Largely an Illusion

Some years ago while walking through the United Airlines terminal at Los Angeles International Airport, I picked up my first copy of The Economist magazine. There were stacks and stacks of the current issue available at no charge to passersby. They may or may not still do this sort of thing, but the recollection is pretty clear - there were literally hundreds of copies just sitting there. Since that time, this magazine has always been one of my favorites.

Apparently at least one contributor to Wikipedia is also fond of The Economist. There is a rather detailed multi-page description, which, at first glance appears to be an experiment in link density - it looks like every fifth word is a link. Nonetheless, it is an informative reference.

The Economist is unique for a number of reasons - it has been published in London since 1843, there are very few advertisements (mostly help wanted ads for economists around the world), and with the exception of a guest editorial or two each issue, the articles contain no bylines - very un-American.

It is famous for it's Big Mac Index, which attempts to informally measure currency strength by comparing the cost of a Big Mac all around the world, and it is known to take positions on a variety of issues ranging from the war in Iraq to gay marriage.

The writers at The Economist have been warning about the world wide housing boom for a few years now, so it should be no surprise, given the recent extraordinary media coverage in the U.S and the topping pattern in the U.K. and Australia, that the current issue would have housing as it's cover story:


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Yes, that is a brick. As in house prices dropping like a brick. Or ... wait, it kind of looks hollow - made hollow to be able to put the lettering on the inside? If it were a brick, the lettering would be on the top, woudn't it? Do they have different kinds of brick in the U.K.? Now it kind of looks like a water trough - OK, it's a brick ... probably.

Being as smart and smartalecky as they are over there, and having probably about had it with the world-wide housing boom, they probably felt that they needed to raise the stakes a bit with this issue, so as not to be confused with the recent Time Magazine or Newsweek housing cover stories - no smiling caricatures here. Inside the cover story contains these quips:

We have been warning for some time that the price of housing was rising at an alarming rate all around the globe, including in America. Now that others have noticed as well, the day of reckoning is closer at hand. It is not going to be pretty. How the current housing boom ends could decide the course of the entire world economy over the next few years.

This boom is unprecedented in terms of both the number of countries involved and the record size of house-price gains. Measured by the increase in asset values over the past five years, the global housing boom is the biggest financial bubble in history (see article). The bigger the boom, the bigger the eventual bust.

The biggest financial bubble in history? Bigger boom, bigger bust? They are obviously not listening to Alan Greenspan and Larry Kudlow enough.

Not only are new buyers taking out bigger mortgages, but existing owners have increased their mortgages to turn capital gains into cash which they can spend. As a result of such borrowing, housing booms tend to be more dangerous than stockmarket bubbles, and are often followed by periods of prolonged economic weakness.

Housing booms more dangerous than stockmarket bubbles? That's way off! Americans are speculating in housing for the exact opposite reason - because housing is safe ... it is stocks that are dangerous.

No wonder that the Federal Reserve is starting, belatedly, to fret about house prices. By holding interest rates low for so long after equities crashed, the Fed helped to inflate house prices. This prevented a deep recession, but it may have merely delayed the needed economic adjustments. Ideally, the Fed should have tried to cool the housing boom by raising interest rates sooner and by giving clear verbal warnings to buyers, as Britain's and Australia's central banks have done. Even now some stern words from Alan Greenspan, the Fed's chairman, could restrain more house-price inflation.

Of course, by the time American prices begin to fall, probably sometime next year, they will not be Mr Greenspan's headache. He will have retired and someone else will be in his job.

The whole world economy is at risk. The IMF has warned that, just as the upswing in house prices has been a global phenomenon, so any downturn is likely to be synchronised, and thus the effects of it will be shared widely. The housing boom was fun while it lasted, but the biggest increase in wealth in history was largely an illusion.

Say it isn't so! An illusion? The locomotive for global growth, the increasing wealth of the unstoppable, free-spending American consumer is surely not an illusion. This wealth is real, very real - look at all the factories in China that have been created as a result of Americans spending this wealth.

The problem is that this wealth is transitory - it is not likely to endure.