Housing Prices in Israel Will Collapse Someday

For the past eight years, housing prices in Israel have risen at an astonishing rate. Have the laws of economics gone mad, or is the end in sight?

Nehemia Shtrasler
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Construction in Israel. Housing prices have risen for eight consecutive years.Credit: Nimrod Glickman
Nehemia Shtrasler

Once again, it has become clear that house prices are still rising. The government assessor said Monday that they continued to climb in 2014, despite the promises of , Finance Minister and Housing and Construction Minister Uri Ariel to reverse the trend. Does this mean something that has risen for eight years in a row will continue to rise forever? Have the laws of economics gone mad?

Every student of economics knows that when the central bank significantly increases the money supply, the result is inflation. We saw how that happens here in the 1980s, when the central bank increased the money supply without reckoning the cost, and we quickly arrived at hyperinflation of 450 percent a year and a deep economic crisis.

Worldwide, central banks have injected enormous amounts of money into the economy over the last 15 years. It began in March 2000, after the dot-com bubble burst, and continued at a rapid clip after the September 2001 terror attack on the Twin Towers. Alan Greenspan, then chairman of the U.S. Federal Reserve, decided at the time to fight the danger of an economic crisis and recession by injecting hundreds of billions of dollars into the market. The result was the inflation of real estate and stock prices, until that bubble burst with a loud bang in September 2008.

Immediately after that collapse, though, central bank governors from Japan, Europe and the United States resumed their policy of lowering interest rates and injecting hundreds of billions into the economy, in an effort to encourage growth. It’s possible they thereby prevented a global recession, but how did it happen that they didn’t cause inflation?

Here in Israel, the story was similar. The Bank of Israel has kept interest rates very low and injected a lot of money into the market for many years. But inflation hasn’t reared its head; there has even been some deflation. How is this possible?

The answer is that inflation found an escape route for itself. It has been hiding in physical assets and financial investments, sending the price of both soaring. Bond prices in Israel (and worldwide) are currently at an all-time high.

If you deposit money in Switzerland, for example, you’ll earn negative interest. If you deposit it in the Bank of Israel, you’ll earn zero interest. If you buy bonds from the State of Israel for a period of three to six years, you’ll earn a negative real return (meaning less than inflation). And that’s something that has never happened before.

If you want to earn some kind of positive interest, you’ll have to buy bonds with 10- to 15-year terms. Then you’ll earn a tiny real interest rate, but you’ll be exposed to the risk that interest rates will rise during those years and you’ll lose a lot of money.

The situation looks even less logical when you realize that yields on shekel-denominated 10-year-bonds issued by the State of Israel are identical to those on similar bonds issued by the United States. Ostensibly, this means that our risk level is identical to that of the United States. Is that possible? After all, America isn’t being threatened by Iran, Hamas and Hezbollah. So what’s going on here?

This hidden inflation isn’t concealed only in bonds. Stock markets in Israel and worldwide are also hitting new highs, as are the prices of artwork and, of course, housing. After all, money has to go somewhere.

So it’s true that Netanyahu bears primary responsibility for the fact that housing prices have risen 60 percent in real terms during his six most recent years in office, because he didn’t deal appropriately with the problems on the supply side. But he’s not the only culprit. With him in the dock stands the governor of the Bank of Israel, whose expansionary policies have fanned the flames incessantly.

One day, all this will change. The economy will return to a normal state, interest rates will rise, bond prices will plunge. And then the prices of stocks, artwork and housing will collapse as well. Otherwise, it really will be necessary to rewrite all the economic textbooks.