Economic Myths: Falling GBP will push up UK house prices

From The Independent:

Estate agents in the UK have been swamped with calls from Chinese, Middle Eastern, Italian and Spanish buyers looking for a bargain after the pound tumbled to more than 30-year lows, making the exchange rate very favourable for foreign buyers.

With global commodities like oil, if GBP falls and world price of oil stays the same, then the GBP price of oil goes up, obviously.

Not so with land and buildings. Land and buildings sell for a multiple of the rental income and the rental income is in GBP. So if GBP falls, the rent falls in foreign currency terms and so the price which a foreigner is prepared to pay also falls in his own currency terms, and by definition is unchanged in GBP terms. The two effects neatly cancel out.

So in practice, GBP levels against other currencies have no little no effect on the selling price of UK land and buildings (in GBP terms). This is easily observable, or more to the point, is not observable at all because the effect does not exist, or the effect is so faint it is masked by 1,0001 other factors.

I can see the obvious counter-objections to this and I might as well deal with them.

1. "Ah, but wealthy foreigners aren't snapping up London homes for rental income, they are buying them to show off to other rich people."

Quite true, but when wealthy foreigners are bidding, the baseline is that they have to outbid the locals i.e. people who earn GBP and will be paying in GBP.

Further, it is a similar set of factors which influence GBP levels as influence the price of land and buildings, the two seem to move in tandem rather than in opposite directions (interest rates being one exception, a cut pushes GBP down but pushes the price of land and buildings up).
------------------------------
UPDATE: Inevitably, people appear to believe that wealthy foreigners don't care about underlying i.e. rental values, or even showing off, they are doing it because it is a safe haven for their money and they are hoping for capital gains. The first part is clearly not true, if they wanted a safe haven for their money, they could buy 100 ordinary homes instead of one mansion in Westminster. So perhaps the second part is true, they are gambling on capital gains - and they have been right so far.

Nonetheless, put yourself in the position of a wealthy foreigner who wants to speculate in high end London homes. Two come up for sale, a smaller one with an annual rental value of £100,000 and a larger on with an annual rental value of £200,000. Which one would you bid more for? Not difficult, is it?

And of course, in all cases, it is local - earning and paying in GBP - who set the baseline for what you have to pay for the top couple of percent, even if we ignore the fact that homes sell for a multiple of rents.
------------------------------
2. "Foreigners will gamble on GBP bouncing back."

Sure, but everybody can do that and there are simpler ways of speculating on currencies than buying land and buildings, with far lower transaction costs. And at any one time, we have to assume that whatever the FX rate (or any other random financial market variable) is, half of people expect it to fall and half expect it to rise.

Nobody move or sterling and interest rates get it!

Yesterday's Project Fear output, via MBK:

From The Times:

Leaving the European Union would immediately cause the value of the pound to plummet by as much as 20 per cent, while income tax would have to rise to counter cuts in migration, a respected think tank has warned.

A vote to leave would result in a “significant shock to the UK economy”, the non-partisan National Institute for Economic and Social Research has said, as it presented prospects for the UK up to 2030 in the event of Brexit.

From The Telegraph:

The Bank of England will need to raise its key interest rate or Bank Rate to 3.5pc by the end of next year if Britain votes to leave the EU, the newest recruit to the Monetary Policy Committee has warned privately.

Michael Saunders, who was chief economist at Citibank, and will join the rate-setting MPC in August, said the drastic rise would be needed because Brexit would cause the pound to collapse, which would send inflation sharply higher.

If we were to stupid enough to reduce 'good' immigration (younger, healthier, skilled/working, ready to integrate) then yes, income tax rates on everybody else might rise a bit, some people say that would be a price worth paying. I don't think it is, but clearly, if we reduced 'bad' immigration, tax rates would go down a bit, which looks like a win-win to me.

The rest of their logic seems to be [unspecified cause] = GBP falls = inflation rises = Bank of England has to increase interest rates.

There's no particular reason to assume that Brexit would cause GBP to fall that dramatically, but even if it did, what would be the knock-on effects? No need to ponder too hard, let's just look at the last two instances of this happening - after Black Wednesday in 1992 and between 2008 and 2012, when GBP fell by a quarter each time.

There was surprisingly little impact on consumer prices (putting land prices to one side) in either instance, and the Bank of England did not increase interest rates - during both periods it actually reduced them (leading to land price inflation).

So nothing to worry about, as per usual.

"Sterling falls on Brexit fears"

Said all the headlines last week. The BBC goes with Pound hits lowest level against dollar since 2009.

As per usual it is a load of flummery. I've done some charts showing each currency against a basket of other major currencies (the vertical scale is arbitrary, the long run average for each is about 1).

It is true that GBP has fallen again recently, but it's still well above its low point of 2011:


Here's the chart for EUR for the same period, in relative terms, EUR has fallen against GBP over the five years, from 90p at the peak, down to 70p and then a recent uptick to nearly 80p:


If anything, it is USD which recovered, from a low of 62p (which happens to be the average since 1990) up to 72p today:

Sterling: still not overvalued

Here's a chart of GBP vs a basket of other major currencies from 2009 onwards.

Clearly, it fell rather dramatically for three years from late 2007 to late 2010, then it scraped along the bottom for two years, but inevitably it has now climbed back a bit to be six per cent lower than its long run average*; there's no reason it wouldn't go back to that long run average over the next year or two.

That all depends on whether the other countries' economic policies are more or less stupid than ours, chances are they will all be equally stupid.


* Because of of subtle difference between harmonic and mathematical averages, the long run average for GBP is actually 0.96, not 1.0.

The UK: a house price based economy with a house price based currency.

The first chart is house prices adjusted for inflation since Q1 2004 from Nationwide. The second is the British Pound (GBP) averaged out against other major currencies (6-month moving average) since 1 Jan 2004. Surprisingly similar.

Scotland and Sterling

From City AM:

If Scotland left the UK but kept the pound, and was cut off in every other way, it would end up like Ecuador, El Salvador and Panama.

These economies are dollarised (Scotland would be sterlingised); they use the greenback but don’t benefit from a banking union or any other kind of assistance from Washington or the Fed.

In the event of a banking or sovereign crisis, they wouldn’t be bailed out by anybody; and they wouldn’t be able to print any money themselves as they don’t control the currency.

If you have a banking or "sovereign" crisis (whatever that is), you are doomed anyway, this is an opportunity to chuck everything in the bin and start again.

See for example Germany in 1948, they just started all over again with the DM, which was a resounding success. If you are stuck in a currency union, this gets a whole lot nastier/trickier, as the PIIGS have found out.

And as he goes on to explain, the lack of a safety net/moral hazard has led to all-round better outcomes in those named countries anyway.

The point is though, anybody can "print" any amount of any currency he likes, because "printing" ultimately means "borrowing". When you take out a loan, you are "printing money". Bank notes, cheques, IOUs are ultimately all the same thing.

The only limiting factor is your credit rating and people's willingness to lend to you, and the fact that you are not in a formal currency union with a Bank of England safety net (which is purely for the benefit of banks and not the country as a whole) is no particular barrier to using Sterling or something bloody close to it - see for example Isle of Man or The Republic of Ireland until 1978.

2013 year end FX musings

GBP appears to have bottomed out. Interestingly, it goes in line with house prices - currencies and land values are both driven by the same speculative flows - rather than moving inversely to house prices:

Most of the currencies are also on the up (from a low base, USD, EUR, CAD) or near all time highs (SGD, CHF and AUD). The only one which is approaching the bottom is JPY:

So if you were thinking of taking a punt from GBP into JPY, those charts seem to say "hang on a bit, give it another month or two". The message from the simple JPY vs GBP chart for the last five years is "pile in now, it's a good a time as any":

GBP versus UK ten year gilt yields

Just for fun, here are charts for the last ten years showing:

a) The yield (interest rate) on UK ten-year government gilts (click chart for up to date version),

b) GBP (£ pound sterling) against a basket of the main currencies.

There seems to be quite a strong correlation, doesn't there?

The simple explanation for this is that people want to invest in currencies where they can earn more interest, so when our interest rate goes up, investors and speculators pile in, and when it falls, they all abandon ship.

It is relative interest rates which matter, i.e. if interest rates around the world are 5% and a country drops it interest rate to 1%, then people will take their money out of that country/currency.

But interest rates move pretty much in tandem all over the world. Since the "financial crisis" most central banks have been paying less then 1% interest on short term stuff. And if interest rates around the world were 5% and they all dropped their interest rates to 1%, then this has no particular impact on currency flows or currency levels. Why does it have such a strong impact on GBP?

GBP, EUR, JPY

I've updated my currency spreadsheets for the first time in a while.

In short:
GBP is still scraping along the bottom.
EUR seems to be bouncing back a bit.
JPY has nosedived impressively by twenty per cent over the past 12 months, it's back below its long-run average. All to do with Abenomics, I guess.

Economic Myths: The UK house price bubble was merely the flip side of sterling devaluation

This is something which all sides like to trot out; mainly the Austrians and Faux Lib's, but also some of the priced out-conspiracy theorists, and the Homeys like to use the retrospective justification that owning land is the only good hedge against inflation (Home-Owner-Ism is in fact the main cause of inflation).

The theory ignores the basic fact that currencies can't all devalue relative to each other, and that there were price rises in nearly all Western countries (and in PR China) between the mid 1990s and 2008 or thereabouts. The argument that net immigration causes house price rises suffers the same flaw: even in countries with net emigration, there were house price rises over the same period.

And all the evidence points in the other direction: there is a positive correlation between the strength of sterling and UK house prices.There are subtle reasons why one causes the other, or perhaps they have a common third cause (it might be as simple as the fact that what is good for the UK economy is good for GBP and pushes up house prices and vice versa), see footnote*, but hey:

I think it would be fair to summarise those charts thusly:
- From 1990 - 1995, GBP and house prices both falling;
- From 1996 - 2008, GBP went back up sharply and then plateaued; house prices rose steadily throughout;
- In 2008 and 2009 GBP and house prices fell sharply
- From 2010 - today, GBP and house prices have been bumping along the bottom, both drifting down slightly.

That looks like a positive correlation, not a negative one which is what the Faux Lib's claim.

* The main cause of high house prices is an increase in the amount of credit created by banks; the bankers are probably the main driving force behind all this, along with a few very large landowners:

GBP, EUR, AUD

GBP is still scraping along the bottom of the chart, and hasn't really changed much in the last two years:
The EURocrats are playing the same game as the British government but there appears to be some way to go yet (another few per cent down?):
The only major currency which looks possible a bit toppy is AUD:
Usual rules apply: the charts from 1990 to date, except AUD which starts a couple of years later and you can click to enlarge.

Euro slides, sterling surges...

... are not the kind of fatuous headlines you will find on this blog, unlike at Reuters and the Wall Street Journal. Yes, over the last 24 months, EUR has gone up a bit and down a bit in terms of GBP, and at the moment it is 'down a bit':But if you look at a twenty-year chart of each currency against a currency basket, the last few months are just little up or down ticks. It looks as if GBP is finally bottoming out again after its precipitous falls of 2007 and 2008, that's about all that's worth mentioning:

Currency Wars: GBP, AUD

Here are the charts for British Pound and Australian Dollar against a basket of currencies since 1990:

Oo-er, this is not good...

From BusinessWeek:

The Bank of England said it plans to sell three-year bonds in dollars to finance its foreign-exchange reserves.

The U.K. central bank hired Barclays Capital, BNP Paribas SA, Goldman Sachs Group Inc. and JP Morgan Chase & Co. to manage the issue, which will be benchmark in size, it said in a statement. The bank paid 106.2 basis points more than Treasuries when it issued $2 billion of three-year notes in March last year, according to data compiled by Bloomberg.

“The notes will likely receive good investor appetite seeing that it’s a AAA rated name,” said Trevor Welsh, a portfolio manager at London-based Aviva Investors, which manages about 10.5 billion pounds ($14 billion) of fixed-income assets. “This bond sale is purely a technical move for the bank’s foreign currency reserves.”

The Bank of England is seeking to raise funds as confidence in the U.K. currency plummets on concern no party will win an outright majority in a forthcoming general election. The pound weakened 7.6 percent against the dollar this year, the worst performer among the 16 major currencies, as traders bet a new administration won’t be strong enough to reduce the nation’s budget deficit of more than 12 percent.

“It will be interesting to see if investors require a slightly higher spread because of sovereign risk,” Welsh said. “But if so, it won’t be more than a couple of basis points.”

The central bank has issued three-year notes in March every year since 2007 to finance foreign-exchange reserves that support its monetary policy objectives, according to the statement.

Make up your own mind whether this means much. Sure, $2 billion is a drop in the ocean, but who's to say it's not the thin end of the wedge? Me, I don't like it. Although to be fair, I ought to seriously consider buying some, just as a hedge...

Via Paul at HPC

Sterling, Australian Dollar

Here's the up-to-date chart showing sterling against a basket of other currencies since 1990. As you can see, it recovered a bit and is now heading back to it's all time low of nine months ago, but it's not an absolute disaster or anything (the UK economy is doing badly, but only marginally worse than the others). Click to enlarge:

The only currency to have done staggeringly well this year is the Australian dollar, as it happens. It crashed late last year when the JPY carry-trade bubble burst, but Australia was one of the few countries to have hiked interest rates slightly in response to the global property price bubble (rather than cutting them to keep it going) and so even though it has reduced its base rate (to keep the economy going - so far they have avoided a recession, allegedly), it's still much higher than in most countries. Click to enlarge:

My currency basket

For the record, when I post charts showing currency movements, these are all against the same 'basket'. Commenters have asked me how I calculate this, so I shall explain it properly and add this post to my 'Quick links' widget in the top right hand corner.

Step 1. I can't be bothered to ascribe relative weights to each country, so I use two currencies from the North American bloc (USD and CAD); three from the European bloc (GBP, EUR and CHF) and three from Asia-Pacific (JPY, AUD and SGD), so the overall weighting is 'roughly right'. I don't include Chinese Yuan or Hong Kong Dollar as I don't trust them as far as I can throw them.

Step 2. Using GBP as a base currency, I download daily rates from the excellent www.oanda.com (starting from 1 January 1990) 'A'.

Step 3. I then adjust the daily value (in GBP terms) of each currency by dividing it by its long-run average value (in GBP terms) 'B'. For example, EUR is currently GBP 0.9021, but its long-run average is GBP 0.7090, so that then goes into the calculations as 1.2724 'C'.

Step 4. For each individual currency, I add up the 'C' values of the other seven currencies (GBP is always 1.00, of course) and divide it by 7 to arrive at 'D', the value of a unit of 'world currency' from the point of view of each individual currency.

Step 5. Each individual currency then gets divided by the value of one unit of 'world currency' to give the final value 'E' that I use in my charts. For good measure, I also add 183-day and 365-day moving averages.

Here's the example of how I calculated the final value 'E' for 10 April 2009 (the actual spreadsheet I use is in rows down, not columns across, of course), click to enlarge:

Just sayin', is all.

Smug, self-congratulatory post

As I said on 29 December 2008, when I swapped my AUD back into GBP, "... there is always a distinct possibility that GBP has overshot its 'fair value' (whatever that is) i.e. is undervalued, i.e. is worth buying. It's not like all the other economies aren't going to tank as well." 

Although AUD has gone up by 1.5% in GBP terms since then, other currencies have gone down a few per cent, so overall GBP has gone up by a couple of per cent against the basket of major currencies. I shall hereby give myself a pat on the back for calling the bottom to within a per cent or two, as per the updated chart (click to enlarge):
I have no strong opinion as to what happens now, GBP might fall again, it might rise, or, what's most likely, it might just bump along the bottom for the next couple of years.

Even if I did have an opinion, I'd also have to choose another currency to move into, and there aren't any that appear to be as undervalued as GBP at the moment anyway. Further, I'm not keen on converting significant amounts of GBP into another currency as I don't really trust banks any more, not even with sums up to £50,000.

UPDATE: re Dearieme's comment, here's CAD against the same basket of currencies (since 1990, not just since 2007, click to enlarge):
Has CAD touched the bottom of a fourteen year upward trend-line, strengthening at a modest one per cent per year? Maybe, but I wouldn't get excited about one per cent growth per year.