Sunday, December 8, 2013

The Death of Economic Cycles

I guess I could say I was born under a lucky star. In the year of my birth, 1979, Businessweek published as their cover story a now famous article "The Death of Equities". What followed was a revival of equities, culminating in the dotcom bubble of 2000. If you bought in 1979 and sold in early 2000, you made a fortune. The big picture is that the standard of living  in the Nordics has mostly been improving during my lifetime (there was a fairly deep recession and house price declines in the late 80s/early 90s, though). It seems that with higher standard of living comes higher house prices, and household debt. One could ask if we have had it too good.

But let's move to the subject. Mark Thornton, an economist, who wrote about the Norwegian housing bubble already in January this year (on my birthday, of all days!), has written a short update on the situation in Norway. In it he links to my blog reports as evidence that Norwegians have entered the "denial phase". I think he's right in that there seems to be a widespread denial of the possible - even likely - negative consequences of the house price decline that has just started.

 It seems that nearly every driver of economic growth is expected to flatten out. An extreme example of this is this Dagens N√¶ringsliv interview with Rune Bjerke of DNB where the leader of biggest bank confirms that

  • investments in new houses [due to declining house prices, I assume],
  • investments in the oil sector,
  • private consumption, and
  • investments by companies in general,
...in other words all the main drivers of economic growth, will more or less flatten out ("flate ut"). "Flate ut" has become a real catch-phrase in Norway during the autumn! It reminds me of "boligfest", housing party, which was all over media just a year ago, but is now gone. It referred to the rising house prices and the related "wealth effect".

What Norway has gone through during the last 20 years could be described as some kind of "Golden Age". And especially the last 3 to 4 years - after the massive worldwide fiscal & monetary stimulus managed to turn the looming, deep downturn into a prolonged boom in Norway - have been seen even as unhealthy (for example, in the article Bjerke talks about healthier, more sustainable housing market and oil & gas sector, referring to the high growth rates of past).

All this takes me again back to Irving Fisher and the "permanently high plateau" of stock prices in 1929. After admittedly unsustainable, even unhealthy growth in house prices and oil & gas sector, what we should expect according to Bjerke and Statistics Norway (see my previous post) is a couple of years of simultaneous flat development in any imaginable indicator in the Norwegian economy, followed by... new growth. And the reason for nothing really going wrong in the coming years? I know I will be underestimating their intelligence, but it sounds to me like the reason is that things are so well in Norway today. Salaries will keep on rising at 3-4 % p.a. and continued work-based immigration will keep demand for housing high. All this despite lack of growth and investments, declining oil price and increasing unemployment. 

Like I mentioned, Statistics Norway even assumes that the oil price will decline over 20 % during the next two years. According to Bjerke and SSB, as well as many other experts in Norway, things just flatten out at all-time-high levels after a long period of substantial growth. There are exceptions, like Nordea Bank (who expect 15-20 % house price decline), but even in their forecast the word recession is nowhere to be found.

In my amateur opinion, based on the decline in nearly all indicators, the base scenario for Norwegian economy in 2014 should be a recession. Unless, of course, one assumes that the economic cycles are dead.


I must finish with a side note. The Norwegian people, experts and media are looking for reasons behind the house price decline, and as I have already mentioned, pessimism is very high on the list of suspects. It's the negative media and all these "doomsday prophets" (forecasting a 15-20 % house price decline makes you one) that are causing the negative spiral. Am I seen as an enemy of the public? Who knows.

The truth is that you need "pessimists" (people suspecting a bubble), and many of them, to avoid a bubble. And you need them to feel free to air their opinion in the media, early on when the prices have taken off, without being branded as doomsday prophets or pessimists. And some people actually need to heed this advice. This has not been the case in Norway, and as a result the public opinion has been the most complacent I've ever witnessed. This complacency, lack of concern, is one of the reasons for what is most likely a housing bubble. Two years ago the previous prime minister, Jens Stoltenberg, tried to warn against a bubble. He tried to affect the sentiment that was too positive. But it seems no one paid attention. Now the widespread concern for "too pessimistic" media coverage just speaks for the underlying concern for a housing bubble. A change in sentiment doesn't take a healthy market down, but it will always help to bring down a bubble.




9 comments:

  1. "Two years ago the previous prime minister, Jens Stoltenberg, tried to warn against a bubble. He tried to affect the sentiment that was too positive. But it seems no one paid attention. Now the widespread concern for "too pessimistic" media coverage just speaks for the underlying concern for a housing bubble."

    But it is not people's behaviour during a bubble which is the problem. People were just mislead by the very low interest rates and took more credit than they should take because Norges Bank set interest rates artificially low and sent out wrong signals. Stoltenberg should have looked that the Norwegian central bank changes its monetary policy. Higher interest rates would have been much healthier for the Norwegian economy. The average monetary inflation has been 7,5% in the last years here in Norway and it has been up to 20% during the crisis in 2008.

    To sum it up, this statement is a typical smoke grenade of a politician. Something which is in a way true but which contains only a part of the whole truth.

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  2. Eric, you're absolutely right. Asset price inflation is not seen as a big enough threat by monetary authorities. Norges Bank has warned against the bubble for long, saying basically that it's not within their mandate, but that someone else needs to do something.

    That someone tried to do something. The Financial Authority (Finanstilsynet) pushed banks to require 15 % equity from borrowers. They also push banks to build up capital. This will affect the price of credit, and that's not what the people or the politicians like. So now they want to backtrack on the 15 % equity demand and politicians are blaming banks for too high margins on house loans...

    If you look at it from a political angle, what would you think would have happened if Norges Bank instead had raised interest rates mostly on the ground of concern for a housing bubble? And this while other factors (Krone) spoke rather for lower interest rates.

    I can only guess that there would have been very few people in Norway who would have taken it positively, or lightly. Think about the outrage of bank economists (can think of Jan Ludvig Andreassen, for starters...) and people on the street (majority of them have mortgages and finance their lifestyle through reverse mortgages). "There is no housing bubble in Norway!" "Why would Norges Bank do this, only due to concerns for some asset inflation and growing household debt?!" "Party poopers!".

    In practice it has been impossible, once again, to avoid this bubble. No one is in a position to take the tough decisions required to avoid a bubble. One of the flaws in democracy?

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    Replies
    1. I think that the strengthening of mortgage conditions you describe could be the reason why this bubble starts to implode now. Do you know when they exactly strengthened the conditions to get a credit? It is maybe no coincidence that prices start to go down after the election...

      "If you look at it from a political angle, what would you think would have happened if Norges Bank instead had raised interest rates mostly on the ground of concern for a housing bubble?"

      I don't know if this would have solved the problem. This maybe contradicts a little bit what I wrote yesterday.
      The Norges Bank might not have such a strong influence on Norwegian mortgage interest rates since Norway is a really small currency zone. Mortgage interest rates could be stronger driven by very low key policy rates in other currency zones like the EU or the USA.
      But it doesn't matter if the monetary instruments of Norges Bank are effective or not. The main problem with central banking is that a central bank cannot know what the "right" interest rate is for which people want to consume and save. And a central bank has always the tendency to set interest rates too low to stimulate employment. Additionally, banks and governments also profit very strongly from this cheap money whereas the average man on the street impoverishes.

      "In practice it has been impossible, once again, to avoid this bubble. No one is in a position to take the tough decisions required to avoid a bubble. One of the flaws in democracy?"

      Maybe you're right. The system gives very bad incentives to politicians or other bureaucrats. They look that they can stay in office and hope that the one who comes after them will be made responsible for what happened. Another problem is that the general public is bad informed and can easily be manipulated and fooled.

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    2. Eric, yes, the tightened credit conditions have surely had an effect on the timing of the downturn, just like they were supposed to have. The 15 % equity requirement came into place in early 2012.

      Financial authorities, including Norges Bank, have long seen that there is a big risk for a housing bubble. They saw a need to stop the house prices from increasing and limit credit growth, and it now seems that they were successful. My only criticism has been that this probably happened way too late, only when the risk of a bubble was already too obvious, and the prices too high. But that's how it is. You're able to take tough decisions only when you see that the option is even worse: an even bigger bubble, that will burst anyway.

      This is not based on my own speculation as much as it is based on the comments and actions of Norges Bank and Finanstilsynet.

      People still complain about the 15 % equity requirement, talk about inequality etc, but most of them fail to see that whatever was the purpose of the tightening, IF this is a bubble that is now bursting like it looks like it is, the consequences of the tightening will be that it has saved a lot of young people from buying on the top. These young people are still called "losers" in Norway, because they couldn't buy, but the real losers will most likely end up being the ones that bought during 2012-2013.

      It doesn't give you less inequality if you help people with little savings to make the worst financial decision/"investment" of their lives.

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  3. You indeed put forward some good points in this article. I've disussed this before in a blogpost titled (translated to English) "About soft landings and a flattening out of prices": http://theboombust.blogspot.no/2013/08/om-myke-landinger-og-utflatinger-i.html

    Economists never expect prices to decline. They always say asset prices (in particular when it comes to housing) will flatten out or see a soft landing scenario. Yet, time after time, they are proven wrong. It's just a shame that they continue to be given so much attention in media.

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    1. Thanks, Boom Bust, and likewise, I enjoyed reading your blog!

      You're one of the few sane voices out there. But this is a very subjective judgement, because I agree with you 100 % ;-) Perhaps there is something we miss? One thing is of course that when you first see the bubble, you can't forget it anymore, and you look at things from a totally different angle than the ones who don't see the bubble as clearly. I just commented above on one clear case of this "bubble perspective", where the losers become winners and winners become losers when you see the bubble.

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    2. You could very well be right in that there is perhaps something we miss. I've pondered about this from time to time, when I struggle to remain sane in between all the insanity that surrounds me.

      Your points about "inequality" and "losers"/"winners" are in my view entirely correct. That no one else points this out is just absurd.

      I look forward to continue reading your blog. I hope you don't mind if I refer to it on The Boom Bust if and when I see fit.

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    3. Would be my pleasure if you referred to my writings, BB! I guess that's how blog world works, you build on someone else's thoughts.

      Talking about the inner doubt and feeling insane, there was something on it in Michael Lewis's The Big Short. Subprime had clearly started to melt, non-performing loans were shooting up, but the price of CDSs wasn't yet following. The guys holding the CDSs, about to get rich if subprime collapsed, were having emotional problems similar to yours :)

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  4. "Financial authorities, including Norges Bank, have long seen that there is a big risk for a housing bubble. They saw a need to stop the house prices from increasing and limit credit growth, and it now seems that they were successful."

    It's funny that the Norges Bank complains about a housing bubble. They are the ones who caused this situation in the first place.
    I also checked the credit growth in Norway. If you look on the official numbers, M2 rose very strongly with 23,3% in august and also in all months before. In september (the month of the election), M2 went suddenly down with 19,2%. September was the first month when housing prices started to decline, right?

    "It doesn't give you less inequality if you help people with little savings to make the worst financial decision/"investment" of their lives."

    I know, this egalitarian philosophy is very strong in Norway. I was quite surprised when a Norwegian told me that politicians discuss how to get even more people into the housing market who can't afford a house (it was maybe two months ago).
    Huple's cat, if you are interested in the Austrian Business Cycle Theory, take a look into this video. It's a debate between two scholars. One of them, Walter Block, is one of the leading Austrian economists today. The other one sympathizes with the Austrian theory, but also brings up very good criticism.
    http://www.youtube.com/watch?v=sJT6WAw0NzY

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