THE AVERAGE British family earned £2,000 in the first week of this month, according to the front pages of several newspapers, simply by sitting in their house. This figure was admittedly based on one volatile and not altogether reliable house-price survey. But given that £2,000 is more than four times average weekly earnings and that several of other indicators have recently been suggesting a surprisingly frisky property market in the past few months, the story of instant enrichment for homeowners raised some perennial questions about the state of modern Britain.
First, are house prices on an up-trend? Secondly, how can house prices keep rising, even in an economy with faltering growth? Thirdly, what does it mean for society if people can earn more money by sitting in their houses and watching the price rise, than by going out to work? The first two of these questions were answered, albeit tangentially, by the Governor of the Bank of England on the very day the property windfall story appeared in the press. Mervyn King pointed out that the prices of houses and other assets were being boosted above “normal” levels by “unusually” low interest rates — but asset prices could be sharply corrected if interest rates were to rise above the rock-bottom levels now seen not only in Britain, but around the world.
My first two questions are thus essentially answered: house prices are so high because interest rates are so low and property will keep rising as long as interest rates keep falling.
The power of low interest rates can be almost incredible, especially in an economy with competitive and deregulated financial markets (in contrast to the strictly rationed credit system that existed in the early 1950s and 1960s, the last time that Britain had interest rates anywhere near as low as they are today). For example, the reduction in real long-term interest rates from about 6 per cent in 1992 to 1 per cent today can be shown to be arithmetically sufficient to account for essentially all of the increase in house prices in the past decade, even without considering the gains in personal incomes and the improvements in economic growth during this period.
The main issue for the housing market, therefore, is what will happen to interest rates. And in the short term, the next move in interest rates is likely to be downwards, which is probably why house prices are picking up steam. But the much more important question, which Mr King examined on Monday, is why long-term interest rates are plumbing ever-lower levels and whether this situation can persist. This leads, in turn, to the even more interesting socio-political issue I raised at the beginning: if interest rates do stay very low and house prices very high for many years or even decades, what will this do to British society and especially to the incentives to work, save and invest?
The main reason for persistently low long-term interest rates is familiar enough, at least to economists. It is globalisation. As Mr King points out, the addition of two billion new workers to the world’s capitalist system in China, India and other developing and ex-communist countries, has slashed prices of manufactured goods and reduced the wages of manual workers around the world. One effect of this huge global change is that countries such as Britain and America, which import most manufactured goods while exporting services not exposed to Chinese competition, have enjoyed a huge increase in living standards, especially compared with industrialised countries such as Germany and Japan. And rising incomes have, in turn, fed through to the price of houses.
But Asian competition has had an even bigger impact on global inflation and money flows. The Asians, as well as working for low wages, are remarkably thrifty, saving a high proportion of their incomes. Moreover, since many of them live in economically volatile and politically risky countries, with little respect for law and private property rights, they naturally want to keep part of their savings in safe, predictable countries with strong financial traditions — of which America, Britain, Canada and Australia are the prime examples.
As a result, the world has experienced a glut of savings and the Anglo-Saxon countries have enjoyed a huge influx of foreign money. Meanwhile, inflation has almost vanished, despite steep rises in particular goods and services, for example petrol or private school fees. The low rate of inflation, in turn, has allowed central banks to inject far more money into their economies at far lower interest rates than they would have dared to do in the past. Indeed, the Bank of England and other central banks have been forced to keep pumping money out to prevent inflation from falling below target levels and to keep their economies out of recession in the face of competition from China and elsewhere.
Like most central bankers, who proudly proclaim that “we are paid to worry”, Mr King is concerned about what might happen if this virtuous circle went into reverse. If the Chinese and other Asians started spending instead of saving, the global savings glut would vanish, inflation would accelerate and interest rates would be jacked up, probably resulting in a collapse of property and other assets.
This is a genuine risk that should be recognised by anybody buying a house (or, indeed, a share or a bond) at today’s high prices — which is why I would strongly advise anyone thinking of borrowing to go for a long-term fixed-rate mortgage, even if it costs a little more than a variable-rate loan.
There is, however, another possibility, which seems to me just as plausible, at least in the next few years. Instead of exporting less and consuming more, the Asians could remain just as competitive and thrifty as they get gradually richer. The result would be a continuing flow of capital from Asia to the rest of the world, and especially to America and Britain. Instead of collapsing, house prices would then go on rising. And homeowners’ prosperity would depend increasingly on the value of their properties, to be cashed in at retirement, rather than on the wages they earned.
What would be the effects of such a reorientation in society towards property ownership, rather than employment? This is a big question, to which I will return in a future column. Let me just end with a few provocative remarks.
While it may seem odd that people’s prosperity should depend more on the assets they own than on the work they do, this has been true of almost all societies throughout 5,000 years of recorded history, whereas the system we live in is a 200-year-old aberration. Moreover, property ownership reinforces political and economic stability, not to mention patriotism, as conservative political thinkers since have long recognised. Margaret Thatcher dreamt of turning Britain into a “ property-owning democracy” by privatising council houses and deregulating mortgages. In this sense, the present era of globalisation, ultra-low interest rates and stratospheric asset values, is Mrs Thatcher’s apotheosis.
a.kaletsky@thetimes.co.uk
