OK and what's the failure mode if broad GDP growth remains stagnant, but the narrow real estate market continue to grow and increasingly unobtainable? Does it fail or does it in effect behave as two economies?
If the GDP remains low and inflation remains low then property prices will continue to rise. In fact if this happens the rate of rise may well increase over the short term.
To fight low inflation and low GDP central banks around the world have all been singing from the same song sheet by adopting the policy of Quantitative Easing (QE).
QE is basically a policy of printing money and it was designed to grow inflation, but all it has done is created a massive oversupply of cash around the world.
It is this massive sea of cash that is driving up asset prices around the world.
If these central banks continue to use QE then these cash levels will keep going up.
Now naturally you just can't keep printing money, but the question is when will the party be over and inflation start to bite?
The bigger problem is these low GDP numbers have a direct impact on society as it drives up unemployment and drives down wages, creating unrest.
You can see this unrest growing with events like Brexit, the rise ot Trump and the rise of extreme right in Europe, Australia and other countries around the world.
Without that GDP growth, political parties around the world will continue to feel the wrath of their voting public and politics and political parties will move further and further to the extremes.
Keep in mind that the poor Australian GDP growth is also whilst we are running record levels of immigration. GDP per capita, and perhaps more importantly, real net national disposable income (RNNDI, [1]) per capita have both performed poorly since 2008. Indeed, RNNDI per capita has declined to be only 0.4% higher than it was in 2008, and has declined continuously since December 2011[2], i.e. living standards in Australia have been falling for five years! House prices keep on rising.
Inflation is not a problem for Australia. Our problem is debt deflation. We owe so much to the rest of the world for our shitty $1 million fibro and brick veneer shacks that as terms of trade decline, servicing that debt (private debt, not public debt) will suck up all the income we have.
OK but not all asset prices are going up, it's pretty much just real estate and in particular residential real estate. Commericial real estate is doing well, but it's lagging compared to residential.
Bank loans are roughly 1/3 real estate mortgages, 1/3 commercial, and 1/3 consumer. QE affects all of these. So why is QE not resulting in growth elsewhere in the economy, being narrowly focused on real estate mortgages?
QE is not resulting in enough growth in the Western world, because there are just not enough profitable businesses for investors to pour their cheap money into.
Supplying cheap money is only one half of the equation to get investors to sponsor businesses: the other half that is needed is businesses with profitable business plans. And there the Western world has a problem: globalisation is moving mainstream business away to cheaper area's in the world. That is not a new thing, and traditionally Western economies have compensated that with new innovative businesses. And although there certainly is some innovation, it is not enough to keep up and keep the GDP growing. The aging populations in most Western countries contribute to that effect because younger generations are much more likely to take risks and start new businesses than the older.
QE is not resulting in enough growth in the Western world, because there are just not enough profitable businesses for investors to pour their cheap money into.
The central bankers created QE as a way to add liquidity into the markets to allow banks to lend, to allow small businesses to grow, to help economies to generate growth.
Unfortunately that money was lent to the big bankers and they realized they could take that money and make much easier profits.
The carry trade has been going on for decades and no one has taken any steps to stop it.
It is very easy to for institutes with big wallets, to borrow large amounts of money from central banks only to take advantage of countries with an interest rate differentials.
Then take a look at how JPMorgan Chase, after loosing billions on hedge positions, they took a US government bale out with the promise not to go back to their bad old ways of gambling with hedge positions.
They took the government money and sure enough put it all back on the table betting red, only find it came up black:
That's a very plausible theory, but I don't think it's the problem at all. It's more that pretty much all QE so far has just gone into financial assets, and extremely little of it has flowed down into the real economy. Hence we see asset prices rising (i.e. share prices and house prices), but little growth or inflation.
Another factor is that employee productivity growth has been very low in developed markets since 2008, as the dividends of the computer & internet revolutions have tailed off.
Car sales growing constantly, 80% of all purchases via borrowing. Prices are up too, but not radically so.
The assumption that money printing/QE leads to increased prices is based on the assumption of relatively limited supply for all things: certainly true in the past when mass manufacturing was relatively new and constrained, but given the huge drop in capacity utilisation after the Great Recession it seems you can grow consumption in some markets quite radically without driving up prices.
So if you print tons of money and it ends up in circulation via loans for cars, it may simply result in lots more cars being made and sold but not really big price increases. It may still reflect misallocation of resources, however.
House prices are a huge problem because supply is heavily constrained by building codes, the desire to live in cities, etc and people got it in their heads that a house is an investment whose price always goes up, so they're willing to pay an almost unlimited amount for one if they can get the credit. This isn't true for most other markets.
The failure mode is one most economists ignore, but was the key for the few who predicted the GFC - private debt. In Australia we have some of the largest private/household debt in the world. There tends to be a point where it becomes unsustainable, and the creation of debt (credit) starts to slow. What was observed elsewhere in the world was that if it slows down and goes negative (that is, the private sector of the economy starts deleveraging), unemployment tends to start to rise. (This is in line with some non-mainstream theories that beleive credit is a major driver of demand in the economy. Mainstream (neoclassical) economic models ignore debt because they assume that it's just a transfer of funds from a more patient person to a less patient person, but that's not actually how modern banks work).
If unemployment rises, people start to not be able to pay their debts. The default rate rises, banks sell up properties, and the prices tumble.
Recently we were reassured by the Government that the private debt level wasn't a problem because the assets (mostly housing) is very valuable and rising, but I saw a quote from the US in 2005 or 2006 saying exactly the same thing...
