Property leads boom-bust cycle

The Melbourne Herald-Sun (June 11, 2007, p.27) says in part:

A 34-year study of Australian property markets, Unlocking the Riches of Oz, has identified that rises and falls in the economy “follow” those in the property market by between 12 and 24 months.

In other words, “the tail is wagging the dog”, the report's author and Land Values Research Group director Bryan Kavanagh said.

“The revelation makes it possible to forecast economic booms and busts,” Mr Kavanagh said, by watching where the property market is heading.

A text box headed “Bursting the bubble” further quotes Mr Kavanagh as saying that in a bubble,

Prices become decoupled from earnings ... and are supported only by the assumption that someone else — the ‘greater fool’ — will pay an even higher price at a later stage. When that assumption loses credibility — when the market runs out of ‘greater fools’ — there is no support for today's prices and the bubble bursts.

Above the text box, superimposed on a picture of a wagging dog-tail, is a graph like the following:

Property sales growth and GDP growth

Well, if we'd known there would be room for only one graph, we probably wouldn't have picked that one, not least because we caused it to acquire rogue ‘%’ signs on the scales (oops). In fact the growth figures are year-on-year ratios (although a later version of the graph indeed shows percentage changes). Another possible source of confusion is that the figures are not adjusted for inflation (because when we compute our most important statistic, namely the ratio of property sales to GDP, inflation cancels out).

That said, the graph makes two salient points. First, in the second half of the period shown, but not in the first half, growth in property sales clearly exceeds growth in GDP. That suggests a bubble. Second, in the middle of the graph (but not at the left-hand end, where high inflation complicates the picture), the fall in property sales (1988–1990) clearly precedes the fall in GDP growth.

The article goes on to quote Andrew Ballantyne, senior economist with Charter Keck Cramer, as disputing our forecast of a general economic slump. He did not think the over-valuation of property was as severe or as widespread as we did. Time will judge us on that point.

A shorter version of the article — omitting the text box, the graph, and (unfortunately) an important step in Mr Ballantyne's reasoning — appeared in the Cairns Post a week later.

[Posted Jan.29, 2009. Last modified Feb.16, 2009.]