Saturday, September 22, 2012

Reckless Behaviour From Statistics Norway

In its latest prognosis for 2012-2015, Statistics Norway (Statistisk sentralbyrå, SSB) forecasts around 7-8 % yearly house price appreciation. I'm sure they have worked on the forecast more than I have on mine, but in my opinion there is a huge weakness in it: it is based on a "Goldilocks" scenario that has shown to be very vulnerable and is more likely than not to change abruptly sooner than later. The big picture is as follows: Fed and other central banks, engaged in fighting a deflationary outcome, have managed to (as a side product) keep the oil price high and force Norges Bank to import low interest rates. This is the only reason we are still looking at rising house prices in Norway. It has nothing to do with Norway doing something right and having built a strong economy that can withstand shocks. In a sense it's a pure coincidence, as Fed and other central banks don't care about the effects on Norway (believe me, there are very big effects) when they make their decisions.

But we don't need to go further into why SSB is probably wrong in its prognosis. Let's assume it could be right in its prognosis. Why would I still place my boot on the butt of Torbjørn Eika, the man I understand is responsible for this prognosis, and kick him out? This is because I think that SSB has enough authority, and does so affect people's take on the housing price development in the years to come: in other words, SSB can play a role in inflating a housing bubble. The current narrative in Norway, very much strengthened by SSB, is that the housing prices will keep on rising steeply in the three years to come (around 30%) and will then gradually flatten out. I warn you: the housing prices never flatten out at all-time-high levels. There is no "permanently high plateau" (as we know, Irving Fisher was wrong) when we talk about real house prices.

SSB should conclude that they can't possibly know what happens with the housing prices in the coming three years. If we assume they still need to come up with a forecast, as it is their not-so-enviable job even in this environment of, to use Fed governor Ben Bernanke's words, "unusually uncertain outlook", why not give a bit gloomier forecast? I suggest this because I think that anyone in their right mind should not think that rising house prices are anymore good for the Norwegian economy, and that everyone (now that Norges Bank's hands seem tied) who has the possibility to cool down the market should be working hard for it.

To me it seems likely that this is a disaster in waiting, and if it is, history will judge that SSB was one of the few players who had a chance to help adjust down the too rosy expectations of home-buying households, but actually ended up choosing to do the opposite.


Edit Sep 23:

Here's how the absolute nightmare looks like from the viewpoint of Norway's biggest bank (underlining by me):

DNB Markets analyst Kjersti Haugland said the bank's worst-case scenario calls for a 10% drop in Norwegian house prices in the next four years, following a euro-zone break-up that would with include five countries leaving the euro, including Italy.
 So the worst that could happen during the next four years is that two years' worth of house price appreciation would be lost? And this in a scenario that many economists believe would mean a deep, world-wide recession? This is the too rosy picture I'm talking about.

Heads: you lose. Tails: you lose.

Referring to my previous posts, I'd say there are two things we can take as a fact:

  1. Norges Bank imports low interest rates from rest of the world (as I mentioned here), where the current growth dynamics are a lot less favourable than in Norway.
  2. These low interest rates have "greased" the wheels of the Norwegian economy, leading to house prices increasing faster than income and, partly through the wealth effect from rising house prices, to increased consumption (cars, trips abroad, luxury items).
Now, if we look at the level of interest rates and think of three possible future scenarios for Norway: a) Norges Bank keeps on importing low rates for some years to come (as it is a fair assumption that rates will be kept low by Fed and ECB). By this Norges Bank would continue greasing the wheels of the Norwegian economy and risk a massive bubble (if we don't have it already). The probable outcome of this would be more negative than positive. And if you consider the reason for low rates elsewhere, which is very low growth and even depression-like environment in many parts of the developed world, you understand that Norway will not be insulated from a downturn forever.

So I'd say this is not the right time to be inflating a bubble. By inflating a debt bubble Norway is getting into a trap: either the interest rates remain low, which means the world economy is in serious trouble, and that will start affecting the Norwegian economy sooner or later, or, b) the world economy improves, interest rates start to rise and the rising share of interest payments of total income will be a big drag on Norwegian economy for years to come. It is of course not much different from the debt trap the whole developed world finds itself in now, and to me it just seems that Norway doesn't realise that it is in the same debt trap already, caused by too low interest rates for too long, pushing us to borrow more and more growth from the future. For too long it has been a lot easier to spend money you don't have than spend money you have.

There is of course a third scenario, and this is the only scenario where Norges Bank would really act and use the power it has, instead of feeling powerless and hoping for the world economy to pick up. I would even suggest that this is the road that Norges Bank should take to avoid a big crash in the likely circumstances that the world economy is going to slow down even more in the years to come. What I'm talking about is, c) Norges Bank increasing the policy rate (let's say by 0,25 %-points quarterly, for the next 3-4 quarters), letting the Krone appreciate in the short-term and cool down the clearly overheated economy. I'm not sure if this would be enough, but I think we are quite close to some "tipping point" in the housing market anyway, so sending the message that the "housing party" is not getting better anymore could be powerful.

I know the last option is in practise hard to accomplish and thus unlikely, because no one wants to be the one who takes the "punch bowl" away and by this risks an economic downturn, even if it would be inevitable soon anyway. I just want to remind that the former Fed governor, Alan Greenspan, did not take the punch bowl away early enough either and we all know what were the consequences of that inaction. It is time to face the facts and start limiting the near-inevitable hit the Norwegian economy is going to take due to the current excesses. I would guess this is something that keeps the prime minister, Jens Stoltenberg, awake at night.

Tuesday, September 18, 2012

Stress-Test The Economy, Not Just Individual Households?

When individuals apply for a mortgage, the bank "stress-tests" their ability to service the loan in a possible future environment of higher interest rates. In Norwegian terms this would mean that, instead of current 3,5-4,0 % rates, what if the mortgage rate doubles up to 7-8 % - can the household still make the monthly payments? I have never been present at a meeting like this, but I would assume (and some logic supports this) that many of the responses follow a similar pattern: "I don't see a problem with higher interest payments, we just X a bit less then...", where X can be replaced by "travel", "eat out" or plainly "consume".

The logic I referred to above is this: paying down the mortgage is one of the few, and in many cases the only relevant way of saving for many households. So instead of saving less (includes tapping your savings account), the households need to curb their spending if a bigger share of their income goes into paying interest on a mortgage. For a household this drag on spending caused by 7 % mortgage rate would amount to 50000+ NOK per year with a typical mortgage of 2-3 million NOK.

So, yes, most of the individuals would be able to tackle a doubling of the interest rate. Stress test performed, loan granted, everyone should be happy? Perhaps not if you look at the "macro" level. Someone more provocative would even say that if you look at this from the viewpoint of the Norwegian economy as a whole, the worry is that these households would be doing just what the banks expect them to do: working hard and spending less to be able to service their loans. I don't have the time and energy to do the math now, lazy as I am (and as a non-economist, I'm more interested in "folksy" story-telling), but my hunch is that this kind of drag would amount to some percentages of the Norwegian GDP. (If you have done the math, feel free to share it in the comments section.) Mildly put, at least many of the restaurants in Oslo would notice this.

In the end, the economy is a sum of our actions, and fairly small changes percentage-wise may lead to big consequences. If households with mortgages curb their spending by 10-30 %, everyone will notice it. This is why I call for stress tests for the Norwegian economy - not just individual households - when the nation continues to build this debt colossus. Debt-to-income ratio of 200 % was passed some years ago and for 11 % of households the ratio is already above 500 %.

The smart homeowner-debtors will now state that the interest rates will not rise but remain extremely low for years to come. I'm not sure how they know it, but they might even be right. I will come to that in my next post.

Sunday, September 16, 2012

Norges Bank Between a Rock And a Hard Place

As I mentioned in my previous post, there is one thing that really bothers me, and it is the record low interest rates dictated by Norges Bank and available to home buyers as well as to folk who fancy a new car, as well as for companies seeking to finance investments. Typically you would expect to see record low interest rates in a weak economic environment when the central bank wants to increase weak aggregate demand and encourage investment. But in Norway the economic environment is currently very strong, by many measures even overheated. Why would Norges Bank want to throw petrol in these flames by lowering the interest rates and keeping them at record lows?

One counter-argument could be that the inflation (CPI) is very low, around 1 %, and so the economy is not overheated and low interest rates are needed to keep the inflation close to the target of around 2 %. How come is the inflation so low? It is certainly not low because there is not sufficient aggregate demand in the Norwegian economy? No. It is low because the prices of imported goods are getting lower when measured in NOK. This is due to low aggregate demand in the U.S. and Europe, which pushes the Fed and the ECB to keep the interest rates at record lows, around 0 %, and in this way make the NOK appreciate vs USD and EUR. To fight this currency appreciation, which makes the Norwegian export industry lose competitiveness by raising its costs compared to foreign competitors, Norges Bank seems to be forced to import the low interest rates from elsewhere in the developed world.

So the hands of Norges Bank are tied when it comes to the interest rate and it has actually quite clearly admitted this by insisting that the rates are low because of the strong NOK, that it does this to protect the export industry, and that it is not the duty of Norges Bank to keep the house prices in check - but that someone else has to take care of that. With the mouth of its governor, Øystein Olsen, it has told that it is worried about the rising level of household debt and house prices. But not able to act to curb that rise because with acting it would invite a stronger NOK and lower the inflation even more.

This is the dilemma Norges Bank faces. I suspect that Øystein Olsen does not feel comfortable about this. With these imported record low interest rates there is a huge risk of forming an economic bubble in a country where the households seem to have an overly rosy picture of the coming years.

Saturday, September 15, 2012

Is Norway Different?

Norway truly is in a different economic situation than most of the other developed countries. It is in no risk of defaulting on its debt, nor does it have any big, under-financed future liabilities in the form of pensions or healthcare liabilities. Its prosperity seems to be secured for decades to come. This is of course solely thanks to the oil under the seabed within Norwegian waters.

But does the (most likely) secured future make economic cycles, and so economic downturns, less likely or less severe? I don't find any reason to believe so. If we look at the reasons behind economic expansions, and at their extreme, economic bubbles, there is nothing suggesting that the laws of economic cycles would not apply to economies that have high starting level of wealth. Surely, the bottom of the cycle is relatively high, but so would be the top of the cycle. When looking at the current state of affairs in Norway, one could even argue that the conditions could hardly be better for irrational exuberance forming and leading to an economic bubble:

  • high level of confidence in a bright future, flirting with complacency
  • record low interest rates
  • overall easy access to credit, with Norway seen as one of the few safe havens
  • fairly long history of rapid house price appreciation with its wealth effect, sustained even in the current weak global environment ("It seems nothing can go wrong for us!")

These are all points that I will have a more closer look at in the coming posts, but at the moment I just note that one of the points is somewhat an outlier and worries me enormously: namely the record low interest rates.

I will conclude that Norway is different but that fact does not make it immune to the follies of human nature in the form of over-confidence, complacency or living beyond one's means - which applies to both poor and rich.

Friday, September 14, 2012

Who Am I To Tell It's a Bubble?

First, allow me to set the record straight and lay the groundwork for this blog:

  1. Financial bubbles are notoriously difficult to detect before they actually burst.
  2. I do suffer somewhat from a "pessimism bias" when it comes to the current world economy. This is mainly due to the high levels of public and private indebtedness, especially in the developed world.
  3. I currently live in Oslo and have lived here for three years. I do not have a Norwegian passport.
I admit that suggesting there is an economic bubble in Norway is provocative and sounds like a marketing plot to gain more attention than I might gain with a title like "Norwegian Economy". And in a sense it is just that. But it is also a wake-up call, an attempt to state it clearly: "Be careful, because the future might not be as rosy as you think!".

I actually first thought of naming this blog "The Norwegian Gamble". This because I think in the end the whole thing comes to the price of oil which is not decided by Norwegians. If oil price goes down enough, new oil extraction and exploration projects will be postponed / cancelled, the windfall profits of oil industry will disappear and Norwegians will find out that they had been living in a (housing and living standard) bubble which is now deflating.

At this point I don't want to go further into detail regarding why the oil price might fall significantly. I think it is safe to just assume that it might happen, since we have seen it happen in 2008, and already in 2012 we have seen a huge rise in oil price volatility, with the price falling sharply just to rise as sharply again. I see that there are at least three relevant forces affecting it: a weaker global demand (pulling the price down), a stronger supply through new extraction methods and new fields (pulling the price down) and geopolitical tensions (Iran-Israel-USA) (pushing the price up).

Even if we didn't currently have an economic bubble in Norway it is fairly safe to say that Norway will have enormous difficulties with avoiding a bubble developing in the future. This is because it actually doesn't matter that much if the current optimism is based on solid arguments and forecasts - too much of a good thing is just too much. Human kind has shown time after time that it is nearly impossible to avoid these bubbles.

There is a huge amount of exuberance in the Norwegian economy at the moment, and to me it seems that it's of the irrational type of exuberance. It is very hard to avoid the signs of over-heating and bubble-inflating, be it in housing, cars or overall consumption. It is these signs I plan to discuss here in the coming weeks and months.

I wish this blog would be of value mainly to two different types of readers: a) Norwegians who appreciate a non-Norwegian's view on their economy, and b) non-Norwegians who have a stake in the Norwegian economy through investments. I have not run into that many publications on the Norwegian economy in English, so I hope this blog would be a small addition to this - in my opinion - needed discourse.

The Neverending Party? (graph from Statistics Norway)