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Housing Bubble on the Thames

With London England the new place to be for oil-rich Russian oligarchs and Middle Eastern sheiks, the question going around is whether house prices are in a bubble. Despite a brief blip down with the credit crunch in 2007-08, prices are back and higher than ever. london real estate The ever-entertaining Tim Harford chimed in recently with a very sensible opinion that economists have a very difficult time identifying what, exactly, constitutes a “bubble.” One way to look at whether prices are “fair” (short of the obvious answer that “they must be if someone is voluntarily willing to pay the price”) is to look at the price of the foregone alternative. In the housing market you either rent or own. We can compare the cost of renting an abode with that of purchasing it outright to see whether property values are fairly valued. By this measure homes in the US and Japan, according to Harford, are reasonably priced by historical norms while in London they are about 1/3 over-valued. Fair enough, but what if the price of rents is also unusually high? After all, the central banks of the world have been pumping aggressively for the past five years. The reason was to keep spending going. One result is that by keeping the printing press running all prices are higher than should otherwise be the case. At the end of the day, it could be that both housing prices and rents are overvalued! Perhaps it is because cheap credit induces more people to live alone than would otherwise be the case, or in bigger houses than are necessary, or in locations (like London) that wouldn´t be sustainable without such easy credit. (Cross posted at Mises Canada.)

David Howden is Chair of the Department of Business and Economics and professor of economics at St. Louis University's Madrid Campus, and Academic Vice President of the Ludwig von Mises Institute of Canada.

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