Tuesday, 8 November 2016

Borrowing to BUILD houses is no more productive than borrowing to buy EXISTING ones.

Some monetary reformers claim that borrowing to fund the production of a real asset like a machine or house creates more jobs than borrowing to buy an existing asset, which in the case of housing for example, allegedly tends to promote house price bubbles. Ergo, so the argument goes, preference should be given to the former type of loans.

Richard Werner seems to back this idea – see Twitter exchange below.

OK, let’s consider this taking housing as an example (and housing is not a bad example given the large proportion of all loans which are for the purchase of houses).

If the existing stock of houses is just enough to meet demand, no houses will be built. But if there is a marginal increase in demand, say in the form of X immigrants arriving plus families, and those immigrants borrow to have X houses built, clearly that will create a fair amount of work for bricklayers, plumbers and so on, which is allegedly beneficial because plenty of employment is created.

In contrast, if the immigrants borrow and buy EXISTING houses, then the price of houses will rise, which in turn will mean the value of houses exceeds the cost of producing them (counting house builders’ profit as a “cost”). Builders will then be induced to start building houses. And how many will they need to build in order to get supply and demand for houses back into balance? Well the answer is pretty obviously X houses! The net effect is the same!

Of course the real world is more complicated than the above over simple scenario, but I don’t see why adding those complexities makes any difference the above conclusion.

For example, it has been alleged that in the UK house builders have set up a cartel which artificially boosts the price of houses. See this Spectator article entitled “Radical reform is the only solution….”, in particular para starting “The UK house-building market….”

Now there is always a limit to how far those who arrange a cartel can exploit the situation before one cartel member breaks ranks and grabs the profits available. So let’s suppose house builders exploit that cartel to the extent of raising house prices by Y%, then much the same argument applies. That is, where demand exactly equals supply (and that will be when houses prices are Y% above the genuine free market price) no house building takes place. Then when the immigrants arrive and buy existing houses, prices will rise. That will induce builders to erect enough houses to bring supply and demand back into balance, i.e. X houses. The end result is the same.

House price bubbles.

The above is not to say that asset price bubbles are not a problem. However, asset price bubbles can inflate even where there is no borrowing at all. To illustrate with an extreme example, it would be perfectly feasible to have an economy where everyone bought their houses for cash. In that scenario, there is nothing to stop one person demanding more for their house than might be expected, at which point the rest of the lemmings that make up the human race might decide to mark up the price of their houses as well.

Tulip mania, house price mania etc can take off anytime regardless of the circumstances.

And finally, having criticised Richard Werner, please note that I am very much a Werner fan. He has produced enough decent and original material to deserve a Nobel prize. He originated the term “quantitative easing”. And the following two works by him are master pieces: simple clear and original.

1.  Towards a Twenty-first Century Banking and Monetary System.

2. How do Banks Create Money….


The twitter exchange: sorry about the poor quality of the images: if you click on them you should get a better view.


  1. Another Werner fan here. However, I thought I had read his writing somewhere that he regarded credit creation for all real estate as "non-productive" (not adding to GDP).

    However, that cryptic Tweet of his seems to say he's ok with lending for building, which on the face of it, is producing something, and also providing employment (for a while).

    Now I think back, I seem to remember his definition of productive credit creation is that where the result of spending the credit produces the means of repaying it (and some), e.g. building a new factory, etc, assuming the factory is profitable and provides an income stream.

    That doesn't normally happen with housing, unless we are talking about buy (or build) to let, which I would not normally regard as productive, at least not in the way it has been done in the UK in recent decades.

    My ideal pattern for housing development would be to allow (and finance, from fiscal deficit) councils once more to build again massively, properly planned and with plenty of amenities (perhaps with strategically placed "new towns").

    However, an update to the traditional council housing model would be to include a generous proportion of something like shared ownership, that would allow tenants to gradually become owners (if they wish) in their own time and at a pace which is economically viable for them.

    The difference between this and existing "right-to-buy" would be (in my ideal picture) would be that councils would carry on building, so that when rented houses are bought, that doesn't leave a shortage of available rentable houses. And hopefully by providing sufficient high quality supply, the average house price would come down (in relative terms) to a lot closer to average income than it is now.

    However, this is probably a bit too socialistic for you, and for most people in this conservative old country of ours. :-)

    1. Strikes me there is a flaw in the idea that lending for production should take preference over lending for consumption (e.g. mortgages), which is that purpose of production is consumption!!

      Re council housing, it certainly looks like the decline in council house building has contributed to the rise in house prices. But this is a complicated area, which I don't claim to be an expert on, so I'll keep my trap shut.

  2. Thank you for sharing this information. It has helped me to know more about
    is it better to own or rent a house


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