Claims by an RBA official -- the aptly named Dr Tulip -- caused a bit of a furore yesterday. You see, Dr Tulip dared to state an obvious truth: that housing is undervalued. And it is --of that there can be no doubt, no debate. It’s simply a mathematical reality.
Unfortunately, the furore over housing affordability -- in the Australian context -- has never really been about the analytical subtleties -- the math -- or even differences of opinion over methodology and the like. Nothing so noble. It’s based largely on pure emotion, in many cases sustained by the rage of those, who having predicted a housing market crash or any one of the many Australian post-GFC recessions, have become incensed by ongoing house price gains and the general resilience of the Australian economy.
That, and some -- mainly young first home buyers – feel frustrated at not been able to buy a penthouse in their preferred inner-city area. That’s not a generalised affordability issue though, it’s an issue of scarcity, value etc. Good old fashioned supply and demand.
In any case, Dr Tulip’s research doesn’t seem to refute the fact that house prices in some areas have had strong gains. Oh no, it’s in the numbers people, the numbers. What it does do, is reject the view that these strong price gains somehow reflect an irrational exuberance -- or some implied stupidity of investors and homeowners, whose puny little brains couldn’t possibly comprehend just how reckless their actions actually are.
Instead, his research highlights the simple fact than in an ultra-low rate world, the concept of value has changed. What may have been subjectively expensive or fully valued in the past, all of a sudden becomes objectively cheap.
The real question then becomes one of duration. How long will this ultra-low rate world last? That is a debate worth having, not whether property or equities etc are expensive. They’re not. They are currently cheap -- very cheap in some cases. All an investor has to think about is the probability that rates are going to spike higher over their investment horizon to somehow force some sort of mean reversion on a spread of asset prices. ‘Normalisation’, some might call it.
On that score I think people need to be honest. It’s not a high probability. The European Central Bank is planning on printing money up till 2016, while the Bank of Japan -- already into its second decade of quantitative easing -- has no credible plans to end its money printing program, ever. With national debt around 400 per cent of GDP, Japan simply can’t afford to. Japan is a nation in decline and for all intents and purposes insolvent. So instead, they print money and buy assets, increasingly foreign assets, in order to offset that debt. Greece can only look on with envy. As for the US, well deflation and depression are long gone, yet rates are still at zero and the Fed still prints money (to maintain the size of its balance sheet).
All the while the unemployment rate has dropped back from a peak of 10 per cent to 5.3 per cent now. Few, other than the most grievous loons, dispute that the US economy is doing well. Yet if having cash rates at the “zero lower bound” was truly meant as a temporary or emergency policy setting -- then you’d think that the Fed would have dispensed with it by now. Oops.
Still think that bond yields are going to normalise? Seriously, think again. Global debt has surged by $US57 trillion since the GFC to about $US200 trillion, or nearly three times global GDP. Back in 2000 that figure was more like $US87 trillion, on McKinsey figures. Bringing rates back to any semblance of what we saw pre-GFC would cause a recession, and that’s what central banks are printing money to avoid.
If still surging global debt -- and an abject fear of secular stagnation -- wasn’t enough to keep rates ultra-low, then there is always reference to low inflation and weak wages growth. Ample reason to expect bond yields to remain at their new normal rates -- perhaps a bit higher, but not much.
In any case, there is more reason to believe that, rather than being at a new normal, bond yields are back to normal. It’s all about perspective. Viewed from the 1970s and 80s, bond yields are scarily low. Yet on a longer time frame, they don’t look so low. In fact in the 100 years from 1870 to 1970, the US 10-year yield spent most of the time -- nearly all of it -- between 2-4 per cent. Why is that important? Because it makes debt repayments much more affordable, and housing much more affordable. If that is the case, then property is unequivocally cheap, and still very affordable. Just as the good doctor says.