It’s not some wayward doom-and-gloomer who said it, but the Economic Research arm of Natixis, the investment bank of France’s second largest megabank, Groupe BPCE.
The analysis was talking about the Bank of England. But the Fed and other central banks, with their ingenious monetary policies, have created similar scenarios where only the nuances are different. And now these “triggers for the next Financial Crisis” are cluttering the future, enough to where an investment bank, an entity that has tremendously benefited from these monetary policies, is beginning to fret.
“We are concerned about the UK economy,” Natixis starts out, though the UK economy is currently the shining model in Europe, where a tsunami of money and government coddling of banks appear to have solved all problems.
The analysis goes through its logic step by relentless step. Since the Financial Crisis and the deep recession it brought to the UK, growth has largely been powered by the inflation of asset prices.
UK household demand “reacts strongly to changes in property wealth,” the report said. So soaring home prices entail a sharp rise in consumption, a phenomenon that appeared in 2003, then 2006, and most recently in 2013. This is followed by a tidal wave of home buying, which started in 2004 (three years before the Financial Crisis) and once again in 2013. It’s followed by a similar tidal wave of housing starts. All of which give a strong boost to economic growth.
That “wealth effect” for property-owning households is paralleled by similar effects on the corporate side. Soaring commercial real estate prices and skyrocketing share prices “helped kick-start corporate investment” from 2005 to 2008 – just before the Financial Crisis – and once again after 2010, when commercial property prices and share prices were re-soaring. Natixis:
It is clear that the expansionary monetary policy pushed up asset prices from 2002 to 2007, from 2010 and especially 2013.
So what’s the outlook? More of the same.
The return to full employment in the United Kingdom has not caused any inflation, due to high labor-market flexibility, and especially the increasing prevalence of very flexible employment contracts, which reins in labor costs.
The number of employees with a “zero-hour contract” has more than tripled over the last three years. These employees have no guarantee of work, no pre-set schedule, and no fixed number of working hours, but can be called in on short notice whenever needed. And they’re paid only for the hours they work. But hey, these zero-hour contracts – labeled “exploitative” by Labour Party leader Ed Miliband, among the losers of the last election – keep labor costs down. The winners love them.
So there are few wage pressures and little inflation for the Bank of England to fret about. But taking away the monetary punch bowl would ruin the party and “cause a downturn in asset prices,” on which the UK so heavily depends for economic growth, and it would therefore cause a downturn in the economic cycle. So the Bank of England won’t raise its interest rates, “even after a long period of expansion.”
So far, so good. Creating wealth out of nothing and out of free debt that then creates real economic growth is the free lunch everyone wants. The process continues:
Given the UK economy’s very great sensitivity to monetary policy via its effect on asset prices, especially real estate, the expansionary monetary policy is irreversible….
This continuation of the expansionary monetary policy “will also ultimately kick-start credit in the United Kingdom, which is starting to become the case for households.” The mountain of debt grows. But….
The Bank of England does not dare to raise its interest rates again for fear of choking growth which is heavily dependent on rising asset prices, especially real estate prices. The persistence of a very expansionary monetary policy is increasingly fueling a price bubble in residential and commercial real estate, and will in the future push up debt ratios.
The inevitable consequences of real estate bubbles? They burst. And when they are bursting, according to the report, they will:
- Cause a fall in demand and activity;
- Cause a fall in the sterling exchange rate, which is boosted by non-resident investments in UK real estate….
- Create a banking crisis if credit has had time to rebound.
What can the Bank of England do to save the day? Not much: “The fall in activity could not be offset by a cut in interest rates, which the Bank of England is keeping very low.”
So the scenario could look like this:
The bursting of real estate bubbles in the United Kingdom, with knock-on effects on growth, banks, and the sterling exchange rate, will possibly be the factor triggering the next financial crisis.
Nice job, Bank of England, and all the other central banks, including the Fed, that have pursued the same ingenious monetary policies to accomplish the same goals of asset price inflation at all costs.
What’s going on in the US today isn’t a housing bubble, of course. Nationwide, home prices are now finally close to where they’d been at the peak of the totally crazy prior housing bubble. Still not quite there, but almost. But already, the “sweet spot” has shifted out of reach. Read… San Francisco vs America in Housing Bubble 2
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