Rescuing the Economy or the Bubble?

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Many ele­ments of the recently announced pack­age are jus­ti­fied. When the econ­omy is about to go into a debt-induced reces­sion, gov­ern­ment spend­ing both boosts demand, and pro­vides the pri­vate sec­tor with cash flow needed to meet its debt repay­ment commitments.

Equally vital was the guar­an­tee of all bank deposits. A run on the banks would be dis­as­trous, and this guar­an­tee ensures that this will not happen.

But yet another increase to the First Home Buy­ers Grant???

Is this because, um, house prices are, like, maybe too low?

Oh please, some real­ity here: the root cause of this cri­sis is exces­sive debt that drove house and share prices to unsus­tain­able lev­els. Times appeared rosy as the house (and stock­mar­ket) bub­ble con­tin­ued, but this was only because bor­rowed money was adding to demand.

No-one wor­ried about this when it was easy to flog a house for a higher price. But unfor­tu­nately, this game had to come to an end, because debt ser­vic­ing became pro­hib­i­tive as house prices rapidly out­stripped incomes. The bub­ble burst first in the USA, and the car­nage it has wreaked there should warn us all that asset price bub­bles are dangerous.

And how does the Aus­tralian gov­ern­ment respond? By pro­vid­ing yet another stim­u­lus on the demand side.

A col­laps­ing hous­ing bub­ble may be a scary prospect, but the more it is inflated, the scarier the final bust. And Australia’s, on any mea­sure, is big­ger than America’s.

A sim­ple com­par­i­son of the ABS Estab­lished House Price Index (ABS 641601 and 641603) to the CPI shows just how large the Aus­tralian house price bub­ble is (see Fig­ure One).

Fig­ure One

Figure One: House Prices vs the CPI

House Prices vs the CPI

Since 1987–hardly a time when Aus­tralian house prices were low by his­tor­i­cal standards–house prices have increased two and a half times as fast as con­sumer prices (see Fig­ure Two). Median incomes have fared lit­tle bet­ter than the CPI, so that houses are 60 per­cent less afford­able now than in 1987.

Fig­ure Two

Ratio  of House Prices to the CPI

Ratio of House Prices to the CPI

That’s also true even when we take into account lower inter­est rates. Yes, rates are about half what they were in 1987 (see Fig­ure Three); but debt is six times larger as a per­cent­age of house­hold dis­pos­able income than it was then (see Fig­ure Four)–so that merely pay­ing the inter­est on out­stand­ing mort­gage debt con­sumes 13 cents in the house­hold dol­lar, ver­sus a mere 3.5 cents back in 1987.

Fig­ure Three

Mortgage rates and payments

Mort­gage rates and payments

Fig­ure Four

Mortgage debt to disposable income

Mort­gage debt to dis­pos­able income

Increas­ing the amount of money that first home buy­ers can slap down on a home may help those who can’t afford to get into the mar­ket do so–great. It will also increase com­pe­ti­tion for houses, and poten­tially sus­tain the Great Aus­tralian Hous­ing Price Bubble. 

Not great. As the USA shows us, the pain of a burst­ing house price bub­ble can be pretty immense–especially since it’s fuelled by exces­sive lev­els of debt.

But that pain will only get worse if the bub­ble is dri­ven any higher. The higher up you are when you fall off a moun­tain, the more it hurts when you hit the ground. The Aus­tralian house price moun­tain, on any mea­sure, is sub­stan­tially higher than the USA’s was when it began its long, painful descent (see Fig­ure Five).

Boost­ing the First Home Buy­ers Grant is a mis­take, just as it was when Howard did it. It will merely delay the day of reckoning.

Fig­ure Five

Australian vs US Housing Bubble

Aus­tralian vs US Hous­ing Bubble

About Steve Keen

I am a professional economist 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 debts accumulated in Australia, and our very low rate of inflation.
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