from Follow the Money

A global savings glut, a global housing market bubble?

June 16, 2005

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Alan Greenspan says there is no national bubble, just pockets of local froth. Or to the housing sector’s in house economists, just a few healthy suds floating on top of a healthy market. Then again, as Justin Lahart notes, there wasn’t a stock market bubble either, just localized froth in the tech sector.

That’s why some argue that the froth is broad enough to be a national issue, even if there are important regional differences. Various local housing markets respond to a variable -- the long-term interest rate -- that is determined in national, not local, markets. Changes in the "technology" of financing houses -- think interest only mortgages for the first ten or even fifteen years -- are a second variable that works at the national, not the local level.

Today’s Wall Street Journal ups the ante, and asks if there is a global housing bubble. After all, as Ben Bernanke famously has argued, US interest rates, at least at the long-end, are no longer set in national but in global markets. A global savings glut -- or a global dearth of investment (other than investment in residential housing) -- is driving down interest rates globally, not just in the US. And housing prices are, consequently, rising globally.

Ok, not quite globally. Manufacturing heavy, rust-belt countries (Germany) and regions (Ohio, Iowa) in already industrialized countries are not doing so well. Sun-belt regions -- California, Florida, Spain -- generally are doing quite well. Kind of what you would expect if China’s savings glut (and export glut) was influencing global markets.

But even if there is not (quite) a global bubble, there sure is a lot of froth in various points around the world.

The money quote comes from the IMF’s Marco Terrones, who found:

40% of house-price movements around the world were driven by global factors that translate across borders, like interest rates and economic growth. "Just as the upswing in house prices has been mostly a global phenomenon," Mr Terrones argued, "it is likely that any downturn would also be highly synchronized, with corresponding implications for global economic activity."

(and there is more in this IMF report)

I am not quite sure how such a synchronized global fall in housing prices and the resulting global downturn would play out - after all, the standard tool for fighting a downturn is lower short-term interest rates, which is not obviously bad for the housing market. Of course, that doesn’t necessarily translate into lower long-term rates, or support for the housing market. The Fed now has built up a bit of ammunition -- so there is room to think about the right policy response to a housing bust.

Update: The Economist covers much of the same territory as the Wall Street Journal, but goes a bit further -- declaring housing to be the biggest bubble in history, far bigger than the global stock market bubble of the late 90s:

According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries’ combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America’s stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.

And this bubble -- for more so than the stock market bubble -- has the the fingerprints of the world’s central bankers all over it. It is more and more clear that the Fed has relied on froth in the housing sector to offset the jobs lost when business investment collapsed, both directly (building homes) and indirectly (borrowing against homes to buy stuff). According to the Economist, consumption and residential construction have accounted for 90% of recent GDP growth, and the housing sector alone accounts for 40% of recent job creation.Three asides:

One. France is -- or at least was -- in the midst of a housing bubble. According to the WSJ, housing prices increased more in France over the past three years than in the US. Domestic demand growth in France has also been relatively strong over the past few years -- France actually was doing its part to support global rebalancing. France is not Germany, where housing prices and domestic demand have been in the doldrums. That makes the French "non" all the more interesting.

Two. The "don’t worry, be happy" crowd in the US argues, more or less, if China wants to subsidize US consumption and the US housing market, the US should thank them for the gift and spend and build away. No need to worry about the plight of the US manufacturing or export-oriented service sectors. The whole point of producing is to consume, and if you can consume by producing IOUs rather than goods, why not. That is a bit over-simplified, but by very much.

The argument then goes that once the subsidy runs out, the dollar will fall and the US export sector will boom. So long as US debt is denominated in dollars, that is a problem for those who have lent to the US and those who now must compete with the US in various product markets, but not for the US. So why worry?

My answer. I am not sure it will be easy to shift from a economy geared toward the production of houses toward an economy that produces goods and services for exports. Labor market flexibility is important, but flexible labor markets alone don’t guarantee a smooth adjustment process. There may be a gap between the United States existing capital stock and skill set, and the capital stock and skill set needed to respond to the opportunities created by a falling dollar. These kinds of structural impediments don’t always show up in a model, but my sense is that they are important.

Real estate brokers don’t become aircraft mechanics overnight, and last I checked, suburban houses were hard to export, and did not generate any external income. The mortgage used to finance the house, on the other hand, is pretty easy to sell into a global market ...

Three. The news page of the Wall Street Journal outdid itself today, with interesting articles on the global housing bubble, proliferation in Asia (Think Japan and South Korea, not just North Korea), strains inside the Republican Party on Iraq and innovative (i.e. risky) mortgages.

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