An oft-asked question today is whether the global housing market is in the midst of a bubble. Behind the question, of course, is a concern that rising interest rates could pop that bubble.
Certainly there is reason for concern in certain markets around the world, particularly in the U.K. and Australia, but also in some selected Canadian and American cities. The symptoms of a bubble include rapidly rising house prices and speculative buying – people buying more than one property on the expectation that they will be able to flip it and profit quickly. Such speculation is vulnerable to higher interest rates, because it is usually done with borrowed money.
Super-low interest rates are clearly part of the strong housing story. Central banks pushed interest rates down precisely because they were hoping to promote spending on houses, cars and business investment.
That is how central banks encourage the economy to grow out of a slowdown. Once the economy recovers, interest rates go back up (as they will in the next few months), but economic momentum remains. To the extent that low interest rates cause people to buy cars or houses, or companies to invest earlier than planned, there can be a temporary plateau in spending after interest rates rise back to normal, but then steady growth usually resumes.
Even allowing for the effects of interest rates, however, there appears to be a bigger story at work this time, as housing construction has risen to levels really not seen since the 1970s. Looking back at the 1970s, many economists would point to inflation as the trigger that made housing the investment of choice at that time. People recognized that owning real estate was one of the few ways to protect themselves from rising inflation.
But today we do not have that problem – just last year many were worried about the risk of deflation, and the recent return to moderate inflation rates has actually been welcome. Nor has there been any acceleration in population growth to explain the surge in housing.
That leaves one significant characteristic about the present that was also present in the 1970s: A profound skepticism about the outlook for stock markets. In the early 1970s we saw a major retreat in stock markets after the so-called “nifty-fifty” bubble. The ensuing bear market proved to be a long one, extended by the emergence of strong inflationary pressures and weak economic growth (stagflation, as it was called then). An entire generation developed an aversion to equities at the time, and it took until the mid-1980s for that aversion to wear off.
The current situation has some parallels. The late-1990s tech equity boom and its subsequent collapse have turned a whole new generation sour on stocks. Corporate malfeasance obviously added to those fears. Couple that with the threat of terrorism, which has led to active “nesting” by consumers, and we have a fundamental and lasting rise in the demand for housing.
The bottom line? There is no question that rising interest rates will take some of the steam out of global housing markets, and there may be some retreat in house prices in the hottest markets. But by all accounts the demand for housing has increased for fundamental, and lasting, reasons.
(Stephen Poloz is senior vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)
