More Housing ‘Bubble’ Scepticism

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if a community experiences a change in its growth rate, property values can increase a great deal over a short time. For the above example, going from 2% to 3% growth would cause the property values to double overnight.

This does not sound like the sound valuation of a very rational financial market, unless interest rates are also assumed to have dramaticly dropped.
A one percent increase in the rate of economic growth rate (believed to be sustainable over the long-term) will certainly lead to an immediate hike in the value of all assets. But it is doubtful that this increased rate of growth would lead to a doubling of asset prices on rational calculation. (Unless of course free financial markets are prone to massive overshooting due to the kind of inefficiencies and inequities - irrational exuberance, insider trading and greater-fooling - that bubble theorists have been claiming all along.
The formula for calculating the time it takes for changes in the the rate of growth to double the total level of some quantity is called the Rule of 70.

To determine the doubling-time (d) for an exponentially-growing quantity, divide the annual percentage rate of increase (p) into 70.
d = 70/p
where:
d = the time it takes for the quantity to double in size;
p = the annual increase expressed as a percentage
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Thus an economy growing at two percent pa we find that real income takes 70 years to double. (70/1 = 70). If you increase the growth rate from one to two per cent pa we find that real income takes 35 years to double (70/2) ie a 100% increase in the rate of growth causes a 50% reduction in the doubling time.
Assuming a stable rate of interest it is hard to see why markets will straight away factor a one percent increase in the long-term growth rate into a doubling of long-term asset prices. This would imply time horizons in excess of investor life-expectancies. This ratchet effect on asset prices is even more unlikely the higher the base rate of growth.

<blockquote>Forces such as these, rather than a random distribution of irrational exuberance, seem a more natural explanation for why some communities got bubbled and others didn’t.

If one looks at the empirical evidence over the past decade it is hard to see how much higher income growth rate translated into booming increases in the hottest property markets. During this time there has been a relative shift of population (and therefore income growth sources) away from the property bubbling metropolitan oceanic cities (London, New York, Sydney). Households in these locales can no longer afford to accomodate children.

One is left with the conclusion that interest rates, rather than income growth rates, are a much more powerful source of asset price inflation. And the less these rates are tied to long term fundamentals the more likely investment decisions will be skewed by the speculative operations of market manipulators.

When the capital development of a country becomes a by-product of the activities
of a casino, the job is likely to be ill-done.

Keynes.

Posted by Jack Strocchi  on  06/21  at  01:58 PM