Massive monetary experimentation has sent price-signalling in our asset markets haywire as speculative temperatures fluctuate sometimes violently. Yet market commentators overwhelmingly cling to the notion that any big swing in price stems mainly from a specific cause, which is their job to discover and reveal. In doing so, they resort to powerful exaggeration. An example is today's popular hypothesis regarding sky-high prices, whether for real assets or bonds, easily summarized as "the foreigner is coming!" Superficially, the theme that U.S. housing prices are being driven higher by investors from other countries seems to make sense, but is largely balderdash, even though embraced by financial journalists and their audiences.
Why? Tales of foreign black money hoards seeking refuge in U.S. real estate as the "new Switzerland," or Chinese billionaires making real estate agents in Vancouver rich, or fund managers fleeing negative interest rates in Europe and Japan and flooding into U.S. long-term fixed rate markets (both corporate and government) are more engaging and readable than analytical investigation into the root causes of monetary malaise and related irrational speculation.
Billionaires and income famine victims make a better story than survey evidence about the "silent majority" of investors who allow their existing exposure to the given asset class to simply rise or fall with the price. Finance 101 tells us that market prices are determined in stock, not flow equilibrium, but tell that to the news editors. They want clicks and eyeballs.
The observed disdain for stock analysis fits with Nobel-winning psychologist Daniel Kahneman's thesis, developed further by the behavioural finance theorists, concerning flaws in mental processes. Most people are too ready to follow intuition based on mental shortcuts ("thinking fast") rather than using considerable energy to decipher how new facts relate to each other and to the still many unknowns ("thinking slow").
The desperate global search for yield weighs the scales even more heavily in favour of thinking fast. All with the predictable result: Many investors and commentators, encouraged by each other's narratives, focus excessively on the recognizable attributes of the flows (who is transacting at present prices) while ignoring or under-weighting the harder question of who is holding the stocks, and why.
Many of the silent investors absorb the speculative stories in a way to justify remaining passive despite a set of prices now very different from when they originally entered the particular market. The storyteller's power to attract followers emanates from the underlying monetary malaise. We can see this phenomenon now in many hot asset markets around the globe, including real estate and bonds, where the speculative narrative gives prominence to "insatiable foreign demand" — meaning that foreigners are prominent on the buy side of the flow analysis.
Take the example of the Vancouver residential real estate bubble. Estimates suggest that around 10% of the sales (by value total) have been to Chinese buyers in the past year (when prices in Canadian dollars rose by over 30% for prime properties). Total sales (both to Chinese buyers and buyers not from China) including net new constructions have amounted to between 5% and 10% of the total stock of residential buildings. Assume that the Chinese maintained their present pace of buying, the rate of increase in their ownership of the outstanding stock would indeed be slow even allowing for their concentration on the high-end of the market. How often do the speculative narrators (whether agents, investors, or counselors) tell and retell the same story of "purchase by a Chinese billionaire," thus reinforcing the distortion of vision in the overall marketplace?
Beyond the obvious, many present owners become infected by the speculative fever egged on by the narrative that an influx of foreign buyers will only continue to rise and will drive prices still higher, ignoring that stocks hold greater importance than flows. The power of the flawed speculative narrative to attract present owners and new domestic investors (many highly levered) stems mainly from the yield famine. Present owners could make a big cash profit in re-arranging their housing in response to current high prices in Vancouver but they fear becoming victims of the income famine.
Some politicians imagine that they can play a role in squelching the false speculative narrative by taking action against the foreign buyers. British Columbia has imposed a 15% tax on foreign purchases, effective Aug. 1; in similar vein the U.K. has levied stiff taxes on foreign purchases of expensive homes, principally in London, and especially those bought by offshore companies. The list of countries taking such action now extends to Australia, Israel, and even the U.S. (driven by expanded Treasury Department monitoring of offshore company real estate transactions in Florida and Manhattan). In London these types of measures have knocked prices. It is too early to say elsewhere. What is the better solution? An abandonment of wild monetary experimentation rather than blunt interference — whether tax or regulatory — with the free play of markets.
The bottom line here is that the long-term mortgage and bond markets in the U.S., like the hot real estate markets, have been driven to highs by excitement about foreign demand — all the more grounds for worrying about the extent of the fall when the fever abates.
Brendan Brown is an executive director and the chief economist of Mitsubishi UFJ Securities International.
