landesbank BayernLB for a nominal 1 euro. But it seems that BayernLB left behind about 2.3bn euros in subordinated debt. And the Austrian government wants to bail this in as part of the winding-up procedure for HAA.....

Read on here.
UPDATE: Klaus Kastner, who knows much more about this than I do, has posted a really illuminating comment on the Forbes post about the background to HAA and BayernLB's relationship. And David Keohane has reminded me about this FT Alphaville post on the subject from December 2013.

The picture is of BayernLB's lions. Seems appropriate. 

Friday, 27 June 2014

Lagarde's apology may prove costly for the Euro area

The IMF’s Article IV consultation with the Euro area makes grim reading. It starts off upbeat:
"The euro area recovery is taking hold. Real activity has expanded for four consecutive quarters. An incipient revival in domestic demand is adding to the impetus from net exports. Financial market sentiment has improved dramatically, particularly after the recent ECB measures. Sovereign and corporate yields are now at historic lows in many countries, and lower funding costs have helped banks raise more capital."
And it then goes on to praise the efforts national governments have made to clean up their balance sheets. It also commends policy-makers and regulators for the nascent banking union and the clean-up currently in progress. “Strong policy actions have boosted investor confidence and laid the foundations for recovery”, it cheerfully proclaims.
But that’s where the cheerfulness ends. The fact is that the Euro area is still in deep, deep trouble....

Read on here.

Are the lights going out for Barclays' investment bank?

My latest post at Forbes looks at the implications for Barclays and for the whole financial industry of the latest in a long line of lawsuits.

A few weeks ago, following awful trading results, much of Barclays’ FICC business was consigned to the outer darkness – placed in Barclays’ internal “bad bank” for eventual sale or wind-up. Barclays’ investment bank was to be reduced to a customer service business around an equities trading core – the former Lehman Brothers equities business.
But now that equities trading core has itself been dealt a major blow. The New York Attorney General has filed a lawsuit against Barclays for misleading clients regarding the presence and activities of HFT traders in its so-called “dark pool”, Barclays LX.
Read on here.


Sunday, 22 June 2014

Into the Light: the changing face of private equity

I recently had the pleasure of attending the European Venture Capital Association's 2014 Symposium in Vienna. Perhaps surprisingly, the theme of the conference was not "how can we survive secular stagnation?", but "how can we get people to understand the value we bring to society?". Though perhaps these two concerns are one and the same.....

Read my thoughts at Pieria here.

Oh, and this was the view from my hotel room window in Vienna!

Saturday, 21 June 2014

Transmission mechanisms do matter

I'm always astonished when someone argues that financial transmission mechanisms don't matter - that somehow money produced by the central bank magically "flows" to the real economy without restriction. I don't think this argument is remotely supported by the evidence: transmission mechanisms do matter, and when they are blocked, restricted or diverted, the effect of central bank reflation on the real economy is much reduced. I should be clear here that by "transmission mechanism" I do not necessarily mean banks: investors, companies, markets and fiscal authorities are all means by which money flows around the economy, and they too can restrict, block or divert the flow of funds from the central bank.

Here is Giles Wilkes arguing that transmission mechanisms don't matter, using Smaug the Dragon to illustrate his point. The deflationary effect of Smaug's gold hoarding has previously (and elegantly) been discussed by Frances Woolley. In this piece Giles takes her argument a stage further and considers the effect of Smaug's demise on the economy of Laketown (my emphasis):
After 150 years of scarce currency and falling prices, Bilbo and his dwarf friends would clearly cause a massive nominal shock by releasing such a huge stash of gold onto the depressed Laketown economy. Gold that over the decades had become far more valuable would see its value obliterated by the onrush of new currency, causing a massive inflation. Upon realising what was about to happen, any merchant with some small stash of gold would immediately buy everything he can get his hands on: goatskins, houses, fishing rights, you name it.  Anything to get rid of something that is about to collapse in value.
Given the depression the effect is likely to be electric in real terms. With rapid rises in prices and wages, any outstanding debts would become easier to service.  Bills would be paid with great eagerness, new working capital sought out. New investments would look far more attractive.  Asset prices would boom.
Indeed, if Smaug's gold was released in its entirety to Laketown, it would be highly inflationary. And Giles goes on to point out that the state of Laketown's banks has nothing to do with this:
Would it make any difference if there was no bank credit, because Smaug had incinerated the bankers? Or if the few banks remaining didn’t understand relationship lending? Or if Laketown had very low interest rates owing to the depressed state of trade and high risk aversion? Or even if the Laketown authorities were on an austerity drive?
I should think not.  Sluice the economy down with enough gold and there will be a huge stimulus.  And this would be the case even if none of it was owned by the people of Laketown.  Even if the dwarves gave none of it away, their huge potential purchasing power would have a massive effect.   Even if they were total misers, and spent little of it, what would you think if you were that merchant? You would not want to hold gold at the same price. That dwarf gold will come out somehow. 
The final sentence of this quotation is a fine example of the "magical thinking" that I complain about. Dwarf gold doesn't have to come out in Laketown at all, as I shall explain. But let's consider the question of gold distribution.

I highlighted "Bilbo and his dwarf friends" in the first quotation for a reason. Implicitly, Giles has assumed that Bilbo and the dwarves somehow distribute all the gold to Laketown in one go, causing a massive nominal shock. There are a number of ways they might do this:
  • They might advertise "free gold" to the people of Laketown, and wait for the gold rush. Clearly, as the gold is in a mountain with no wheelchair access, the principal beneficiaries will be the able-bodied. Additionally, unless Bilbo and his friends rationed the distribution, rather as supermarkets ration free offers to ensure everyone can benefit, the first to arrive would gain the largest amount and those who arrived last - the weakest and slowest - would get nothing. This approach to distributing Smaug's gold might be seen as rather regressive.

    Also, as it is a one-off distribution, we might expect that a large amount of it would simply be hoarded rather than spent: after all, when are the recipients ever going to see gold again?Alternatively, the beneficiaries might invest the gold - but not necessarily in Laketown businesses. After all, Laketown is depressed....they might be more likely to buy horse farms in Rohan or condominiums in Minas Tirith.

    So this approach would have some reflationary effect on Laketown, but I suspect nowhere near as much as Giles anticipates. 
  • They might blow the lot on a massive party. Perhaps this is where Bilbo got the idea for the Birthday Party at the start of Lord of the Rings? But the party would have to be both truly massive AND resourced entirely from Laketown suppliers for it to have the reflationary effect that Giles anticipates. After 150 years of depression, would Laketown suppliers be up to the job? I think not. After all, just look at the London Olympics, which is possibly the closest we have seen to a party on the sort of scale that would be needed.Was it resourced entirely from the depressed East End of London? No, it was not. Supplies came from other areas of the UK, and even from other countries. To the extent that the London Olympics had any reflationary effect (which is questionable), it was far more broadly distributed. The same would be true of a Laketown party. I imagine the Mirkwood Elves might have done rather well out of it, actually.

    Anyway, would the Dwarves want to spend their newly-recovered gold on a massive party? Anyone who has read the beginning of the Hobbit knows that Dwarves prefer to party at someone else's expense. Why on earth would recovering their gold change their attitude?
  • They might invest their gold in Laketown businesses. But these are Dwarves, and Laketown is populated by Men. I hate to be racist, but are Dwarves really going to invest in the businesses of Men, especially when they have a mine infested with Orcs to liberate? Surely they would be more likely to use the gold to equip an army to invade the Mines of Moria. Indeed, as anyone who has read the Lord of the Rings knows, this is exactly what they did. That gold would not go to Laketown - it would be diverted to the suppliers of goods and services to the army along its route. And much of it would be lost in Moria, of course.
  • And of course, since Dwarves are notoriously miserly, they could simply hoard the gold themselves. They could deny entrance to the mountain to anyone except Dwarves, and kill any Laketown residents (and hobbits) who attempted to burgle the mountain. One Smaug begets another.

In short, the liberation of the gold by Bilbo and the Dwarves would not necessarily relieve Laketown's depression, let alone cause the inflationary shock that Giles anticipates. For the gold to relieve Laketown's depression, Bilbo and the Dwarves have to actively distribute it in some manner that is not regressive and does not result in gold hoarding by Laketown people. And for it to be inflationary, it has to be deliberately directed into Laketown and nowhere else, so its effects are not dissipated*.

In fact, as Frances Woolley explains, the gold was shared out equitably. And the means by which it was distributed is all too familiar (my emphasis):
Upon the great worm's demise, the wealth it had stockpiled was shared between the dwarves and others who had contributed to the fight. Much gold was sent to the Master of Lake-town; followers and friends were rewarded freely. The result was an immediate increase in the money supply, and a rapid growth in overall economic activity.
So gold was not "liberated" into a free market. It was deliberately distributed by the Dwarves. And it went not to banks or markets, but to Laketown's equivalent of the government, which then further distributed it to, er, voters. It was fiscal stimulus directly financed by the central bank. Or - since the Dwarves are a foreign power - a Marshall plan.

But the future of Laketown, completely dependent on Dwarf gold, does not look bright even after the death of Smaug. The Dwarves would stand in relation to Laketown exactly as the US does in relation to Panama, Ecuador and the other users of the US dollar. Laketown's money supply would be entirely dependent on the generosity of Dwarves. I'm not sure this is such a great idea: Panamanians may think otherwise, but then they control a goods distribution channel that is rather important to the US. Does Laketown have a similar hold over the Dwarves? If not, they need to end this foolish dependence on Dwarf gold and set up their own fiat currency and central bank.

This is of course exactly what Sauron did. And the effect is striking. Seemingly limitless money poured into Mordor and its fiefdoms, generating a massive increase in production - of all kinds, including reproduction (the Orcs had a baby boom). Admittedly, the extent of his reflation is so huge that after his death Mordor would probably have suffered hyperinflation due to the collapse of his war-driven production engine. But that's another story.....

Related reading:

The Hobbit - J.R.R.Tolkien
The Lord of the Rings - J.R.R. Tolkien

* Mind you, dissipation of Smaug's gold more widely might be a good thing. After all, gold scarcity is a feature of Middleearth as a whole, not just Laketown.

Friday, 20 June 2014

Towards a new Golden Age

At the launch of Nesta's book “Our Work Here Is Done: Visions of a Robot Economy”, Carlota Perez described how our current economic troubles are an inevitable and necessary part of the process of technological change. We are at a turning point: if we get it right, there could be a new Golden Age. But for this to happen, there needs to be radical change in current social structures and norms. Do we have the vision and courage to make this happen?

Read on here.

Thursday, 19 June 2014

Robots and the future of work

NESTA's book "Our work here is done: visions of a robot economy" was launched yesterday. I had the honour to contribute a chapter to the book, and also to speak at the launch yesterday.

The launch, hosted by Stian Westlake, featured presentations by Ryan Avent, Izabella Kaminska, Ellie Truitt, Nick Hawes and the awesome Carlota Perez, and demonstrations of real live robots. I think the robots rather stole the show - perhaps that is a sign of things to come!

The text of my speech at the launch is below.

Robots and the future of work

Last September, a research paper by Frey and Osborne scared the world. It concluded that as many as half of all American jobs could be automated. Not content with the loss of jobs from offshoring, the capitalist system now threatened further destruction of the American way of life.

Not surprisingly, the “robots will eat your job” movement went into overdrive. The Atlantic listed some of the jobs most at risk:
  • telemarketers
  • sewers ( though I thought all those jobs had already gone to Bangladesh)
  • insurance underwriters
  • mathematical technicians (watch out, quants!)
  • tax preparers and accounts clerks
  • librarians
But they also listed some of the jobs least at risk. Social workers. Therapists. Managers. Fire fighters. And, for some reason, dentists.

What is interesting is the nature of these jobs. The jobs most at risk from automation are those that don't involve the creative, the unpredictable and above all, humans. The jobs least at risk, by and large, are those that do. Creative jobs also feature in the “least at risk” category.

But of course both lists are jobs that exist now. Yet the jobs of the future may be very different. It's very hard to predict what jobs that exist now will still exist in 5 years time, and even harder to foresee what jobs there will be in 50 years time that don't exist now. When I was a small child, no-one could have foreseen that 50 years time I would be writing articles using a computer and distributing them on something called the Internet.

And yet – some things never change. Although the medium I use to write did not exist 50 years ago, writing did. So did reading. So, thankfully, did imagination. A robot could attend a conference and report on the proceedings: that type of journalism is one of the jobs most “at risk”. But creative, thoughtful writing remains the province of humans, and gazing into my crystal ball, I predict that will remain the case. The core skills of reading and writing – perhaps redefined as “comprehending and communicating” - together with the disciplines of thinking and imagining, will remain at the heart of what humans do in the new world of work.

And so will caring. Indeed it is probably fair to say that “caring” jobs will feature largely in the workplaces of the future. But they won't be caring jobs as we know them now, largely concerned with looking after people's physical needs. Those aspects of care can, and in my view should, be automated. The care that humans uniquely give to each other is not fundamentally physical, though there might be a physical component to it. As any hairdresser will tell you, the most important part of her work is the coffee & chat with her clients. That's where a human adds value. A robot will do a perfectly good haircut, but it won't be an experience. The time will come when we will pay more to be served by a human, because we value the emotional interaction – even though the physical aspect could be better done by a robot. Indeed, perhaps the hair salons of the future will be staffed by humans who are experts in understanding their clients' needs and directing robots in how to meet them – an interesting combination of the creative, the social and the technical.

Indeed that fusion of creative, social and technical is likely to define the work of the future. And the young people of today already understand this. They may not turn in good results in traditional school subjects, but they are experts in the worlds of social media, crowdsourcing and imaginative use of technology. The skills that will be important in the future are learned through play, not formal education.

The days when “work” meant spending long hours pushing paper around or endlessly repeating the same part of a production cycle are over. Those jobs are going – not because we no longer need information to be manipulated, not because we no longer need to “make stuff”, but because robots are much more suited to these kinds of routine tasks than humans are. And to me, this is not a disaster. This is a wonderful opportunity. We can eliminate drudge work and free humans to spend their time interacting with each other, caring for each other and creating clever and beautiful things to brighten up everyone's lives.

Of course, this requires a shift of attitude. For much of history we have valued producing more than caring: caring jobs are poorly paid relative to producing jobs, or even not paid at all. But in the future, robots will be able to produce all we need far more efficiently and cheaply than human workers. The jobs in which humans will be needed, and therefore valued, will be the ones where robots can't cope. And there is one thing above all that robots cannot do – and that is understanding and responding to human needs and wants. That will always remain the primary responsibility of humans. Communicating, empathising and innovating will be the highly-valued skills of the future.

Our work here is not done. But it is set for fundamental change. In the post-technological world, the work of humans will be understanding each other, and in partnership with robots, caring for each other and for the wonderful world in which we are privileged to live.

Tuesday, 17 June 2014

Carney on interest rates

Markets are a gullible lot. In my latest Forbes post I explain how they have been comprehensively outflanked by a very clever Bank of England governor: 
In his speech at the Mansion House last week, Mark Carney appeared to indicate that interest rates might rise sooner in the UK than markets have been expecting. Predictably, media and market hawks seized upon this as indication that rates will rise towards the end of 2014. Sterling rose, gilt yields rose and the yield curve steepened.
This was, of course, exactly what Carney wanted....
Read on here.
 (picture: Carney speaking at the Mansion House dinner. Courtesy of the Wall Street Journal)

Sunday, 15 June 2014

How a Danish king ruined some hopeful research

This post on VoxEU purports to show that there is no house price bubble in the UK, and perhaps more importantly, that there was no house price bubble in the run up to the 2007 crash.

This may come as something of a surprise to those who are used to looking at charts like this:

This chart shows the rise in average UK house prices since 1973 (source: Nationwide). There is clearly a steep rise in prices from 1995 to the crash in Q4 2007, which dwarfs the previous housing boom and bust in 1987-8. Many people would regard such a dramatic rise and fall as evidence of a bubble.

But the VoxEU authors don't think it is. And they base their argument on a unique feature* of the UK housing market - the existence of very long-term leases as well as freeholds.

Typically, in the UK housing market, houses are freehold and apartments leasehold, though this is not universally the case. A lease is a right to use a property for a period of time. In effect, it is a time-limited, pre-paid form of ownership. Properties that have leases close to expiry decline in value rapidly, making them difficult to sell, so most leases are automatically renewed. So that leases don't have to be renewed very often, many are very long-term - up to 999 years.

As the authors explain, such a long lease means that there should be no difference in value at its expiry from that of a freehold property. Both, at current prices, should be zero:
....the leaseholder owns the property for 999 years. The freeholder owns the property not only for the first 999 years, but also for all periods after that date. Therefore, the difference in the price of the freehold and the leasehold reveals the value today of owning the property 999 years from now. Ownership of a house 999 years from now is essentially a claim to the bubble asset. It entitles the owner to a single payment (the value of the house) in 999 years. This is so far in the future that it should have no value today, even if discounted at extremely low rates (say 1% per year).
They then go on to show that there is indeed no difference in price between properties with leases of 700 to 1,000 years and freehold properties. And they conclude:
We find that extremely long leaseholds are valued identically to otherwise similar freeholds. Our results, therefore, show no evidence for infinitely-lived bubbles in these markets. We find this to be true even in geographic regions where people argued that housing bubbles were likely to be present (e.g., Prime Central London).....the price discount is small and not statistically different from every year since 1995. In particular, we find no evidence of infinitely-lived bubbles even during the house price boom that culminated in 2007
This is simply absurd. It is impossible to predict what will happen at the expiry of a 999-year lease. The property may not even exist any more, and nor might the laws that govern the lease. Just to put things in context, 999 years before the present date was the year 1015. That was prior to the signing of Magna Carta, which is the foundation of all present UK law. It was prior to the Norman Conquest. It was prior to the building of most of the surviving castles and cathedrals in the UK, let alone the houses. It was, in fact, during the Danish occupation of England, and the reigning king was Aethelred the Unready (he died the following year). If there was a system of law in England at that time, it was - presumably - Danish. Would documentation for a lease issued under Danish law in 1015 AD even exist today, let alone be recognised as legally binding? Who would own the lease, anyway? We don't have many Danish thegns left in the UK now.

For all practical purposes, a 999-year lease is indistinguishable from a freehold. The only reason for having leases of such length at all is that lessees don't have quite the same rights and responsibilities as freeholders: they usually pay "ground rent" to the lessor, who remains responsible for maintaining the fabric of the building and communal areas. The fact that the authors could show no significant price difference between long-lease properties and freeholds demonstrates that the pricing of ground rents is generally efficient and fair. But it says absolutely nothing at all about the existence or otherwise of bubbles in the pricing of freehold properties. We are, in short, no further forward.

Personally I am of the opinion that there was a bubble in house prices from 1995-2007, which only partly burst. It was initially prevented from deflating fully because of severe supply restrictions and the collapse of the construction industry, and further deflation is now actively being prevented by government and central bank intervention.

The chart above suggests that there is no new housing bubble, not even in London: the fact that house prices remain elevated is simply unfinished business from the 2007-8 crash. But houses remain significantly overvalued relative to incomes. Either incomes must rise significantly, or house prices must fall. The question is how this can be achieved without trashing the economy. I admit, I do not have an answer. There is no simple solution.

Related reading:

The British obsession with property - Pieria

* Well, not quite unique. Singapore has these too.

Saturday, 14 June 2014

The British obsession with property

This is a version of a speech given at IPPR North on 10th June 2014.

How many people reading this post own their own home, or would like to do so?

I do. I am one of the 60% or so of people in the UK who own their own home. The percentage is currently falling, as housing becomes more expensive and mortgage standards are tightened. But it is still well over half the population.

Opinion surveys consistently show that most people aspire to buy their own home. For many young couples, buying a home together has become a statement of commitment: the traditional sequence of engagement followed by marriage is replaced with moving in together then buying a home together. Property has replaced children as the outward sign of shared lives and shared responsibilities.

Nor is it just couples. Single people, too, aspire to buy property. They may not want a relationship but they want to own their own place.

But why are we so obsessed with property? It's expensive to buy and expensive to maintain. If we neglect it, it decays. It discourages us from moving to find better-paid or more interesting jobs. And as the US housing crisis shows, there is no guarantee that it will necessarily be worth what we pay for it. It is a risky investment.

Housing is indeed expensive to buy, though the burden does vary: in the North East of England, property is nowhere near as expensive to buy as it is in the South East. Yes, people earn more in the South East – but the difference in mortgage commitment far outstrips the difference in incomes.

But it has not always been so expensive to buy. Housing is considerably more expensive now than it was twenty years ago. And because house purchase is a long-term commitment, therefore, housing is not as expensive for the old as it is for the young. The longer ago you bought your property, the cheaper it was to buy and the more you have benefited from rising house prices. Not only that, but older property owners who still have mortgages have benefited hugely from the very low interest rates in recent years. Their mortgages are low risk because they are so small relative to their property values, and therefore they are paying far less in interest than people who have bought more recently. I admit, I am one of them: my mortgage has been at 1.5% for the last six years. My parents never had it so good.

But property prices even twenty years ago were high compared to those enjoyed by the post-war generation. My parents bought their first property when I was three. My mother didn't work, so the mortgage was granted on the basis of my father's income alone, and he paid all of it. A single male middle-income earner could afford the mortgage on a three-bedroom semi in the suburbs of London.

Now, the house I grew up in is beyond my reach: indeed it is beyond the reach of most people I know. One middle-income earner can't possibly afford that house now. If my parents lived now, both of them would have had to work full time in good jobs to afford that house.

They sold that house when I was sixteen for approximately double what they paid for it. And they bought a six-bedroom Victorian house in Beckenham for £16,000 – again, on my father's income alone. They sold it in 1998 for £200,000. Anyone who thinks that house price inflation is a recent phenomenon should look at the rise in house prices over the last 50 years. Yes, the last ten years or so have been insane. But the previous forty weren't much better.

Yet the evidence that house prices have risen to levels never imagined by our grandparents doesn't dissuade people from buying. Indeed, people are MORE likely to buy when house prices are rising, because they think they can benefit from the house price rises. And they have reason for believing this. House prices have risen pretty consistently for over fifty years: yes, in that time there have been three crashes, but the losses in the first two have all been more than recovered, and the losses from the most recent one will soon be recovered too. Property is risky in the short-term, but as a long-term investment it is high-yielding and virtually risk free. And that makes it a better investment for ordinary people than virtually anything else. No wonder people prefer to buy property than save in bank accounts or stocks & shares.

So the fact that property is expensive, and becoming ever more expensive, is actually one of the principal reasons why people want to buy.

Property is expensive to maintain: if you own property, the entire cost of maintaining it falls on you. But maintaining your property maintains its value, and improving it generally improves its value.

Perhaps more importantly, though, ownership of property gives people a degree of control over their home environment that they don't have in rental accommodation. Yes, you are responsible for maintaining and improving your property: but you have freedom to decorate your house in every colour of the rainbow, plaster it with garish stone cladding, concrete over the garden and – provided your neighbours agree – build ugly extensions. When Right to Buy was first brought in, Bromley Council sold off its houses at a rate of knots, while neighbouring Lewisham Council sold as few as possible. You could tell when you crossed the borough boundary between Lewisham and Bromley; the appearance of the houses changed from uniform drabness to a riot of colourful home improvements, many of them admittedly in questionable taste. Often the first thing a former tenant did when they bought their council house was paint the front door a different colour. It marked the place as “theirs”.

The desire to have a place that is “yours” is very deep-rooted. I remember Liam Halligan talking about his parents, immigrants from the West Coast of Ireland (another place obsessed with property) working incredibly hard to afford to buy a house. He described it as “an asset that no-one could take away from them”.

Of course, a mortgaged property CAN be taken away from you, if you default on your payments. But no-one can come and serve notice on you to quit because they want the house back. The lack of protected tenancies in the UK is a serious driver of the desire to buy, rather than rent. But I still think that the desire to control your own environment is at least equally important. Council tenants when Right to Buy began had protected tenancies: they were difficult to evict even if they were massively in arrears. But they still wanted to buy their own places.

There is also the desire to have something to show for all those years of paying for shelter. Rent or its equivalent is usually the largest item of household expenditure. So it's understandable that when mortgage payments are similar to rentals, people might find buying, rather than renting, attractive. After all, mortgages come to an end, and then the house is yours. Renting never ends.

But I think there is something even deeper – and that is the desire for attachment to “place”. Young people often like to wander, and for them property is not only too expensive, it is too much of a tie. But most people eventually want to stop wandering and put down roots. They want to be part of a community. And for people with children, stability of place and involvement with the community is extremely important. Buying a house is making a statement that says “this is MY place. This is where I want to be”. It's no accident that the classic 1920s property resembles an upturned ship, sometimes complete with portholes. Once you've upturned your boat, you will go sailing no more. "Dunroamin", indeed.

The British obsession with property is as much emotional as financial, driven by the need for stability, the need for security, the need to prove that you have a place in the world, the need to show that you are a person of substance. What is the first thing that people who suddenly acquire wealth do? They buy a large house. It's the modern Western equivalent of owning a lot of cattle or large amounts of valuable jewellery, both of which have in many cultures been ways of impressing the neighbours. 

We often think that the driver behind people's desire for property is the need to fund their old age. And to an extent, that is true. But actually many people don't regard their houses as pensions, and they resent being expected to sell their houses to pay for residential care – even if they cannot live in their homes any more. They want to pass their homes on to their children. A house, once bought, is yours not only while you live, but yours to dispose of as you please when you die. Thomas Piketty reminds us that inheritance is becoming more important as capital destroyed by the cataclysmic wars of the 20th century gradually rebuilds. For many young people, inheriting capital is becoming the only way they can afford to buy a house. Or perhaps, being gifted capital rather than inheriting. Many parents and grandparents now are remortgaging or selling their own properties in order to provide their descendants with the means to buy a house.

To my mind it is completely immoral that the owners of houses should be supported in their dotage by the taxes of those who are not rich enough to own houses, purely so that those home owners should be able to bequeath their property as they see fit. Where is the justice in such a scheme? Thus inequality is perpetuated down the generations: but because home owners vote, politicians will always accede to their demands, however unjust. Attractive though it may seem to require that the elderly fund their own care from the sale of their own assets, this is unlikely to happen while they and their legatees make up the majority of the population.

The property-owning revolution of the last fifty years was founded on the concept of individual, rather than shared, ownership: there have been experiments with various forms of shared ownership, but they remain limited and at time exploitative. The vast majority of people wish to own their houses outright. They wish, in short, to own and control an asset.

The owners of assets understandably wish to ensure that the assets yield a positive return: this is as true of property as any other kind of asset. And when housing is seen first and foremost as an individual asset, rather than a basic need common to all, the ownership of housing becomes a zero-sum game. Those who own houses want to ensure a positive yield, but they can only do so at the expense of those who do not own houses.

And yet....with all this emphasis on ownership, we forget about the primary purpose of a house. It is not to provide a high-yielding safe asset for people with wealth to spare. It is not to show to the world how rich you are. It is not even to provide you with a link to your community. It is, first and foremost, to provide shelter. And the fact that 60% of the UK population like the value of their houses to rise means that there are a growing minority whose basic need for shelter is not adequately being met. Reducing housing benefit payments whilst house prices are rising prices people out of rented accommodation, because rentals tend to reflect house prices. The bedroom tax forces people into arrears because of a shortage of smaller properties for them to move into, and because of inconsistent and at times illegal enforcement of the new rules. Homeless people are left with nowhere to go, and overcrowding is becoming more common.

Much is made of the shortage of housing supply. But this cannot be relieved while home owners expect rising prices and the private sector is relied upon almost exclusively to relieve supply pressures. Builders will not build into a falling market: home owners will obstruct developments they believe will reduce their house values. The two combine to prevent us building the houses we need.

If we wish to break this doom loop, we need a resurgence of social housing – both to rent and to buy. We need a return of long-term protected tenancies. We need alternative savings vehicles to break the dependence on property. We need to find other ways of enabling people to feel in control of their finances, their environment and their lives, both now and in the future.

But beyond that, we need to re-think what we mean by “ownership”. Perhaps we could look at limiting individual ownership to a lifetime, just as hereditary peerages have given way to life peerages, so that property cannot be bequeathed. Perhaps we need to reinvent he concept of “family” or “clan” property, enabling whole communities to own and control their own land and property down the generations. Though I am not blind to the problems with this – exclusion on grounds of race and class, for example. There are no doubt better ideas.

But of one thing I am certain. The present arrangements for ownership and control of housing foster inequality, injustice and social exclusion. As we move from a competitive society to a collaborative and sharing society, so our attitude to property ownership needs to change. We need to rediscover and recreate the “commons”.

Related reading:

A question of justice

A version of this post can also be found on

Friday, 13 June 2014

Consumption booms and housing busts

A bit of detective work at Pieria. I was puzzled by Mian & Sufi's claim in their book House of Debt that from 2006-8, falling house values caused householders to cut back spending sharply enough to cause a recession. Although wealth effects were severe, particularly for lower-income households, there didn't seem any reason for them to have such a dramatic effect. What was really going on? And what has this got to do with current London house prices?

Read the article here.

Sunday, 8 June 2014

There's more than one kind of money demand

We are used to money demand diagrams that look like this:

If the money supply is fixed, the demand for money reduces as the interest rate rises. This is because investors substitute interest-bearing assets for zero-interest money. As the interest rate falls toward zero, investors become indifferent between other assets and money, and demand for money rises.

In this sort of model we talk about investors being willing to "hold" money in preference to other assets. This is, of course, stock thinking. It says nothing at all about the flow of money. Indeed in the quantity of money equation MV = PY, V (the velocity of money) is often assumed to be constant. Yet we know that the velocity of money reduces as economic activity slows, and increasing the stock of money does not necessarily increase its velocity. Indeed, it could be argued that providing investors with all the money they want to hold itself tends to slow velocity. If money is hoarded, it is not spent - and it is spending that increases the velocity of money.

But investors are not the only people who demand money. Borrowers do, too. And their demand for money ALSO falls as the interest rate rises, and rises as the interest rate falls. However, it is not the interest rate on equivalent assets that they might "hold" that determines their demand for money, but the interest rate (or discount rate) on the assets that they must supply in order to obtain money.

As borrowers usually spend the money they borrow, borrowing tends to increase the velocity of money. So we might expect that a falling interest rate would encourage borrowers to borrow more, thus increasing the velocity of money and offsetting the stagnating effect of investors hoarding money. Increasing the stock of money reduces the interest rate, encouraging borrowing and helping to maintain money velocity.

If only it worked like that in reality. The problem is that falling interest rates on alternative assets for investors don't necessarily translate into falling discount rates on loan assets supplied by borrowers. Changes in borrower creditworthiness - whether real or perceived - mean that banks and markets may offer far higher discount rates than borrowers are prepared to accept. Even if banks and markets maintain low discount rates, borrowers themselves may be less willing or able to offer loan assets at those rates, because of falling net worth and/or falling real incomes.

So in a debt-deflationary slump, not only do investors hoard money, reducing the amount of money in circulation and slowing its velocity: borrowing reduces too, and the supply of money falls (because banks create money when they lend). Rather than money hoarding by investors being offset by increased spending by borrowers, the two combine to depress not only the amount of money in circulation but also its velocity. The fall in money velocity in the US since 2008 is staggering:

Efforts by monetary authorities to raise the velocity of money tend to focus almost entirely on reducing interest rates to investors and increasing their stocks of money in the hope that this will encourage them to spend. But this only addresses one side of the problem. While banks - encouraged by regulators - continue to demand high discount rates on loan assets, and households and corporations continue to offer much lower rates (if they offer them at all), borrowing will remain depressed, the money supply will be smaller than it should be and the velocity of money will be on the floor.

Belatedly, monetary authorities are beginning to understand that reducing policy rates and flooding banks and markets with money isn't sufficient. Unless money reaches those households and corporations whose ability to supply loan assets has been impaired, the velocity of money does not recover and the economy remains stagnant.

Governments have exhorted, cajoled, bribed and kicked banks to try to make them lend, but the reality is that damaged banks under pressure from regulators to repair their balance sheets only want to lend money to people who don't need it, not those who do. The much-maligned Help to Buy scheme is at least an attempt to reduce the very high discount rates faced by certain kinds of borrower. And it does work: there is increased activity in the housing market across the whole of the UK, not just in London and the South East where inflows of foreign money are pumping up prices. The trouble is that it also pushes up house prices, making the UK's housing affordability problem worse.

The UK's Funding for Lending scheme was less effective because it provided banks with cheap money rather than improving the creditworthiness of borrowers. Banks used the money mainly to refinance existing portfolios and offer lower interest rates to people they would have lent to anyway. But despite this less than encouraging response,the ECB has now joined the Funding for Lending party with its Targeted LTROs. It is hard to see that these will make much difference to the credit bifurcation in the Eurozone:

(chart courtesy of

Real discount rates on loan assets in Italy and Spain are far higher than those in France or Germany, partly because of lower inflation but partly also because of higher perceived risk. As the Italian and Spanish sovereigns themselves are perceived as higher risk than Germany or France, sovereign loan guarantees are likely to be of limited effectiveness. Some form of ECB guarantee for SME lending in those countries seems likely to be necessary if the ECB is serious about ending credit bifurcation.

But government or central bank guarantees for the loan assets of high-risk borrowers won't be enough to end the deep-rooted depression in the Eurozone. Renewed spending does not have to come solely from bank borrowing. It can also come from higher wages, lower taxes, more benefits, increased government capital investment. All of these are impaired in the Eurozone. Because of ridiculous political restrictions, Eurozone sovereigns cannot borrow to invest in their economies even though yields on sovereign bonds are historically low and falling rapidly. They cannot put together a New Deal to support the people and businesses that are being hurt by this depression.  They cannot reflate their economies with helicopter drops to businesses and households, bypassing damaged banks. Nor can they write down excessive debts. Even increasing the money stock to meet investor demand is politically suspect, because it involves buying other assets. Just about everything that might help appears to be verboten.

If the overriding need is to get the economy out of a slump, does it really matter how the money is provided, provided it gets to people who will spend it rather than sitting on it? I speak here of the Eurozone, because it is by far the worst offender: if present political restrictions remain, this depression will never end. But in reality no country has paid enough attention to repairing the net worth of borrowers and improving their incomes so that they can start spending again. And because of this, recovery from the financial crisis has taken far longer and been far more painful than it needed to be.

As Willem Buiter says, debt-deflation driven stagnation is a policy choice. It doesn't have to be like this.

Related reading:

Sacred cows and the demand for loans

Draghi's Latest Announcement is a Big Nothing - Capitalism and Freedom

Helicopter money: why it works - always - Willem Buiter

Can labour markets be too flexible? - Pieria

House of Debt - Mian & Sufi (book)