Growing Asset Inflation Can Pop Even London’s Bubble

In last weeks’ London art sales at Sotheby’s (NYSE: BID) and Christie’s, no fewer than forty two artists had their works reach record prices.  I used to work in the rare book trade, and I can remember a similar boom in the early months of 1989, which is now seventeen years ago.  In Britain the housing market had already turned down, though only slightly.  The art market went on booming until May 1990, but turned down decisively in June, when the Japanese uniformly stopped buying, like a regiment when the Sergeant Major calls “halt”.

High contemporary art is now a billionaire’s market, and there seem to be a lot of billionaires about.  Certainly there are more in London than we have ever seen before.  Ordinary Londoners feel that they have been priced out of their own City.  Apart from bankers with their bonuses, ordinary successful London professionals can no longer afford the houses that used to be the normal reward of professional success.  An apartment in London is now considerably more expensive than a comparable one at a good address in New York.  Even fashionable dentists are being outbid.  How the infrastructure workers, who drive the buses and nurse the sick can live in, or even near London, nobody knows.  Nannies are being paid the salaries of bankers’ receptionists, rightly so, since the bankers depend on their nannies to make their families viable.  Those fortunate people who can afford to live in Central London are either billionaires who buy a £10 million West End house out of income, or have big mortgages.

If consumer durables were not still so cheap, we would be having a debate about the causes and consequences of inflation.  Despite the recent fall in the nominal inflation rate, it seems clear to me that this inflation of asset values as the same causation as any other inflation.  As Milton Friedman used to tell us, all inflations have the same cause, and that is monetary excess.  If every sale at Sotheby’s, and every sale of a flat in Eaton Square reaches a new record, someone must have the money to pay the record price.  The situation in London is particularly exaggerated because London has become the financial work station of the very rich, and the international playground of multi-billionaires.

The money supply is global.  It is not just the Russian billionaires, or the international bankers or the oil rich who are indulging their taste in Renoir, or football teams.  They are only the conduits which drain off an excess of money into the art market.  What matters is the excess of money, and the apparent inability of the world’s central bankers to stop the flow.  At this level of asset prices, money is being devalued.  When a painting which was worth £100,000 five years ago sells for £1,000,000, the quality of the painting has not changed.  The extra ‘0’ on the price represents a devaluation of money in terms of the painting, not a rise in its real value.

We all know that consumer durables, largely manufactured in China, have not risen in price in the same way, indeed Ipods are cheaper than they were a year ago.  As a store of value, houses and works of art have outperformed household goods.  That is one reason why the rich buy works of art, and why people have been buying gold.  To some extent, the low prices of Chinese manufacturers have offset the rising prices of assets.

However, this may now be coming to an end.  The main cost of what may be called Asian goods is not the manufacturing cost, but the cost of distribution and marketing.  Retailing has indeed become savagely competitive, with very tight profit margins.  It is very likely that the new electronic novelties of the future will come onto the market at a high price, and then fall in price as the initial market becomes saturated.  That is a normal pattern.  But distribution of the mass of low price goods may now be as cheap as it is going to become.  Even China has its cost limits.  At some point asset inflation will cease to be balanced by the China effect.

Inflation, once it takes root, tends to spread.  I hear stories of rising farmland prices in England.  Until quite recently, land was fetching £2,000 to £3,000 an acre in the West Country.  Now one hears talk of prices of £4,000 to £5,000.  Farmland may not be a fashionable asset, but it is a real one – it does not depreciate over time.  I suspect that global asset price inflation will be a growing concern in 2007, and that it will take time to get rid of it.  It always does.

William Rees-Mogg
for the Daily Reckoning Australia

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