Chimerica: Housing and haircuts
I recently spent 3 days in the SF Bay area of California. Great place to live! My wife and I visited some friends in a San Francisco suburb call Millbrae. Just your ordinary 2 bedroom ranch, with a kitchen out of the 1950s and no back yard. You know, the kind that sells for $1,000,000 (even more to the south, in Burlingame or Palo Alto.) And that’s after the bubble burst—prices are rising fast again. It turns out the bubble-mongers were wrong–Bay area housing really is very valuable. Later we were walking around San Francisco and I saw a sign in a barbershop window: “haircuts for $6.” That’s strange; I thought San Francisco was an expensive city.
Then it hit me. Houses and haircuts—the examples I always use for China. Chinese houses seem ridiculously expensive, relative to Chinese incomes. And haircuts are incredibly cheap, even in cities like Beijing (about $4.) And guess what, our friends told us that the Millbrae school system is 50% Chinese. And that $6 haircut? Yup, right in Chinatown. Then I recalled all those ultra-cheap meals in great Chinese restaurants in Boston. Or those $15 Fung Wah bus rides from Boston to NYC.
The obvious schlock theory is that the Chinese bring their economy with them when they move to the US. Stuff that’s cheap in China stays cheap in the US, and vice versa. But I have bigger fish to fry.
People often tell me that the Chinese housing market is a giant “bubble,” because it’s somehow controlled or distorted by government policy. The construction bubble is fed by easy credit, and the housing price bubble is caused by a lack of alternative outlets for those high-saving Chinese. The Chinese stock market is full of lousy SOEs, and they can’t freely invest outside of China (although some money does leak out.)
But then what about Singapore, Hong Kong, Vancouver, Sydney, and Millbrae, where ethnic Chinese are free to buy alternative investments? Why are those housing markets so expensive relative to incomes?
Some will read this post as a claim that the “Chinese housing bubble will never burst.” That’s not right at all. I’m claiming that there is no bubble, but what people think is a bubble will eventually appear to burst, but not really. When that happens, the bubble-mongers will claim they were right all along, but they will have been wrong. Just as they were wrong in 2007-09, when falling Millbrae house prices caused them to say; “I told you so.” Yes, you told us so, and now in 2013 we know you were wrong. Prices are back up to peak levels.
Here’s my prediction. Any place in the world with large numbers of ethnic Chinese and sharp limits on new construction will see housing markets rise to seemingly “unaffordable” levels. That’s “unaffordable” relative to incomes.
My dad was a real estate broker, and when I was young told me a story of going to the bank with a client who was seeking a large mortgage. The banker asked the client a serious of questions about income in recent years, and the client kept reporting trivial numbers. My dad kept smiling while the banker looked more and more frustrated. Finally my dad said:
OK, now ask him about his stock holdings.
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26. May 2013 at 07:28
So how exactly are ethnic Chinese causing these effects wherever they go? All cutting hair and saving intensively (they cut their own hair at home)?
26. May 2013 at 07:35
This is not something I know much about – you submit an interesting idea – but how bad will it be “when” the “bubble” bursts?
In America it was bad because for half a century we made it our goal that home ownership be equitable. But in China property inequality is much higher, and there are tons of poor people.
Right now, I don’t think there’s overdevelopment. Prices haven’t adjusted. Can it kind of be like “sticky” wages? Except they have to at some point, when developers will want to cut their losses.
At which point the poorer Chinese will be able to buy and rent (relatively) affordable property. Am I missing something?
26. May 2013 at 08:50
Ashok Rao,
I think his point (and I’m sure Sumner will correct me if I’m wrong) is that there is no bubble. Not even a “bubble”. Of course, prices move up and down, and someday housing prices in China will fall. A bubble suggests that they are somehow at unsustainably high levels that can only persist if they continue to increase until they consume all of GDP. Eventually, everyone realizes that and the price collapses. The fact that bay area houses have already recovered to peak levels is pretty strong evidence that the fall in prices was just a fall in prices, not some realization that prices were at unsustainably high levels.
26. May 2013 at 08:53
Ashok Rao,
Indeed, by most theories of what a bubble is, it’s hard to believe in the continued existence of a bubble amongst many famous people proclaiming that there is a bubble. Bubbles, if they occur, persist because no one realizes they are bubbles.
26. May 2013 at 09:05
“Indeed, by most theories of what a bubble is, it’s hard to believe in the continued existence of a bubble amongst many famous people proclaiming that there is a bubble. Bubbles, if they occur, persist because no one realizes they are bubbles.”
Just like no one can forecast a recession.
As for your first point, I think Sumner’s criticism is that people claim a bubble, and many times even if there is a sharp and rapid fall in prices (the “burst”), they remain elevated from the price level at which the bubble was called. That seems like the fundamental flaw.
Regardless, my point is even taking the standard definition of bubble and burst, I fail to see why a burst is a bad thing. Sumner is arguing that bubble is the wrong framework from which to interpret this price dynamic; I’m saying that even if it is, the burst would be a good thing.
26. May 2013 at 09:25
Ashok Rao,
I’m not sure what you are implying with “Just like no one can forecast a recession.” Bubbles rely on irrational investors because they will inevitably burst (by the definition of a bubble). Moreover, they are fragile; if the price does not increase quickly enough, then the bubble collapses. If everyone is saying that there is a bubble in some asset, then how are investors still irrational? If there is a treasury bubble, then why don’t the repeated claims that there is a treasury bubble do anything to mitigate irrationality?
A bubble bursting would be a bad thing because it suggests that money was poorly invested. If there is a housing bubble, then more developers will build more homes. Eventually, when the bubble bursts, it will be clear that there is no demand for all the new homes. Sure, poor Chinese people may then be able to afford homes. But, suppose Toyota accidentally made too many Camrys and too few Corollas. Some poorer people would be able to afford the Camrys with lower prices due to excess supply, but it wouldn’t necessarily be a good thing in net.
In addition, wealth uncertainty is probably bad and negative wealth shocks can cause recessions when the central bank is afraid of ‘unconventional’ monetary policy.
26. May 2013 at 10:09
Saturos, There are lots of ways to save a lot without cutting your own hair. I speak from experience. For instance, I’ve never bought a new car, or a single family home, despite an income in the top 10%.
Ashok, The “bad thing” was the tight money, not the house price crash. If you mean it might be a good thing because houses are more affordable, I don’t really disagree, but I’d rather not describe market prices as either good or bad.
The “poorer Chinese” will no longer be poor when the China boom ends—they’ll be middle class and thus able to buy Chinese houses at current prices.
J, Very good points.
Ashok, I agree with much of your second comment. Also J’s final comment.
26. May 2013 at 10:39
Scott you said, “Ashok, The “bad thing” was the tight money, not the house price crash. If you mean it might be a good thing because houses are more affordable, I don’t really disagree, but I’d rather not describe market prices as either good or bad.”
I guess I wasn’t trying to say that a change in the market price is good or bad. Just that an adjustment (what we might call a “burst”) isn’t characteristically bad as it might have been for the US. And we reject the market price argument for the US, because consistent government regulation encouraged broad home ownership. Therefore it was – market price or not – bad.
“The “poorer Chinese” will no longer be poor when the China boom ends””they’ll be middle class and thus able to buy Chinese houses at current prices.”
Yep. Though I think we’ll have to update our views on what’s an okay rent-to-price ratio.
26. May 2013 at 13:23
Scott: Very interesting. Your father’s story speaks to high savings propensity but it doesn’t explain $6 haircuts in SF (I leave aside the bubble debate). I have always wondered about how the Chinese willingly appear to “undervalue” their own labor services.
My working hypothesis had been that it was tied to the huge rural population in China and experience of years of famine. Now bear with me a little. Growing up, my mother (came from China as a little girl) would always tell me that Chinese businesses compete via quantity and normally willingly accept razor-thin margins. She ran a retail grocery store in Penang, Malaysia, and yes, we sold at razor-thin margins. She would also tell me that Chinese labor in Chinese establishments (e.g., in my father’s wholesale shop) would work for less than the Malays and Indians in Malaysia. Ok, all these observations can be rationally explained.
However, even after all her kids were doing well as adults and supporting her, I would observe that my mother (in her sixties then) would rather walk long distances in the hot Malaysian sun to take several buses than take a taxi–no matter how much I implored her to take a taxi, offering to pay for the taxi. I could only infer that somehow she must have valued the pittance in savings more than the time and effort needed to catch one Penang bus and then another. The only explanation I could think of was that her choices must be related in some way to her personal (and cultural) memory of the years of famine in rural China (from her stories) when money was hard to come by even though many able-bodied in her village wanted to work.
I had thought that perhaps within the greater security of a wealthier economy, this relative undervaluation of own labor would not exist. After all, the opportunity costs of labor-time should be the same regardless of racial heritage, all things equal. And indeed I don’t see this “undervaluation” attribute among the American-born Chinese. But it seems to exist still among the China-born immigrants. Your story of the $6 haircut in S.F. speaks to that. Recently, I was looking online for a Matlab tutor for my son. Guess what? The Chinese tutors (G.W. Univ. students from China and even one well-established middle-aged, full-time tutor from China) tended to charge about $30/hr while the other tutors cost anywhere from $45 through $80/hour. Note that these China-born tutors have the same great testimonials as the others. Incidentally, this also leads me to the many Chinese restaurants, which are way, way cheaper than Indian or Japanese and of course Western restaurants. (A weakness of the cultural thesis is of course that the Indian immigrants who would arguably have the same cultural memories of large unwanted surplus labor in their mother country do not seem to share this relative “innate” insecurity about job prospects). But forgive this personal note that my mother’s dicta always ring loud in my ears whenever stories like your $6 haircut in a super expensive city like S.F. comes up!
Jeff Lim
26. May 2013 at 19:30
Maybe an ethnic angle; but down in L.A. you get cheap haircuts in any Hispanic neighborhood.
I think there may something else going on: As disposable incomes rise, and as gewgaws cost less and less (furniture, electronic goods, washers etc) money is left over for consumption.
That pours into housing, and maybe art.
What has happened in art markets in the last 30 years is amazing—and in China too, for antique vases etc.
27. May 2013 at 00:51
Is there a formal definition of ‘bubble’ that’s in wide use among economists or are a bunch of very smart people just having metaphysical arguments with each other?
27. May 2013 at 05:23
Dr. Sumner:
“I’m claiming that there is no bubble, but what people think is a bubble will eventually appear to burst, but not really. When that happens, the bubble-mongers will claim they were right all along, but they will have been wrong. Just as they were wrong in 2007-09, when falling Millbrae house prices caused them to say; “I told you so.” Yes, you told us so, and now in 2013 we know you were wrong. Prices are back up to peak levels.”
This is a gross mischaracterization of those who warn of bubbles. (Note that “bubble monger” is a rather silly label, since “mongering” is a word that refers to someone who is promoting something, a dealer in something. A “war monger” is one who brings war to others. A “fear monger” is one who brings fear to others. A “bubble monger” would of course be those who bring bubbles to others (e.g. central banks). To call those who identify war, identify fear, and who identify bubbles to be “mongers” is shooting the messenger).
Back to the main point. It does not follow from the fact that home prices rise back up after a sharp decline, that there was no bubble. You are ignoring the fact that post housing bubble, the Fed reinflated the money supply, which reinflated the fuel for housing purchases. This was not necessary in the sense of a law of nature. The Fed made a new choice to reinflate. This doesn’t contradict the existence of the prior bubble. It is fully consistent with there having been a bubble.
For imagine the counter-factual. Imagine the Fed did not reinflate post 2008 at all, and let credit deflate and spending to decline to whatever levels the market process would have brought about. At this point, it is likely, indeed almost certain, that home prices in Millbrae (and across the country) would have been lower “now” than they actually are now. Historical home price trends would have resembled a rapid acceleration, a peak, and a rapid fall, and no reinflated prices afterwards.
If this occurred, it would be wrong to argue that then we are justified in calling it a “bubble.” It doesn’t matter what happens after there is a collapse in home prices due to Fed reinflation. A bubble is a bubble not because the Fed failed to reinflate after a price decline, but because the Fed inflated in the first place, redirecting real resources into physically unsustainable projects. That is the bubble. A bubble is not a run up in prices and a subsequent decline in prices. An inflation fueled bubble has the potential to be postponed, i.e. lengthened, if the Fed continues to choose to reinflate after each “dip.”
Those who warned of a bubble during the 2000s, were indeed proven right by the events in Millbrae, and elsewhere. It is not a refutation of their warnings that soon after the onset of corrections began, the Fed made a new chice to reinflate once again, thus putting upward pressure on housing prices once again, such that we see a historical price trend of a rise, then a dip, then another rise again.
The “bubble warners” would again be correct, if there are again too many resources pouring into housing, as home prices rise in Millbrae, and again experience a future decline in prices should the Fed not continually accelerate inflation, and instead “take a couple days off” such that the corrections again ensue, before they get back from the beach and again reinflate.
Dr. Sumner, I know it makes you slightly peeved that your chosen theory does not account for, and cannot explain, bubbles. But this continued attempt to deny everyone else the ability to explain it, on the solipsistic basis that if you can’t do it, nobody else can, is just head shaking. You’re like a creationist attending a conference on evolution or cosmology, and attacking every researcher there for being wrong about this or that, not because they actually are wrong, but because his own theory cannot give an adequate account for the events he observes.
27. May 2013 at 06:03
In other words, the choices and actions that people take after a bubble, do not change the nature of what occurred in the past during the bubble. The future doesn’t influence the past.
If the Fed reinflates after a past series of events in the housing market, these subsequent actions do not change what that same past is about. If someone argues “there is a housing bubble”, and prices fall, but then afterwords they rise back up due to new choices and new actions of people, it doesn’t mean the past is something else that refutes the bubble warners.
It would be like a consciousness arguing during 65 million BC that dinosaurs are the world’s strongest animals, and then another consciousness 65 million years later says “Aha! You’re wrong dino mongers! An asteroid subsequently wiped away the dinosaurs, and now mammals are now the world’s strongest. Your argument is refuted.”
27. May 2013 at 06:33
Jeff, Yes, I’ve heard similar stories.
Jim, The latter.
27. May 2013 at 11:52
Geoff: So fun to see your wacky sensibility back here again!
Perhaps you could just clarify for me: you said “A bubble is … physically unsustainable projects. … A bubble is not a run up in prices and a subsequent decline in prices.”
So, you’re apparently attempting to define a “bubble”, not by the path of prices (like almost everybody else), but instead by “physical unsustainability”.
But you also think that US housing, 2000-2006, was a “bubble”, right?
I see zero evidence that US house construction was physically unsustainable during that period. Can you help educate me? Can you point me to the data, during that time period, of how US housing construction was unable to acquire raw materials, or couldn’t locate sufficient skilled labor?
I’ve seen lots of data about how house prices weren’t as high in 2007-2008, as builders expected from 2006-2007. And so nominal ROIs plummeted. But you’ve now clarified that prices are not your concern.
So: In your mind, was US housing a bubble in 2000-2006? If so, why? Can you present your case for it having been a bubble?