Here the theory, there are lots of theories of long waves in house prices (Homer Hoyts is my favorite) but Fred Harrisons is most well known.
There is an 18 year business cycle observed empirically and a 14 year house price cycle within that. This can be observed from epirical data going back centuries.
But why?
I’ve tried to explain the 14-year periodicity of the housing market in terms of the 5% interest rate, rate of return on mortgages, historically, the average in the long run, which gives us a payback period of 14 years. And when people stop taking out mortgages, when prices have been driven up as high as they can go, according to levels of income at the time, the whole house of cards collapses. I posed this 5% theory in a book in 2005.
Fred hypothesises theri are typically tax cuts at the end of a cycle which get capitalised into house prices, which peak and then crash.
What is unusual about the last four years is Covid, Brexit and Ukraine have knocked points off GDP, government borrowing has filled the gap – capaitalised into house price rises, with the downturn coming earlier because of an interest rates rise to fund the extra debt, protect the pound and control infation – caused in part and at precisely the wrong time in the house price cycle – by tax cuts.
Markets panicked. The prescription was that a weakened post-brexit UK was too weak to afford the borrowing, even as a sovereign currency issuer, as it had a long term balence of payments deficit. Living beyond its means for years. prompting a sought of mini emerging economy currency crisis. A small scale version of the economic collapse in Sri Lanka. Noahopinion sets out the theory well.
callling this a “crisis” might be a bit overblown compared to what, say, Sri Lanka is experiencing, but unless things improve quickly, British people are in for tougher times ahead. The crash came on suddenly, but it had its roots in long-standing, chronic economic weaknesses. And the country’s leaders seem paralyzed, flummoxed, and utterly unprepared. So I guess using the word “crisis” here is acceptable.
So what is happening to the British economy, and why? The easiest way to understand this, I think, is to analyze this episode as a milder, gentler version of the kind of crisis that tends to plague emerging markets.
Timothy Ash of Blubay Asset Management explains as follows:
Welcome to today’s Britain, a mature G7 country, where it all sounds very emerging market.
The United Kingdom’s economy has deep structural problems, and a fundamental lack of competitiveness as reflected in a current account deficit of over 8 percent of GDP. Years of underinvestment in public services, education, housing and transport have left a poorly skilled and regionally immobile labor force struggling to fill the gaps left by the departure of foreign workers, which was caused by the ruling party’s nationalist agenda.
Similarly, years of underinvestment in the energy infrastructure has left the economy dependent on energy imports and, with little storage capacity, dependent on the vagaries of global spot prices. Inflation is rising, living standards are falling and workers are striking for higher wages. A wage-price spiral looms….
Predictably, the market has been unconvinced by the new government’s dash-for-growth economic policy. Borrowing costs for the government have risen, making its macro forecasts now appear unsustainable. Everything is unraveling, and talk of crisis is in the air.
With the bond vigilantes out in force – the Bank of England may be forced to riase interest rates. This panics mortgage lenders who have ceased lending.
[it is the] leading indicator for growth, the global credit impulse, flashes a warning to major economies. IIt tracks the flow of new credit issued by the private sector as a percentage of GDP [or can be mesured as GDP +delta debt]…
The notion of Credit Impulse was introduced for the first time by Michael Biggs in November 2008. The Credit Impulse represents the flow of new credit issued from the private sector as a percentage of GDP. It is the second derivative of credit growth and arguably the largest driver behind economic growth.
The thinking behind Credit Impulse is based on basic Keynesian economics. Since spending is a flow, it should be compared with net new lending, also a flow, rather than credit outstanding, a stock.
The main advantage of Credit Impulse is that it helps to solve a number of conundrums that cannot be explained by an analysis focusing on the stock of credit. In addition, it has been demonstrated that, for many time periods and countries, a strong correlation exists between Credit Impulse and other economic data, especially private sector demand, and financial assets.
For a morre thorough grounding on the concept in macro see the many books of my Friend Professor Steve Keen, about the only guy who predicted the 2007 crash.
The Credit Impulse helps explain the ‘merging markets’ aspect of the British crisis. Normally higher interest rates strengthen currencies, in emerging markets they can weaken them because of risk of debt default. Therefore you cant just look art the overall credit impulse, you have to split it into public and private components, and look at real debt repayment costs in the currency of the debt issuer. in the short run it is the flow of debt not stock that swings markets and prices of credit. Indeed my own theory of interest rates the LP-RL model can fully explain this – This I think is the only key weakness in Modern Monetary Theory, sovereign currency issuers can default because of the weakness of their currency. Indeed any more MMT really only applies to the dollar, possibly no longer even the euro, certainly not the pound.
So at a time the impulse is pointing down, with exquisite timing makes it crash down. Within 6 months expect a house price crash as the impulse is a leading indicator.
Kwateng may go down as making the worst economic mistake at precisely the wrong time in history – except perhaps John Law, who Kwateng did his PhD on.
Decisions, Decisions, Decisions 