Sunday, September 19, 2010

Government will inflate away the property bubble

Don’t bet the house on a property plunge

The bubble may have burst, says Ross Clark, but a crash looks unlikely. For now, property remains a sensible investment — better than sticking cash in a low-interest account. "Why risk your capital in a savings account for puny interest which isn’t even keeping up with inflation? I keep wanting to put it into something solid: gold or property. I remain convinced that we face a second correction in real property prices. Rental yields remain too low. And yet still I don’t believe that investing in property is necessarily a disastrous thing to do at the moment. A fall in real property prices, yes, but a crash in actual prices? I wouldn’t bet on it. The coalition will try every trick to generate inflation rather than suffer millions more being plunged into negative equity."

Posted by drewster @ 01:21 PM (3646 views)
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30 thoughts on “Government will inflate away the property bubble

  • Hat tip to MoneyWeek for pointing me to this article in this week’s issue.

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  • “Why risk your capital in a savings account for puny interest which isn’t even keeping up with inflation? I keep wanting to put it into something solid: gold or property.”

    ————————————–

    The article was an interesting read but like most that talk about using property to protect wealth they only seem to make ‘sense’ if the person reading it is sitting on a huge pile of cash and can’t figure out if they should buy a house or tonnes of gold or keep it in the bank. It seems to have escaped Ross Clark’s notice that the majority of people in the U.K are flat broke and in debt. The U.K government can inflate away all it wants but who in their right mind would lend money out at a rate lower than inflation? That doesn’t seem like good business sense. I mean, if you had £165K would you rather buy a house yourself or lend it to someone who wants to buy a house and let them pay you back over 25 years.

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  • Interesting article. Some thoughts:

    1) Interest rates being less than inflation is hardly new. My suspicion (until proven otherwise) is that this is normal except for when they lie about it through sophistry that is hedonics. See http://dshort.com/inflation/inflation-update.html and note the second chart.

    2) Actually bursting the bubble is what happens when interest rates rise – and they will. Even the lenders are setting their fixed rate deals to acknowledge the prospect of a rise.

    3) If the bubble bursts then he has a house that may turn out to be hard to sell in a market where transaction levels get very low (and prices continue to fall).

    4) In the bull phase of the market it was comon to get the biggest house you could afford; whereas this character will do better to get the smallest that is suitable and perhaps trade up at a later stage.

    5) The choice between gold and a house is a false one. There are good arguments to say that both will fall over the next 9 months.

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  • estrader @ 2: Who in their right mind would lend money out at a rate lower than inflation?

    The moment I see a “good” interest rate, it usually involves two things:
    1) A lock in – 2 years, 3 years and 5 years.
    2) An institution with wobbly foundations.

    My view is that:
    – yesterdays zeitgeist involved “the best interest rate” – i.e. return on capital,
    – tomorrows zeitgeist may worry a whole lot more about return OF capital!

    In a deflationary environment just feel different. The HPC crowd are already inherently deflationary thinkers, deferring purchases in expectation of lower prices ahead.

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  • The coalition will try every trick to generate inflation rather than suffer millions more being plunged into negative equity.”
    Too damn right.

    estrader said…who in their right mind would lend money out at a rate lower than inflation? That doesn’t seem like good business sense. I mean, if you had £165K would you rather buy a house yourself or lend it to someone who wants to buy a house and let them pay you back over 25 years
    It’s about keeping interest rates low.

    sureseam said…Actually bursting the bubble is what happens when interest rates rise – and they will. Even the lenders are setting their fixed rate deals to acknowledge the prospect of a rise.
    There will simply be more QE will keep interest rates low.

    sureseam said…The choice between gold and a house is a false one. There are good arguments to say that both will fall over the next 9 months.
    You can make good arguments that almost anything could fall in the next 9 months – depends on what lobby groups and what propoganda you read.

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  • In a deflationary environment just feel different. The HPC crowd are already inherently deflationary thinkers, deferring purchases in expectation of lower prices ahead.

    Not at all. House prices dropping is not necessarily a sign of deflation.

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  • “It’s about keeping interest rates low.”

    Thanks for that glib summary of Q.E 🙂

    My question isn’t about the ‘why’. The article is written from the perspective of the borrower/investor. But what if you are a lender? Why would YOU lend someone money for 25 years if the total return is less than inflation? There is a belief that ‘investing’ in property is a better than saving with a bank, but, saving with a bank essentially means that you are a lender. So if it is so bad business to lend your money to a bank, why would it be good business for a bank to lend money to someone who wants to invest in property? I’ll tell you why, because the total return on that mortgage will be above inflation, that is why…and where are they getting that return from…the gullible individual who was told to buy property because it is a good ‘investment’.

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  • The individual, (saver), who places money in a savings account will likely receive a below inflation return so his capital is shrinking.

    The Bank is borrowing this money at the interest rate paid to the saver. As long as they can lend this money out at a higher rate that they pay the saver, they are laughing. It is no conequence to them how fast the saver’s capital is shrinking.

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  • Thanks for that glib summary of Q.E 🙂

    Wasn’t intended to be glib – just trying to explain why your point isn’t an issue for them.

    But what if you are a lender? Why would YOU lend someone money for 25 years if the total return is less than inflation?

    There are a few things going on there, not least allowing the banks to build up their balance sheets.

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  • Why would YOU lend someone money for 25 years if the total return is less than inflation?

    1. Security of capital. You’re (almost) guaranteed to get your money back, no ups and downs like property.
    2. Ease/laziness. No property hassles.
    3. You don’t think the total return is less than inflation.

    In the UK, the 30 year gilt currently yields 4.14% (source: FT). If you lend the government £100,000 today, with compounded interest it would be worth £337,700 in 30 years time. To put that into perspective, if you’d bought a house 30 years ago worth £100,000, today it would be worth £722,641 (source: Nationwide). You’d also have rental income, which you don’t get with bonds (the interest rolled up is included in that £337k).

    If you are Japanese, your capital would be much safer if you’d bought bonds 20 years ago rather than buying shares or property, both of which have plummeted in Japan. However I don’t know whether the rental / dividend income would have made up for it. Anyone know?

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  • I’m with hpwatcher.

    If I may add – As long as there are overseas buyers, interest rates will be kept low to keep our currency weak and there’s always more QE to support this. That’s the reason why I have been in the inflation camp and there’s also the BOE angle which is another subject.

    Savers and FTBers are being sold wholesale, down the river. There’s more than one way to skin a stubborn cat, or rat as ‘they’ will not do it for you. To me, this is a monetary war, waged on a generation and beyond. Don’t expect any favours or tips on buying silver, gold and oil in the future.

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  • @8. righttoleech,

    Where does the bank get the money it lends? If a bank is making a profit on the mortgage then WHO is paying that profit? It HAS to be the borrower and nobody else. So when somebody ‘invests’ in property they have to get a total return that greater than inflation + profits the bank makes on the mortgage.

    To put that into perspective, if you’d bought a house 30 years ago worth £100,000, today it would be worth £722,641

    1) Yes, and how much interest would you have paid on the mortgage over that time?

    2) If you bought $100,000 worth of gold in 1970 it would be worth $3,272,493 or £2,097,752

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  • Anyway, if you think the article makes sense, rush out and buy 10 houses first thing Monday.

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  • estrader,
    I don’t post articles because I think they make sense. I post them to generate debate.

    30 years ago is 1980, not 1970. Gold has only risen by ~50% since its 1980 peak, so bonds or property would have been the better bet.

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  • Used to live in Japan… Unlike here, besides paying a deposit to rent a place, you also have to give a ‘gift’ to the landlord of one to two months rent, which has to be given again every two years you stay! This is theoretically for the upkeep of the property, but that rarely happens. It’s also a given that if you get half your deposit back, you’ve done well. The govt had to intervene on this latter point because tenants were being fleeced left, right and centre over this.

    I have intended to make a longer post about how and why the UK and Japanese housing markets can and cant be compared. Have a Canadian friend out there who waited out their housing bubble for 15 years before finally snapping up a place a couple of years back – possible because his wife’s Japanese.

    The mood over there now is that property certainly isn’t an investment, unless you are planning to rent it out (which as explained above can be very lucrative). Other things to consider are that houses there are made of surprisingly feeble stuff (in a major earthquake zone!) and certainly in a major city like Tokyo, stuff gets knocked down and redeveloped at a much faster rate than the UK.

    Back to the original post – doesn’t inflating the debt away assume that, in the case of house prices, salaries are rising? If inflation is rocketing ahead, while house prices and nominal salaries remain flat, then how does that make them more affordable? I think I can speak for many when I say my salary is certainly not matching the rate of inflation and I don’t see that changing any time soon (annoyingly).

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  • estrader……I am not trying to justify the article……far from it. Just trying to illustrate that it would normally be Bank type institutions lending on property, and since the money lent has been borrowed from savers, (depositers), the Bank can profit regardless of the general inflation rate. It is not the Bank’s money. If the saver’s (depositer’s) aim was to keep ahead of inflation he will win or lose depending whether his net return is greater than RPI. The borrower, (property buyer) may calculate whether he makes a loss or profit based on increase, (he hopes), in the value of the property, less maintainance costs, less interest payments, and taking into account rent that would have to be paid if he had not purchased. Of the entities involved the Bank is is best placed to make money, and whether on not the Bank makes money is independant of the position of house buter or saver.

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  • Surely any sensible investor would be more interested in the return over the next five years.

    That should be the debate.

    Also, why would anyone want to commit all their savings to an illiquid asset that is rated overpriced by even the EAs.

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  • Drewster,

    I understand, but I am stating something that doesn’t require debate. A bank is in business to make money. They would be out of business if they got back less money than they lent out, it’s simple economics. As I said earlier, the article only makes sense if someone is in a position to buy property outright. Very few people are in a position to do that and anybody who is/was would have already done it or bought gold or something else. The SMART money doesn’t need an article like this to tell them what to do because they are usually months and years ahead of the rest. So who is left? The average person and as I said earlier, the average person is flat broke or in debt so they have no wealth to protect or money to invest. I used the gold example to illustrate how easy it is to say what you would have done in hindsight. Your house example did not include insurance, interest charges, loss of income and all other perils associated with property ownership.

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  • 14 righttoleech,

    That isn’t completely true. They have bank staff and shareholders to pay, buildings to maintain etc. They are not a magical business.

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  • The bubble has not yet burst. The reason we are still in a bubble is because everyone is still obsessed with property. We have had property bubbles before but this time the obsession has been manic. However, sentiment is now turning and people are starting to come round.

    12 years ago, when I purchased my first property, no one was interested buying property. TV programmes were all about the FTSE and how to invest in the stock market and people wouldn’t touch property with a bargepole unless they were buying a family home.

    Eventually the average property in the UK will be 3.5 to 4 times the average salary. This can only happen through a house price correction or wage inflation and there is no way we are going to see wage inflation this time round.

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  • hpwatcher @ 5: There will simply be more QE will keep interest rates low.

    QE in sizeable doses, tells the bond markets that they won’t get their money back, in real terms, at maturity. Central bank interest rates follow their bond markets – they do not lead them. Even Gordon Brown had plans for an austerity program. QE is sadly not a cureall.

    I started out thinking major inflation was inevitable and deflation was impossible. Now I have evolved towards the metaphor of a tsunami: the tide appears to go a long way out before coming roaring back in (not one) but several large waves.

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  • estrader,

    Your house example did not include insurance, interest charges, loss of income and all other perils associated with property ownership.

    I was comparing £100,000 invested in bonds with £100,000 on a house – no mortgage, no interest charges, no loss of income as long as you set the rent at the right level. You’re right that I didn’t include buildings insurance – but it would be comparatively small, maybe £400pa on a house of that value, and easily deductible from the rental yield. The perils of property ownership are few in the UK, fewer than in most other countries (e.g. in the USA there’s hefty annual property tax, in China there’s the threat of government building a motorway through your garden).

    The SMART money doesn’t need an article like this…

    I don’t believe in “smart” money. Everyone makes decisions based on what they know – the difference is that CEOs and bankers know more about the global economy than the average man on the street. There are a lot of people who aren’t particularly smart, but who have amassed a considerable amount of savings in their lifetime and are now distressed because they aren’t getting the yield they expected from their savings account. These people (a disproportionate number of whom read the Spectator) are the ones targeted by this article. I know quite a few of these people – mostly older couples with grown-up children – and they are agonising over what to do with their cash pile. Some have already taken the plunge into property, although it’s fair to say that they aren’t cut out to be landlords and are struggling with the practicalities of it.

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  • This is a thoroughly interesting discussion, keep it coming guys.

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  • Well Drewster it seems we agree – Judging by the performance of other asset classes in the last few years compared to property this article is aimed at people with lots of cash but no sense.

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  • if I had cash I would buy gold not property. Why buy the bubble which is still bursting when you can buy in to an incipient bubble ?

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  • mark wadsworth says:

    RTL: “The Bank is borrowing this money at the interest rate paid to the saver. As long as they can lend this money out at a higher rate that they pay the saver, they are laughing. It is no conequence to them how fast the saver’s capital is shrinking.”

    That’s a good way of looking at it. I must remember that.

    But my (personal) way of looking at it is to simply ignore general price inflation and look at how fast house prices are falling in nominal terms (not fast enough, obviously!). So far, my money on deposit earning f- all interest minus rent paid is still a lot less than the money I would have lost by buying a house two and a half years ago, and that is the end of that.

    The article is nowhere near as gung-ho as the title suggests and is largely factually correct. It ends with this: “The British property market has been a story of boom and bust for at least two centuries.” Land Value Tax will sort that out 🙂

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  • In a Fractional Reserve banking system the banks don’t even need to lend out at a higher rate than they are paying savers. Suppose they have a 10-to-1 ratio and are lending out £100,000,000 at 2% p.a. To service that they need to have reserves of £10,000,000 which will be provided by savers. So they have revenue of £2,000,000 p.a. from the loans. Supposing they pay 50% of that to the savers, then the savers are getting a return of £1,000,000 p.a. on deposits of £10,000,000 which works out to 10% p.a.

    The only reason that the banks don’t pay a higher rate to savers than they charge to lenders is that they don’t want more money in reserves than they absolutely need to cover requirements. It hurts the shareholders profits otherwise. So they drop the saver’s interest rate to dissuade people from saving with them. But from a strictly profit-and-loss point of view they could afford to do it.

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  • Hello Mark, yes, there is much general agreement here amongst like minded people. The postings rarely go into full analysis mode or they would be weighty tomes that would never get read. Beyond the general principles we all have different opportunity costs that may make one choice that is good for one person poor for somebody else. e.g. somebody temporarily working abroad with accomodation provided would not have a rental cost to take into account for their calculation.

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  • Mark,
    Where is land value tax in British policy debate? There are reports coming out on it in Ireland, e.g. by the “smart tax network”, but here?
    N

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  • Nick B, there’s a revolving door policy on LVT.

    While in opposition, Vince mumbled vaguely about Mansion Tax, but that was promptly forgotten once he was in his minsterial limousine on the way back from the DTI (which his own party had long promised to scrap).

    Conversely, now that David Millipede and Andy Burnham are out of power and running for Labour leadership, they have picked up on Vince’s Mansion tax and LVT respectively.

    It’s got to do with Home-Owner-Ism I suppose. I can’t imagine the banks would like it as it would keep property prices low and stable, for example, and it’s quite possible that it’s bankers who run the country.

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