Tuesday, May 9, 2017

Hot Housing Markets And The Dutch Tulip Bubble Of 1637


Ambrosius Bosschaert  (1573–1621), Flower Still Life [with a yellow tulip]. Via Wikimedia Commons.

A friend of mine sent me this article about the "overheated" condo market in Toronto. I own a condo in Toronto, so I guess issue is certainly relevant to my interests. Personally, the price fluctuations don't matter much to me. Partly, this is because we bought our place before prices got so high, and we are using it more as an actual place to live, rather than an investment, so who cares? Partly, this is because I'm the sort of person whose eyes glaze over when we talk about money.

So, sure, I open the unsolicited mailings that real estate agents send us, with their reports on what sold for what and their endless rhetoric of optimism. And sometimes I'm like OMG, how much?? But who knows what's going to happen next? I don't get too excited. From a personal point of view, it's more like entertainment or a spectator sport than anything else.

Of course more generally, I worry about rising housing prices, because I want people to be able to afford housing. Housing prices are one of the weirdest things to read about in the news. When housing prices go up too fast, it's considered bad. When housing prices fall, it's also considered bad, because people use housing as a way of saving for the future. When I see the news about falling housing prices, I sometimes think, "Yeah, I know. But isn't this also a good thing? For people who want to be able to afford homes?"

You might think that rising housing prices would be a reason to create more housing, the theory of supply and demand suggesting that the more supply there is, the more the cost would go down. But in the article my friend sent me, the chief economist at Bank of Montreal is cited saying this isn't so. Creating supply in response to more demand, he said, creates more demand. Prices will then go even higher.

He mentions the example of the example of the Dutch Tulip Bubble in 1637, when people starting paying more and more for tulip bulbs, with prices reaching obscene levels, before a sudden crash in the market. The economist asks rhetorically, "Do you think that the best response to the Dutch Tulip Bubble in 1637 was to cultivate more land and grow more tulips?"

Later he makes the same point with the example of the dot-com bubble of the 90s, asking whether the right response would have been an increased supply of shares of Pets.com or Toys.com.

I don't know if he's trying to simplify a complicated point or something, but these struck me as peculiar analogies. I mean, tulips and dot-coms shares are something no one needs. Housing is something everybody needs. I know, not everyone needs housing in a particular place. But still, tulips and shares are like the opposite of homes: the former you can buy and sell easily and there's no point to owning them beyond making money and impressing people. The other is a huge pain to buy and sell and most people use them for something essential to life. It doesn't add up.

Perhaps the implication is that housing prices are surging in Toronto not for normal supply-and-demand related reasons, but because people are doing with condos what they did before with tulips and dot-com shares, namely buying them not to live in, but more to make money and impress people.

I have no idea if this is true -- in fact, I'm not even sure how someone would know whether it is true. But if it is, even a bit, true, then I guess this means that there are a lot of people with a lot of extra money to throw around and a lot of leeway with respect to how they're throwing it. Are there really so many people who can afford to buy a whole condo just as an investment for the future? In addition to the home they're actually, you know, living in? Tossing them around the way you might throw around a tulip?

I've always thought these kinds of discussions were haunted by the old idea of a "just price." As I've written about before, a long time ago there was the idea that there was a "just" or "fair" or "appropriate" price for something. This makes it easy to explain how a tulip costing ten times someone's annual salary is insane. In some basic sense, a tulip just isn't worth that much.

But as economics developed, the idea of a just price started to seem unscientific and impossible to define. What would it mean, to say one thing is "worth" a certain amount? All the data we have just concern prices: what it's "worth" in modern parlance is just what people think it is worth, which is basically what people are willing to pay. The idea that there is "worth" inherent in objects, that transcends what people want to pay, seems peculiar, like some kind of weird bad metaphysics or voodoo science. 

But if worth is just what people are willing to pay, then it's difficult to say that things are costing "too much." You can't say that tulips were insanely overpriced, and by extension, you can't say that the housing market's pricing is out-of-whack. At most, you could say something about the future: that you think prices are going to come crashing down. But you'd have to refrain from saying anything about which price is what the housing is really worth.

The reason I say just price theory "haunts" these discussions is just that I think certain intuitive but hazy background ideas about worth are sometimes in play. When the pharmabro guy wanted to put skyrocketing prices on his drugs, people said he wasn't charging a "fair price." When people talk about housing prices being out-of-whack, there's a suggestion that there is something a condo is actually worth, generally speaking.

So when someone says it would be silly to make more tulips in response to demand, I think one reason this rings true is because we feel, in some inchoate sense, that tulips just aren't worth that much. After all, if tulips were found to have some cancer-curing chemical we could use to treat people, then a rational response to skyrocketing tulip costs would be -- of course, for God's sake, make more tulips.

It wouldn't be surprising if judgments of whether housing has some inherent worth varied along with wealth: if you think of housing as a think you use to live, like those life-saving tulips, then it seems to have some hazy inherent value relative to other goods in your life and so on. And a rational response to demand is to make more.

But if you think of housing in terms of a thing people just buy and sell, then it's hard to see how its "value" can be understood in any way except what people are willing to pay. And in that case, it might seem that the creation of supply would be, on balance, not a good thing.

I don't know all the ins and outs, so I can't say what will cause what to happen overall. But as someone thinking of housing as a good thing, the analogy to the tulip market doesn't ring true to me. If you have a good thing, and costs for it go up, then why not make more?

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