For the past few years – since the stock market collapse of 2000 and the mild economic recession of 2001 – a consumer-led boom in the US and other so-called Anglo-Saxon countries, such as the UK and Australia, has buoyed up the world economy.
Underlying the propensity to splash out money has been property. House prices have risen hugely, contributing to a significant increase in household net wealth. That has enabled households to borrow on the equity in their homes and spend, spend, spend. This borrowing has compensated for a relatively weak rise in employment, wages and investment in the OECD countries since 2001. But the great property party is nearly over. Will households and the world economy be left with one hell of a hangover?
I reckon that last year’s house price corrections in the UK and Australia are models for what could happen in the US this year. Even though the UK and Australia have not experienced outright nominal house price falls, in real terms (compared with general inflation) they have. And the fall in real house prices deducted two to three percentage points from real personal consumption growth in those economies.
UK retail sales are now growing more slowly than at any time in the past 20 years and in January, for the first time since 1945, sales failed to exceed those in the same month the previous year. The chancellor of the exchequer has been forced to halve his economic growth projections for this year. In Australia, real retail sales are growing at just 1% year on year and business confidence is at a three-year low. In New Zealand the story is even more gloomy.
Soft landings
In the US, when newly appointed Federal Reserve chairman Ben Bernanke presented his first monetary report to Congress in February he argued that “a levelling out or a modest softening in housing activity seems more likely than a sharp contraction”. He might well have been be right. However, a soft landing in housing could still translate into a hard landing for the economy.
What makes the US vulnerable
Households with mortgages, 2005 |
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| Source: RBA, BoE, Federal Reserve |
On many measures, Americans are now more vulnerable to a housing bust than Australians or Britons. Household debt as a proportion of GDP is higher in Australia and the UK than in the US but only 30% of Australian homeowners have mortgages at all, compared with 45% of Americans. And when mortgage debt is measured against assets, Australians have only 21% of their home value mortgaged; the American figure is double that. As a result, it costs Americans around 14% of their household disposable income to service their housing debt; Australians shell out just 11% and Britons 10%.
At the peak, UK and Australian citizens sucked out the equivalent of 8% of aggregate household disposable income in equity from their homes. In a recent report, former Fed chairman Alan Greenspan calculated that US households had extracted much the same amount from their homes in 2004. This extra boost to incomes was a crucial factor driving the consumer-led boom in the UK, Australia and the US.
US bond yields are now beginning to rise and mortgage interest rates will follow them up. It won’t take much of a rise in mortgage rates to kill off the current US house price boom. According to the National Association of Realtors, US houses are at their lowest level of affordability for 15 years.
After rising at an annual 12% in 2005, US house prices could well be falling by the end of this year. That would end any contribution from housing-related consumption to private consumption growth.
Current business investment growth in the US was about 6.5% a year in 2005, thus contributing about one percentage point to average real GDP growth in 2004/05. To compensate for the loss of consumption growth resulting from a housing slowdown or bust, real business investment would have to grow at more than 20% to 25% a year through 2007. That’s not going to happen. So US economic growth could well have fallen below 2% by the end of this year.
Global impact
Most important, a property bust in the US, unlike those experienced by the other Anglo-Saxon economies, would have a significant impact on the global economy. I reckon that each percentage point reduction in US annual personal consumption growth will reduce global growth by 30 basis points. And the dynamic impact is likely to be much worse. Slowing US economic growth and the rising cost of capital globally will drive down global growth rates. The US dollar is going to fall in value.