The Parliamentary Library arranged a debate between myself and Rory Robertson of the Macquarie Group on the financial crisis today. We had a good audience of about 70 Parliament House denizens. You can download the Powerpoint Slides slides for my presentation, and the Vissim model of Minsky’s Financial Instability Hypothesis which was part of the presentation ( Right click and choose “Save As” since this is a text file; then install the viewer, which can load the file and let you run it (I’ve also loaded the EXE file of the viewer onto my site as another way of getting the program). You can make changes too, but they can’t be saved).
The Library has put the recording of the debate up on its Vital Issues page. Since this will change over time, shortly I’ll add the MP3 file to my list of podcasts.
Hi Ned,
The cash strategy is for a time and that time too will pass. For the last year it has been the best strategy by far. Who can say what will be the best for the next year? I’m saying the best bet is still cash. That’s just my call.
What’s your call? Are you willing to make one? Have you got an active strategy or are you following the hold and it will all be OK strategy?
That one has worked well in the past and it may well work well in the future.
Good luck time will tell.
Bull,
I agree cash has been excellent over the past year. I would impressed with your strategy if you told me you sold all your Australian dollars and bought $US or Yen in about June this year.
However from what you said in your earlier posts you don’t have cash as an investment strategy, it is a survival strategy in the case you were putting forward. If the events you foresee come to pass I still don’t think holding cash will make you better off, actually in that scenario you are pretty much backing everyone on the planet being far worse off than they are now, so far worse off that virtually no strategy will be able to do allot about it!! Even warren Buffet’s not safe if there’s a nuke headed for Omaha.
My strategy is the same as it was before, buy things that aren’t valuable now and hold onto them until they are. I think that commodities are things that will be valuable and in short supply in the coming years that are cheap now. For now I don’t need to hold them, I am prepared to invest in a index or company that produces these, but if things get worse I will want to hold onto these assets physically. And if things get as bad as you predicted earlier I wouldn’t give you a thimble full of oil for all the dollars you hold, I probably would give you some for some of your grain you posses though.
And if all else fails then I guess I can always join the army.
Hi Steve,
Well done on the debate. Excellent points with very valid logical a neoclassicalist could never comprehend.
I am continually mystified why pundits compare our property bubble to US. I’m the first to concede they are fundamentally different (particularly we are far more overvalued!). The UK market is highly equivalent to our own, and I note prices residential has now fallen 14.46% there. Why did Rory concentrate on the US comparison when the UK is FAR more relevant for the future direction of our property bubble? (namely down, and down BIG).
His analysis smacks of every other institutional economists failure to recalibrate for the transcendental change we are now experiencing.
“Big rate cuts, full-recourse loans and absence of overbuilding offer strong protection from Prof. Keen?s forecast of 40% drop in Oz-wide home prices” – good luck..
Keep up the excellent ground breaking work
Cheers
Mark
The bet has made the SMH http://business.smh.com.au/business/rate-cut-rory-bets-his-boots-on-house-prices-20081128-6mis.html
They didn’t comment that both Steve and Rory Robertson agree that a 30% drop is quite possible. I assume the percentage drop is in real terms, although with deflation it probably doesn’t make much difference.
On a side note…I made sent an experimental e mail from domain to an agent selling a property in Westmead last night:
“Regarding property ID XXXXXXXXXXX, Ill offer 25-35% off the asking price. 700K you have to be kidding. Call me when the seller wakes from his dream. ”
First thing this morning I get a call on my mobile.
The agent is really enthusiastic (desperate?) and tells me he and the owner are willing to “discuss” my offer!!!
So I tell him I didn’t even expect a call, well since you are so desperate I think I will offer 35 – 40% less…The line falls silent. He then gives me this big spiel that the place can be redeveloped and I could make 200k clear off it in a year!!!
I go, “call me back when you wake up pal”
The wolvers are at the door…It’s coming, tick, tick, tick…
BullTurnedBear,
While advocating in the other forum a Holding Tax on cash to assist in a deflationary environment (where nominal rates may be zero & real rates negative), I agree with you – Cash is King for the foreseeable future.
Unless one is able to pick up distressed assets. I know of reasonably quality commercial property that is positively geared within the mandated bank LVR’s. Still, one faces tenant risk and lack of general demand – even with signed long term contracts the risk of tenant insolvency remains.
Equities have clearly been in the pits and plenty of advisers were pulling out their “long-term value” charts suggesting 3600 – 3900 was “fair value”. Where those charts were a year before, I wouldn’t know. But the logic behind their notion of fair value is reasonable enough – around 10% p.a. since 1980 or longer if one does good research. However, since these are a little far from “normal” times, I’m not sure that a notion of “fair value” – which normally contains quite a range depending on particular circumstances – is the relevant notion.
Besides, why do people expect shares to bounce back when shares – by definition – represent the excess beyond creditor’s claims. And creditors, as measured by Credit Default Swaps, feel particularly nervous that they’ll be doing at least some of their dough – suggesting equity holders ought to be *quite* nervous.
Of course, without getting into technical difficulties of doing so, equities can be valued as a call option over the returns excess to creditors claim valued at a strike price of zero.
And while shares do bounce back before the end of the recession, I haven’t seen anyone suggest that such occurs more than about six months ahead of end of recession. If roubini is right and the USA is headed for – at least – a 24 month recession, then what does this mean for Australian equities ?
So, bonds, cash or property ?
Well, Steve Keen has expressed opinion about the return of residential property. Regardless whether he or Rory is correct, is ain’t going up much in the near term.
Bonds, well, look at Credit Default Swaps..
… to the individuals who “diversify”, well, I hope it works for you.
Plenty of studies indicate that upwards 90% of all portfolio returns come from getting asset allocation right. I’ll leave it to Beaver to work out what that means for diversify.
Just remember, every rule of thumb, followed in all circumstances, will lead to ruin with a probability of one.
So, Cash is King and will be until this deflationary thing takes over and interest rates are zero.
Oh, that won’t happen in Oz, since we are already the emerging market and have an insufficient amount of supply… ok, well, then Cash is King.
I’m with BullTurnedBear. But, as mentioned, good luck. Time shall tell.
Furball
Hi Ned,
I still have $600K in US dollars. I repatriated $350K when the $A bottomed just over a week ago.
I believe the $US will continue to strengthen and the $A will deteriorate. $A in the 40s next year is likely. But that’s just guessing. If the Bond markets keep deteriorating any number could be possible. Because Oz is dependent on raising foreign capital.
Even though I talk defensive, I am a trader. When and if the Dow gets to 9600 again ( a one third retracement). I will short it again. In saying this only a small proportion of my cash is going to that risk.
Deflation and liquidation suggests a rising $US. That has been playing out. When the music will stop though is hard to say.
Also I expect the share markets to keep falling next year (not in a straight line of course). Therefore the best play in my mind is to “sell the rallies”. That play has been working well for me since I lost money being long in January.
This site is not about trading though. It is about Economic theory. I find that really fun to discuss and debate.
One of the few institutions of sanity left in regards to the housing bubble is Australian Property Monitors. Their quarterly reports are quite interesting.
http://www.homepriceguide.com.au/media_release/index.cfm?action=view_archives
Outback Oracle
A very good summary but I do disagree with one point. There has been a strong bias to fiscal surplusses over the last several years, so the government fiscal account is also out of balance. Curiously my model indicates that these surplusses have actually exacerbated the problem. By taxing us more and then not spending it the government has caused people to borrow more increasing household debt and caused the running down of vital infrastructure which is a state resposibility. Both of these factors are now causing pain.
The reverence in which the libs hold their surplus is cult like. I was dozing in front of the TV on wednesday night when I heard words to the effect “they are going to have a deficit” which were followed by oos and ahs, what was it? tele evangilism? who was the pastor? No it was the house of reps no need to say who the pastor was. Labor is not far behind, in reverence for the “Surplus”! Don’t get me going on their mantra of growth, or is that Groeth, or Groath.
Your refering to those in command as psycopaths is a little harsh on mentally ill people. These people are either idiots, or just plain intellectually lazy (or both). With neo-classical economic theory they could earn fortunes doing nothing other than uttering weaseal words and cliches to reporters, while they were losing our superannuation and destroying the world economy.
I don’t think that they can do much now, it is beyond help (like Humpty-Dumpty), in a state of collapse. What is important now is that we round up competent people to organise the recovery after the collapse has run its course.
It will be interesting to see how far down the AUD will go when the RBA reduces interest rates next week.
cheers
BrightSpark, a surplus doesn’t seem to make much difference but at least they were trying to save. Unfortunately it just seemed to allow the RBA to keep interest rates lower. However our economy does seem to be standing up a bit better than US, UK and NZ. New Zealanders borrowed massively in a higher interest rate environment simply because their economy was even more overheated.
There might be an argument that they starved the states of funds resulting in them using public-private funding. Looking at NSW they seem to have spent the last 10 years giving away money on cheap electricity, water, public transport. For anyone else borrowing has been for real estate so giving them more money would have just meant that they could have borrowed more.
In summary, once monetary policy is wrong and keeps interest rates too low you’re stuffed. Add in bad fiscal policy by spending the surplus that has been generated by the bubble and you’re doubly stuffed because when things go bad, blink and you’re in deficit.
I see in the press how chief economists are saying that everything will be under control and the property prices will start growing again so we should not worry!
I don’t see how having growing prices is good for anything (defenitely not good for me), can someone please explain me how exactly this is good and to whom exactly it is good?
Hello chris
It would be good for the neo-classical (chief) economists of course. They are now left with the last control (they would call it “a lever” to borrow an engineering term) measure that they can think of, controlling “sentiment” by trying to “talk up” the situation. Don’t worry the probability of this happening is lower that the chance of scientists inventing a GM flying pig.
Ken
On your last point high/low (RBA set) interrest rates. These (high rates) seem to have kept the AUD exchange rate high completely negating any stabilising effect of rate falls reducing imports, causing a reduction in the CAD. As I understand it this is the simplistic mechanism suggested by, but negated by, these idiots. You suggest a bad result of low interest rates and I have no doubt that your assesment is correct. Also there are many more parameters in play.
As I see it it is not bad monetary policy but the result of bad stewardship of a out of control system. This has brought about the current (monster) crash.
Will Steve Keen win his daring bet?
http://auschart.com/2008/11/will-steve-keen-win-his-daring-bet/
Bull,
Fair enough, but originally I was adding to your 6 point plan, looks like you’re not obeying your own point 3 though.
3. I mean physical cash. As much as possible. Do you know how hard it is to get money out of the banks. The RBA has run out of $100 notes. You also need to book in at least a week to get a significant amount of cash out of the banks.
Anyway, good luck man, but sounds like your mattress is going to get awfully lumpy stuffed with all those bank notes man!!
Some info on the ground.
I was speaking to a property banker from one of the majors on Friday and he told me about one of his clients. No specifics of course.
I don’t know where this was. But I assume somewhere in NSW or South East Queensland.
The development is now finished. Before construction began 16 contracts were exchanged off the plan. I am not sure how many units there were all up. All 16 contracts have now defaulted and their deposits have been forfeited. The contracted sale prices were mostly in the $900K to $1M range.
The units are now on the market for between $500K and $600K and there are no sales as yet.
The property sector will explode next year. If it hasn’t already?
Look for Perth to have a very rough ride after it had such a large boom in a very short period of time.
G’day Brightspark
I don’t think I disagree with you re the Fiscal imbablance. My point was that the “surplus” was created by exacerbating the imbalances in the other sectors (as you describe). However there is the question of what is ’cause” and what is “effect”. I guess that is pretty normal in the world of economics. You argue that the govt surplus is “causing” the increase in private sector debt. My thinking was that Costello (with that idiot Henry’s advice)solved his problem by stimulating the profligacy and distortions in the private sector.
I guess i don’t see ’cause and effect’ so much as one gigantic FUBAR.
My greatest amazement is that the whole shenanigans has never been questioned by even one Financial journalist or Economist (with the possible exception of Steve)
Now as to psychopaths…these people are not mentally ill! Psychpaths know full well what they are doing, they just don’t care what harm they cause.
Your position is i understand it is somewhat akin to a version of Occam’s Razor
“Never attribute to malice that which can be adequately explained by stupidity.
I don’t think they are that innocent!
Elect me dictator and i’ll sort it all out!!!!
Ah brightspark…morning brings a little dawning! I missed the essential point of your post perhaps. A surplus IS an imbalance. I guess that is true if continued over too long a time frame.
Cheers
Steve,
Is the article in the newspaper correct? The guy made it seem like you chickened out of your bet about the 40%. The article mentioned that you stated it could take 15 years for it to play out? Made it seem like you were nervous and not confident with your bet. Can you please clarify these views.
Cheers!
Hi Toby,
This real estate thing is becoming a bit of a bore, but to clarify the whole thing:
I was asked what I thought would happen to Australian real estate prices about two months ago, I said that I expected them to mimic what happened in Japan–which was roughly a 40% fall over a 10-15 year period.
That set the economic chatterati going like nothing else I’d said beforehand–even though by then my Minsky-inspired predictions about economic performance had been very accurate, and the neoclassically-oriented predictions they had been making had been abject failures.
When I spoke at the Parliamentary seminar, I didn’t even mention house prices–instead I detailed the theory that had led me to anticipate the serious financial crisis we are now in. That included running the simulation program featured in my most recent Debtwatch.
Rory opened his comments by observing that I was obviously a lot smarter than some of my critics had assumed (thanks Rory), but then continued that he thought that most of the audience at the seminar had come expecting me to explain my prediction of a 40% fall in house prices.
I just reiterated that this wasn’t a prediction so much as an expectation that, having had a bigger price bubble than did Japan during its Bubble Economy days, our asset price fall would be of a similar magnitude.
He then suggested the bet–he walks for a 40% or more fall, I walk for a 20% or less. I thought that was fair enough, so I said yes. But my time frame was always of the 10-15 year period. Real estate is a slow moving train wreck compared to shares.
Somehow some of the chatterati got it into their heads that I had said a 40% fall in five years–Joshua Gans apparently believes so. I never said that, and when Rory suggested a 5 year horizon after the seminar, I said in that case I’d drop the range from 40% to 20%.
He instead said let’s go for the 40% as originally, but from peak to trough.
That raises the question of when the peak occurs, as well as how does one determine the trough.
I expect that the March figures may be the peak–an ABS index reading of 131 from memory–but there is a slim chance that the First Home Buyer con may push the index a bit higher, so that the peak might be more than 131 and later than last March. I don’t expect so, but it’s possible.
Also, a trough has to be a clear turning of the market–not just a one quarter blip in the index. The Australian market moves a lot more slowly than the US, which has fallen every month since it turned in 2006. I doubt that the Australian, when it does turn, will be as consistent as the Case-Shiller Index. So I’d refer to see 3 quarters of rising prices before I’d call the trough as having occurred.
So that’s the basic bet: from peak to trough, with 20% and 40% triggers.
But I reiterate that this issue is a trivial one to me alongside the macroeconomic disaster that this crisis is going to become. I’d rather forget the whole wager until such time as it is triggered one way or the other.
Nice presentation Steve –
Firstly, I can also see from your occasional paper to the Centre for Policy Development, “Deeper in Debt”, that you are not afraid of proposing some policy prescriptions radical enough to shake the establishment (in order to save it).
Secondly, there are those who argue that it is only demand that is forcing up house prices. The Age‘s property writers have been suckered into this theory which is being popularised by Macquarie Bank. Robertson thinks the reason why house prices have gone up in some places but not others is because some places are “sexy” and others are “dull”. Australia is rather flattered by this perspective because on the Robertson gauge, all our capital cities must be sexy. If there were no restrictions on land for building, it would cost $60,000 for a fully serviced block on the fringe of Melbourne. Yet, according to the Urban Development Institute, the average price is $145,000, having doubled since 2001. In Perth, government restrictions have brought a four-fold increase in land prices. Slow land releases around the country have identified as the cause of higher house prices. Higher house prices in turn push up rents. Labor’s housing spokesperson Tanya Plibersek’s solution is more levies on new houses to cross-subsidise low-income housing.
Thirdly, analysts at Goldman Sachs JB Were have written a remarkably honest confession to their clients about why analysts keep getting profit forecasts wrong in a downturn like this. And it contains the first public admission I have seen from any analysts that it is hard to reduce earnings forecasts because they need to “curry favour” with company management. The confession was contained in last Friday’s daily to clients from GSJBW and was written by Sam Ferraro and Matthew Ross:
They haven’t seen anything like this before — that is, “the paucity of financial crises … in recent history” means they tend to “underestimate the effects of systematic or top-down developments”.The companies haven’t seen anything like this before. A survey of analysts reveals that 25 per cent of companies that used to provide profit guidance no longer do (and guidance is all-important — see the next point, below). CEOs, they say, are chosen for their “left brain skills: optimism, ambition, hard work, focus and decisiveness. Patience and an appreciation of history are not considered virtues for these individuals”.Analysts “seek to curry favour with management in order to preserve their information networks”. Everyone knew this already, but it’s the first time I’ve seen it admitted.Analysts need to manage their “reputational risks”, so they “engage in herding behaviour”. That is, the costs of getting a big call wrong far outweigh the benefits of getting a big one right.
The bottom line, Steve, is that analyst forecasts — such as those of Robertson — are virtually useless.
- RJW
Dear Prof. Keen,
I come to your very much with cap in hand sir. I am certainly not an economist, more of a computer geek who has some familiarity with simple economic theory.
As a new husband and an even more recent father and have not yet entered the housing market but having compiled the sum of $1h for a house deposit, I do have a question if I may be so bold?
Are house prices going to fall or is the value of houses going to fall by the prices staying the same and high inflation taking place which would cause the real value of all assets to fall. I don’t really want to think about the ramifications if this is correct. Are we all going to have to pay for this abuse of credit? Even for those of us who haven’t used it much (we have only one credit card with a modest limit), we currently have no debt and in the face of inflation would suffer a loss in real terms of our earnestly assembled house deposit.
I hope that you receive this message at a time that allows you to give a benefactory response.
Sincerely
Dr. Bob
Hi DrBob,
Forget the cap mate; this is a pretty egalitarian (if not libertarian) site!
On house prices, since I expect deflation, I also expect falling house prices in nominal terms–which was the Japanese experience. Inflation may ultimately occur, but it will be some years in the future I expect, as it was in the Great Depression.
The best guide you can have to what’s likely to transpire here is the record of Japan’s economy over the last two decades.