Stevens is from Mars, Bernanke is from Venus?

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Note to Sub­scribers: I have been on study leave in Europe for the last month, and get back to Syd­ney late on Mon­day Feb­ru­ary 4th. I will be avail­able for com­ment from the morn­ing of Tues­day Feb­ru­ary 5th.

Chart of the Month: Who’s hav­ing a hous­ing bub­ble then?


A SMH arti­cle claimed that 17 out of 19 econ­o­mists sur­veyed expect­ed the RBA to increase rates in response to the Jan­u­ary CPI fig­ure:

Dol­lar inch­es towards US90 cents on rates expec­ta­tion

In that case, count me as num­ber 18 of 20. But unlike the oth­er 17, I believe that a rate rise now would be a mis­take. The real dan­ger to the Aus­tralian econ­o­my is not a mild resur­gence in infla­tion, but finan­cial fragili­ty, caused by exces­sive debt–the phe­nom­e­non that is lead­ing the US’s Fed­er­al Reserve to move rates aggres­sive­ly in pre­cise­ly the oppo­site direc­tion.In fact, the dis­con­nect between Aus­tralian and Amer­i­can inter­est rate poli­cies is once again so extreme, that it seems the two Cen­tral Banks reside on dif­fer­ent plan­ets. Aus­trali­a’s “Ram­bo” RBA is still wag­ing the war against infla­tion, while the “Sen­si­tive New Age” Fed­er­al Reserve is clear­ly try­ing to soothe the trou­bled finan­cial mar­kets. In mid-2006, Reserve rates had con­verged to dif­fer by a mere 0.5%; now, they are 3.75% apart after the Fed’s dra­mat­ic Jan­u­ary pre-meet­ing rate cut of 0.75%, and sub­se­quent meet­ing cut of anoth­er 0.5%. Aus­trali­a’s reserve rates are now 2.25 times those of the USA’s. 

In 2002-06, when there was last such a pol­i­cy dis­con­nect, the dif­fer­ence was jus­ti­fied by clear­ly diver­gent eco­nom­ic con­di­tions. The USA was severe­ly affect­ed by the burst­ing of the Inter­net Bub­ble, while Aus­tralia had escaped rel­a­tive­ly unscathed. Then, the USA’s rate of growth fell to a bare­ly pos­i­tive 0.2%, while Aus­trali­a’s real rate of eco­nom­ic growth slowed, but remained above 1.5% p.a. This time, a sim­i­lar gap has opened up after the burst­ing of yet anoth­er bubble–the so-called Sub­prime Lend­ing Cri­sis. To date, our RBA seems to have tak­en a punt that his­to­ry will repeat itself, and the neg­a­tive effects of this bub­ble’s col­lapse will also be con­fined to the USA.
But what if the wrong his­to­ry repeats: what if, rather than repli­cat­ing the 2000 expe­ri­ence, we repli­cate the 1990s?

Then, both coun­tries expe­ri­enced a stock mar­ket bub­ble and crash, fol­lowed in short order by a com­mer­cial prop­er­ty mar­ket bub­ble and crash.The Aus­tralian gov­ern­ment increased inter­est rates far more aggres­sive­ly that the US gov­ern­ment, in an attempt to rein in both infla­tion and the ram­pant prop­er­ty mar­ket.It was exces­sive­ly suc­cess­ful: not only was infla­tion dri­ven out of the sys­tem, but growth col­lapsed as well. Aus­trali­a’s rate of eco­nom­ic growth tum­bled from more than 2 per­cent above the USA to over 3 per­cent below it. The 1990s reces­sion in Aus­tralia last­ed longer than in the USA, and drove unem­ploy­ment high­er. The Aus­tralian gov­ern­ment was forced to rapid­ly change tack on inter­est rates, drop­ping them from 18 per­cent to under 5 per­cent over the next 3 years.

Which way should rates go?

Today, the US Fed clear­ly believes that rates have to fall sub­stan­tial­ly to avert a seri­ous finan­cial cri­sis and a pos­si­ble reces­sion, where­as the RBA believes rates have to rise to con­trol infla­tion. Both Cen­tral Banks can’t be right, unless the fun­da­men­tals in the two economies are fun­da­men­tal­ly dif­fer­ent. So just how dif­fer­ent are they?

Eco­nom­ic Growth

The dif­fer­ence in rates of eco­nom­ic growth are exag­ger­at­ed by the US prac­tice of mul­ti­ply­ing the cur­rent quar­ter’s rate of growth by four to esti­mate the annu­al rate of growth; Aus­tralia, on the oth­er hand, uses the rolling sum of the last 4 quar­ters to esti­mate the annu­al rate of growth. When the less volatile Aus­tralian stan­dard is applied to both economies, Aus­trali­a’s econ­o­my still appears to be grow­ing more rapid­ly than the USA, but the cur­rent gap was just one percent–prior to the release of the anaemic growth result for the Decem­ber quar­ter.


The rates of infla­tion are almost iden­ti­cal today, and well below the mean for the last two decades, when gen­er­al­ly Aus­tralian infla­tion was two per­cent high­er than the USA’s. Today, as mea­sured by the CPI, our infla­tion rate is the same as Amer­i­ca’s.

So rates of eco­nom­ic growth are sim­i­lar, and rates of infla­tion are almost iden­ti­cal. How dif­fer­ent then are asset mar­kets?  

Asset Mar­kets

Since the Sub­prime Cri­sis broke, the Fed­er­al Reserve has clear­ly been con­cerned that the col­lapse in US house prices will dri­ve its econ­o­my into recession–and the pre­cip­i­tous fall in the US stock mar­ket since the begin­ning of 2008 has only added to the wor­ries that a seri­ous “cred­it crunch” is tak­ing place. It is ignor­ing signs of a resur­gence in inflation–driven by ris­ing glob­al ener­gy prices–and dri­ving inter­est rates down aggres­sive­ly.The Aus­tralian RBA, on the oth­er hand, has been out­ward­ly con­fi­dent that there is no local par­al­lel to the Sub­prime Cri­sis, and more wor­ried that a fast grow­ing econ­o­my is induc­ing ris­ing infla­tion. They seem to believe that Aus­tralian asset markets–both stocks and housing–are not as frag­ile as their US coun­ter­parts. They there­fore regard the pain that high­er inter­est rates might dam­age growth and asset mar­kets are as worth the gain of low­er infla­tion.I think the RBA’s judg­ment here is flawed. On the data, the Aus­tralian stock mar­ket has out­done the US mar­ket on irra­tional exu­ber­ance since mid-2004, while the Aus­tralian hous­ing mar­ket makes the US look sub­dued by com­par­i­son. The his­toric par­al­lels are not with 2000, but with 1987/89.On the stock­mar­ket front, while our mar­ket has been grow­ing more slow­ly and sane­ly than the US since 1984–and it clear­ly did­n’t join the US in its orgy of spec­u­la­tion over the Internet–since mid-2004 the ASX has clear­ly been in a bub­ble. The annu­al growth rate dou­bled from the 1984–2004 aver­age of just under 9% to almost 20%. On the oth­er hand, the US mar­ket’s growth rate in the last three years has been 13%, only slight­ly above its trend rate of growth since 1984, of about 11%.

On the oth­er hand, the long run rate of growth of the DJIA (since 1914) is only 6%, and the long run result for the ASX (since 1984) is 9%… So what­ev­er way you cut it, both Aus­tralia and the USA have been Bub­ble Economies for the past two decades–and the stock bub­ble is clear­ly burst­ing in both economies. The real “gimme” though is in hous­ing, where our bub­ble makes the USA’s look pos­i­tive­ly anaemic. Ours began ear­li­er, climbed high­er, grew faster, and is still growing–whereas the US’s mar­ket is clear­ly in free-fall.

The US price index is now falling at a rate that exceeds one per­cent per month–an unprece­dent­ed rate of decline.

Both asset bub­bles in both coun­tries were dri­ven by the Ponzi-Scheme belief that house prices could for­ev­er rise faster than con­sumer prices, so that lever­aged spec­u­la­tion on hous­ing was a sure “road to rich­es”. But while Ponzi Schemes work for those who get in and out ear­ly, those who hang around too long find out the hard way that it’s the sure road to bank­rupt­cy instead. Once a Ponzi Scheme ends, all that’s left at the nation­al lev­el are

  • over­val­ued assets
  • much high­er debt, and
  • a com­pro­mised finan­cial sec­tor.

These are the con­se­quences that the USA is now grap­pling with–and while I think the Fed­er­al Reserve is right to wor­ry about the state of the USA’s econ­o­my, it is also undoubt­ed­ly com­plic­it in allow­ing these bub­bles to devel­op in the first place.

As is obvi­ous from the above graphs, Aus­trali­a’s asset prices are just as overvalued–and just as shaky–as those that are cur­rent­ly tum­bling in the USA. What we gain by way of a com­par­a­tive­ly respon­si­ble stock mar­ket since 1987 (recent bub­ble behav­iour except­ed), we lose in terms of an even more over­val­ued hous­ing mar­ket.

We can tick the first box on the Ponzi scheme check­list.

The sec­ond is even more eas­i­ly ticked. Though the Sub­prime Cri­sis has dis­tinc­tive fea­tures that are not repli­cat­ed here–such as the wide­spread use of “Adjustable Rate Mortgages”–lending to house­holds for real estate spec­u­la­tion has been even more ram­pant in Aus­tralia than in Amer­i­ca. In 1985, Aus­trali­a’s house­hold debt to GDP ratio was half that of Amer­i­ca’s; today, it is the same.

What about the third box–the state of the finan­cial sec­tor? Here, though there have been obvi­ous casualties–RAMs, Cen­tro and now Tri­com in particular–the wide­spread bank­ing trau­ma that has afflict­ed Wall Street has been notably absent here, and the lev­els of per­son­al bank­rupt­cies and mort­gage fore­clo­sures are much low­er.One impor­tant rea­son as to why may sim­ply be the nature of the hous­ing mar­ket. In many Amer­i­can states, a bor­row­er who can’t meet mort­gage com­mit­ments has the option of a “key drop”, as an almost cav­a­lier means to hand own­er­ship of a house back to the lender. Mort­gage orig­i­na­tors are then oblig­ed to sell as soon as possible–hence the pre­cip­i­tous decline in US house prices.Giv­en that so many of these loans were syn­di­cat­ed into bonds, the col­lapse in house prices has in turn under­mined the bond mar­ket, and in par­tic­u­lar the “repo” busi­ness (when com­pa­nies extend short-term loans to each oth­er by sell­ing a bond and an agree­ment to buy it back a short time after­wards at a high­er price). The col­lapse in house prices can force these bonds to be “marked to mar­ket”, elim­i­nat­ing their notion­al values–and mak­ing hold­ing them even for the short term of a repo agree­ment too risky for financiers to con­tem­plate.In Aus­tralia, even though repos­ses­sions and bank­rupt­cies are occur­ring at a height­ened pace, the process of liq­ui­dat­ing a repos­sessed house is much more cum­ber­some, and lenders pre­fer to pres­sure a mort­gagor into a forced sale to avoid the 15–20% hit on prices that a mort­gagee sale caus­es. So house prices hold up, bonds don’t need to be marked to mar­ket, and the finan­cial sys­tem con­tin­ues to func­tion, albeit at a reduced pace.The role of the Chi­na boom also can’t be over­looked: just as Chi­na has boomed sell­ing con­sumer goods to the USA, we have boomed sell­ing the raw mate­ri­als to Chi­na. As long as Chi­na con­tin­ues to boom, we are to some extent quar­an­tined from the US’s prob­lems.

But if irresponsible lending, rising household debt, and unaffordable house prices have caused a financial crisis in the USA, then sooner or later, we’re in for a bigger one still here.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.