When Herds Collide on the Yellow Brick Road
2010 is shaping up as the year that the bulls and bears of the world’s last unpopped asset market bubble—Australia’s property market—will collide head on. The gap between those predicting yet another bubble, and those predicting its ultimate demise, has closed.
The bulls as always, emphasise the “fundamentals”—population-fuelled demand outstripping laggardly supply—and that “Australia is different”.
The bears, as always, emphasise leverage— that the true fundamental behind asset prices is people’s willingness to go into debt to buy them, in the belief that they can flog them for a leveraged profit to the next Greater Fool. And on the “We’re different because we have kangaroos” theory, the bears contend that Aussies are just as susceptible to a well disguised Ponzi Scheme as anybody else on the planet.
I doubt that most people realise just how different Australia has to be to the rest of the world to sustain the bulls’ expectations of yet another explosion in house prices in 2010. Not only do we need to defy a worldwide trend of falling house prices, we need to sustain that on top of a house price bubble that has already exceeded the best the rest of the debt-driven world has achieved in the last 20 years.
Australian house prices rose by a factor of five since the 1987 Stock Market Crash, far more than even US house prices. Even adjusted for inflation, Australian house prices increased by over 250 percent from 1987 levels. The best the US’s housing bubble could manage, before it burst in 2006, was a meagre 180 percent rise.
One irony in the bull case is that it relies on the market not working properly—though the bulls push the “supply and demand” line, they also rely on supply failing to do what it allegedly does in normal markets, and responding to increased demand in a manner that tempers the demand-driven price spike.
They also are happy to receive state handouts when it keeps the bubble afloat. 2009 was clearly the year of the government-sponsored house price bubble, with the First Home Vendors Grant driving up sub-$500,000 prices by as much as $40,000. Those happy vendors then leveraged their bonus $40,000 from panicked First Home Buyers into an additional $200,000 or so on their next purchase—which inflated houses up to the $1 million mark.
On January 1 2010, that government boost completely disappears, while the “right wing” of our schizophrenic government economic management system, the RBA, has declared that it might attempt to prick the bubble caused by the boost its fiscal ”left wing” gave to house prices this year.
So with one artificial prop to the market removed, and the monetary wing of government threatening to prick what the fiscal wing re-inflated, we’re down to the final battleground: will Australians willingly increase their exposure to debt to finance yet another acceleration of house prices, and will banks and lenders accommodate them?
Lenders don’t have much room to add to leverage in the Land of Oz. We’ve long left the Kansas of the 1960s, when banks required a 30% deposit—so that someone with a $50,000 deposit could bid no more than $167,000 for their dream home. But having skipped down the Yellow Brick Road of rising leverage, the Global Financial Crisis has stopped the Wizards in their tracks. Without it, we may well have cracked through the 5% deposit—which turns a $50,000 deposit into a $1 million purchase price.
Now there are rumblings that, gasp, a 10% deposit might be required in future—and suddenly that $50,000 deposit will only finance a $500,000 dream home.
That could be a nightmare for vendors this year—and of course for the Wizards of Debt as well. I’ll almost certainly find myself (and some friends) trekking from Parliament House to Mount Kosciuszko in late February 2010, since the final gasp of the FHB is almost certain to drive the ABS’s established house price index above its pre-Boost peak of 131. But I expect that as I come down from the mountain, Australian house prices will also be losing altitude.
BTB: Max Keiser has warned NZ on the dollar carry-trade. Is the money being withdrawn from the share market going into the dollar carry-trade in a big way? Is there any evidence that Australia is being targeted?
Hi ReversePolish comment #17,
Good observation. What has occurred to me recently is that what you have described as may happen is what has been happening for the last 7 months. Money has been flowing in to OZ. The $A has risen, equities have risen and the capital raisings have been gigantic. Over $100B (or some silly figure) raised.
I suggest, that the trend you have identified is just about over. Probably has already ended. If fear rises again soon, as I expect it too, the $A will reverse sharply and the money will be flowing out again.
Some possible side affects to a flip back to fear could be:
1. $A crashes down to 45 cents (just a calculated guess). Those that have bought $US should be ready to switch back from $US quickly when sentiment against the $A becomes extreme. I don’t believe the $US will rally forever.
2. Confidence and liquidity (ability to sell things) crashes down even harder. Expensive properties will crash down very hard. Commercial property will be virtually worthless.
3. Equities will crash to new lows and many small, medium and some large companies will collapse due to an inability to raise new debt or sell previously inflated assets.
4. The retail sector will panic as their input costs skyrocket but demand crashes.
5. The papers will be awash with negative stories again. Talk of systematic collapse will be re-ignited.
6. Steve Keen will be like a rock star again. Only this time the detractors will be too embarrassed to speak out against him.
There’s my speculative rant for the week.
Hi Laurence,
When the carry trade is reversed the money is pulled back to pay off debt. Remember the carry trade is all about cheap debt. So if money is being pulled out of NZ, I’d see that as a canary in a coal mine, not a signal that the boom is back on. The fear/optimism is global. When fear rises again, we will see money flow out of Oz big time. IMHO!
Many thanks BTB. Apparently, the size of the dollar carry-trade can overwhelm the NZ economy in a matter of months. My gut feeling is that the size of the Australian economy is not completely immune either. Just wondering where we can run or hide from this catastrophe.
What are your opinions on Jim Rogers? He used to run the Quantum Fund (one of the first major mutual funds w/George Soros) back in the early ’80s.
His big selling point for his Commodities Index is China’s still almost “unlimited potential.” For a long time many of his points have been valid. But now as they re-direct their investment of dollars overseas, is that still true?
I think Jim is a smart trader and has made many good calls. I think he talks his book like everyone else though. I suspect he makes big money through management fees. So if he has a story that he can sell when everyone is confused, his funds will benefit from large inflows. Last year he was big time talking up agriculture as the way to maximise during the downturn. I’d say many believed his story and funds flooded in. At that stage and still mind you, the world feared inflation (wrong IMO). He was selling to the herd.
In terms of Farm prices in Oz. I think they are in an unprecedented bubble. And I have thought this for 10 years. I spoke with a client on Thursday who has owned large wheat and cotton farms for many years. He sold one of his very large cotton farms in 2006 or 2007 for $17.5M. He had not been able to make money from that farm in many years. The profit failure was not because of drought either.
China is dependent on global demand. I believe demand is in a downward spiral. I suspect the MSM and the herd are very wrong about China. But then, I am a contrarian.
Scepticus,
In terms of political reform perhaps we could insist on reforming the measures by which our politicians and institutions are judged as being successful or not, pushing for reforms along these lines seems achievable through simple public debate, particularly if MSM attention can be consistently attracted, and may lead to further reforms later:
For a start see:
http://www.theage.com.au/opinion/society-and-culture/a-better-measure-of-societys-wellbeing-20091002-gghw.html
“But what is the point of having a measure of national progress, GDP, which is based on a paradigm that stupidly insists more is better? GDP goes up with increased spending on crime, natural disasters and tobacco, and does not count in the equation activities that destroy natural resources and the quality of life. GDP supposedly measures national income on goods and services, but excludes the cost benefits of caring for the aged, voluntary work and the value of housework and child care, all worth billions to the national economy and the nation’s wellbeing.” The Age Ref #58 MMitchell link.
Really? Today I have learned something about GDP.
I am not sure, but some people here might be interested in the following:
http://www.huffingtonpost.com/ellen-brown/the-imf-catapults-from-sh_b_306665.html
Quote:
“A year ago,” said law professor Ross Buckley on Australia’s ABC News last week,”nobody wanted to know the International Monetary Fund.” … Now it is back in business with a vengeance;
“At the moment the debt is owed by poor countries to banks, and if the poor countries had to, they could default on that. The bank debt is going to be replaced by debt that’s owed to the IMF, which for very good strategic reasons the poor countries will always service. . . . The rich countries have made this $500 billion available to stimulate their own banks, and the IMF is a wonderful party to put in between the countries and the debtors and the banks.”
hi ak,
thanks for the link, much obliged
I have just read bills blog and his arguments for ZIRP.
I think that the one thing that is missing from all discussion is that no model can predict human behaviour.
Maybe I misinterpret the argument but to say the ZIRP has not inflated prices in Japan does not take into consideration that they have gone through a huge deflationary period. Herd mentality is that you dont think on the way up but when burnt on the way down you remember it for a very long time.
Those burnt in the Japanese bust will not sign up again regardless of the interest rate policy.
The US is another case, ZIRP is not doing anything to encourage buying, QE to reduce interest rates is just as impotent. They too have a First home vendors grant and still prices fall.
Once bitten twice shy – no model can predict that effect on consumer/investor behaviour.
However fiscal policy distortions should be removed. Getting rid of tax concessions and grants from the system will go a long way to normalising the market. Once all fiscal distortions are removed then you can get a better idea of market dynamics and then you may get a better idea about what method (fiscal/monetary) is the most effective.
But based on politicians use of fiscal policy to date my money says that with the government out of the housing market, monetary policy (while a blunt tool) would PROBABLY be the best method of moderating bubbles.
” I plan to walk half and run half each day, walking in the morning, running in the early evening”
bloody hell steve, i’m thinking you’ll need st john’s ambulance to come along under this scenario
i thought the idea was to increase your blog membership, not kill them off
Ho ho again mahaish!
I think I’ll let my blog walkers skip the running stages! There are a couple of exercise junkies out there who have said they’d join me for the jogging portion, but the main thing I’d like is to have bloggers join me for the morning walk each day–and then get into their cars to drive to where the next day’s walk will start from.
I’m a bit of a mad exerciser, doing 3 days a week at the gym and 3 middle distance runs each week of between 8 and 15km; but I always want to do more. So I intend enjoying this thing (if I have to do it), and using it as a fitness boost as well, with a run of up to 21km each day, as well as walking say 10km each morning.
And yes, I’ve signed up a paramedic for the event!
Not a great day for the green shooters in the US yesterday.
Incidentally, a nice vid here on the biggest and original green shooter, such an illustrious track record. I trust this guy IMPLICITLY when it comes to economics. He would be a key member of any chartalist line up
(sorry);
http://globaleconomicanalysis.blogspot.com/2009/10/collectively-economists-are-perpetually.html
From the engine room of global economic growth and green shoots;
U.S.,
Non Farm Payrolls:Prev Neg 201k,Expect neg188k,ACTUAL -263k
Ave Wkly Hrs: Prev 33.1, Exp 33.1, ACTUAL 33.0
Factory Orders: Prev 1.4, Exp -0.6, ACTAUL -0.8
Unemployment Rate U3(the spin version):Prev 9.7%, Sept 9.8%
UE rate U6 (the one you feel):Prev 16.8%, ACTUAL 17%
More green shoots , let’s see if the MSM runs this on the front pages. This is a revelation (not);
“The Labor Department today also published its preliminary estimate for the annual benchmark revisions to payrolls that will be issued in February. They showed the economy may have lost an additional 824,000 jobs in the 12 months ended March 2009.(THEY MISSPLACED 824K JOBS??!!!) The data currently show a 4.8 million drop in employment during that time.
The projected decrease was three times larger than the historical average, the Labor Department said. Most of the drop occurred in the first quarter of this year, probably due to an increase in business closings, the government said.”
““Most of the additional job loss… appears to be due to in part to an increase in the number of business closings,” said BLS Commissioner Keith Hall in a statement.
The BLS’s birth/death model underestimated just how many businesses were folding — particularly during the January through March quarter — as the recession worsened.
Economists had been bracing for a downward revision, but not necessarily one of this magnitude, which means the U.S. has likely shed more than 8 million jobs since December 2007. For example, in a note Thursday, Goldman Sachs economist Ed McKelvey said he expected the revision to be “on the order of -150,000 to -200,000.”
http://globaleconomicanalysis.blogspot.com/2009/10/huge-downward-jobs-revisions-coming.html
As Mish says;
“At any rate, that is an extra 68,666 jobs per month the BLS was off between March 2008 and March 2009 with most of the drop coming January-March 2009.”
Did we see a top in stocks this week? Has the next leg down (C) of the A,B,C, stockmarket correction began? No one can be sure and quite possibly more upside is left. But, if I had my savings/super tied up in shares, after all that has passed, I would be extraordinarily nervous. Govt’s and the MSM are spending/spinning like demons to keep citizens engaged- to prevent them bailing out on the “recovery” propaganda.A logical person must ask- why? Let’s see what form the investor “epiphany” may take.
Steve,
Will you will be letting bloggers know where each day’s start-point will be? (to book accommodation etc.)
I guess bloggers can have ANYTHING THEY WANT on their T shirts like “Steve Keen wrong? – Don’t bet your house on it!”
Mike.
You bet! One of our blog members volunteered a couple of days ago to help organise the walk, and we’ll plan out a daily route, start and end times, lunch and dinner locations, the whole thing. Having got ambushed into this farce I intend enjoying it and making it a promotional event (and I’m also going to keep a good eye on the real core of Rory’s bet with me–the 40% peak to trough decline–until the “statute of limitations” on it expires in 2025). I expect it will be a lot of fun as well.
I’ll have to wear the designated T-shirt (and I’ll prepare a detailed Debtwatch-style answer for its implied question) but what other people wear who join me is entirely up for grabs.
“The only factor that could move things the other way would
be a genuine recovery, or another massive stimulus. I rule out the possibility of the former while private debt remains high but does not increase faster than GDP (and that if it happened would be a Ponzi recovery anyway, on the way to Reykjavik, as you say). On the latter, regardless of the rights or wrongs of the Chartalist argument as discussed in the previous debate, I think that’s politically feasible only one or two more times, and not to a level that will contain private debt deleveraging.”
you have a point steve, its going to be interesting to see how long political inertia can hold out against the housing bubble popping,
however i feel we may have to adjust our timetable significantly if we are expecting it to happen in the current electoral cycle.
political rule #1
no government is going to dismantle the spending and taxation regime that helps keep it in power.
political rule #2
all politics is local, in this case what matters least is the deficit and the debt , and what matters most is jobs and wallets as far as the voting public is concerned.
no ones going to care how big the deficit is as long as they have a job and can service their debts. turnbull, hockey et al are going to learn this lesson at the next election.
and if the chartilists can get their PR right , the government might have an easier time of explaining their case
this is pure crystal ball gazing mind you , but much of politics can be sometimes,
but this is the scenario as i see it, and i wont be walking anywhere if this lands on my face like the egg i cooked this morning, which it might.
given the current declines in domestic demand, and the projected budget deficits, i suspect the government has bought itself atleast 2 election wins since taking power. so we may have to wait till post 2013 before we see any major downturn in the housing market.
i’ll go even further to suggest that given the government has pegged the potential maximum cumilative deficit figure at a little over 300 billion, and that by the next election the government revenue position will be upgraded again from its most recent upgrade, they may be able to stretch things out till 2016.
infact i think it will take a change of government with a more right wing idealogical agenda to bring this deck of cards tumbling down, or an extrnal shock of some kind. from what i can see this wont happen in 2010 (i expect rudd to be elected with a bigger majority than he has now). if it doesnt happen in 2010 we will have to wait till 2016 because the libs will be too far behind to get elected in 2013.
i think 2016/17 is a perfect storm scenario, a long term government with a new leader( i expect rudd to learn from john howards mistake and retire during his third term), an even bigger bubble and more debt, a demographic transition under way as scepticus and others have mentioned and an idealogically right of centre opposition taking power.
all the makings of a disaster,
i mean , i’d rather the housing correction tomorrow, but i have the feeling that house prices are going to go up rather than down in the short to medium term care of government intervention.
mental note:
must give the crystal ball a quick spray and wipe
know the feeling steve, bit of a fitness fanatic myself. unfortunately my vanity has got the better of me, and so i spend my time in the gym throwing dumbells around, and practicing my arnold schwartzenegger impression
just a further muse on the trip
i’m thinking you will need a plaque to nail somewhere on kosiosko , you know to those fallen comrades on the walking /running/suicide campaign
you know on the theme of kosiosko, i’m thinking its a pity we couldnt hold a neo classical economists only conference in the snow fields in the dead of winter,
one well timed avalanche and the diginity of the whole economics proffession would be restored
The article below was printed in the Economist a few weeks back, but I think it’s worth reviewing given Steve’s post this week.
http://www.economist.com/businessfinance/displaystory.cfm?story_id=14365068
The main thrust of it is that in U.S cities that had a demand/supply imbalance prices and debt levels soared the most. No surprise there perhaps. However what the reasearchers discovered was that a large proportion of the new debt was taken out by current owners off the back of rising house prices – i.e. equity withdrawal to fund consumer purchases. This obviously makes the market much more vulnerable to a downturn in prices, paper profits having already been spent.
Brief excerpt:
“They found that house prices and household debt increased most where the supply of new housing was limited—in places that are hemmed in by hills, rivers or the ocean. But in cities where housing supply is very “elastic”—where homes can easily be built to meet demand and prices did not rise—debt barely rose either. This suggests that house-price rises led to more borrowing.
How much of this was simply down to new buyers needing bigger home loans? By limiting their sample to those who were already homeowners in 1997, before the boom in housing and credit, the authors were able to measure how much of the rise in debt was the result of cashing in on higher home values. They reckon almost 60% of increased debt between 2002 and 2006 came from this source. Put another way, every $1 increase in home values led to a rise of 25-30 cents in borrowing. That is far bigger than some long-standing estimates of the wealth effect from rising asset values, which are in the 3-5 cent range (though these include the response of renters, too).”
Everytime I hear a commentator banging on about the “demand/supply” imbalance in Australia pushing up prices I can’t help but think of the Economist article. Thank God it is all different here….
Hi Steve,
Your ‘Wizard of Oz’ theme was most appropriate for this piece – maybe on purpose ? Some of your readers may not know that many have considered this story to a monetary allegory on sound money based upon the bi-metallic silver and gold standard, with the yellow brick road (that must be followed, despite the difficulties) representing the gold standard (ref).
Checkmates in professional chess can be announced several moves ahead with the defeated player often resigning to show graciousness. The reason that the game can be abandoned long before the final coup de grace is that it is possible in chess to work out all possible best moves to avoid checkmate. When all possible combinations have examined exhaustively and checkmate is unavoidable, then a checkmate can be announced ahead of time.
Pessimistic economic forecasts are nearly always wrong, in timing, if not in predicting the actual disaster, because if a forecast is at all creditable, economic agents particularly the government will do almost anything to prevent it, as it is their job. For forecasts of economic depression or of the collapse of the housing market to have any chance of being accurate, every reasonable move by the government to avoid it has to be considered, before any checkmate can be announced.
Under Greenspan the US government had been doing for decades what Keynesians and chartalists would have been doing, which is to use loose fiscal and/or monetary policy to avoid being checkmated. The “maestro” has been so successful that he had been knighted by the Queen. However, the global financial crisis has forcefully indicated that those policies may be
merely postponing small disasters for bigger ones, because the policies are based on flawed assumptions (e.g. infinite resources) of nearly all economic theories. The US economy and the global financial system are fundamentally as weak I have ever seen, being artificially propped up. The question is when is the next disaster? Given that government positions are strategically in serious disarray, one senses a forced checkmate is looming.
The reason I say this is because the US and other governments have been firing from both barrels for some time to keep the bailiffs away. At near zero interest rates, monetary barrel is firing blanks, done just to make a loud sound for effect. The fiscal barrel is jammed with a mountain of debt and is threatening to blow the weapon apart, so that the monetary barrel cannot even make a sound to frighten anybody. Under what scenario would governments be forced to raise their hands above their heads?
I’m assuming governments will maintain interest rates as low as possible, unless they have no choice. I’m assuming they will spend as much they can and “do whatever it takes”, unless they have no choice. They have no decent economic theory to tell them that they cannot or they should not take such courses of action. Interest rates will be raised and government spending will be restrained only when those actions are forced on them. I assume that governments will do whatever appears to be the best courses of action when all things are conisdered, but they are not omnipotent and they are politically driven.
There is normally a large set of relationships between key economic variables such as inflation, wages, consumption, business profits, asset prices etc. This makes forecasts very difficult, as at the beginning of every chess game. But economic conditions have reached such extremes that many economic variables are more like constants and the system has shrunk to such an extent that possible scenarios may be enumerable and the situation is more like a chess endgame. The assessment of potential checkmates may be possible. It is a lot easier, but still not necessarily easy. My remarks apply both to our housing market and the economy generally.
There are many ways in which supply and Demand is different in asset markets versus goods markets:
When you have 10 people who want an apple, and only 8 apples, the “auctioneer” shouts out “$1 for an apple! $2 for an apple!” until finally he is pelted with apples as those within earshot dig around their cupboards and part with apples in exchange for more cash.
With housing, when the auctioneer shouts “$100,000 for a house! $200,000 for a house!” everyone within earshot calls up their banker and gets a home equity loan, getting the cash without parting with the house. When it comes to lending on assets, demand often *is* supply.
A good article on the ‘unimportant’ people in the US, detailing the disaster over there.
http://www.zcommunications.org/zmag/viewArticle/22730
Lyonwiss I agree with some of that. But viewed another way, it simply means change and abandonment of old conceits about who we are and what our money is rather than an endgame.
That kind of change seems to come, in economic ‘rules’ terms about every 30-40 years.
Rather than speak about endgames we might rather speak about phase changes or something, and rather than assuming that the game has an end, assume we’ve only just started.
All equally valid perspectives I’m sure you’ll agree.