2000 should have been the natural end of the BabyBoomer-led economic SuperCycle. The oldest Boomer (born in 1946) was about to leave the Wealth Creator 25 – 54 age group that drives consumer spending and hence economic growth. And since 1970, Boomer women’s fertility rates had been below replacement level (2.1 babies/woman). So relatively fewer young people were joining the Wealth Creator generation to replace the Boomers who were leaving.
But instead, central banks decided that demographics didn’t matter. They believed instead that monetary policy could effectively “print babies” and create sustainable demand. So instead of worrying about financial stability – their real role – they aimed to stimulate the economy by boosting financial asset prices – primarily shares and housing markets.
London’s housing market was a key target as the Bank of England’s Governor told Parliament in March 2007:
“When we were in an environment of global economic weakness at the beginning of the decade, it meant that external demand was declining… We knew that we had pushed consumption up to levels that could not possibly be sustained in the medium and longer term. But for the time being if we had not done that the UK economy would have gone into recession… That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out.”
But instead, when the Subprime Bubble burst, policymakers did even more stimulus via Quantitative Easing (QE).
The chart of London house prices since 1971 (in £2017) therefore shows 3 distinct phases:
- 1971-1999. Prices were typically Cyclical – (1) up 51%, down 31%; (2) up 37%, down 15%; (3) up 109%, down 43%. But they averaged around 4.8x average London earnings
- 2000-2007. Central banks panicked after the dotcom crash and kept interest rates artificially low – creating the Subprime Bubble as prices rose in more or less a straight line, till they were up 196% from the previous trough
- 2008-2017. The market tried initially to return prices to reality, and they slipped 10%. But then central banks rushed to flood it with liquidity and created the QE Bubble, causing prices to soar 46%
Now, however, the Stimulus Bubble is ending and a “perfect storm” is developing as 3 key myths are exposed:
The end of the ‘London is a global city’ myth. The house price/earnings ratio averaged 4.8x between 1971-1999. But it then took off into the stratosphere to reach 11x today, as the myth grew that Londoners weren’t relevant to the housing market. Instead, it was said that London had become a “global city” where foreigners would set the price.
Chinese and Asian buyers boosted this myth as vast new apartment blocks were sold off-plan in the main Asian cities – often to buyers who never even visited their new “home”. But the myth ended last year when China introduced severe capital controls – capital outflows collapsed from $640bn in 2016 to just $60bn in 2017.
The scale of the this retreat is overwhelming as The Guardian reported recently:
“The total number of unsold luxury new-build homes, which are rarely advertised at less than £1m, has now hit a record high of 3,000 units, as the rich overseas investors they were built for turn their backs on the UK due to Brexit uncertainty and the hike in stamp duty on second homes….
“Henry Pryor, a property buying agent, says the London luxury new-build market is “already overstuffed but we’re just building more of them. We’re going to have loads of empty and part-built posh ghost towers. They were built as gambling chips for rich overseas investors, but they are no longer interested in the London casino and have moved on.””
The end of the buy-to-let mania. Parents of students going away to college began this trend in the mid-1990s, as they bought properties for their children to use, rather than rent from poor quality landlords. After the dotcom crash, many decided that “bricks and mortar” were a safer bet than shares, especially with the major tax breaks available.
Banks were delighted to lend against an asset that was supported by the Bank of England, finding it far more attractive than lending to a business that might go bust. And so parents held on to their investments after their children left college – further reducing the amount of housing available for young people to buy. But as The Telegraph reports:
“Buy-to-let investors now face tougher conditions. A weakening housing market, tough new legislation and the tightening of affordability checks by lenders are but a few problems causing landlords to run for the hills. According to the National Landlords Association, 20% of landlords plan to sell one or more of their properties in the next 12 months.”
Interest rates will never rise. Of course, the key to the Subprime and QE Bubbles was the Bank’s decision to collapse interest rates to stimulate the economy. Monthly payments became much more affordable – and ever-rising prices meant there was no longer any need to worry about repaying the capital.
But some people still couldn’t afford to buy even on this basis, and by 2007 around 30% of mortgages were “interest-only” with no capital repayment at all. These buyers should have been forced sellers when the Subprime Bubble burst; prices would then have returned to more normal levels. But instead, the Bank of England stepped in again, as the Financial Times has reported:
“During and after the 2008 financial crisis Britain’s mortgage lenders took a more tolerant approach to non-payers through the use of forbearance ….at the height of the housing market troubles in 2011 Bank of England research suggested that as many as 12% of all UK residential mortgages were in some form of forbearance. This helped prevent the downturn from developing into a 1990s-style crash, the Bank suggested.”
PRICES WOULD FALL 60% IF THE HOUSE PRICE/EARNINGS RATIO “REVERTS TO MEAN”
All “good things” come to an end, of course. And the London property bubble is probably no exception. Its 3 key drivers are now all reversing, and there seems little sign of any new factors that might help to keep the bubble inflating.
The risk is that interest rates continue to rise, forcing many owners to sell and bursting the Stimulus Bubble. UK 10-year rates have already trebled from their 0.5% low in Q3 2016. Most rates seem likely to go much higher now the 30-year downtrend has been broken, as I discussed last week.
Today’s high prices will also make it difficult for sellers to find local buyers, as the number of homes being bought/ sold each year has fallen 25% since the 2007 peak. Most young people cannot afford to buy. And if many people do decide to sell, potential buyers might panic, causing the slump to continue for many years – as happened before 2000.
Nobody knows how low prices might go, if they start to fall. But ‘reversion to mean’ is usually the best measure. If this happened, today’s average London home, selling at 4.8x earnings, would cost £193k – a 60% fall from 2017’s average price of £475k. This figure also highlights the risk that policymakers’ denial of demographic realities has created.
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US retail sales have failed to see the rise that most economists, and the US Federal Reserve, confidently forecast at the beginning of the year. The theory was that lower oil prices would stimulate discretionary spending, and ensure that the long-promised economic recovery finally arrived.
But September sales were up just 0.1% versus August, and even this small amount was only due to a 1.8% increase in auto sales. Excluding autos and gasoline, sales were flat versus January:
- Consumers are now increasingly focused on price and convenience
- They are “time rich and cash poor”, the opposite of the boom years when they were “cash rich and time poor”
- Thus Wal-Mart, the US’s largest retailer, has just forecast a 12% fall in profits next year
Wal-mart’s news is confirmation, if confirmation were needed, that the formerly profitable middle ground of value-added products is fast disappearing. Affordability is the key driver for future success.
So what has gone wrong?
“TIME RICH” BECAUSE PARTICIPATION RATES HAVE FALLEN
The key issue is policymakers’ refusal to confront the issue of the ageing society, as they worry they will lose votes. They prefer to pretend that low interest rates can somehow restore full employment, and to ignore the structural change in the US population:
- People no longer mostly die before retirement
- Instead today, a 65-year old man can expect to live to 84.3 years on average, and a woman to 86.6.
As a result the participation rate in the US jobs market (the percentage of people actually in a job) is in long-term decline. It peaked at 68.1% in 1997, compared to just 62.3% today:
- It has been in long-term decline since World War II for men, due to increasing life expectancy –
- Life expectancy was just 60.8 for men in 1940, meaning that most people could expect to die before retirement.
- There were only 9m Americans aged 65 or older
- The rate for women has also fallen back to 56.3% today from its 60% peak in 1999
- This has reversed the decades-long increase due to Equal Opportunity movements, which allowed women to stay in the workforce after marriage
- One likely reason for this is the lack of support for working parents, which has helped to push US participation rate for women below that for Japan. As the Financial Times notes, “A quarter of all women return to work less than 2 weeks after having a child“
“CASH POOR” BECAUSE MEDIAN EARNINGS HAVE FALLEN
The second chart (showing median US earnings in constant dollars of 1982-4), highlights another reason for households now being increasingly “time rich and cash poor”:
- Average earnings today are actually lower at $337/week than in 2009, when they were $345/week
- Average earnings for men have fallen from $402/week in 1979 to $373/week today, and are back at 2003 levels
- Average earnings for women have continued to increase relative to men, but are still at only $305/week today
Clearly therefore, the situation today is quite different from 1985, when oil prices last halved (from around $65/bbl in $2015). Then, more and more BabyBoomers were entering the workforce and more and more women were working – and earning higher wages. This created a SuperCycle of demand for the economy, which saw personal consumption expenditure soar 45% in real terms by 1998, according to Census Bureau data.
But now we are set to see the reverse of this process, as the Bureau of Labor Statistics has noted:
“Slower GDP growth (will) become the “new normal.” In addition to the recession’s impact on potential growth, the economy faces a number of hurdles. As the nation’s demographic shift continues, with the baby-boom generation moving into retirement, the labor force participation rate will continue to decline, moderating growth.”
London house prices are one of the major faultlines in the debt-fuelled Ring of Fire created by central banks stimulus policies:
- It is crazy to have created a situation where potential buyers are asked to pay hundreds of thousands of pounds to buy even very basic apartments in unfashionable area
- It is complete madness that developers are now building 54000 supposedly luxury homes in central London that will sell for at least £1 million ($1.56m)
- As I discussed earlier this year, these developments cannot possibly work, as only 3900 homes were sold in this price bracket in 2014
The Greater London region is also quite out of line with the rest of England, as the chart above shows – presented by Merryn Somerset Webb at this year’s MoneyWeek conference. Everywhere else apart from Brighton (effectively now a London suburb), has seen prices either fall or remain stable in inflation-adjusted terms. Prices in the northern half of the country are down by 20% or more.
And now it seems the bubble is starting to burst. London’s biggest development – on the River Thames at Nine Elms – is reportedly now seeing a wave of “flat-flipping” as investors try to sell unbuilt properties before the crash comes. Nine Elms has 20k units under construction, which have attracted speculative buyers eager to take a financial position rather than buy a property. As one agent told the Financial Times, it had become:
‘Singapore-on-Thames’. Buying off-plan was the ultimate option play for a lot of the buyers [who are] Asian. You only need to put down 10% and then see how the market goes. A lot of buyers are effectively taking a financial position rather than buying a property”
And another commented that:
“The Nine Elms area is particularly prone to speculative buyers: It’s a dog-basket of developers all whacking stuff up, all jam-packed against each other, and walking out of the door and trying to find a pint of milk is really hard. Looking at what’s coming out of the ground, I wouldn’t want to live there and not many people we talk to want to buy down there.
“Investing for capital appreciation rather than yield is gambling. If you can find some other patsy then my advice would be absolutely to sell. As long as the music keeps on playing, everyone is happy, but at some point the music stops.”
This mirrors the famous pre-Crisis comment of Chuck Prince, then CEO of Citi, who dismissed worries in 2007 about sub-prime lending by saying:
“We see a lot of people on the Street who are scared. We are not scared. We are not panicked. We are not rattled. Our team has been through this before. We are “still dancing“”
History, as American author Mark Twain noted, may not exactly repeat but it does rhyme. Anyone who still thinks London property might still be worth buying has been warned.
“Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back.”
That was the comment, last August, from the new deputy chairman of the US Federal Reserve, Stanley Fischer. This year, he won’t have to wait until mid-year to start the explanations, as yesterday’s US GDP report showed it had risen just 0.2% in Q1. In fact, the underlying position is even worse, as the chart above shows:
- It shows the quarterly change in US GDP (blue), versus the change in US inventories (red)
- An inventory drawdown normally boosts GDP in the next quarter, as businesses restock
- Similarly, an inventory build normally reduces GDP in the next quarter, as businesses destock
- Q1 inventories actually rose by 0.7%, which will reduce potential Q2 GDP growth
The actual GDP figure was no surprise, given the Atlanta Fed’s GDPNow forecast a month ago. But this had just given more time for the excuses to be prepared, of “the dog ate my homework” variety:
- The arrival of winter meant it was often very cold during Q1, particularly in Northern parts of the US
- Housing markets continued to turn in a weak performance
- Job growth stalled as the shale bubble ended
- Plus there were new excuses such as the strike in the W Coast ports and the rise in the US$
It is hard to understand why anyone pays any attention to these excuses. It is, after all, more than 6 years since the financial crisis began. If policymaker’s stimulus policies were going to work, they would have worked by now.
The reality is that the US has an aging population, as does most parts of the world. One simple fact explains how yesterday’s demographic dividend has become today’s demographic deficit. As the above chart shows, there are now more people over 65 in the world than aged under 5. In 1950, by comparison, there were 3x as many under-5s.
Key for the US economy is the lack of babies to replace the declining demand of the ageing BabyBoomers. But for some reason best known to themselves, policymakers simply refuse to accept this could impact economic performance. Yet consumption is more than 2/3rds of the US economy.
I wonder, sometimes, if these intellectually brilliant men and women simply lack common sense? It seems rather obvious, after all, that older people will consume less: they already own most of what they need, and their incomes decline as they enter retirement. The issue of retirement is critical, as due to the miracle of longer life expectancy:
- A male American can expect to live for 19.3 years on reaching the age of 65
- A female American can expect to live for 21.6 years after reaching 65
- US Census data shows there were already 43.1m Americans aged 65 and over in 2013
- This means they were 15% of the total population – and the percentage is rising every day
Would we rather have growth, or live for an extra 20 years compared to our grandparents? I often ask this question at conferences, and the voting is always unanimous in favour of living longer, as one would expect.
Hopefully one day, this simple message will get through to policymakers. I fear, however, they prefer to be willfully blind to its implications for the economy.
‘Nothing succeeds like excess’. That seems to be the motto of London property developers at the moment. According to researchers LonRes, developers are currently building or planning the staggering total of 54000 new luxury homes in central London.
These will all be offered at prices of £1m ($1.5m) and higher, according to the Financial Times. Yet just 3900 homes were sold in this price bracket in central London in 2014. So who is going to buy the vast supply of new homes?
It certainly isn’t Londoners. I highlighted the record level of London house prices relative to average earnings last March. Then, first time buyers were paying 7.5x average earnings for an apartment, just topping the previous 2007 peak. And relative to median earnings, London property was also at a record 10x multiple.
Instead of being sold locally, of course, the hope is that these developments can be sold “off-plan” to panic-stricken buyers in Asia, the Middle East, Russia, Latin America and continental Europe. These have all heard that London is now a ‘global city’, and that it offers a safe home for their cash compared to their domestic market:
- A year later, prices have risen even higher as a result
- The first time buyer ratio is now an eye-popping 9x earnings across the whole of London, according to Nationwide
- And average London prices have risen 12% over the same period
- Yet government data shows the number of actual sales has fallen by over a third on a seasonally adjusted basis
One major concern is that nobody now remembers that London prices fell by a third in the 3 years between 1989-92, and by more than 40% in real terms (adjusted for inflation). Most younger and foreign buyers instead believe that “London prices can never fall”.
But the problem, as Minsky would have reminded them, is that someone has to be able to repay the capital cost at some point. And if the capital can’t be repaid, as is clearly the case in London today, the buyers will simply default.
The question is only one of timing. Last year, I thought the bubble seemed capable of continuing to expand. But today, with prices now so much higher, I fear the end is not too far away.
The combination of higher prices, falling sales, and increased supply usually means a market is close to collapse. Plus, there is a real sign of desperation creeping into the estate agents’ literature.
Vauxhall is home to my beloved Surrey County Cricket Club. And I can understand an agent describing it as “up-and-coming” – clearly this could be true of almost any area.
But those responsible for selling the St George’s Wharf development have taken hyperbole to a new level in describing it as “prime central London“. This is the first time I have ever heard somewhere on the wrong side of the River Thames being described this way.
Anyone thinking of paying £2m – £4m for its 2-bedroomed apartments might first want to check its location on a map.
Maybe there are 54000 millionaires, or people who can borrow millions, already rushing to buy these new properties. But more likely, growing awareness of this excess supply will prove the factor that brings the market back to its senses.
The UK no longer leads the world in soccer, as next month’s World Cup will confirm. But it can still hold its own when it comes to creating house price bubbles.
China would be the obvious winner of the World Bubble Championship, with Shanghai prices at an eye-watering 29 times average earnings. But London would have a good chance to reach at least the semi-finals, as the above chart shows (based on data from the UK’s largest lender, and National Statistics):
- It shows prices adjusted for inflation, to enable comparison over the period since 1971 when records began
- Today’s nominal price of £362k ($615k) becomes £29k in £1971
- London house prices have risen four-fold over this period, from £7k ($11.2k) to £29k today (blue line)
- Even more importantly, London prices are now at 10 times median London earnings, an all-time record
- This is also double the long-term average between 1971 – 2000, highlighting current unaffordability
Of course, policymakers deny there is any sign of a bubble. Their predecessors have built up a global reputation for only shutting stable doors after the horse has bolted. Clearly, they wouldn’t want to spoil this record by recognising the obvious signs of a bubble today, before it bursts:
- The first bubble took place between 1971-3, when prices rose 51% in real terms, before falling 31% by 1977
- The next bubble took prices up 37% by 1979, before they then fell 15% by 1982
- The third bubble was a real winner, doubling prices by 1989, before they then almost halved by 1995
- At this point, one in seven home-owners owed more on their mortgage than the house was worth
The next bubble was the one that future historians will research with wonder. By 2007 it had trebled prices in just 12 years. This was exceptional even by comparison with the US subprime bubble. And unlike 1989, prices then only fell a modest 10%, before rebounding to reach today’s new record level.
Yet unlike the early 1970s, when large numbers of BabyBoomers searched desperately for somewhere to live, there are few signs of a real shortage of accommodation. Instead affordability is the key concern for many UK homebuyers, with 1 in 8 borrowers (and 1 in 4 first time buyers). forced to take on mortgages with up to 40 year terms:
“As the Financial Times has reported, “whole sections of London have become completely unaffordable” for even solidly professional middle class families, whilst “34% of resale transactions in prime locations now involve international buyers, who also account for almost three out of four sales of new-build homes in prime central London.”
These international buyers don’t normally even live in their homes, as their aim is simply to move money out of unstable areas such as Russia, the Middle East and Asia. Instead of discouraging such capital flight, the UK’s finance minister has chosen to further inflate the bubble. His Help to Buy scheme allows people to buy with just a 5% deposit.
A sign we are probably near the peak of the bubble has come from 3 former finance ministers, and the OECD. They have broken with tradition and warned that a house price bubble may be underway. Similarly, the Governor of the Bank of England has warned that “the biggest risk to financial stability…centre(s) in the housing market“.
But for the moment, the current policies remain. Their attraction is obvious to a government seeking votes in the short-term:
- Higher house prices create a ‘wealth effect’, and so encourage consumption
- Consumption is 60% of UK GDP, and so economic growth is artificially increased
- Higher prices also disguise the fact that UK real incomes have fallen since 2010 in every income bracket
There seems little now to do, but wait for the inevitable crash. Experienced players, such as the Duke of Westminster’s property company, have stopped building new homes for sale as they believe “the prospect of a correction is becoming more likely”.
Young people who recently bought their first homes will as always be the major losers. Like their predecessors in 1973, they may have to wait decades for prices to fully recover (if they ever do).
The blog’s fear is simple. This bubble has effectively run for 20 years, with just a minor correction after 2010. It has been so vast, and so extended, that the crash may also be on an epic scale.