Economics is full of paradox and stuff that many of us find counter-intuitive. House prices are a prime example. An individual will always and everywhere feel better off when the value of his house goes up. Our media celebrates when property price indices show an increase. While this might make us feel more financially secure and lead us to spend more money on other things, for the most part this seeming rise in wealth has zero impact on the economy as a whole.
Rising house prices are good for those of us with home equity but this is offset by the simple fact that potential house buyers are now made worse off.
The illusion of rising prosperity that comes from higher house prices still grips us, notwithstanding the lessons that should have been learned very recently. When it comes to housing, the only thing that makes the economy – and society – better off is if we build more properties.
Higher house prices might make us more confident that the banks are not going to go bust (again) but we can have too much of a good thing: from here, the best thing that can happen, but probably won’t, is if house prices stabilise as both supply and demand come back in to balance.
Many of us carry around peculiar ideas about the bond market. Even market analysts get confused about the messages that bond prices and yields send. We often hear that falling interest rates and bond yields are a sign that monetary policy is being eased. Daily, we see celebrations of new lows being set for Irish government bond yields. We rejoice when Greek and other troubled bond markets see their yields continue to drop. Up to a point, there has, indeed, been good news in this: a yield falling from crisis levels is a reason to think that the problems of the euro area are fading. But, again, we can have too much of a good thing.
The father of monetarism Milton Friedman tried to teach us that things monetary are often very counter-intuitive. In particular, he showed how very low bond yields, far from signalling stimulative monetary policies, actually tell us that central banks are running things way too tight. When yields are ultra low we are being told something about what very sophisticated investors expect for economic growth and inflation going forward. The message is not a good one: markets are signalling that economies are, in fact in trouble, growth is likely to be low for a very long time and that central bank policies are far too restrictive.
Falling European bond yields are now a source of very serious concern. There is nothing positive about them. If things were normal, bond yields would be higher along with actual growth and growth expectations.
As with house prices, any normalisation of bond yields is to be welcomed. But further house price rises and falling bond yields are differing signals of trouble ahead. Policy should react to all of this by encouraging house building and further monetary stimulus.
Central banks usually relax monetary policy by cutting short-term interest rates. If this is likely to stimulate the economy, bond yields rise. But even with short rates close to zero, bond yields continue to fall. That's partly because of the "zero bound": despite ECB muttering about negative short rates they really have nowhere to go. The new 'stagnationist' theories of ex-US Treasury Secretary Larry Summers amount to saying that the correct interest rate for our economies right now is rather negative; anything higher, including zero, is too tight and will restrict growth, potentially by a lot.
One reason why bond investors are so pessimistic about growth is the observed fact of very low levels of capital investment, both public and private.
A prime source of growth tomorrow is the investment we make today. Almost everywhere we look, governments and companies are desperately trying to do anything but invest. This amounts to another paradox: those low bond yields are there to be availed of, should anyone be so inclined. Borrowing to invest in infrastructure, health, education and broadband networks should all yield much higher returns than the current cost of borrowing so is, as the experts say, a no-brainer. But the experts that matter all say that we can’t do this because it is obviously wrong. While some countries might well be constrained by existing levels of debt that is by no means obvious for all governments. And it does not explain why companies are refusing to invest on both sides of the Atlantic. Paradox is everywhere: hope for higher bond yields.
