Sunday, November 3, 2013

An Answer To Christian Vammervold Dreyer

Christian V. Dreyer, the leader of an association for Norwegian real estate brokers (EFF), writes in his latest blog post about the falling house prices. He himself has worked as a real estate broker/agent in the past. Now, is there any sense in arguing with a real estate broker about a housing bubble? After all, Dreyer and EFF are not hiding their agenda, which is to work for the benefit of real estate brokers. Real estate brokers usually lose jobs if house prices drop in any significant way. House prices can drop in a significant way if the majority of people expect them to do so. Dreyer and EFF thus have all the reason to tell people that house prices will not drop in any significant way and so it's safe to buy.

I write this post for two reasons. One is that Christian Dreyer is presented as an expert even by the financial media in Norway, and so gets his message through to people. The other reason is that many other experts, or "experts", are using arguments similar to Dreyer. It's like the whole country is full of real estate brokers? Perhaps that's what you get when over 80 % own the house they live in and are lured by the "wealth effect" of ever rising prices.

An Answer To Christian V. Dreyer

In his post Dreyer first goes through some reasons for the current price decline:

  1. Strong and sustained house price increases which have lead to high household indebtness.
  2. Higher bank capital requirements set by the authorities.
  3. Increased inventory of dwellings for sale, due to slower demand and a glut of finished new home projects where speculators/"flippers" (!) want to sell and people moving in sell their old homes.
  4. First-time buyers having difficulties with entering the market (due to high prices and increased equity requirement, I assume).

I mostly agree with these, so I won't go through them in more detail. It's nice that we can agree on something. But then comes the conclusion. Dreyer argues that the above-mentioned factors have led to the media taking a negative view on the housing market, and this media coverage and the effect it has on sentiment are the real culprit behind the price decline. Sure, psychology is an important driver of the market, like I have mentioned on many occasions. But I don't understand why Dreyer goes through all these more fundamental reasons for the decline only to say that in the end it comes to sentiment (psychology), while at the same time he admits that this change in sentiment is a result of the more fundamental factors he just presented?

Or perhaps I understand. After having put all the blame on sentiment, he goes on to argue that the strong fundamentals of Norwegian economy will in the end win over the negative sentiment. There has never been more people at work in Norway, never have we had more purchasing power. Low interest rates, low investment in new housing and low unemployment, he argues, will make sure that the prices will soon rise again.

So, no matter how high the prices have got, they are safe from a significant decline because of strong economic fundamentals? The problem is that bubbles are never formed when the economic fundamentals are weak. Currently strong fundamentals can never be an argument against a bubble that can burst in the near future. Quite the opposite, you get a bubble when the absolute majority of people think like Dreyer thinks - that this can't be a bubble. And that happens when the fundamentals are at their strongest and the future at its rosiest, just when the Dreyers of this country think that nothing can go wrong.

What Dreyer also forgets here is that sentiment affects fundamentals, just as well as fundamentals affect sentiment. A positive feedback loop between sentiment and fundamentals has taken us to where we are in Norway today. But you can't have the cake and eat it too. So when the sentiment turns more and more negative as it has done now (and this is not just true about house prices but also about the economy), it will start to affect the fundamentals as well. Anyone with a basic understanding of bubbles should know this.

My conclusion is that Dreyer has no valid arguments when it comes to the question of if this is a bubble that has started to burst or not. At best, he manages to present many facts that actually speak for a bubble.

This Is Not a Peter Schiff Fan Blog

I want to bring this subject out of the shadows of the comments section on my previous post and open up my thinking on money and credit.

This is not a Peter Schiff fan blog. But this will neither be a fan blog for "serious, academic economists", who in my opinion have been dangerously out of touch when it comes to the implications of the massive credit expansion of the last 30 years, credit which has been used increasingly for purposes of pure consumption or, at best, low/negative return investments. My limited understanding is that we have been bringing forward a lot of future growth through this credit expansion. Excess "borrowing from the future" is made possible by the fact that no one knows how much growth lies in the future. What we can be sure of is that a) it's less of it there now that we have brought it forward, and b) it only takes some greed and optimism - basic human characteristics - to borrow too much of it. This is my "big picture", which makes me quite pessimistic about future growth (if we first don't see creative destruction √† la Joseph Schumpeter), and it makes me see more "bubbles" around the world than the average person.

I recently read a speech by Adair Turner ("Credit, Money and Leverage: What Wicksell, Hayek and Fisher knew and modern macroeconomics forgot") and it was an important confirmation to me that I've been onto something in my thinking the last couple of years - and it made my thoughts more structured. (I found it thanks to Buttonwood/Philip Coggan of The Economist who linked to this speech in his blog post.)

If there is one writer I seem to agree with surprisingly often, it is above-mentioned Philip Coggan. His book, Paper Promises, reflects quite well my thoughts on the subject. I can highly recommend it.

I also appreciate hedge fund legend Ray Dalio and his thinking on the subject of money and credit. You can find his original text "How the Economic Machine Works: A Template for Understanding What is Happening Now" here, and a simplified Youtube version here.

These are just random examples of people who have influenced me greatly through their writing, and I should definitely mention Bill Gross (of PIMCO), Howard Marks (of Oaktree Capital) and Nassim Nicholas Taleb as well.

So, overall I think we have too much debt in the world. The moral hazard related to no one possibly knowing how much growth lies in the future and so no one being able to set a limit to how much of it we can bring forward through credit-driven consumption and commitments related to pensions and health care has enabled us to live way beyond our means. (I'm not exactly repeating anyone I know, so I don't know if I've got it all wrong)

I just think that there has been a deficit in "sound money" thinking in the world during the last thirteen, if not thirty, years. There will no doubt come a time when we will have a deficit in "loose money" thinking. But because of the experimental, exceptionally massive fiscal and monetary stimulus we saw in 2008-2009 (and one might argue we've seen since 2000), we never really saw that deficit in loose money thinking take place (at least not for more than a couple of months). We have opted for fighting problems related to excessively loose money with even looser money. People wiser than me argue that it's the right thing to do, while other people wiser than me say it's wrong. I'm just very suspicious of this strategy because it is 100 % compatible with avoiding short-term pain, which is something that is very much hardcoded in our brain but often leads to inferior long-term gain.

Does this make me an "Austrian"? You decide. But I don't want to hold on to any school of thought, at least not indefinitely. To me the answer, like usually, lies somewhere in between.