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The 'beer goggle' effect

Canadian housing prices surged ahead again last month, despite declining sales. According to the Canadian Real Estate Association, the national average price for homes sold during December rose an impressive 10.4 per cent to $389,119, compared to the same period in 2012.

The Greater Toronto and Greater Vancouver regions led the way, but even if those sales are excluded, the average price in the rest of Canada rose 4.6 per cent: Still impressive, given that we are in a period of weak inflation.

Canadian housing mirrors U.S.
This strong performance roughly tracks that of residential real estate south of the border, where sales and prices continue to strengthen, following a devastating plunge during the 2008 financial crisis and ensuing recession.

Economists generally attribute the strength of both markets to continued low mortgage rates, which drive down borrowing costs, and boost corporate profits. On paper, this should reduce potential layoffs and foster hiring. Ironically the Canadian economy unexpectedly lost 46,000 jobs during December and job creation south of the border slowed significantly as well.

The beer goggle effect
Richard Fisher, president of the Federal Reserve Bank of Dallas, recently shed light on why asset prices south of the border may be so strong, despite a sluggish underlying economy. And, his comments may have resonance here in Canada.

Fisher, who also sits in the Federal Open Market Committee that sets U.S. monetary policy, attributes strong U.S. stock prices, which rose close to 30 per cent last year, to the 'beer goggles' effect. In a presentation made at the Brookings Institute, Fisher described this as: "The effect alcohol has in rendering a person, who one would ordinarily regard as unattractive, as alluring."

He explained that when money available to investors (and by implication home buyers) is close to free and there is a presumption that the central bank will keep it that way indefinitely, stocks move into a bull market.

If Fisher is right, this implies that U.S. equities, which are trading at historically high levels, relative to average profits during the past 10 years, may be heading into overvalued territory.

His logic also suggests that Canadian housing, which is also trading at high levels -- relative to both household income and rents -- may also be being boosted by the beer goggles brought on by low interest rates, which are clouding investors' judgments.

Banks play down bubble talk
Economists at the large Canadian banks play down bubble-talk. For instance, Robert Hogue, an economist at RBC Economics, says, "Our outlook for 2014 calls for a continuation of this very slow rate of increase (in home sales relative to 2013)." However, he adds a cautionary note: "Recent re-acceleration in home price increases could result in deterioration of affordability if the phenomenon is sustained."

In short, if you believe RBC and the other big Canadian banks, which have all made similar statements in recent months, homeowners here are unlikely to suffer from beer goggles induced hangovers any time soon.

Peter Diekmeyer is Bankrate.ca's economics writer. He can be reached at peter@peterdiekmeyer.com

-- Posted February 3, 2014
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