Forgive me for copying and pasting some of my previous arguments on housing bubbles.

I am one of a few but growing number of people who believe that people like Hugh Pavletich, Wendell Cox, Oliver Marc Hartwich, and Alan Moran have the key to this problem and we are ignoring tham at our peril. For the benefit of those who haven't followed the argument, here is what I insist you should check out.

Wendell Cox and Ronald Utt: "Don't Regulate the Suburbs: America Needs a Housing Poliicy that Works".

http://www.heritage.org/Research/SmartGrowth/bg2247.cfm

Alan Moran: "The Tragedy of Planning: Losing the Great Australian Dream"

http://www.ipa.org.au/library/MORANPlanning2006.pdf

Those who insist that factors other than land use rationing, such as taxation treatment of housing, are responsible for housing bubbles, should look at page 54 onwards, (page 61 of the PDF) where Moran gives analysis charts of these factors accross a number of countries that have exerienced housing bubbles.

Oliver Marc Hartwich and Alan Evans: "Unaffordable Housing: Fables and Myths"

http://www.policyexchange.org.uk/images/publications/pdfs/pub_38_-_full_...

On page 17 is a graph of previous house price bubbles in the UK. The UK just happens to have had land use rationing decades ahead of everyone else. They have also had house price bubbles decades ahead of everyone else; they just never got the connection.

Oliver Marc Hartwich and Alan Evans: "Bigger Better Faster More: Why Some Countries Plan Better Than Others"

http://www.policyexchange.org.uk/publications/publication.cgi?id=47

Germany has policies of funding local government which are powerful incentives to development and construction. Consequently, Germany has not had a house price bubble other than in a few locales where local anti-development sentiment was strong enough to survive the cost impact of consequent loss of funding. They have had a nationwide 1990's construction boom and subsequent depressed property prices which are frequently misinterpreted as a "bubble". They do not, however, have huge increases in household debt backed by the "faery gold" of house price inflation, and subsequent wipeout of equity bringing the whole banking and finance system down. Germany can honestly say that the impact on their economy is spillover from outside their borders. Just about no other country can say that, including NZ and Australia.

I badly wish for more evidence than this, but this is pretty conclusive to my mind.

Why property price bubbles, nearly everywhere, at this time? There have been numerous periods of monetary looseness in the past which have led to bubbles in the share market. I would argue that every potential property bubble in the past was spiked in time by construction booms, other than in the UK, obviously. But the 1980's and 1990's were marked by the advancement of environmentalism and urban limits and planning and land use rationing. Just as environmentalist mismanagement of forestry policy has finally had to be blamed for unprecendentedly destructive forest fires in California and Australia, it is high time that the true blame for the housing bubble crises was directed that way also.

I also insist that a property price bubble will get underway against all other obstacles, because of land rationing policies alone. Alan Moran's comparisons are conclusive that CGT's and other taxation treatments made no difference. I would argue that land rationing policies could cause property price bubbles even under a gold standard. Think about this. All that is required is for prices to be unable to be relieved by supply, and mania to do the rest. The (temporary) gains for speculators in such a bubble will naturally be more attractive than virtually any other investment. The starving of productive capital of investment, as a result of the bubble, will indirectly contribute to the bubble's ultimate collapse. This is because of the effect on incomes, of productivity being affected adversely.

Did the famous tulip bubble not take place under a gold standard?

When a housing price bubble gets underway, Reserve Banks increasingly find themselves "holding a tiger by the tail". Raising the base interest rate will depress PRODUCTIVE activity which is already being depressed by the diversion of investment into real estate. But the demand for finance for the housing bubble will have been having an upward effect on interest rates anyway. Meanwhile, the cashing-out of increased house owner "equity" will have been driving consumption, which will not have been resulting in increased productivity either.

But a lower base interest rate, in the absence of other seriously depressing effects, will immediately have a highly volatile effect. NZ did not get this effect like the USA did, as our Reserve bank did not "do a Greenspan" any time there was a clamour for lower interest rates. In a way, we can thank them for that, but on the other hand, a housing bubble will inflate and blow up regardless, it will just blow up quicker under the low interest rate scenario. That is what we desperately need to avoid now; we desperately need to avoid tracking the US experience any further.

As I intimate above, NZ is thus far avoiding the highly volatile response to lower interest rates that was experienced in the USA, at least partly because we are already up to our eyeballs in debt even under the higher interest rate scenario, and partly because there are other depressive factors at work, like the rest of the world imploding around us"¦"¦"¦

But what would Bollard and Co hope to achieve by "stimulating the economy", Greenspan style, with lower interest rates? All we would be doing, is tracking the USA from 2001 onwards, only we would be starting from a very much worse position regarding our debt and the inflated prices of our houses.

The biggest favour the National government could do our economy now would be to just let the builders loose on whatever land anyone anywhere will sell them, and let low interest rates combine with LOW HOUSE PRICES and small mortgages, to leave as many income earners as possible with as much REAL discretionary income to spend, as possible.

One of the problems in trying to control a housing bubble by the base interest rate (Greenspan didn't even believe there WAS a housing bubble in the USA) is that not only is the housing bubble not based on the other fundamentals of the economy, it is de-linked from them. In some cases, the fundamentals are being driven by the housing bubble; like consumption being driven by people cashing out home "equity", rather than by incomes. As long as house prices cannot be brought down by the building trade and free availability of land, bubbles will occur and will blow up eventually. The OCR will seem to have played a role in so far as the bubble has been inflating more rapidly when the OCR is low, and possibly bursting at some point when the OCR is raised, but meanwhile everything else in the economy will have been pushed completely out of kilter. Incentives to save, what to invest in, productivity, wages"¦"¦.

The fundamentals should drive house prices and the fundamentals should also drive what the Reserve Bank does with the OCR.

The global crash problem in a nutshell; investment in productive capital was siphoned off into a speculative bubble in real estate.

Previous speculative bubbles have been mainly confined to financial markets. Why? There is a certain limitation on "supply" of business, in the shares of which speculation can take place. Such bubbles ultimately pop, and investors lose, in a matter of hours.

Speculative bubbles do not take place in commodities for which supply responds to demand. What Austrian economists call malinvestment can occur when production is boosted to meet demand that is not "real", but damaging as this is, it is nowhere near as damaging as speculative bubbles are in their own right. What some people call a "housing bubble", where a lot of cheap homes are built as in Texas recently, is really "malinvestment". In these conditions, prices of all real estate is actually kept low because of the over-supply; that is not a "bubble". Left to itself, these over-supply situations would be limited in their consequences as the suppliers would quickly adjust to the reality of lack of sales, and demographics and migration and economic reality (affordability) would ultimately take care of the empty homes. But price bubbles just carry on and on inflating until they reach the point where the economy cannot sustain them, by which time catastrophe is the unavoidable consequence.

Why did speculative price bubbles not take place in real estate before this particular time? The simple reality is that land supply was not restricted to the same extent or for as long as was required for bubbles to get underway. An interesting exception I can point you to, is the UK. The UK has been experiencing severe housing price bubbles since way back in the 1960's; the obvious consequence of their much earlier adoption of anti-development land use restriction policies.

Allowing these bubbles to occur in real estate is an economic error of an order of magnitude of difference to bubbles in financial markets which the small proportion of people with money to burn enter voluntarily, and the fortunes that are made on paper and wiped out do not leave huge economy-distorting amounts of debt behind them.

Not so housing. Housing affects everybody. The total sums of money are not only much larger than the sharemarket, the debt that remains when the values on paper collapse is an order of magnitude larger and affects a high proportion of the population. Nor does the bubble burst in a matter of hours, with values quickly resetting at realistic levels; denial and paralysis besets the whole economy for years.

Productive capital gets starved of investment both coming and going: both as the bubbles were inflating and as they deflate. This is grave in its implications.

Did ANYONE have the wisdom to see this coming? I'll tell you what, precious few have even got the wisdom today to see that this is "what happened" and what "is happening" still.

First, we need "domestic savings". It wasn't "domestic savings" that were going into buying houses, it was borrowing - debt - created by monetary inflation.

We need to be prepared to utilise resources, and utilise them efficiently. We need to make it less hassle and less risky and just plain less unpopular to be in business and make money. We need to reduce if not abolish corporate tax; we need to abolish the employment grievance shakedown industry and wind back the holiday and maternity leave and so on that we thought in the years 1999-2008, that our economy could afford. And we need to wind back the toxic combination of the RMA (Resource Management Act) and the anti-development powers bestowed on councils that are responsible for the double whammy of restricting productive investment and allowing house prices to bubble by interfering with supply, and also wind back the fee gouging by councils.

Our economy could NOT afford it in reality even then. THIS assessment, which I have just read, is exactly applicable to our situation; I have been looking for a long time for this sort of assessment:

http://www.dailyreckoning.co.uk/economic-forecasts/the-mystery-of-britai...

Fred Harrison: "The Mystery of Britain's Missing Recession"
EXCERPT:

(You could change "Gordon Brown" to "Michael Cullen" and it would still be true)

""¦..If the business cycle had played out in the way that we would have predicted on the basis of historical trends, the price of houses would have deflated in 2001-2. This would have been the outcome of a mid-cycle recession. Instead, under Gordon Brown's stewardship, the residential sector was allowed to bubble. This set new benchmarks for prices: the next housing bubble would have to inflate to stupendous levels before finally collapsing and driving the economy into the Depression of 2010.

But in the meantime, Britain's consumers were on a spending spree. They borrowed like there was no tomorrow to finance the purchase of luxury goods, holidays in exotic locations, new cars, and improvements to their homes. Following the election of New Labour in 1997, consumption grew faster than output, with retailers sucking in imported goods to make up the difference. Between 1999 and 2001, consumption grew exactly twice as fast as Gross Domestic Product (GDP). Unsecured consumer debt rose at an annual average rate of nearly 11% over the five years to 2004. While Gordon Brown preened himself with declarations about his virtuous "˜prudence' in handling the nation's public finances, he sanctioned private bingeing that undermined the culture of thrift"¦"¦"

PhilBest adds:
While Michael Cullen preened himself about fiscal prudence, NZ consumers went on a spending spree that artificially inflated our GDP and our business turnover and profits and the government's taxation revenue. We SHOULD in reality, going by what was happening to NZ's productive capital and productivity, have been in recession already and tightening our belts and the government should have been cutting wasteful spending, not embarking on new binges; and the government should also have been freeing up the productive sector, not imposing new burdens on it.

Interest rates need to be decided by the interaction between the willingness of people to save and the demand for productive capital.

The interference with this that results from housing bubbles (and any other speculative bubbles) is what is destroying modern economies today, even leaving aside the issue of whether the central banks can get the OCR's right.

A bubble develops through expectation of returns. Those expectations cannot be dampened by interest rates. Interest rates that would dampen a housing bubble, would kill productive business off in the process. That is why Reserve Banks are "pushing on a string" as long as housing issues are unresolved.

As Hugh has pointed out, the correct term for building lots and lots of houses, is a "boom" rather than a "bubble".

The effect of the two different things on the issues at hand, are quite different.

We definitely are in agreement about the need to get investment going in the direction of productive activity. But in the light of the huge "pluses" that result from affordable housing, I would be prepared to simply ignore the occasional building of "too many" new homes; in fact, the effects of prices being too high are so much more serious, that I think a little bit of oversupply would be the "best" sign to look for at all times; it would show that the market is not being interfered with in the direction of rationing.

A price "bubble" drives itself to the level at which it collapses, only through mechanisms that will ensure economy-wide destruction in its wake. But a construction "boom" rapidly undermines the reason for its own existence, it is self correcting.