A blog by Patrick Crozier

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January 31, 2003

The Coming Crash

House prices in London are going to fall by up to 80%. That is the view of someone I met recently.

OK, so anyone can come up with something like that but what impressed me was the analysis.

The way my correspondent - let's call him Theodore - sees is it is that stock market falls are invariably followed by house market falls with a time lag of about 2 years or so. That would seem to correspond with the only crash I am really familiar with - the one in the late 1980s and early 1990s - when the stock market fell by about 20% in 1987 and house prices fell by up to 50% starting in 1989 and bottoming out in about 1992.

But what is the mechanism? According to Theodore what happens is that as the stock market rises people find that they have more money and so spend it. Often this goes directly into the housing market and so prices start to rise. When the stock market starts to fall, people find that they have less money and so house prices start to fall.

But Theodore has also spotted other things happening. First of all, we are starting to see strikes in the state sector - eg. fire and trains. This implies the growth of inflationary pressures. Actually, we are all very familiar with this. We know that the Chancellor has opened the flood gates of state spending and it is not entirely surprising that state-sector workers should start fighting to get their snouts in the trough.

Secondly, we are beginning to see price rises in the service sector. Lawyers and accountants are starting to raise their fees in response to lower business volumes. (So much for supply and demand). Oil prices are already at a high level and are likely to increase with the Second Gulf War. This (along with the government's borrowing requirements) could well lead to an increase in interest rates as there is less money to lend and the Bank of England starts to get edgy about inflation. And we all know what happens when interest rates start to go up.

Thirdly, Theodore has already started to spot falls in house prices at the top end and transaction levels are off by 40%. This is likely to trickle down to the lower end before long. Yes, trickle down works both ways.

All this was a hell of a shock to me. For many years I have gaily assumed that the days of boom and bust are over because we have tamed state-induced inflation. After all, all the busts I had ever seen were state-induced. But this is different. This is the business cycle - that natural economic cycle in which people keep on getting richer until the horrible day arrives when they realise they have been doing all the wrong things eg. internet and telecoms. The adjustment, to doing the right things is known as a recession. And it hurts like hell.