Buttonwood

The great divide

Why American house prices have corrected more than those in Europe
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Apr 28th 2012

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ANDREW MELLON, Herbert Hoover’s treasury secretary, advised the president to “liquidate real estate” as part of a plan to “purge the rottenness out of the system”. Eighty years later, America has pretty much followed his advice. House prices have lost nearly all the real gains they notched up in the bubble period (see chart). That makes for a marked contrast with Europe, where prices may be off their peaks but have not lost all their real gains. Why the difference?


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Many people think that owning a house is a certain moneymaker, but this is not the historical experience. In his recent bookSafe as Houses? A Historical Analysis of Property Prices”, Neil Monnery presents data from an array of nations going back (in some cases) several centuries. What he discovers is that real house prices have generally been flat over time, or have increased by at most 1% a year. Rather like gold, then, house prices have been a good store of value rather than an automatic route to riches.
The exception is the period of the past 15 years or so, when real house prices took off in a few countries. But not everywhere. In Germany and Switzerland the trend has been flat-to-lower. In Japan there has been a decline which has pretty much wiped out the rise in house prices that occurred between 1970 and 1990. So there are really three types of market to explain: America and Japan, where real prices rose sharply then corrected; those where they rose sharply but have yet to lose all their gains; and those where the markets have been flat in real terms.



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It is hard to find an explanation for price movements that applies across markets. Some cite low real interest rates as the main reason that prices have held up in Europe. But real rates have fallen sharply in America as well. For homebuyers, the best measure of the real rate is the gap between the average mortgage rate and annual wage growth. In America this is close to its lowest level in 24 years but the housing market is still flat as a chapati.


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Indeed, if you divide that period into three, house prices rose faster when rates were high than when they were low. In Britain, real house prices fell by a third between 1973 and 1977, even when real interest rates were sharply negative.



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Just as the best way to view equities is as the discounted value of future cashflows, the best way to view property is as the discounted value of future rents. The temptation is to think that, as real rates fall, the present value of housing must rise. But why are real rates low?


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They are being held down by central banks which are worried about the economic outlook. If the central banks are right, then rents will surely grow more slowly in future. A paper* by Christian Hott and Terhi Jokipii calculates that on this basis, British, Irish and Spanish house prices are still well above their “fundamentalvalue, while those in America are about right.
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 Explore and compare global housing data over time with our interactive house-price tool


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Another potential explanation for America’s housing collapse relates to supply. Developers went on a building spree in places like Florida and California, and the result is a glut of empty condominiums. In contrast, Britain’s strict planning laws mean that too few houses have been built to satisfy demand. But overbuilding in Ireland or Spain reached chronic levels, too, and yet their house prices have not corrected to the same extent as those across the Atlantic.



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What about demand? Houses behave more like a financial asset than a consumer good: as prices rise, demand seems to increase. In addition, there has been a trend towards smaller households (thanks to divorce, greater longevity and so on). But high house prices and tighter lending standards may have brought that process to a halt. Young people are forced to live with their parents or flat-share with contemporaries. These trends are pretty widespread, and it is hard to use them to explain national differences.




So perhaps the difference is institutional. American banks had poorer lending standards and have been quicker to foreclose on properties; borrowers have been readier to walk away from their homes. In European countries, owners have been able to sit tight in the hope that prices will recover. European markets are certainly a lot less liquid. Irish transaction volumes dropped by 83% from their peak and Spanish ones by 64%, but American deals fell by just 46%. Europe is going in the same direction as America. It is just getting there more slowly.


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April 26, 2012

Death of a Fairy Tale

By PAUL KRUGMAN




This was the month the confidence fairy died.


 
For the past two years most policy makers in Europe and many politicians and pundits in America have been in thrall to a destructive economic doctrine. According to this doctrine, governments should respond to a severely depressed economy not the way the textbooks say they should — by spending more to offset falling private demand — but with fiscal austerity, slashing spending in an effort to balance their budgets.


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Critics warned from the beginning that austerity in the face of depression would only make that depression worse. But the “austerians” insisted that the reverse would happen. Why? Confidence! “Confidence-inspiring policies will foster and not hamper economic recovery,” declared Jean-Claude Trichet, the former president of the European Central Bank — a claim echoed by Republicans in Congress here. Or as I put it way back when, the idea was that the confidence fairy would come in and reward policy makers for their fiscal virtue.


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The good news is that many influential people are finally admitting that the confidence fairy was a myth. The bad news is that despite this admission there seems to be little prospect of a near-term course change either in Europe or here in America, where we never fully embraced the doctrine, but have, nonetheless, had de facto austerity in the form of huge spending and employment cuts at the state and local level.

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So, about that doctrine: appeals to the wonders of confidence are something Herbert Hoover would have found completely familiar — and faith in the confidence fairy has worked out about as well for modern Europe as it did for Hoover’s America. All around Europe’s periphery, from Spain to Latvia, austerity policies have produced Depression-level slumps and Depression-level unemployment; the confidence fairy is nowhere to be seen, not even in Britain, whose turn to austerity two years ago was greeted with loud hosannas by policy elites on both sides of the Atlantic.


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None of this should come as news, since the failure of austerity policies to deliver as promised has long been obvious. Yet European leaders spent years in denial, insisting that their policies would start working any day now, and celebrating supposed triumphs on the flimsiest of evidence. Notably, the long-suffering (literally) Irish have been hailed as a success story not once but twice, in early 2010 and again in the fall of 2011. Each time the supposed success turned out to be a mirage; three years into its austerity program, Ireland has yet to show any sign of real recovery from a slump that has driven the unemployment rate to almost 15 percent.


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However, something has changed in the past few weeks. Several events — the collapse of the Dutch government over proposed austerity measures, the strong showing of the vaguely anti-austerity François Hollande in the first round of France’s presidential election, and an economic report showing that Britain is doing worse in the current slump than it did in the 1930s seem to have finally broken through the wall of denial. Suddenly, everyone is admitting that austerity isn’t working.

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The question now is what they’re going to do about it. And the answer, I fear, is: not much.


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For one thing, while the austerians seem to have given up on hope, they haven’t given up on fearthat is, on the claim that if we don’t slash spending, even in a depressed economy, we’ll turn into Greece, with sky-high borrowing costs.


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Now, claims that only austerity can pacify bond markets have proved every bit as wrong as claims that the confidence fairy will bring prosperity. Almost three years have passed since The Wall Street Journal breathlessly warned that the attack of the bond vigilantes on U.S. debt had begun; not only have borrowing costs remained low, they’ve actually fallen by half. Japan has faced dire warnings about its debt for more than a decade; as of this week, it could borrow long term at an interest rate of less than 1 percent.


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And serious analysts now argue that fiscal austerity in a depressed economy is probably self-defeating: by shrinking the economy and hurting long-term revenue, austerity probably makes the debt outlook worse rather than better.


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But while the confidence fairy appears to be well and truly buried, deficit scare stories remain popular. Indeed, defenders of British policies dismiss any call for a rethinking of these policies, despite their evident failure to deliver, on the grounds that any relaxation of austerity would cause borrowing costs to soar.


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So we’re now living in a world of zombie economic policiespolicies that should have been killed by the evidence that all of their premises are wrong, but which keep shambling along nonetheless. And it’s anyone’s guess when this reign of error will end.

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Larry Summers is playing economic Jeopardy

Glenn Hubbard

April 27, 2012


Larry Summers’ considerable intellect suggests that he would be an excellent contestant on the popular game show Jeopardy. Of course, on the show, the question offered by the contestant must match the answer on the board. Summers and I disagree on the answer that matches the questionWhat is President Obama’s budget?” Let’s see why.



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I asked two questions in an op-ed in Wednesday’s Wall Street Journal. (Neither question was addressed by Mr Summers, or in the simultaneous parallel critiques offered on the airwaves by US Treasury Secretary Timothy Geithner and former Council of Economic Advisers Chairman Austan Goolsbee). The first question was whether the tax increases on high-income individuals proposed by President Obama (the Buffett rule, higher taxes on dividends and capital gains, a higher top marginal rate, and so on) raised enough revenue to materially offset the country’s large budget gap or higher federal spending under President Obama. The answer, using revenue estimates from the Treasury Department and spending estimates from the President’s budget is ‘No’. The second question was what that spending growth implied for future tax rates. That is, if federal spending as a share of gross domestic product was to increase permanently as the president proposes, by how much would taxes need to rise? Answer: a lot and for everyone. This simple thought experiment presumes that we will not ratify permanently larger deficits.



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Without addressing these questions, Mr Summers proposes a different one. President Obama’s budget is supposedly fiscally sound because the Congressional Budget Office (CBO) has estimated that the budget would stabilise federal debt as a share of GDP for a short while. Yet, let’s look at what the CBO said. First, while the CBO shows the debt-to-GDP ratio stabilizing for a period of time – at an uncomfortably high level – in the budget window, it is not stable in the long run.


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Second and more importantly, in its April 20, 2012 report, the same CBO that Summers cites so selectively observed that the permanent deficits in the President’s budget would reduce the level of economic activity. By CBO’s estimate, under the President’s proposals, the CBO estimates for the 2018-2022 period, that the nation’s real output would be between 0.5 and 2.2 per cent lower compared to what would occur under current law. This adverse effect would grow in the future, as deficits continue to mount.



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The President’s budget has met with little success in Congress. The 2013 budget was voted down in the House of Representatives, 414-0. The Senate did not bring the 2013 budget to the floor, though the 2012 budget was voted down in the Senate, 97-0.



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And Mr Romney? The Romney budget proposes to reduce federal spending as a share of GDP to 20 per cent (its pre-financial-crisis, long-term average level) by 2016. It is ironic that the administration has criticised Mr Romney for specific cuts (for example, block granting the Medicaid program), while Mr Summers now argues the plan is not specific. Mr Romney is also the first candidate to propose specific ways of slowing the growth of Social Security and Medicare, a subject not mentioned by the president. And Mr Romney’s call for fundamental tax reformreducing marginal tax rates accompanied by reducing tax expenditures to be revenue-neutral and distributionally-neutral captures the spirit of the bipartisan Bowles-Simpson commission, which was both appointed and ignored by President Obama.



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In a ‘Final Jeopardy round, if the answer is long-term fiscal sustainability without large, across-the-board tax increases, the question cannot beWhat is President Obama’s budget?”. There are important debates to be had over policyMr Summers is right that this is a “very consequential election”. But we first must make sure that we agree on math.


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Fortunately, the concept that permanently higher spending eventually requires taxes to match is not a controversial one to most Americans. And, at the levels of higher spending proposed by President Obama, higher taxes on the well-to-do won’t fix the gap.



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Budgets are statements of national priorities and require economic leadership. Mr Romney has made tough calls in his budget – there will rightly be a debate over whether they are the right ones.


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That debate will be more illuminating for voters than Secretary Geithner’s statement to the Congress: “We’re not coming before you to say we have a definitive solution to the long-term problem. What we do know is we don’t like yours.”



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The writer is dean of Columbia Business School, former chairman of the Council of Economic Advisers, and adviser to presidential candidate Mitt Romney.


Markets Insight
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April 26, 2012 1:19 pm
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BoJ’s tests to hit other central banks
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By Henny Sender

Masaaki Shirakawa, the governor of the Bank of Japan has travelled around the country in recent months, meeting and exchanging views with members of the business community.



The session in Nagoya in November, with the yen at its peak, was particularly acrimonious, with a deputy president of Toyota assailing the central banker for not doing more to bring the yen down.

 

 

Mr Shirakawa has been the object of increasing ire from the Japanese establishment. In February, that criticism was briefly suspended when the BoJ announced it was expanding its asset purchase programme and committed itself to an inflation goal of 1 per cent.




At that time the market interpretation was that the Bank of Japan had finally begun to heed the voice of reason coming from politicians and business. The yen sank to about Y83 to the US dollar from its highs of about Y75. The stock market rallied.



Unfortunately, the lull was only temporary. A mere 10 weeks later, the markets believe the change hasn’t been enough. The pressure to do more has steadily increased, triggering just the kind of political pressure the BoJ most fears. On April 27, the BoJ is expected to announce that it will expand its asset purchase programme yet again.



These days, the BoJ must walk a tightrope that is ever more taut. The stakes are high. If it goes too far, central bankers fear a vicious circle in which the yen weakens, exposing the country to the danger of rising inflationary pressures and destroying confidence in both the central bank and the currency.



That means in turn that the real value of the savings of Japan’s ageing population will drop and real incomes will decline, further suppressing weak domestic demand. But if the BoJ does nothing, Mr Shirakawa will continue to be blamed for Japan’s two-decade-old slump.



On April 5, the upper house of the Diet rejected a nominee to sit on the BoJ board who believes – like Mr Shirakawa – that monetary policy alone cannot solve Japan’s problems. The vote was a victory for those who want to see even more aggressive monetary easing.
Parliamentarians submitted a bill to the Diet that would make it possible to remove the central bank governor.



Diet oversight even forces Mr Shirakawa to ask permission from parliament whenever he leaves the country.



Little wonder that senior people at the BoJ believe that central bank independence, whatever the law states, is essentially an illusion. In the quiet corridors of the central bank, the response to the market’s view of the BoJ has been one of frustration.



Mr Shirakawa has always objected to being described as conservative and has tried to point out that monetary conditions in Japan are far more accommodative than those in the US.



Meanwhile, the need for a credible plan to tackle the deficit is growing more urgent after Japan produced its first trade deficit in two decades for 2011 and 2012 appears to offer more of the same.



Moreover, bearish economists such as Masaaki Kanno, chief economist for JPMorgan in Tokyo and a former BoJ official, predict that Japan’s current account will also slide into deficit by 2015.



That means the government will eventually have to import capital from abroad and sell its debt to foreign investors, who will demand higher yields to compensate them for the risk that the currency will move against them.



Still, as Mr Shirakawa and other BoJ officials stress, to raise potential economic growth isn’t the job of the central bank – it is the job of the government. But there isn’t much of an effort from either the government or the private sector to come up with a precise new template for growth. Instead, Japan’s reflex is to rely on a cheap yen to support exports to generate growth.



The hostility from bureaucrats, businessmen and politicians comes at a sensitive time. Mr. Shirakawa’s term is up on April 8 of next year and the jockeying to succeed him has already begun. The appointment is subject to approval from the Dietfurther undercutting the independence of the BoJ.



Both the bureaucrats and politicians are determined that the next BoJ governor be more pliable, preferably an appointee with close ties to the Ministry of Finance.



What the BoJ is grappling with today, other central banks will grapple with tomorrow.


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“The Bank of England and the Fed are in the same place as the BoJ,” says Mr Kanno. “But the marginal return of quantitative easing diminishes over time. Everyone is in a similar position but the tragedy of the BoJ is that they are the first. They are ahead of everyone.”


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Copyright The Financial Times Limited 2012

Building euro-zone competitiveness
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Mobile moans
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It should be easier for unemployed Europeans to move in search of work. The latest in an occasional series
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Apr 28th 2012
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NEARLY a quarter of Spain’s workforce—and roughly half of Spain’s young people—have no jobs. Unemployment rates in Austria, Germany and the Netherlands, by contrast, are dramatically lower.


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When Americans are faced with depressed labour markets, many saddle up in search of work. But Europeans are far less likely to uproot, both within borders and, especially, across them (see chart).



There is an obvious reason for that: Europe’s linguistic diversity. Language matters. In Canada, for example, mobility is much higher across the country as a whole than it is between French-speaking Quebec and the English-speaking provinces and territories. An analysis of European language borders, by Nicola Fuchs-Schündeln of Goethe University Frankfurt and Kevin Bartz of Harvard University, concludes that language hurdles are better predictors of low mobility than national borders.


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Europe’s demography also counts. Migration does less good to older workers, who have fewer working years ahead of them in which to benefit from moving.
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Such built-in barriers make the need to clear away other obstacles all the more important. In principle, migration across European Union borders, except Bulgaria’s and Romania’s, is as easy as migration within member states. In practice, residents face a pile of disincentives.



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Tax and benefit policies that compress Europe’s wage distribution are one of these. Income differentials gave East Europeans a very good reason to move to western Europe after the 2004 enlargement. But income gaps are much smaller within the euro zone. Generous severance packages and unemployment benefits also reduce the incentives to migrate.
Peripheral governments are under pressure to rein in such benefitsSpain and Italy are trying to chip away at lavish severance pay, for instance—but opposition is fierce.



The housing market is another source of friction. Transaction fees and taxes for home-buyers are much higher in Europe than America, according to the OECD, a think-tank. Transaction costs are 10-15% of the price of a house in Greece, Italy and Spain, compared with roughly 5% in America. Renters are discouraged from moving by generous rent-control policies and public-housing programmes.



Research by Peter Rupert of the University of California at Santa Barbara and Etienne Wasmer of Sciences Po in Paris suggests that housing-market frictions may account for about half of the difference in mobility rates between Europe and America. The push for austerity across the euro zone may yield thinner public-housing subsidies: Spain has cut housing benefits in its latest austerity plan, for example. But budget problems may actually increase governments’ reliance on property taxes, making it less likely they will be cut.
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However persistent the European Commission’s demands for uniform labour-market treatment of all EU citizens, the red tape between national labour markets remains frustratingly thick. For those who are employed, changing countries often endangers national pension-scheme rights. Workers may lose part of the value of earned pension benefits or the right to continue accumulating generous benefits in their native country. And inconsistent application of laws on pension taxation means that residents run the risk of double taxation if they move. The commission routinely argues for greater pension portability. On April 18th it also called for exportability of national unemployment benefits. It may seem curious to ask indebted governments to pay citizens to live on the dole in another country, yet increased employment should eventually result, as those who move find work.



Professional qualifications act as a further barrier to movement across borders. EU law states that qualifications from one member state should be valid in another, but in practice recognition often requires negotiating a tangle of local rules. The OECD notes that just seven out of more than 800 professions identified by the commission qualified for automatic recognition of qualifications across borders. In 2011 the commission proposed simplifications to recognition procedures, including a Europeanprofessional card” that would summarise relevant professional information. Progress has been slow.

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Off to join the Mittelstand


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Hurdles are highest for workers within the public sector. Such jobs are still occasionally reserved solely for nationals, even outsidesensitivesectors. In 2005 2.5% of British teachers were non-nationals. That compared with 0.7% in Portugal, 0.4% in Greece and too few to count in Italy.



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Raising these numbers is not easy, of course, despite a reported jump in demand for German-language tuition in peripheral economies. Job-seeking Europeans will never be as footloose as their American counterparts. But the gap can be narrowed. The periphery may now be the main target of structural reform, but streamlining relevant rules in the core economies would do as much to help euro-zone citizens.