Thursday, September 02, 2004

Hamish McRae tells Britons not to worry about the end of their housing bubble.
The dangers of the credit boom are not as great as they were in the late 1980s. People are richer than they were in the early 1990s, roughly 50 per cent richer. Their incomes and their wealth have gone up.
Is McRae's optimism well placed? On the whole, well, not really. Let us count the ways.

First McRae touts the independent pound.
For a start we now have an independent monetary policy, whereas in the early 1990s we were part of the European Exchange Rate Mechanism and found our interest rates pulled up by the circumstances of German reunification.
This is just flat-out silly. British interest rates today are 275 basis points higher than eurozone rates!

Second, McRae touts British household wealth.
Equally important, people are richer than they were in the early 1990s, roughly 50 per cent richer. Their incomes have gone up and their wealth has gone up.
He does admit, however, that debt levels have increased remarkably compared to income.
prices are now more than five times earnings. Even on the other two measures the ratio is about 4.5 to 1 - similar to the 1988 peak. It may be that the dip of house prices during the mid-1990s was an aberration, but this still looks uncomfortably high. But maybe in a world of low inflation and low interest rates, high debt will become the norm.
Again, McRae is comforted by low interest rates which will persist and allow Britons to carry a greater debt load than ever before. But as the General has said before, real interest rates in the UK are not terribly low. It is true that they are much lower than in the late 1980s. For example, in November 1989 real British mortage rates were running at 9.1% whereas today they are only half that, around 4.5%. But compared to anytime since 1991 real mortage rates in 2004 are only at the low end of average.

When comparing housing prices to income, there is little reason for consolation. Between 1997 and 2002 the gap between British annual real housing price growth (10.4%) and annual real disposable income growth (3.16%) was the largest of 11 countries studies by the IMF. Considering the housing price bubble was even greater in 2003 and the first half of 2004, one can safely assume an even larger gap more recently.

McRae predicts a plateau, not a crash, for British housing prices. Much depends on how much control the Bank of England has over its own monetary policy. The UK runs a big fat current account deficit every year and may not be permitted by transnational capital to lower interest rates or even keep them under 5.0% in the medium term. Plus, tighter fiscal policy is in the cards for the UK due to its big budget deficit. Combined with slower global growth, this will likely cut into domestic demand and attack housing prices.

I will say this, however; the British are much better placed for a plateau than are American homeowners in the most bubblicious states such as California and Flordia. The Australian housing boom ended first, and then Britain's. The end of the US bubble seems now to be upon us, too. Plateau or pop? Keep your eyes peeled.


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