For the past few years, there has been a record flow of capital into domestic and international real estate markets. This flood has had an enormous impact on property markets. But where did all this money come from?

One factor is the huge increase in the size of the low-wage industrial labor force in Asia, especially in China. The new industrial workers in China and India expanded the world's industrial labor force by about 30%, all at low wages.

Increased competition from China prevented many industrial firms in developed nations from raising or maintaining prices. Hence a deflationary force hit world manufacturing in the late 1990s, causing central banks in developed nations to expand liquidity and reduce interest rates to avoid economic slowdowns.

The stock market crash of 2000, plus the economic slowdown caused by the terrorist attacks on 9-11, pressured central banks to flood their economies with even more liquidity, and to push interest rates even lower to prevent a major recession. At the same time, investors began fleeing sinking stock and bond markets, looking for somewhere else to put funds. The natural target was real estate.

Savers exercise clout

The Federal Reserve believes another major cause of this capital flood has been excessive savings by both firms in developed nations and households and firms in emerging nations like China.

Since the Chinese have no national government safety-net system to protect households, its residents have high savings rates. As investment capital poured into China to take advantage of low wage rates, savings by Chinese firms and households soared.

But most Chinese savers have nowhere to put their funds except into Chinese national banks. Those banks are burdened with supporting national government-owned firms, most of which operate at losses. That fact, plus corruption among Chinese officials, means the banks are not competent to make profitable domestic investments.

So the Chinese government has pressured banks it controls to invest overseas, especially in U.S. Treasury securities. This gives Chinese banks higher yields than they can earn at home, though it risks losses through devaluation of the dollar.

Such purchases of U.S. Treasury securities also help finance continued trade deficits by America as its residents buy more and more imports from China. China needs to keep expanding such exports to employ the millions of workers who continually stream into its cities from depressed rural areas. Ironically, much of the savings of Chinese workers and firms invested in the U.S. then underwrites American capitalists and firms who invest in Chinese enterprises.

Another factor is the explosion in oil revenues to nations with large oil deposits, especially the Soviet Union and nations in the Middle East. These oil producers have enjoyed huge profits from the world's rising demand for oil, adding to the world's savings that must somehow be absorbed.

Safe haven in a volatile world

Yet another cause of the financial flood into real estate has been uncertainty about the future of the world's economic prosperity. War in Iraq, Afghanistan, Somalia, and Sudan, the threat of more terrorist attacks around the world, plus sluggish economic growth in Japan, have made investors reluctant to put their capital back into non-real-estate stocks and bonds.

Meanwhile, with population growth rates in Europe and Japan falling close to or below zero, and people living longer, there is a rising need for capital to support more retiring workers. So households and governments are under pressure to increase savings for this purpose and to invest those savings somewhere now.

The final factor is that real estate has performed better than stocks and bonds over the past decade. The National Association of Real Estate Trusts maintains an index of all equity REITs.

If that index is set to 100 on Dec. 31, 1998, it stands at about 384 today. In contrast, if the S&P 500 index is set at 100 on the same date, it is only 115 today. REITs have almost quadrupled in value in the same period that the S&P 500 index rose only 15%. Other major stock indices also lag far behind REITs.

All of these factors explain why so much money has flooded into property markets in the past decade. How long these factors will remain effective is another issue.

Anthony Downs is a senior fellow at the Brookings Institution and a visiting fellow at the Public Policy Institute of California. He can be reached at anthonydowns@csi.com.