The RBA has put rates up now on the belief that the financial crisis is behind us, and it has to return to its established role of controlling inflation.
That this decision was likely was flagged by the speech by Anthony Richards last week, which implied that the RBA, having ignored the house price bubble created by private credit growth in the preceding two decades, was worried about the renewal of the bubble initiated by the Government’s First Home Vendors Boost (I refuse to call it by its official name, since the money clearly went to the vendors, while the buyers copped only higher prices).
Needless to say I am all for trying to contain the house price bubble, which I regard as a disguised Ponzi scheme that has sucked Australian households into unsustainable debt levels. It is quite possible that the increase in interest rates (which is sure to be fully passed on by lenders and will add $20 a week to the servicing costs of a now commonplace $400,000 home loan), combined with the phasing out of the Vendors Boost, will be enough to prick the bubble–especially if it is followed by another rise next month.
But the RBA is doing this in the belief that the economy will return to normal after the recent mild recession–normal meaning growing at about 3% per annum in real terms, and faster than that as it rebounds from the recession.
Unfortunately “normal” in our post-War experience has also involved a return to a rising private debt to GDP ratio. Every recession has involved a fall in debt-driven demand, and every recovery has involved a return to debt rising faster than income. As the global financial crisis has made many people realise, this is simply a formula for avoiding a crisis now by having a bigger one in the future.
I doubt that the RBA appreciates this even today. It is still mired in a neoclassical way of thinking about the economy, which myopically ignores the impact of debt-driven demand on the economy. This is why it can put up rates now in the belief that this will merely fine tune the economy’s performance–reducing the likelihood of inflation in the future.
I think it is likely that the RBA will achieve far more than it intends. The last time the RBA put rates up to attempt to control an asset price bubble that was already out of hand was back in 1989. That exacerbated the economic downturn that was already in train as the debt bubble of the 1980s started to collapse. I expect the outcome of this rate rise will be similar: a downturn that is already in train as a debt bubble bursts will be made worse by this increase in rates at a time of greatly heightened financial fragility.
The problem this time is I believe far worse than 1990. Then the household sector had a relatively low level of debt–the mortgage debt to GDP ratio was a comparatively trivial 18 percent, compared to its now record level of 87.5%. It was therefore possible for the financial sector to lend willy-nilly to households, something neoclassical economists facilitated by their enthusiastic deregulation of the financial sector.
Who is there to lend to today? All sectors of the economy except the government are carrying record levels of debt. Thus while the Vendors Boost and other enticements encouraged some additional borrowing by the already massively leveraged household sector–and gave us a household debt to GDP ratio that now exceeds America’s–I simply can’t imagine who (apart from the government) the financial sector can now sell debt to.
As a result, I doubt that we will see any sustained acceleration in the debt to GDP ratio, with the consequence that the debt-financed component of aggregate demand will be anaemic at best. Since that has been the major source of growth in aggregate demand for many years now, I expect that economic growth will be substantially less than the RBA anticipates.
If so, just as it killed a dragon that wasn’t there by its inflation-fighting rate rises up until March of 2008, it may be taming a lion that is sound asleep with its rate rises now. If economic growth does in fact stay well below levels that reduce unemployment in the coming two years, then there will be very good grounds for revoking the independence that the RBA has had in setting monetary policy. We may as well hand it back to the politicians, if the alternative is to leave it with neoclassical economists who don’t understand the dynamics of our credit-driven economy.
debtjunkies,
Thanks for the comments,
I agree that changing the zoning laws will have minimum impact on the current bubble, it would minimize the influence of the developers on the government and that could only be a good thing.
My thoughts no changes to the tax system:
1. Negetive gearing should be allowed, or at least deductability for interest payments. Why should a person be treated differently to a business which is able to deduct every cost from its income before being taxed? Also applies to shares or other investment.
2. Capital Gains should not be added to current years income for tax calculation, even a minour capital gain event pushes over into top marginal rates. Maybe use the average tax rate for the person over the period of the investment, base tax on entire value of capial gain (not half).
3.Taxing family home is only viable if there was a provision to defer taxation if proceeds reinvested into another property. Otherwise moving house would be impossibly expensive.
I do not think that these tax system changes can prevent a property bubble. These are at the limit of what I believe are acceptable to the masses.
Also, I in principle agree (with a previous post) that a home owner should not be penalized for holding an asset in times of inflation, so possibly need to use inflation adjusted base value for calculating capital gain. Yes the CPI measure is rubbish…
So, I’m with Steve, regulation focusing on the lending criteria would be the best way to stabilize the property market.
Disclosure, Im a home owner with small mortgage, only possible due to past capital gains (tax paid).
“Negetive gearing should be allowed”
…
“These are at the limit of what I believe are acceptable to the masses.”
If I read comments like this…
Karmaisking you are right. We truly deserve a crash.
Why should people who actually earn money by working be penalised in Australia?
Look at the German system – may not be ideal but at least it is less unfair.
http://www.ptireturns.com/en/tax_info/de.php
ak,
“Why should people who actually earn money by working be penalised in Australia?”
Signs of late stages Minsky scam Ponzi finance are all around us.
This article tells it like it is (warning: XXX rated economic content).
http://marketoracle.net/Article14223.html
MechanicalEngineer,
“I like the idea put forward previously of taxing the unearned capital gains on real estate.”
Since the 1970s, financial capital has been engaged in class warfare against industrial capital. If unearned financial capital gains could be taxed away, this would relieve labor and industrial capital of a great burden. The economist Michael Hudson has done some excellent work on this.
“Negetive gearing should be allowed, or at least deductability for interest payments. Why should a person be treated differently to a business which is able to deduct every cost from its income before being taxed?”
This is insane. This is one unnecessary interference that taxpayers can be relieved of. It does not help the average middle/working class person. Studies into negative gearing show that it overwhelmingly benefits the rich. Negative gearing is an economic mechanism designed to redistribute money from taxpayers to the rich, as well as helping to fuel the property bubble.
The tax system and taxpayers would be a lot better off it all deductibles were eliminated and the marginal tax rates lowered to compensate. It would have the effect of clearing out a lot of paperwork and corruption.
Karmaisking,
“Until then, these govt-sponsored distortions (including the insane taxpayer-funded-govt-guarantee of ALL bank deposits – moral hazard anyone?) are just feeding the bubble.”
I agree with the sentiment but banks are somewhat different to other firms. We have nothing like the fabled perfect competition in financial/banking services, where it is assumed that if one firm goes down, then there is no real loss to consumers and the economy.
However, given that we have an oligopoly (The Big Four), combined with an interconnected web of complex derivative instruments, it makes sense for the government to protect deposits. If one bank goes down, it would initiate a bankruptcy cascade and bring the whole system down.
I hate the banks and bankers a lot (perhaps not so much as pharmaceuticals), but until our financial system can be reformed by eliminating the oligopoly and severely regulating derivatives, protecting deposits makes sense. The banks have used the ‘too big to fail’ doctrine to great effect.
During the Howard years, the Big Four attempted to break the policy of not allowing mergers or takeovers of each other. Howard thankfully resisted such a move, even though there is not much difference between a Big Four and Big Three or Two.
ak,
“The best case scenario is another series of bailouts and a long stagnation. The worst case is what happened in the US.”
Both are occurring in the US. Whether the US economy will go in the direction of Japan since 1990 remains to be seen. The Alt-A and option adjustable rate mortgages have yet to reset on mass.
Philip,
Agreed. Which is why I favour nationalisation and break up of all TBTF institutions. Keeping the big 4 zombies alive through govt guarantees just engenders moral hazard and bigger busts later. If NO big bank can fail, then really we just have an oligarchy with different brand names and a govt guarantee backing up their stupid bets, don’t we?
MechanicalEngineer,
Whilst I agree that lending standards are lax to continue to give investors benefits that are not available to others is inconsistent.
How is this for a solution:
1. All interest on all loans for homes is tax deductible.
2. The 50% reduction of capital gains is removed.
3. The sale of all houses is then subject to capital gains tax at the time of the sale.
4. All stamp duties and other transfer duties are permanently removed.
20% deposit and 30% income serviceability requirements are regulated for and are required regardless of the purpose of the lending (owner occupied or investment).
The concern I have with restricting lending to owner occupiers but maintaining tax deductibility for investors is that it will give investors an unfair advantage.
I think that the only way to get the market back on an even keel is to get everyone playing on the same field.
AK,
I normally completely agree with your comments, so I think we are generally on the same wavelenght. So let me try to explain my position.
If I wish to buy real estate to rent out to tenants. There is two tax structures I could use. I can do it under my own name as part of my income tax or I can start a company, put in some directors capital and borrow to purchase a property in the companies name. In the later case there is no restriction on the deductions, all company costs are deductable. You could stop negetive gearing, but then business losses are also allowed to reduce taxable income.
So preventing “investors” from deducting interest cannot work without significant changes to the company tax rules as well.
@debtjunkies 223
This is not directed at you personally but your statement (one of many comments by different people) allows me to raise some concerns and issues.
“You may be right and that a massive shock is what is needed. But I believe that it will be lost as an opportunity – can you imagine the stimulus and interventionist policies of govt to try and rectify the status quo with no changes – it’s happening in the US as we speak. After 3 years of price falls they still have not made any moves to rectify the structural problems in their markets.”
The crisis in the US is not structural problem in their markets. The problem is Corporatism.
http://en.wikipedia.org/wiki/Corpratism
All better put as this article states, “Neo-Corporatism.” Think of it like a large pyramid with Ponzi schemes build into various layers or vertical shafts. When particular layers (structures) fall, it causes some pan caking of layers. This is what the US is facing now. Another 7.5 million newly unemployed added to the existing 7.5 million unemployed before the GFC. This could be 30 million unemployed if the official statistics are ignored. This is the direct result of the transfer of wealth that has lasted over 30, 40 or 60 years and has accelerated. When too many layers of a structure of a pyramid collapse the end result is the total collapse of a pyramid.
I knew that capitalism as we know it would collapse 20 years ago when seeing the statistics of transfer of wealth in the 1980s. I knew nothing about economics, politics, created debt or corruption back then. I was just being a realist.
Australians must become realist and not live in an outrageous fantasy. Our Government and mainstream media can softly break this truth and disentangle us from Neo-Corporatism. If the powers that be want to keep the status quo then the ordinary non-informed Australians will suffer the consequence.
Continuous cycles of inflation are the myth that keeps the pyramid from collapsing. Speculation on housing values rising due to inflation is just riding a major structural problem which is continuous inflation. As has been seen in various recent threads on this blog, the world has faced huge mini boom bust cycles. The booms were created by the bankers and investment class. Is it possible to think outside the narrow perspective of inflation and deflation and see that this is really as ever changing cycles of demands and supplies?
To be a revolutionist as George Orwell wrote about, “in times of universal deceit, telling the truth will be a revolutionary act.” Inflation should never be allowed to happen since it debases the labor and true asset accumulation of prior generations, but since it does happen, then deflation (an unknown by product) is the cure of wrongful inflation.
“And personally i think there are some in politics in Australia that understand the problem but are careful how they voice that concern. Henry has already flagged the tax free status of housing, Stevens has made references to a bubble and even Tanner realises the problems.”
Lindsay Tanner couldn’t handle truthful facts about the world when I was allowed to comment on his blog. Now I am censored by the moderator.
“Maybe between them they can come up with a solution. But a large fall will see Rudd the giver of life, come flying in on his white cloud, halo burning to save the day with a bail out for everyone except the responsible.”
When do us as people living in a democracy act as democratic citizens. These solutions are utter garbage. It time (which is long over due) that we begin to govern ourselves. The established elites can not govern their universal lies, deceit and corruption. A leader is one who should lead by a good example. If this does not happen now, then again it is a missed opportunity.
Karmaisking, ak,
I do not understand: “Why should people who actually earn money by working be penalised in Australia?”
I agree that “we” do deserve the crash, though I will not suffer as much some…
I am a regular wage earner, who was purely lucky enough to finish university before the 2000 property “boom”. The prices at this time were unsustainably low for some reason I do not understand (Minsky at work). So I was able to buy into the market an get a cheap house. With a family we bought a bigger (average) house and were able to keep the mortgage relatively small (to the average).
I for one would have no problem if the “value” of my home did drop by 40%, as this is more like the price I paid for it anyway. Clearly this would make life much better for anyone wanting to “enter the market”. Those who have bought into the market at high prices will unfortunately suffer if this occurs, which is why Steve suggests making the banks suffer.
Philip,
I tend to agree, the tax system is way to complicated and should be reduced to an absolute minimum.
This includes a drastic reduction in midle class welfare.
See my not to ak above re company investment as to why I think interest deductability should be allowed.
This system most dfinitely has help manny working class people, including my parents, who were dirt poor in the 60′s.
I have not seen any studies but unfortunately almost everything in our society favours the rich getting richer. Other than death taxes and the land tax system mentioned above I do not see that changing. Neither of these would be pollitically acceptable.
debtjunkies,
I like your idea’s. I still think that there would need to be roll over provisions, otherwise mobility of labour would be seriously compromised and the economists would not like that at all.
Say i bought a house for $100k in newcastle in 2000 (yes they were available), then needed to move to Sydney for work, sold the house for $300k, to try and buy in Sydney for $500k. If there was a $100k tax bill involved this would be bad… or amybe not, the capital gains in the lower maret are surely responsible for much of the price inflation in the market above…
You know what you suggest might just work.
MechanicalEngineer,
I haven’t said that fixing the system is a matter of repelling just one legislation. If there is a loophole elsewhere – it has to be plugged.
The difference is that if somebody sets up a company there are different rules regarding borrowing money from a bank.
I would be very happy to open a Ltd company just to implement some crazy ideas related to derivatives trading – and borrow 99% of the capital. Bear in mind that I have more than one passport in my drawer…
Alan,
I personally think it is useful and insightful to have people post views such as your on this site. Typically others here are kind enough to provide thoughtful feedback, however, I do not think that one can expect any more than this from these posts, as this is not a political activist site, and others have suggested organising politically in the past and it has fallen flat (I am not sure that would work anyway). How to take ideas of reform and act on them seems to be an ongoing issue for many of the ideas presented here. Steve is working in one important area against large odds, but wider meaningful change is possibly beyond him and his blog. I think many people believe that significant change will not happen until things cannot continue as they are any longer, that said the least likely people to drive substantial change are those tied to mainstream interests and parties.
ak,
The fundamental idea is that the cost incurred to provide a good or a service (in this case accomodation) is deductable from the income of the business before the profit is declared. I do not know the rules for a business loan on real estate, but suspect that with a directors guarantee and a mortgage on the property it would not be very different to personal borrowing.
For example, how many retirement homes would be built if the builders could not deduct the costs of setting up the premises. A large part of these costs is interest.
So I do not understand how preventing this is plugging a loop hole.
If interest on the house is tax deductible – rent must be tax deductible! Not sure there is an end to this.
One other danger is that we are trying to get rid of the idea of the house as an ‘investment’ and return it to being a ‘consumption’ item. If interst is tax deductible the same as for an investment in a factory etc then we are notionally elevating to an investment. Just a thought.
MechanicalEngineer,
The state should provide these facilities. There is no need to profiteer from running retirement homes. It is the duty of our society to look after the eldery. Saying that “oh this is not our problem any more they should invest in super and then pay for their own retirement” is plainly wrong because there will always be people who haven’t accumulated enough or whose super has been mishandled by investment funds.
If a fox is invited to the henhouse – don’t be surprised that profits have to be made from something found inside.
We all have to pay for the profits of companies involved – in the form of tax exemptions for example. I personally prefer the state to pay directly for these services and do not open loopholes exploited by greedy corporations.
This is what I’ve found about the issue:
http://www.uow.edu.au/~bmartin/dissent/documents/health/central.html
The Outback Oracle,
One big problem with considering housing as a consumption item, is that in general it is not consumed. my house is 40 years old and will be suitable for keeping me dry for the rest of my life (with a little maintanance), then i will be able to pass to the kids.
So rather than a consumption item real estate is a store of wealth. regardless of what the book value of the property, a home owner is “wealthy”.
Even at 40% drop this is possibly a better bet to store wealth than other options available (super funds, shares, gold etc.)
ak,
OK I should not have mentioned health care. I agree, old age care should be freely provided for those in need. I mentioned because my grandmother has just moved into one (paid for by the government). And we will be needing more in the coming years.
This is beside the point, businesses are able to deduct costs from income to declare a profit. Individuals investing (in whatever enterprise) have to have the same accounting. To prevent this simply shifts the ballance in favour of the rich who are more likely to run companies, family trusts and all manner of other tax minimizing structures.
MechEng.. post #230.
“My thoughts no changes to the tax system:
1. Negetive gearing should be allowed, or at least deductability for interest payments. Why should a person be treated differently to a business which is able to deduct every cost from its income before being taxed? Also applies to shares or other investment.”
Negative gearing is allowed and I too believe it should remain. The dispute I believe should whether the losses one would expect in the initial phase should be able to be offset against other forms of income, or should capitalise in the asset itself.
I believe being able to be offset against other forms of income promotes speculation, and more importantly mispricing.
—
“2. Capital Gains should not be added to current years income for tax calculation, even a minour capital gain event pushes over into top marginal rates. Maybe use the average tax rate for the person over the period of the investment, base tax on entire value of capial gain (not half).”
I believe the best way to approach it was the previous indexation system that we had introduced by Keating. Totally equitable.
The 50% discount rule truely promotes short term speculation, and punishes people who do commit to the type of investment we should promote, such as those who build up a business over the course of 30 years.
—
“3.Taxing family home is only viable if there was a provision to defer taxation if proceeds reinvested into another property. Otherwise moving house would be impossibly expensive.”
The premise behind this is it is taxed as as source of wealth, if the cost of capital is tax deductible, i.e the interest payments.
Seeing as one family can only have one residential dwelling, I don’t believe it really impacts a great deal one way or the other.
—
“I do not think that these tax system changes can prevent a property bubble. These are at the limit of what I believe are acceptable to the masses.”
Bubbles are prevented by the equivalent supply side responses being allowed to run their typical course. If demand pushes up the price, the supply reponse is to bring more product to market, unless we have intervention restricting supply.
Capital allocation that arguably fuels demand is restricted by the cost of capital. However in our current environment the demand on housing bears very little influence on the calibration on the cost of capital, thus they currently have an assymetrical relationship.
—
“Also, I in principle agree (with a previous post) that a home owner should not be penalized for holding an asset in times of inflation,”
Indexation for capital gains prevents that.
—
“so possibly need to use inflation adjusted base value for calculating capital gain. Yes the CPI measure is rubbish…”
Not if it is used as a discounting factor. However CPI is a narrow band of overall inflation as its measurement is (currently) politically motivated in its assembly.
—
“So, I’m with Steve, regulation focusing on the lending criteria would be the best way to stabilize the property market.”
Much less deregulation of property zoning, and to a lesser extent land release is a much better solution.
—
“Disclosure, Im a home owner with small mortgage, only possible due to past capital gains (tax paid).”
If you’ve been resident in the house for the entire time you’ve owned it you shouldn’t have any.
Rustypenny,
Indexation was what I was thinking of, the problem is CPI is understated for political reasons. Even with indexation, it is not fair for a low income working class person who has a single investment property to be taxed at highest marginal tax rate in the year the property is sold. Hence me suggestion to use average tax rate over the life of the investment.
Population policy (inc. supply of accomodation) should be a central pillar of government, but it is never discussed in terms of we choice of population target. Clearly if the population is rising, the accomodation must meet the increase.
Further to my post #235,
Another option instead of giving owner occupiers the same benefits as investors, what about reducing investor benefits and bring them back down to the same as occupiers with no negative gearing benefits or tax deductibility of interest and expenses can only be offset against the income derived from the individual property.
This will reduce the level of speculation and investors will need to assess the merits of each investment decision.
This then will address some of the concerns raised by oracle @244 so that business investment decisions are given more favourable taxation treatment than that of housing investment.
I think at the end there could ba a range of options including tax and lending standards that could be used to keep speculation out of the housing market but all players should have the same set of rules.
debtjunkies,
Deductability of mortgage interest will inflate the bubble higher as any mortgage amount’s repayment becomes more affordable due to the tax deduction achieved.
As I understand it the US had home loan interest as a tax deduction. This just drove people to refinance homes to consume on the tax deductable equity in the home. This is clearly a bad idea.
But ME their bubble did inflate to the level that ours has so therefore based on your argument maybe it is the tax deductibility of interest that kept their market from over inflating to levels ours are currently at.
Seriously thou, if you then tax the capital gain made on housing then this will reduce the level of capital that continues to roll over in the property market inflating it further.
If you give people a little each year (via a tax deduction)they may use it to boost savings, reduce debts or they may even choose to use it to consume, but if you give that same person an untaxed $100K profit from a sale that will get rolled into the new transaction bidding up the price.
I think if you follow Steves idea of ensuring serviceability and deposit standards then you can mitigate the unrestricted bidding up of property as it is restricted by the borrowers ongoing capacity to service the loan (the interest tax deduction should not form part of the loan serviceability assessment).
Karmaisking-
You can zoom any web page in or out to suit your font size preference (View menu -> Zoom on both IE and firefox, or Control – / Control + keyboard shortcuts). Personally I like the current default size on this site.
Or if you meant the size of the text entry box, you can type elsewhere and copy/paste into the form.
Hi Steve,
RE RBA and Interest Rates.
While I find your web site very interesting and valuable for its information I am not really a blogger.
I just want to say that Elliott Wave International have produced a chart of the Aust 3 Month Treasury Bill market rate and superimposed a line showing the RBA’s interest rate movements. The correlation is amazing. The same thing occurs with virtually all central banks. Central Banks follow the market rate. They do not lead the market, they do not set or control interest rates!
My question is if this is true why do we have to continue with the delusion that central banks have any serious role to play?
If all they do is follow the market rate, what useful work do they really do, what does all their so called research and analysis amount to?
Any highschool student could look at the market rate chart and say “Gee time for interest rates to go up.”
Hong Kong never had a central bank and did very well!
Please keep up the good work.