Homeowners in the UK, depressed by Britain’s economic outlook, will have been cheered by evidence that the asking prices for London houses are now at least 20 per cent higher than they were this time last year.
This may be because cuts in public spending promised by UK Prime Minister David Cameron’s coalition government will probably fall most lightly on those living in the British capital. But there is, nevertheless, something perverse about the trend. Why should the book value of the assets of UK property owners rise so fast when everyone else is expecting to get poorer?
The confusion seems to be spreading. Expert opinion is divided about the right way to deal with the Greek debt crisis. There are signs confidence is draining from the whole eurozone. Stock market volatility everywhere has increased.
Everything looks more like a gamble. BP shares, the cornerstone of many Briton’s pension funds, fell 13 per cent on 1 June on fears the company’s future was being jeopardised by its failure to contain the Gulf of Mexico oil leak. Its chief executive Tony Hayward may not be the only business leader who might soon be displaced. Tidjane Thiam, chief executive officer of UK financial services company Prudential, was under pressure in early June amid signs his company’s attempt to buy the Asian arm of US insurance corporation AIG had failed.
Almost three years after the global credit crunch reached a climax, there is no sign that lasting stability has been restored. This is still regarded by most economists as an aberration. The majority continue to believe markets automatically stabilise. And even critics of conventional economics, such as Nobel Prize-winner Joseph Stiglitz, argue that stability can be regained by judicious regulatory action.
The Stiglitz view will soon be put to the test. US Congress is debating a new regulatory system for American banking. The detail is not yet agreed, but there will be a big increase in the amount of capital banks will be required to have to support lending.
Even the new code’s supporters say it will lead to a sharp reduction in the amount of bank lending as a proportion of total economic activity. Sceptics argue the measure will throw the US and the global economy into a new recession.
But most experts believe it will reduce volatility. They argue banks were critical in creating the bubbles that burst in 2008. If they cannot lend as much, there will be fewer bubbles. When they burst, the impact will be smaller. And if closer regulation and more supervision are added, then the chances are greatly improved that global economic growth will sustainably resume.
Conventional economic thinking, however, is based on the idea that markets for intangible goods operate identically to those for tangible ones. So as long as buyers believe that intangibles, such as loans, are conceptually interchangeable with tangibles, such as cars, the economic outcome is the same.
This reasonable proposition is logically false. A good that has no physical existence could not be more different to one that does. Trade between buyers and suppliers of intangibles is only possible if the parties to the transaction agree that they are dealing with the same thing. In other words, that what they are independently imagining is in fact identical.
This may be possible in unmediated personal transactions, but it is not when an intangible is traded and re-traded through an electronic market. You can be motivated by dreams and sometimes fooled by them, but you cannot trade dreams like gold or wheat.
The key to transactions in intangibles are interpersonal relationships. But these are the very things markets displace. Buying a promise made by someone you do not know to someone you do not like is not the same as making and accepting a promise directly. Market mediation automatically increases risks in intangibles, consequently driving up prices unpredictably and fuelling speculation.
Policymakers have yet to recognise the main reason why markets everywhere are going nuts. Rather than dealing with the fact that markets for intangibles always fail, they are focusing on one of the symptoms, which is excessive bank lending.
They may even appear to be right for a while. De-leveraging and more regulation may have no serious impact on the global economy if government fiscal and monetary policies continue to be permissive. But they will do nothing to reduce the volatility and short-termism that has the global market by the throat. The effect will be probably the opposite of that intended. An economic policy that causes big London house price rises will only encourage people to invest more in UK property. This will inevitably lead to another enormous bust.
The short-term problems have long-term counterparts. Advanced economies have good infrastructure, but they need to keep investing in it to support future population growth and economic activity.
And yet, governments around the world are spending practically all their time worrying about regulating finance and other intangible markets, rather than ensuring that vital infrastructure is built. The idea that properly functioning markets will automatically deliver roads, railways, ports, airports and houses was always misconceived. At a time when intangibles dominate most advanced economies, it is a theory that is actually positively damaging.
The issue is even more pressing in the Middle East and other economies that are seeking to grow their way out of poverty. What they need most is massive investment in basic transport, energy and social infrastructure. Whether that is delivered by public investment or though private-public partnerships is a matter of indifference. Developing countries need to build for the future, not tinker with policy.
Modern economics is a hypothesis made by brilliant yet impractical people. As a new bout of volatility gets under way, what economists see in their imaginations will come increasingly into conflict with the reality obvious to the rest of us: That the world is still on the wrong track.