When Will the Bubbles Burst?

Many young people hoping to buy a home of their own, and older folks with money they hope to save for retirement, have to decide their course of action in a world of debt-driven asset price inflation enabled by central bank interest rate policies that have driven bond and bank deposit yields to near zero or beyond.

House price indices from China to Peru. Source

If that world remains unchanged, the best investment strategy is to assume as much debt as possible and buy real estate or stocks. From China to Peru (see graph), this is what many people are doing.

But that strategy raises the key question: what will cause the asset price bubble to “pop”? And when?

In answer to that, many will say nothing in the foreseeable future, since the deflationary forces of globalization, automation, computerization and robotization combined with effects of income redistribution are so powerful that only a central bank pyromaniac would provide sufficient monetary stimulus to create inflation. Thus, according to this view,  interest rates will remain low or negative indefinitely, and asset prices will either reach a permanently high plateau, to quote one of the sages predicting continued prosperity just moments before the Great Crash of '29, or they will continue to inflate.

The logic of that position is clear. All other things being equal, ever cheaper money means ever more debt, of which much will flow into assets, mainly RE and stocks. Under these circumstances, the only thing that could cause RE to implode is overbuilding, which, so the received wisdom maintains, could only happen in a crazy place like China where they build cities for millions entirely on spec.

As for stocks, the sky's the limit as long as the yield is higher than on the alternative — mainly bonds, which in many cases now have negative yields.

So what could cause interest rates to rise? Western central banks are surely in no hurry to repeat Alan Greenspan’s pre-2008 exercise of 17 successive rate increases, and the forces of deflation will continue inexorably.

But Donald Trump has a plan. He plans to build two walls. A tariff wall to keep out cheap Chinese stuff; a prefabricated concrete wall to keep out cheap labor. The result, if this plan is implemented? A return to good old 1960’s style inflation driven by increasing labor costs at all stages in the design, manufacture and distribution of goods. That will drive interest rates much higher, which  means that houses in North America will revert to two to four times family income from the present crazy multiples in cities such as New York and San Francisco, Toronto and Vancouver.

Whether such a scenario will play out, who knows? But if by November Donald Trump has sold off most of his RE holdings (during his campaign he has often boasted of the terrific prices his NY apartments are selling for), watch out.

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