Housing Market Braces For Interest Rate Hikes?

Per square meter prices for condos in the central Stockholm region has decreased recently, according to statistics from brokers, diagram above (SEK/m^2). A temporary effect or the impact of signals from the Riksbank, the Swedish Central Bank, that interest rates are soon going to be hiked from today's record low level of 1.5% p.a. As most households here fund their house or condo at short variable rates that are closely related to the Rikbanks' repo-rate, the Bank's decision has a direct impact on households finances. Conspiratory speculation: the bank cut rates this summer even as most Riksbank Deputy Governors during the spring told they were in favor of hikes. There is a general election this year so one could ask about the extent of political influences in the Riksbank. Or perhaps the other way round, will they hike in January just to show off their independence?

Money Talks Again

I don't know if it is because of the headline of the latest post, or if it is the lack of policing (my bad), but comment spam relating to money-making has apparently flourished here. Furthermore, a commercial enterprise in the finance-sector has asked to place a banner on this blog, paid for on a monthly basis. I'm most fluttered. Still it's not yet clear to me about what to post on a blog, and when to write it. Ideally, as I see it, inspiration and ideas gained from blogging should be a valuable input to your daytime job. Risks are of course that time gets wasted on interesting and exciting thoughts that eventually turn out to be unfruitful from a commercial perspective. My daytime tasks right now relates to the implimentation of the EU occupational pensions dircective (IORP) into Swedish law and pension managers' long term investment plans. Who on earth wants to read, where on blogosphere could I get some input? Anyway, I'll surf around and see what I can find, when I get some spare time.

(I swear this is wholly unintentional on my part, but the blogger spell check just suggested me to change the occurence above of "blog" to "bloc", and "blogging" to "flogging"!!?)

Money Talks

This blogger evidently took a long and unannounced vacation. It was not really vacation from writing; it was more the case that the texts I write for a living - about news with an impact on the Swedish bondmarket - got increasingly demanded and spare time hence increasingly scarce. Because of almost everyday practice from blogging in English? Maybe - anyway here is a text in Swedish by Liza Marklund, a successful writer of detective stories. It is about labor taxes, gender and everyday economics, all of which are favorite issues of mine (published as a column in the leading Swedish tabloid Aftonbladet; Social Democratic). With impressing clarity of thought she efficiently reveals how an important, but underestimated, sector of the economy and its taxation is built on old-fashioned and obsolete attitudes towards gender. I would have loved to summarize it for you together with a short background. Some other time maybe.

"Employment Lags GDP" - Really?

Amid faltering job-growth pressures have risen on the Riksbank to cut rates. There is hence a fierce debate focused on these two issues going on here in Sweden right now; the job-market and the central-bank policy (here is the latest contribution, in Swedish). Rather than adding anything to this, which seems more than fully covered by mainstream media, I would just like to comment on a very common but partially unclear use of language in this context. It is often said things like that "the labour market lags the business cycle". But plotting annual changes in GDP against annual changes in employment as measured by non-farm payrolls, the two appears to have developed synchronous from 1970 up to today. Hence it is actually perfectly safe to say that:

the labour market does not lag the business cycle!

Still the above sounds highly controversial - why? To me it seems that when it comes to employment, we are not satisfied with seeing the annual change of it rising - we do not feel that things are going in the right direction before the employment itself is acutally rising. With GDP however, the story is different, as soon as the annual change of GDP - or "growth" - is rising, we cheer the event that the business cycle has bottomed out and brighter times lies ahead. That the GDP change is still negative does not seem to matter in this respect as long as it is rising. So when we say that

"Employment Lags GDP"

we simply mean that the number of employed lags the rate of change of annual GDP growth. Given that employment and production is neither significantly lagging or leading each other, this is the same as saying

"GDP Level Lags Annual Changes in GDP"

which is trivial. Yet it might have given many of us the false impression that much faster job creation lies ahead. But in the US, job creation is conditional upon GDP growth, which has recently stagnated. The best thing we can hope for in Sweden is for job creation starting off with the much awaited expansion in the service-sector. But so far we are still waiting.

Why Are Asian Savings This High?

As I was writing about the bond-yield conundrum from the perspective of household savings in countries that are rising or recently have risen from poverty, Institutional Economics have apparently done the same thing. There, John Quiggin is quoted as writing "there is no convincing micro story as to why people in poor countries should want to save massive amounts", in direct opposition to my thoughts below. I was writing that a poor household optimally saves as much it can to lower the risk of facing starvation. This need not amount to much, or even to any net savings at all over time, as these households may now and then have to liquidate funds to survive. But, if these households, or households in the next generation apply the same method of saving when its possible, they might well end up with to massive if household income steadily grows in a prospering economy.

The general view, which is represented by Instituinal Economics, is however not that oversaving is caused by households, but by Governments:

I agree with John that it is perverse that we should see developing countries saving to fund investment in rich countries, but this is due to forced saving via managed exchange rate regimes. It is indeed ridiculous that China is issuing domestic debt to fund purchases of US debt instruments, as Deepak Lal has noted, but symptomatic of its mercantilist development strategy. I agree that this will not be sustained because fixed exchange rate regimes always come unstuck, but I see this as being more of an issue for China than for the US or Australia.

But to me, the claim that [the government of]China is "issuing domestic debt to fund purchases of US debt" seems a very good support of my household story. As domestic investors could find it more difficult to invest in US than domestically, the government here sees a natural business opportunity to channel the domestic Chinese demand for savings into US assets. Furthermore, I would like to question the currency-peg explanation. It is true that an undervalued currency stimulates export industry at the cost of domestic services, hence stimulating savings. But with arguments similar to those in the Balassa-Samuelson framework, the real exchange rate will anyway be adjusted by inflation, eventually neutralizing the nominal peg.

Why Are Interest Rates This Low?

Interest rates for long-term gov't guaranteed loans (yields on T-Bonds in the US) having fallen back to where they were when Greenspan in February called the low rates a "conundrum". Hence an opportunity to get back to the discussion on why most countries today have such an unusually low interest rate levels, at odds with economists repeated predictions of higher rates. For us in Sweden, this discussion is important for our central bank, the Riksbank's, whose board sees their interest rate levels as "basically very low", and looks for arguments to hike them in. This is troublesome, as politicians and some leading economists are calling for cuts amid a faltering recovery in the labor market and low inflation rates. Nevertheless, one board-member, perhaps by the market considered as the most hawkish, recently managed to discuss the subject in a speech called Unusual market rate developments, much influenced by that of Greenspan mentioned above with my comments here.

Several different reasons for low rates have been put forth, and it is easy to agree that factors like low expected inflation, central bank inflation targeting in increasingly productive economies, and decreased need for investments in an industry that manages to increase output while slimming production are important. Asian central bank buying and currency pegging is also to some extent helpful in explaining the low first world rates, but do these factors really have a bearing on the world interest rates, or are they merely increasing the spread between the effective interest-rates in e.g. China and the USA? But one factor, the hedge fund buying, long-standing member of the usual suspects, should be off the list since bond-yields now probably is seen as too risky, with all its variation (in the 4.0 - 5.0 % range for the 10-year treasury) for the return, especially in the view of decreased carry (aprox. bond-yield minus repo-rate). A new explanation has however materialized: pension reforms in Europe, and possibly elsewhere, that requires life insurers to match their liabilities, i.e. buy long and even ultra-long bonds.

But on the other hand are factors that acts in the other direction, interest rates are buoyed by consumers, most notably in the USA, that are rapidly expanding their debt, and by most of the largest world-economies' governments that are borrowing at a pace corresponding to several percent of total production, GDP.

All in all, the old rule of thumb that the rate net of inflation, the real rate, should correspond to the expected economic growth rate, does simply not work that well these days, as was mentioned in the Riksbank speech. Even though it is a rule with quite some support in economic theory, one should find good reason to examine, and perhaps overhaul it, today. Before, I have done so from several perspectives concerning households investment in their own human capital, skills and education. Today it should be enough to concentrate at the households financial savings, as the production perspective has, at least when it comes to the companies, been discussed in e.g. the Riksbank speech mentioned above. According to the rule of thumb, we save when we see worse times ahead, and borrow when the future looks brighter, to smooth out variations in lifetime consumption. Theoretically, we are assumed to optimize derived utility, which is supposed to be a smooth function of consumption with declining steepness.

In everyday life, at least in a place that has industrialized rapidly, consumption smoothing seems not to be on all household's agendas. The rule is rather that you should save while you can if you can, at least if you talk with people in older generations. And this rule was probably rational in the old days when saved money could save your life in times of economic hardship. Furthermore as we know that - or at least assume in policy-making regarding pensions - life-time saving decisions by individuals are not rational (a claim that is made probable by the lack of learning - you only retire once), the save-if-you-can rule might be inherited by younger generations. Theoretically, if your utility function displays a sharp knee between a steep line at poverty-level consumption and a flat one above, it might be rational to save, even at low or zero rates, until your risk of dropping back into poverty becomes low. Let us hence revise the rule of thumb:

A. If the representative household faces little risk of poverty and has distanced itself from traditional views on savings, real rates correspond to expected growth.

B. If the representative household still holds the traditional views on savings, real rates are much lower than you should expect in A.

And if we take the representative household to be one that belongs to a group that is responsible for a large part of world consumption, we should be much closer to the low-rate regime in B. than the old regime where the world outside USA, Japan and Europe really didn't count.

Free Lunch for Writers!

Some of us that are writing about the economy, especially with applications to finance, are sometimes getting away with earning almost free lunches. At least we sometimes get good paid by stating the bleeding obvious. If demand rises relative to supply, prises increase! Regions where this rise is the strongest will be net importers of the good in question!

From the Wall Street Journal via Institutional Economics:

in a world of excess saving relative to investment, not only will real interest rates be driven down, but some country or group of countries must run current-account deficits to absorb the excess saving

Update: Broken link fixed, thanks to Frans for pointing it out for me, and for the link from his post on a nearby issue. It seem that things like the changing distribution of world growth, directions of investment flows, and the new level of international interest rates are things that we still could discuss some more.

Job Vacancies Down

The number of new job vacancies were down for yet another week, according to the latest weekly report from the Labour Market Administration. Now the picture is beginning to look less optimistic than it did in the beginning of this year and in the end of last. The Riksbank wrote in its latest Inflation Report under the headline "Signs of improvement in the labour market" that "the number of new job vacancies reported to employment offices has risen". As is clear from the diagram is that this rise has slowed and reversed during the last couple of months. (Being more careful with seasonal adjustment makes the situation look brighter for the recent months, but worse for the beginning of the year. At any rate, the situation seems worse than it did according to the Riksbank's description)