Capital speculation

I should always begin a blog on economics with a confession that I am not an economist. If the brief argument I am about to make is conceptually holed below the waterline I will be happy to admit my stupidity…..

The announcement by Bank of England Governor Mark Carney of the intention to keep interest rates low until unemployment falls below 7% is surely good news for most of the UK, although there are riders to attach to the welcome. Powerful work from NIESR shows that underemployment can go up even as unemployment goes down. And, as the controversy raging over zero hours contracts reminds us, millions of people in the UK are working to take home a few quid a week more than they would be receiving on benefits (and that’s not because benefits are generous).

People may debate the economic virtues of Carney’s implicit message that low growth and unemployment is a bigger problem and risk than inflation but there is little doubt it is a good thing for social need and human welfare.  Although the Governor is careful not to overstate the shift, the move to a more balanced mandate for the Bank of England is long overdue.

However, there is one area where the argument looks different –where I am sitting right now, in central London.

Even before the economy picked up and Carney’s announcement I was boring people with a question that has been bugging me: whether, when and how the London boom will end?

Recently Mo Farah suggested a race with Usain Bolt, presumably on the basis that after falling behind over the first few hundred metres he would easily catch up over the long run. But, as the latest figures show, the national house price race is more like a race between Mo and a hundred Usains running in relay. It is not just that prices are going up but that the process of gentrification out from central London is accelerating. It took a generation for the rough part of Balham in which I grew up to transmogrify into the outer limits of the much sought after Nightingale triangle but Dalston, to take one example, seems to have gone from grimy backwater to being achingly trendy and eye wateringly expensive in about five years.

Part of the reason for this – one often cited to explain why the process of property inflation can continue unabated – is that central London is a global property market: a sure fire investment haven for international money (both legitimate and dodgy).

If central London were a country people would surely be making the case right now for some pressure valve measures. Indeed Boris Johnson has argued against various Government policies which will accelerate the process of central London becoming an overpriced, under-occupied ghetto. But the Mayor has few relevant powers and, with interest rates staying low, the bubble looks set to keep growing.

All bubbles eventually subside – the question is whether it happens gradually or through a big messy bang. Are the risks of the latter growing for London property? Perhaps so for two reasons.

The first is the size of the gap between the market value and the use value of an asset. The use value of property combines its material characteristics (size and state of repair) and its location (the various advantages that come from central London living). It is the latter that makes London properties more attractive. But there must ultimately be a price point where the inconvenience of commuting and the loss of inner city ambience seems worth accepting. As long as we assume prices will rise this isn’t relevant but if London property started to lose value the equation would rapidly look very different. Threatened with losing the gains they have made on their house value, renting, downsizing or living in lower priced areas of outer London or the suburbs might seem urgently attractive to owners, particularly if growth in the rest of the economy was seen to presage higher interest rates.

The main check on house price volatility is the costs and wear and tear of moving. But with more property owned by investors or buy to let traders there are more people for whom putting their house on the market is no more complex than a call to their financial agents. Threatened with losing the gains they have made on their London investments, international buyers would certainly have no compunction in trying to dump their assets while they can.

The London bubble may carry on growing for a lot longer. Maybe the adjustment when it comes will be predictable and smooth. Certainly, such an adjustment would, over the medium and long term, have many upsides for the economy as a whole. But a contagious collapse would not only be potentially disastrous for hundreds of thousands of Londoners but it could – given the importance of the capital to the nation as a whole – have major knock on effects.

We pay careful attention here at the RSA to our risk register and take mitigating action if the combination of likelihood and salience goes beyond a certain level. If I were in the Treasury or the GLA – or even if I were a highly mortgaged London property owner (which, as it happens, I am) I would be putting a London bubble burst quite a bit higher up that register. Whether anything much could be done in mitigation is, of course, another question entirely.