The real cause of Western world high property prices

A documentary on Dateline in Australia highlights the perils of Chinese investment in Western property. The argument is brought to the forefront of people’s concerns because local people are purportedly being hurt by said ‘property speculators’. In this article I want to highlight the folly of those who would argue that the Chinese investor is to blame. Instead I will draw attention to the real cause and what ought to be done.

economists-so-they-sayFrom the start, it is important to acknowledge that we are really talking about ‘two markets’ – the market for land and the market for ‘rental’ or ‘owner-occupied’ abodes. Of course these markets are linked, but seldom do people discern the difference. The reason why it’s important is that it raises issues of ‘rental supply & demand’ as well as ‘owner-occupied housing’ supply & demand. There is a dispensation for people to simply read ‘high prices’ as a signal of ‘excess demand’. This is the popular folly of economists who don’t understand, or didn’t study finance. It cannot be forgotten that all asset prices are trading at very low yields because global interest rates are at unprecedented ‘low levels’, and asset yields, in the pursuit of ‘any yield’, have seen money leave China in search of other markets. This doesn’t make Chinese money the problem – merely the ‘point of differentiation’. Chinese people simply are correlated with the problem because that’s the only ’cause’ discernible to observers. This should however highlight the limitations of correlation, pattern recognition and observation, and elevate the value of sound analytical argument, and the utility of ‘coherent’ world views. This however is not a cultural context that heeds sensibilities of integrity. The recent US political election only highlighted the extent to which the media is biased, and political interests bought.

The folly of many economists, and most of the media, who possess only a basic understanding of economics and finance, is their propensity to think only in terms of ‘the physical supply & demand’ for property. This is commonly called the ‘real economy’. They fail to consider what is happening in the ‘non-real’, ‘paper’ or speculative market for assets and liabilities, which is of course the plaything of investors. The size of the speculative market dwarfs the real economy for two reasons:

  1. Over time people are able to accumulate assets far in excess of their income in any year, as well as the spending they perform, which is destined to be a fraction of their income, as they direct most of their surplus savings to repaying debt rather than conspicuous consumption.
  2. Those investors, along with typical wage earners, are able to borrow at low rates to leverage themselves into property and other assets of far greater worth than their annual income. Now, that leverage becomes immense as interest rates fall to ‘record lows’, and their ‘equity’ tied up in assets becomes greater.

realproperty

Add to this ‘bubble’ the fact that few people realise that prices are going to stay high, and you start to realise that ‘this is no ordinary bubble’, and that these Chinese investors are either lucky, or rather astute to seize the opportunity. The nature of their ‘luck’ is their good fortune to observe a trend, and then to buy into it, without the causal ‘analytical’ arguments that I am expressing here. You might wonder ‘how long the trend will continue’? The answer ultimately depends upon:

  1. The sustainability of credit growth which depends upon the sustainability of low inflation, which depends upon the sustainability of global unskilled labour liberalisation, and the underlying ‘cultural values’ that decide if workers are ‘disciplined workers’ or obstructionists to low wages. It is fair to say that we have seen the ‘best conditions’ with Chinese, Vietnamese, Korean, Thai and other workers. It is fair to say that certain other cultures like the Philippines and Indonesia, are destined to learn slowly the requirements of ‘disciplined’ industrial relations. The pace of these adjustments will weigh on ‘inflation outcomes’ globally.
  2. The extent to which governments persist with high debt levels in Western nations, by funding QE programs and now, infrastructure spending–> The extent to which these policies are embraced is the extent to which their underlying currencies are ultimately debased and ‘real assets’ like property and stocks adjust accordingly. For this reason, there is no telling how asset prices will go, though given the inflation outlook will eventually turn, and the real economy will eventually recover, there is no reason to expect interest rates to turn significantly negative. This concern is suspiciously a ‘non-issue’.
  3. The extent to which ‘dogmatic’ policy makers don’t disrupt the economic cycle by attempting to impose context dropping policy proscriptions like higher interest rates. There is some scope actually for the US Federal Reserve to raise rates, however it would be silly to do it prematurely. The time to raise rates is when the real economy has resumed growth. Emerging markets are growing, and Western households have been paying down debt levels for the last 8 years since the GFC. For this reason, there is good reason to actually raise rates, however it is a policy which would be made more sustainable if it was deferred until emerging markets, which are really now the engine for global growth, could actually be allowed to grow a little more. That said, it wouldn’t make a lot of difference for the Fed to raise rates because there are other options:
    • The US government, and other Western and emerging market governments could raise spending on infrastructure.
    • The US and other governments could elevate productivity and lower the costs of living by cutting the size of their bureaucracies, and the extent of unnecessary and fruitless regulation. It isn’t enough to say ‘there is a benefit from spending’. The question is whether said spending could be better and more productively performed by a private party. The answer is of course ‘yes’.

productivity‘Local’ Western people who are missing out on property are of course incensed by the fact that they are missing out on the opportunity to buy property. This raises several questions:

  1. What is the cause of the problem?
  2. How should the problem be addressed?

Do we prohibit Chinese buyers? Just Chinese buyers, or all foreigners, or all speculators? It would seem unfair to target just Chinese people, and yet people could canvas the ‘practical’ benefits of doing just that, with seemingly little impact on the Western economy. That is however not a ‘moral argument’, but a case of using the extortive powers of government to ‘attempt’ to solve a problem. This is of course what people look to government to do – extort influence over others who upset them. The irony is that, this was one of the reasons why Chinese people left China (with their money) in the first place, and also one of the reasons why the West has long been suspicious of Chinese investment, military build-up or simply their broader political proclivities. The spectre of arbitrary interference. So Western governments, backed by arguments from emotive ‘liberals’ and the left side of politics, is being drawn into ever-more fascist rhetoric and policy proscriptions.

The problem with placing a blackband upon Chinese investors is that they simply go somewhere else, and ‘white elitists’ buy up where the Chinese left off. It doesn’t solve the problem, it just reshuffles the deck chairs, or defers the inevitable result, which arise because of (i) low inflation and (ii) subsidised interest rates. Whilst Fed chair Yellen can do something about raising rates, she can only make a modest because any action by central banks interpreted as ‘harsh’ by the market will lead to a global collapse. The markets are of course expecting Trump to ‘back off’ as soon as he takes advice on the issue from people who know.

market-is-not-always-rightWhat people don’t realise is that you can’t treat ‘distorted markets’ with ‘market solutions’. People might argue that the market is always right. But the truth is that markets don’t care if they are right or wrong. Individual market participants do, and it’s pretty certain that they, acting with full awareness of the ramifications of central bank ‘harshness’, would not want central banks to collapse the banking system, even if they are not happy with the state of financial market regulation. That is another issue. Moreover, we need to accept that there is no prospect of ‘free markets’ as long as there are states organised to marshal resources to take over the world. The problem is one of responsibility. It has long been accepted that Western ‘egoism’ is the foundation for ‘bull-headed’ stubbornness, that precludes the West from thwarting a ‘united China’. The argument was accepted long ago that Westerners have to be subjugated to achieve collective outcomes that elevate the state. This ‘mercantilism’ is taken as ‘economic policy’, but it actually has an overt political imperative more important than making money. To be sure, the bankers want to make money, but they also want to ensure there is a ‘safe haven’ to stash it, and that means the US alliance and preserving it. The origin of this debate debates back to the late 1800s, when Western nations were determining the nature of their public eduation systems, as well as their military training regimes. The poignant lesson came from the Prussian military. Today, these strategic objectives seem to have taken an ideological direction of their own, however no one considers them in such terms. It is overtly an ‘amoral’ question of competing vested interests. Today it’s the Chinese investor vs poor/young families who have yet to secure a family home, or elderly pensions who are struggling to believe that contemporary interest rates will yield them an adequate return moving forward. The issue is serious if you consider that rates are destined to remain low, population rates are destined to decline, and real incomes destined to fall. You might wonder why this is the case. The answer is simply:

  1. The West is overpriced and politicians won’t allow products and services in the market to find their ‘natural price’ level free of interference and unnecessary regulation. This is not to spurn all regulation; merely state regulation, and its arbitrary ‘extortion-based’ nature.
  2. The West isn’t taking steps to make the imbalance less pervasive. Instead it is adding to the regulation, further undermining the inefficacy of public policy, and accentuating the disparities between vested interests. It elevates some interests whilst spurning others. You would think by observing political discourse that ‘women’ and ‘gays’ are the only vulnerable minority groups, whilst intellectuals or university graduates have no grievances, despite huge debts and the prospect of being forced to study for years an anachronistic education course, simply to please an employer they have no desire to work for, beyond the attainment of nominal skills.

chineseSpeaking of persecuted minorities. We spoke of the Chinese investors above, and how they were not to blame for the rising property prices in Western ‘coastal’ property markets. To reiterate ‘the reason why equities and property are at such high prices, is not because of the Chinese, but because investment yields are so low’. This is the ‘finance puzzle’ that people don’t get. Asset markets are an arena where both small and large investors alike search for greater returns. In tumultuous times, people (including the Chinese and larger institutional) investors will look abroad. So why focus on the Chinese? The reason is because, unlike the institutional investor that builds high rise ‘mass market’ properties, or commercial properties, lone high net worth Chinese investors are focused on the types of property that ‘we’ want – stand-alone housing. More importantly, their language any physical appearance makes them stand out in the marketplace, whether they are a buyer or not.

The notion that property prices are at the levels we would associate with being a ‘bubble’ is based on several misconceptions:

  1. What goes up – must come down? The property with that argument is the hidden, and seldom understood, concept of asset inflation. People look to the debt levels in global markets and argue that the debt will be liquidated, and that will result in a financial collapse. It is wrong. The reason why it’s wrong is because there is no vested interest in causing that to happen, and therefore it can’t happen.
  2. Market imperative for interest rates to rise. The reason why there is no reason for property prices to fall is because there is no reason for rates to rise. There is little ‘cost of living’ inflation to precipitate a rise in rates. The folly of central bankers and economists who take the Keynesian argument that deflationary pressures are due to ‘subdued demand’ – it’s not. The cause is an oversupply of labour.
  3. Sound money. There is an expectation that asset prices can be accepted at ‘face value’. We know of course that inflation erodes the value of dollars. The problem is that people are not acquainted with the prevailing type of inflation – which is asset inflation. They are ‘gripped’ only by an awareness of ‘cost of living’ inflation, which has been low for decades. The reason why ‘asset inflation’ is so serious, is because it works inversely to cost-of-living inflation. i.e. Wage restraint in emerging markets is driving down wages, and this is resulting in savings going into investments in the knowledge that those ‘unskilled workers’, who comprise the majority of workers, will not be bidding up product prices in the real economy’. i.e. Resources are being ‘stolen’ from the real economy and directed into the speculative economy. This problem actually highlights another problem – and that is….
  4. The constraints on capital flows. The emerging markets is the natural place for Western labour skills, capital and laws to migrate, except for the fact that, ‘nationalists’, collectivists, or embedded power brokers in these countries want to control the benefits of their markets as long as possible. It is fair to say, they will keep the West out as long as their wages are relatively cheap. That is a long time – from 10 to 30 years depending on the level of advancement made by said economies.

There are of course natural fluctuations in markets, whether it’s changes in government policy, interest rate adjustments, news reports, inter-regional price dynamics. Notwithstanding those factors, the outlook for property prices is ‘up’, even if those increases are justified or facilitated by:

  1. The creation of more debt-funded by government bond buying programs or ‘real wealth creation’
  2. The repayment of debt or the funding of government spending initiatives  through the printing of money

In either case, there is every reason to expect these policies to result in higher property prices, even if the value of the underlying currency falls in value. The people who will ultimately be hurt are:

  1. Those people who defer buying ‘any assets’ because they are ‘over-priced’
  2. Those people who buy ‘cheap property’ in no growth areas because they feel they have ‘missed out’
  3. Those people who rely upon government to solve their plight, or they rely on government for welfare support.

So the perverse fact is that the left, who profess to help the poor, are actually bringing about public policy that is antithetical to the interests of the poor. i.e. With asset prices set to spiral, a number of Western governments like Australia and NZ have placated the media (serving their leftist cousins), by curtailing the ability of the poor and low-income earners to enter the property market by raising the equity they need to buy property. This is silly. These people, who have the most dire need for ‘effective investment’, are effectively being forced to buy ‘fixed income’ bonds or hold cash, and locked out of property, which would have to be considered the easiest type of property investment to understand. This perverted policy goes unchallenged. It goes to show that the media is serving as exponents of fear and greed, and that they are not objective interests, but rather part of a shady extortion racket, that has its origins in the nature of democracy itself – majority rule – which is the foundation for extortion. Yes – the noble value of democracy is misplaced. It’s a common law crime. And for vested interests who benefit from that racket – it’s very practical – and they don’t want to change it – lest ‘victims’ start to feel aggrieved.

This is not to say poor people or ‘cashed up’ people will not get support from government. It is merely to convey that they are vulnerable, as anyone who relies on others is ‘vulnerable’. Dependence is not a value proposition.

Aside from the ‘debasement of money’, there is another reason to hold assets, and that is the persistence of low inflation, and the strong economic growth outlook that assures investors. The globe might appear vulnerable, but the truth is that, conditions have never been better for investors, consumers and producers. It is true that incomes are not high, but produce prices are relatively low. This argument will appear ‘misplaced’ for some, and the reason is that it’s a ‘Western’ parochial story. The gains made by the West in the past are now being enjoyed by constituents in emerging markets. It’s their turn. Which is why we need to appreciate that whilst people talk of a ‘global economy’, the truth is that the West and Eastern (i.e. emerging markets) have never been more divided in terms of outcomes. Or more actually, outcomes have never been reversed like they are today. The ’emerging markets’ were yesterday’s ‘third world economies’, and before that they were impoverished, war-torn, tribal economics. So it’s good it’s their turn. Given they are often living on a few dollars a day, it would be unsettling to think a ‘parochial Westerner’ would be seeking wage claims to raise their income to $15+/hour, when it is not justified by productivity gains.

So for this reason, ‘cost of living’ inflation is low in the West, but high in emerging markets, to the extent that wages are rising quickly, and people are less price sensitive. This is not to say inflation is crippling people’s capacity to buy the things they need, before their wages are growing at rates as high as inflation, if not higher. Of course the emerging market experience is no less ‘unfair’ or ‘unequal’ than in the West. The government worker engages in corruption because they are so underpaid. The skilled worker employed by a Western company is paid twice as much as an employee at a local company. The sore point is that – asset inflation in the West, but it’s not in the emerging markets because interest rates are very high.

Now, the reason why low inflation (in the West) is destined to persist is because there is a over-arching ‘excess of unskilled labour’ in the world. You might think that there are rising wages in China, and that this will lead to higher wages, but consider several factors:

  1. India, Bangladesh, Indonesia and the Philippines has a vast pool of unskilled labourers who are looking for work. There are of course a lot of unemployed around the world as well, say in Brazil and Argentina, who could also be ‘tapped’. Now, not all of these cultures are ‘hot beds’ of ‘disciplined’ or ‘skilled’ labour, but everyone is ‘trainable at a cost’.
  2. Chinese workers are capable of higher productivity in order to preserve their economic relevance. They of course have debt obligations that demand that they ensure the continuity of their incomes.
  3. Many workers are of course vulnerable to ‘automation’ and ‘consumer reproach’. i.e. A consumer can simply decide to defer spending if prices are not ‘fair’. If they are comforted by the deflationary impacts of technology/productivity, they can wait for the next model of the I-phone. S0, we can see that consumers enjoy a lot of power in the ‘high end’ of the market place. At the low end, in areas like food, they have less power, particularly if they are adamant that they must enjoy the convenience of ‘air conditioned’ super-malls. If you are more thrifty, you can of course buy cheaper from small grocery stores, who need to be ‘economically astute’.

Knowledge can be empowering for people who are ignorant. It can give them a path to follow. This brings us back to the Chinese investors. There is considerable fear because people in Australia, Canada and NZ remember the impact that Japanese investors made in the 1980s when they started buying foreign property. This time, the market dynamics are different because there is no imminent threat of rising interest rates to quash those investors, and the Chinese economy is going to surpass the Japanese in terms of its capacity to finance these investments moving forward. i.e. China’s population is 10x larger than Japan’s. Moreover, Chinese investors show a greater propensity to invest abroad than the conservative Japanese.

Interestingly, you have to ask:

  1. Would it not serve China to curtail it so that investors reinvest outside of China?
  2. Why Chinese are buying abroad?
  3. Would it serve the West to limit such buying?

The answer to these questions is that:

  1. Chinese investors can readily ‘loophole’ any laws to prevent investment in the West. The boundaries for speculation are very hard to prevent from their end because it is hard to know what the funds are buying, or what ‘assets bought’ are being used for, i.e. funding property purchases
  2. Chinese investment is high because Chinese markets are themselves overpriced, and local interest rates even lower. That is part of the driving factor behind interest rates. The implication is that some Chinese investor interest will ‘dry up’ when the Chinese economy recovers, however there will always be those compelled by ‘lifestyle’ objectives, or ‘risk diversification’ motivations
  3. I would argue that it does not serve the West to limit Chinese property speculation because – they ought not be discouraged from diversifying their risk. Their investing can lead to greater economic activity in recipient countries, though clearly investments in ‘existing stock’ does not result in direct spending beyond ‘agent fees’ and ‘government land taxes’.

The important fact to consider is that:

  1. Western property prices might be rising faster than Westerners would like because of Chinese involvement in their local market, however this is not the ’cause’. The cause is ultra-low global interest rates. Local investors are equally active in the NZ, Australian and Canadian property markets. The appeal of these markets is that they are moving faster because they are smaller.
  2. If we acknowledge that there is an oversupply of land and that the outlook for rates is good for borrowers, there is no concern about people being denied housing. There is no ‘physical shortage’ of housing. The media like to ‘show off’ the tragic plight of ‘homeless people’, but they are not homeless because of high housing prices. They are homeless because they don’t want government support, or they have betrayed the terms of said support by using alcohol, or because they have a mental illness, that has prompted them to live on the streets. There is of course people inconvenienced in the short term because they are ‘too proud’ to ask for help, or because governments adopt ‘arbitrary limits’ or because people don’t plan ahead.

housing-crisisThe ‘housing crisis’ is really a ‘convenience crisis’, or otherwise stated, a crisis of expectations. Disappointed people are being polarised or incensed by liberals who like to elevate the apparent state of tragedy in the world, whether because they have an overarching sense of vulnerability, or because they are self-serving, and they want to profit from a narrative that offers more support to canny liberals, who are the first in line when there is support in the offering. Conservatives are not much different. It is hard to make a distinction, other than to conclude that conservatives are simply people who have not suffered the fate of their sanctioned arbitrary proscriptions, or those of like-minded people, whether their representatives, university professors, or parents. It’s free money and it comes from government. In the case of the media, it’s just a good ‘bullshit story’ that serves their ratings and commercial goals.

What is apparent however with these stories is the spectacle of the media becoming a ‘partisan political engine’ with its own agenda, to drive government policy. The media is in a powerful position, to not just report facts, but to give them a ‘spin’ in society that can drive public policy, community attitudes, and this is concerning. We will explore this aspect of this issue in PART 2 of this story.

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