There’s a saying in central banking. Bubbles are like porn. No one’s got an exact definition, but you know it when you see it.
Those crazy central bankers.
But probably the key indicator of bubbles is a disconnect between prices and fundamentals – particularly supply and demand.
To make that clear, compare two significant economic events: The dot-com bubble, and …
… the ‘Tickle Me Elmo’ doll.
The Tickle Me Elmo doll was a flash-in-the pan phenomenon just prior to the Christmas of 1998. For some reason, this useless and annoying toy became the MUST-HAVE item of the year.
Demand went ballistic. The manufacturer had the conveyor belt going day and night, but just couldn’t pump enough of the critters out. And with only so many shopping days before Christmas, surging demand and limited supply sent prices through the roof.
And there were reports of Tickle Me Elmo dolls going on the black market for thousands of dollars.
But was it a bubble?
I’d argue that it wasn’t. It was just the market doing what it does. Demand was greater than supply. Prices rose. Once demand cooled (after Christmas), and supply caught up, prices returned to what we might call ‘sane’ levels. No bust. Just a predictable wind-back of prices.
This is a market functioning perfectly. More-over there was no speculative element to the Elmo craze. No one was buying up Elmo dolls in the belief that they’d be able to sell them at a handsome profit next Christmas…
Compare this to the dot-com bubble. Companies were being floated for insane amounts of money, with out ever having turned a cent – without even having a demonstrated business model!
Demand was high, but supply was high too. New, and ever more useless companies floated every day.
The point I’m trying to make is that prices followed a similar course in both markets. One was a bubble. One wasn’t. One was completely disconnected from reality. One was predictable and vanilla market functioning.
Just because prices rise, doesn’t mean there is a bubble.
Remember this. This is a very important point.
Just because prices rise, doesn’t mean there is a bubble.
The other day I showed you this chart here.
Bubble-blowers in Australia point to this chart and say, ‘See. Look at how much house prices have risen, especially relative to other housing indicators. There must be a bubble.’
But just because house prices have risen, doesn’t mean there’s a bubble. You need to take supply and demand into account, because it’s entirely possible that supply and demand fully account for this differential. And I’d argue that they do.
The other thing bubble-blowers love to do is point to the run up in Aussie prices, and say, “See. Looks like the run up in the US. Must be a bubble.’
But there’s a key difference here. And that’s supply. There was a glut of properties in the US, which meant the run up in prices wasn’t in line with fundamentals.
But in Australia, we just haven’t been building enough new houses. For years. Supply just hasn’t been keeping pace with demand.
To get a feel for that, compare population growth with growth in the housing stock. It’s a pretty crude measure of supply and demand, but it will do.
What you’ll find is that in the 70s and 80s, the housing stock was growing at a much faster rate than the population. Between 1976 and 1991, the housing stock grew by 41 percent, while the population grew by 23 percent.
But from that point on, the balance started to shift. Between 1991 and 2001, Australia’s population grew by 11.5 percent, while the housing stock grew by only 18.3 percent. That differential of 18 percentage points in the 70s and 80s shrunk to less than 9 p.p by the 90s.
But the balance just kept on shifting.
Between 2001 and 2011, the population grew by 15.9 percent, while the housing stock grew by only 15.2 percent. Population had outpaced housing stock for the first time since the end of World War II!
What this means is that if you want to make the argument that Australia has a bubble, then you have to make the case that there’s a hidden glut of supply now. That somehow it’s worse now than what it was back in the 70s – back when the housing stock was growing twice as fast as the population!
It’s not clear exactly where the balance is now, but it’s certainly clear that the market is a lot tighter than what it was – and only getting tigher! Increasing prices are just what you’d expect to see in a market like this.
Aussies just don’t build enough houses. The credit crunch that followed the GFC has put the brake on developers in recent years, but this has been several decades in the making. Check out this chart.
It’s data on New Home Sales from the Housing Industry Association. What it shows is the trend long-run decline in new home construction – down from around 120,000 houses a year in 1997, to around 70,000 a year today.
So if you want to argue that there’s a glut (and a bubble) today, you have to explain why there wasn’t a glut and a bubble back in 1997, when supply was that much stronger.
And why aren’t we building enough houses? Well, that’s an interesting question, and I’m not sure what the answer is. I think it probably has a lot to do with the way we lock up land around the cities. This pushes up land prices, and makes building houses a less profitable proposition, even with rising prices.
Whatever the case, it seems extremely unlikely that we’ve ended up with a glut in the national market (though perhaps there could be pockets here and there.)
And without a glut, we can’t have a bubble. And without a bubble, we can’t have a bust.
That means supply and demand will keep driving market direction. And with fewer and fewer homes coming to market each year, that direction’s going to be up…
… especially as demographic factors super-charge demand. More on that next time.