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.
Karmaisking
Fascinating links. Suffice to say, I think Mr Wood’s analysis has done more to convince me that the Depression of 1921 did more to vindicate Keynesian ideas, rather than to refute them. After all, tax cuts (which occurred in 1921) and public works expenditure (which rose in all three levels of government, even though there was a surplus on the Federal government) are your classic Keynesian prescriptions to tackle a Depression (indeed, Keynes’ said deficits are the most likely, but not necessarily, compulsory outcome when one engages in public works).
Thus, the problem is not fiscal stimulus per se. It’s the type of fiscal stimulus that is the issue. Unlike today’s imprudent bailouts to borrowers etc., the Depression of 1921 involved lower taxes and government spending in appropriate areas which help demand elsewhere (i.e. highways, railways, auto permits, finance etc) which got the people moving from the country to the city (as the country side collapsed). The stimulus was not big. It was merely prudent.
Of course, however, there is a broader irony here: the sort of public works advocated by Keynes is what helps initiate the boom-bust cycle; building roads, canals, railways etc., is precisely the sort of “socialisation of investment” that caused a speculation in land and other assets and a rise in the “unearned increment” which initiated the large construction boom of the 1920s (and of the 1810s, 1830s, 1850s, 1870s, and 1890s also).
The Andrew fellow whom you cite is engaging in word games- is credit money debate in economics is frivolous. In a Wittgenstein-ian vein, look at effect, not intent. Use, rather than meaning.
spadijer89,
I gather that behind almost every recession/depression is the buildup of speculative bubbles in assets, primarily stock markets and property. If such speculation can be neutered, then capitalist economies would be far more stable which is why Steve’s ideas concerning mortgages and the stock market could go a long way into preventing such problems.
The main problem with the Australian housing Bubble is the lack of immigration control of wealthy people obtaining a permanent visa, then obtaining duel citizenship, and purchasing property to rent out. The Chinese, Russian and Indian investors are everywhere at the moment.
The house prices in Australia have exceeded America for the main reason. Safe Western economy, no crime, and a shortage of land release pushing up prices. The local population has no hope in hell of servicing a mortgage. Most property titles have caveats that restrict the size of the dwelling built. You have a Mc Mansion built with brick, solid frame, and heavy tiles on a small block.
When I was born, my family was comfortable in a 10 square home, we had a back yard to play in, I was happy, had a garden, and I went to University. This was in a neighborhood that had a good mix of public housing. Sure some of the kids came from broken homes, but I know so many people who broke their class barrier because we all mixed together and saw how the other families lived. This made us aspire to break the poverty cycle.
Philip,
Indeed. Thus, my point, “the sort of public works advocated by Keynes is what helps initiate the boom-bust cycle; building roads, canals, railways etc., is precisely the sort of “socialisation of investment” that caused a speculation in land and other assets and a rise in the “unearned increment””. The property cycle is the 18 (Kuznets) business cycle.
But the best policy prescription is land tax, not mere “regulation”. Anyways, I have written a paper on the idea of making Canberra a “single tax (enterprise) zone” . I’ll let you know when its published in the ANU economics journal.
FYI- UK enterprise zones are interesting case study, because despite the fact virtually all taxes were virtually abolished (land taxes included!), the unemployment rate rose. Why? Amongst other things, because rents quadrupled in the space of 18 months as land speculators rushed in and withdrew land from supply, waiting for a capital gain. The tax system touts idleness over hard-work. The “rent-seeking” taking place in this microcosm, is emblematic of what happens in the wider economy before any deep recession.
spadijer89,
All valid points, but speaking of relevance and avoiding frivilous discussion – what are your prescriptions now? Reducing taxes whilst maintaining a budget surplus doesn’t seem likely today in Australia (in the US such a suggestion would be laughable).
Productive public works expenditure would be a good idea, but for some reason today’s govts are so stupid they can’t do it properly. Pink bats and second (third?) gyms at public schools, whilst public hospitals in Honsby and Tasmania are starved of funds (bizarre). If they did konw what they were doing they would be raising public health expenditure to prepare the infrastructure for the ageing population and they would be subsidising research into solar energy production.
So, sticking with the relevany theme, great work on the 1920s, but what do you recommend today?
relevency.
Or relevancy? Who cares….
the only reaon I contribute to Ozrisk.net is that the size of the comments allows me to type easily. Just on the topic of interfaces, Steve really needs to look at upgrading the size of the font on the comments pages. I can barely read this stuff – and I’m short-sighted!
I’ll see what can be done Karmaisking!
Philip, spadijer89,
Living in NSW the topic of Government corruption and real estate speculation appear very closely liked.
I like the idea put forward previously of taxing the unearned capital gains on real estate. This would clearly be very unpopular with many voters.
So I’ve been thinking, maybe it would be possible to change the planning laws, such that only government owned land could be rezoned.
If a farmer wanted to build housing on his property, it would have to be sold to the government, rezoned and then sold at public auction. Then the profit is not from the rezoning, but from the capital improvement required to form the subdivision (roads sewage etc.)
I thought this idea had a chance of passing the voters, but not the political parties, who are indebted to the developers.
Any thoughts?
MechanicalEngineer,
IMO the greatest problem in the debate about property is not land or development it is the way in which property is treated, that is a tax free speculative investment.
Until you change the fundamental premise of what property is you will never be able to come up with a solution where the profit motive does not control property outcomes.
In that case of the above, one of the problems is that farmers do bank the land and release it when the $’s offered are substantial and whether they sell it to private corps or govt is not going to change that. During the development process, councils will use the services of private certifiers and contractors again introducing the profit motive into the process.
If it did gain some traction as an idea could you imagine the outrage from existing owners if the govt flooded the market with cheap home building blocks thereby lowering the price of existing homes.
I think that we need to come up with ideas on how to deflate the existing bubble, reduce prices by 20-30% over a period of 5-10 years, change the tax treatment of property and modify owners expectations.
Then ideas such yours like changing development controls and land releases will be able to work as intended.
But I do agree it does appears as if NSW has be hijacked by the property spruikers.
Spadijer
Sorry if you saw my response to your post as something of an attack on your thesis. It certainly was not meant to be as I have appreciated the quality of your posts. So again I apologise.
There is a problem here with the size of posts…we talk about massively complex problems in a few short sentences. So I guess we can be easily misinterpreted. As to using ‘spurious’ figures in my stats, yes, and I sort of apologised for that at the beginning of my post.
I post here for two reasons. The first is to test my thoughts a bit given that I am not an Economist by trade. I spend my days, and quite a few nights, running my company so I don’t have ready availability of stats, models etc. I pull them from memory (you might accuse me of pulling them out of my a..e!!) Second, through age, a life spent in industries and work that 99.99% of people in here would never be in, and a lifelong fascination fascination with Economic theory and practice, I do have a different perspective on some things. (As do the engineers, architects etc who post)I merely post to offer that perspective FWIW. I’m not vehement.
I guess my main point WAS that I agree we didn’t run into massive liquidity problems because of the reasons you outlined. I do think that long-term (and here I mean decades – 30 to 40 years)too much of our savings has gone into housing. The jobs thus generated are not all ‘construction’. You get ‘retail’, coffee shops, legal services Govt etc etc growing as a result. So yes, the % construction jobs is no doubt as you report, however in the long term a whole lot of ‘stuff’ is built on the foundation of ‘housing’.
I think we maybe just have a different perspective on the time frame in these particular posts. I keep looking at what I have observed happen to Australia over 50 years.
However, I also believe that we have a massive problem in our external account that is ignored by pretty well all commentators. (I am a bit lucky in having Ross Garnaut’s timely input on 7.30 Report)We fund our CAD through both borrowings and sales of our resource assets and equities. Given that the amount the Banks rolled over last year was in the vicinity of $400B it had a fair bit to do with liquidity within Aus as well. In addition we had massive equity raisings that were externally funded. Were we not able to fund the equity raisings externally the downward liquidity spiral you describe would have also come into being.
I agree that the maintainence of the property market was probably more significant in preventing this happening. However I do think that if a card had been pulled out of the house anywhere, there would have been a cascading effect – a bit like the sand pile demonstration. once it’s unstable anything can happen.
“I think that we need to come up with ideas on how to deflate the existing bubble, reduce prices by 20-30% over a period of 5-10 years, change the tax treatment of property and modify owners expectations.”
Tell this to the 60% of the electorate that they have to relinquish 20% of their wealth in order to change certain parameters in the set of second-order non-linear equations.
Unfortunately there is only one way. The hard way.
I meant differential equations.
“I also believe that we have a massive problem in our external account that is ignored by pretty well all commentators. (I am a bit lucky in having Ross Garnaut’s timely input on 7.30 Report)We fund our CAD through both borrowings and sales of our resource assets and equities. Given that the amount the Banks rolled over last year was in the vicinity of $400B it had a fair bit to do with liquidity within Aus as well.”
If we want to have free lunch we only need to make sure that the waiter doesn’t have a kalashnikov rifle hidden under his clothes. Then we can truly enjoy it for a while as the Chartalists have proven we can always pull a money printing machine. “Carpe diem”.
AK
Thanks for the Billy blog reference. I had bookmarked Mitchell’s site a long time ago as containing a bit of good sense. Through everyday life stuff it dropped from my reading list and i had not revisited it in a long time and . That article gave me a much better perspective on what he is on about. I agree with much of his take on the problems re CAD’s, exchange raters and interest rates etc. I need to read the paper a few more times. I’m not too certain about solutions. I’m on the side of ‘there aren’t any!…which is not very helpful!!!
ak,
I agree that it is going to hard to swallow but i think that we need to look at ways to reduce prices in real terms over an extended period, if the bubble just pops and prices drop by 25% in 12 months then we could end up with some unintended social impacts as has happened in the US.
I think the potential problems associated with a quick solution would be massive for the ecoomy and would take a substantial period to recover from.
I think you may be missing my point – i agree housing is treated as a speculative overpriced investment and the basic premise of what a house should be has been lost along the way.
I personally think it would be carnage if the bubble was to burst in a BIG way – the banks, the govt, the economy would almost come to a grinding halt – i want to see prices back to there long term average – but to say burst and be damned I think is the wrong way to go.
Debtjunkies
I saw it put in interesting terms somewhere yesterday…in teh FT I think
We have three choices
1. Implicit default (Massive Inflation)
2. Explicit default (default and bankruptcy)
……
3. ‘Eternal stagnation’
I can’t help but feel that this steady solution we have in mind might result in 3. There’s so much belief in BS, and the BS is so deeply entrenched in our beliefs, politics and media that maybe it requires a major shock to change it.
Oracle,
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 interventialist policies of govt to try and rectify the status quo with no changes – its 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.
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.
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.
Steve has noted before that he is working on a future entry about these concerns and hopefully it will tackle some of the issues we are discussing now.
The problem is that in the middle of a crisis every one is thinking about how to minimise its effects.
They talk about change and why it happened but by the time everything has stabilised and is starting to recover the need to push on with change while not diminished is no longer seen as a major concern.
Why, because the crisis has passed – lets worry about it the next time.
Guys,
The massive shock will occur if there’s a spike in unemployment. As quoted above, you can’t modify someone out of work. If there’s a wave of credit defaults, these guys won’t be able to borrow easily again.
The system will eat itself.
Karmaisking,
Thats why i believe that we should try a change the way in which property is viewed, change the structure of the system while the broader economy is performing reasonably well as there may be a chance to unwind the bubble.
I know im harping on this issue but do we really want the system that we are a part of to eat itself (when put like that it is actually quite amusing).
Oh stuff it im tired of arguing,lets feast on the carcass!
debtjunkies,
My point is that we are doomed to some extent here in Australia regarding housing bubble and nothing can be done due to the irrational behaviour of people and manipulating power of the housing bubble stakeholders.
We ar more apes with slightly overgrown brains than rational creatures or robots like “homo economicus”.
The best case scenario is another series of bailouts and a long stagnation. The worst case is what happened in the US.
Median house prices and mortgage debt are both ‘measured’ in the local fiat currency
House prices ‘measured’ in gold at the current gold price and fiat exchange rates are…
150 oz in USA ~ population 300 million
300 oz in UK ~ population 60 million
360 oz in Australia ~ population 22 million
In all three countries the 130 year median house prices low points have been ~100 oz in 1895, 1935 & 1980
ak,
It could be that the “best case” scenario is what is happening in the US. With our levels of record private mortgage debt, and our income to debt levels, it could be much worse if unemployment spikes.
Bailouts only add to the madness. The bailouts stifle the necessary, urgent need for resource reallocation and economic readjustment (Japan anyone?) and if continued will eventually just find their way into the hands of the bankers and their cronies.
We desperately need the markets to “clear” (no FHBG, higher interest rates worldwide (not just in Aust), and capital gains tax applied consistently to include residential property, to stop these crazy distortions in investment).
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.
http://globaleconomicanalysis.blogspot.com/2009/03/bonus-bonanza-bingo-blessing-in.html