Curse of rising house prices

The hardest thing to do during a revolution is to grasp how it might be perceived a decade later
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The Independent Culture
INFLATION IN Britain is at the lowest level for a generation; yet house prices - in the south at least - and share prices are soaring.

This strange paradox, that one sort of inflation has disappeared yet another sort is whizzing away, is not just a British phenomenon. In just about every developed country the prices of current goods, the things you buy in the shops, are more or less stable. In some they are falling. Meanwhile the price of almost any kind of asset - land, homes, fine art, and, of course, shares on the stock exchange - is at record levels.

On the one hand, if the present trend in inflation is truly set, and the majority of economists now think it is, people are on the brink of experiencing something of which no one under the age of 70 has any knowledge: true and lasting price stability. Not since the Thirties has there been real stability in prices in the shops - even during the Fifties and Sixties prices crept up a bit - and companies and retailers are still struggling to work out what it means in practical terms for the way they run their business.

Yet on the other, there seems to be a boom in asset prices that is not so different from the excesses of the Eighties. That strange word "gazumping" has returned to the headlines, raising the nasty thought that maybe, just maybe, that other expression that succeeded it - "negative equity" - might be just around the corner.

So is one sort of inflation bad and the other good? Why do central banks and finance ministers preen themselves when prices are stable in the shops but seem almost proud that the prices are rising on the stock exchange? One is always presented as an evil that must be crushed, the other, apparently, a vote of confidence in their sound economic management. How do we make sense of it all?

I think the hardest thing to do when we are in the middle of a revolution is to grasp how this time might be perceived a decade or more hence. People who have lived all their lives on the assumption that inflation will continue in some form or other inevitably find it almost impossible to envisage a world in which prices are as likely to fall as to rise. It is as hard for us now as it was for an earlier generation, schooled on a century of price stability, to understand that inflation could destroy everything that had saved for their retirement.

And not just hard for us. It is hard for central bankers, reared on the principle that your prime job was to kill inflation, to realise that your guns might be pointing in the wrong direction. The old enemy is dead; but there is a new one lurking round the corner.

It is very easy to make the case for the advantages of reasonable price stability of the things we buy in our daily lives. Inflation in the price of ordinary things was at best a nuisance and at worst deeply damaging. For a start it created conflict. Remember how workers had to confront their employers simply to get enough of a pay rise to compensate for the loss of purchasing power of their wages? It became impossible to work out what was a fair price for something because the seller could always say that inflation had pushed up the cost of making it.

It was unfair, since workers in strong bargaining positions and companies with monopolies could use their power to garner a larger share of the cake for themselves. The weak, the old, the unemployed, small companies, children - indeed anyone who was in a poor bargaining position - duly lost out.

And it was inefficient, because sometimes a surge of inflation would bail out a company that had made a bad investment decision, while sometimes a similar surge in another part of the commercial forest would mean that a good company, caught on the wrong side, went bust.

Maybe there is some nostalgia for those large but ultimately illusory annual pay rises, but there shouldn't be. In both social and economic terms inflation in goods and services was almost invariably a disaster.

But if we believe that now, with a pretty high level of confidence, what about the other sort of inflation, the one we are still experiencing, even enjoying? Is boasting about the rise in the price of your house as self-defeating (not to say distasteful) as bragging about the size of your salary increase?

I suggest it is, and that we will come to see the present surge in house and share prices as almost as dangerous economically - and certainly as divisive socially - as the old inflation in the price of consumer goods in the shops.

Think about the rise in house prices. Who benefits? People who have already bought their homes are, generally, relatively well-off. The bigger the house, the bigger the gain. So it has been the people nearest the tip of the pile who have done best. True, they may feel no better off in the sense that they are still living in the same place, but in relative terms they are certainly better off - relative, that is, to the poor people who are starting out or to those who never managed to get their toes on the housing ladder in the first place.

So the rise in house prices in general transfers wealth from poor to rich, from young to old, from financially inept to financially astute and, since there are vast geographical divergences in price trends, from people in the north to people in the south. Can it really be desirable to make it harder for young people starting families to buy a home for themselves?

What about other asset prices? The key ones here are shares on the stock exchange. If a rise in share prices reflects a genuinely better performance by the company concerned - if it is doing well, producing better products and, hence, profits and paying out higher dividends - then sure, it is welcome. To some extent the rise in share prices over the last decade just about everywhere in the developed world bar Japan does reflect improvements in the way the underlying companies are run. The best try harder to please their customers, produce better products and harness the enormous power of the technologies to produce a genuinely better outcome.

But not all do. Share prices here, in most European countries and, particularly, in the US, are very relative to their profits. As a result, the actual payout a saver gets in dividends for any pound or dollar invested is about half what it was seven or eight years ago. It might seem great for people to feel richer if you are not interested in the running return from those savings, just as it seems great to have lower interest rates for anyone wanting to borrow money. But for people reaching retirement age and finding that their pension is much lower as a result of this fall in returns, the fall in yields has been a disagreeable shock.

In any case, share price inflation also redistributes wealth in a capricious way. The winners, of course, include the rich and the children of the rich. The losers include those who have been unable to amass the pot in the first place and those who happened to be born to less wealthy families. Socially this is tremendously divisive. While few of us resent people who work hard being well paid for their efforts and most of us would want people who save to have a decent return on those savings, asset inflation by definition hands out wealth to those who already have assets - and makes it harder for others to acquire wealth in the first place.

To say all this is not to call for a house price crash or a collapse of share prices. That would be just as divisive socially, hitting people just as capriciously, and it would naturally be damaging in economic terms, too. It is to say that, while we should certainly be pleased about the fall in one sort of inflation - that measured by the monthly price indices - we should also be concerned about the other sort, the sort reflected in house and share prices.

Be concerned, yes, and be sensible. Much of the present buoyancy in house and share prices may be justified by the performance of our economy. But all of it? I think not.