Debtwatch No. 43: Declaring victory at half time
on March 1st, 2010 at 10:41 am
Note: the first part of this post will mainly be of interest just to Australian readers, but I conclude with a numerical explanation of “Why Debt-Deflation Causes Depressions” that will be of interest to readers everywhere.
Last week I took part in a debate entitled “The Great Residential Housing Debate – the next Bubble or a legitimate Boom?” at the annual conference for Perennial Investment Partners; I put the Bubble case and Chris Joye of Rismark International presented the Boom case (here is my paper and my presentation). As is well-known, Australia is one of the few countries in the OECD not to experience two quarters or more of falling GDP as a result of the GFC, and probably the only country that has not experienced a fall in its property market.
The conference was held twice, firstly in Melbourne on Wednesday February 24th, and then in Sydney on Friday 26th. There were roughly 400 people in the audience on both occasions, all of whom were customers of Perennial–with the majority (roughly 75%) being financial planners. The conference employed an electronic voting mechanism that let participants answer general questions, as well as rate the speakers. In our debate, it was used to work out where people stood on the “Bubble vs Boom” spectrum both before and after the debate. A “1″ indicated a complete Bear who expected property to crash and advised getting out now, while a “10″ was a complete Bull who advised “Buy, Buy, Buy”.
Prior to our debate in Melbourne, the average score was 4.9. This surprised me, because I expected the audience to be generally pro-property; however a score of below 5.5 indicated that overall the audience was bearish on property (since the average of the ten numbers from 1 to 10 is 5.5; also see ** below).
After our debate, the score was 5.2–a small move in favour of the bullish position, but still slightly in the bearish camp. Chris commented that this was “about even” and “too close to call” as he left the stage, which I thought was a fair enough summary of the outcome.
So I was stunned when Crikey asked me to respond to the report Chris had given them of the Melbourne debate (“Reflections on Cage Match Mk 1“), which included the statements that:
So I think I pretty comprehensively monstered Steve Keen at our debate in Melbourne yesterday. That was certainly the feedback from those who attended (there were 500)…
While I felt I was able to intellectually tear Steve apart limb-by-limb, I will say this: he is a lovely guy. Very diplomatic and humble in defeat…; and
Unfortunately, the electronic scoring in yesterday’s debate was a bit convoluted: it measured the shift in the audience sentiment from bearish (Steve) to bullish (Chris) before and after the event. On that basis, I won. But I think a simpler Chris versus Steve voting system would have made the difference much more striking…
Huh? The rest of the post was of a similar vein–though there were occasional caveats such as “As I noted in my presentation, Steve has made some valid criticisms of conventional economics, and its neglect of debt capital market imperfections. And he deserves some kudos for anticipating a credit crisis” (gee, thanks!), even this was immediately followed by “But whatever strengths he possesses are overwhelmed by his propensity to make silly statements.”
I had no intention of commenting on the debate prior to seeing this hit a national news site, but of course this couldn’t be ignored–though at the same time it didn’t deserve to be taken seriously. So I took a facetious approach–opening my reply with “I don’t know what Chris consumed after our talk at Perennial’s conference yesterday, but if he has any spare I’d like to try it at a party tomorrow night”, and concluding with the advice to Chris that, “Next time, after a conference, don’t consume anything, just take a cold shower” (I also pointed out the statistical fact Chris apparently missed, that the middle point in scores from 1 to 10 is not 5, but 5.5).
Chris took this rejoinder very well–despite our fundamental differences over this issue, we get on well personally, and unlike some participants in this debate, he does have a sense of humour.
And so we proceeded to Sydney. There the audience was slightly less bearish than in Melbourne: the average score prior to the debate was 5.3, just slightly below the neutral level. But after the debate, there was a significant shift towards the Bear case. The post debate score was 4.6.
Chris had made the classic mistake of declaring victory at half-time, only to get a cold shower with the full-time result (see below however under **).
Why Debt-Deflation Causes Depressions
“Declaring victory at half-time” is a syndrome which afflicts the entire debate over our current economic situation: optimists are of the opinion that the crisis is all over now, while pessimists think it’s only just begun. On this front, as always, I regard history as the best indicator of who may be right. On this front, I can’t commend highly enough the site New from 1930, which from January 1 2009 began publishing summaries of the Wall Street Journal from January 1 1930. The last few entries include these pearls of wisdom from February 1931:
An Old-Timer believes the market rally “will do more to restore prosperity than anything else.” Total security values have increased over $20B since start of year; barring another dive in the market, this assures a recovery since the 10M-15M US owners of stock feel richer. Bulls say the ease with which considerable profit-taking has been absorbed recently is “the surest indication of a strong healthy market.” Market has rallied very substantially; “if it runs true to form, it will have one of those ‘healthy reactions’ that will, according to the bulls, strengthen its ‘technical position.’” “The buying power of the people and the corporations still is large … In other words, the country never was in a better position to stage a comeback after a depression … (Feb. 25th)
One banker cites plenty of evidence that the backlog of consuming power is largest its been in years: corp. inventories are down 20% from a year ago, and even more from 2 years ago; corps. are holding more cash; production of many products is below requirements; products have been wearing out for 18 months of deferred buying; security values up $20B since Jan. 1; easy credit; record-breaking savings deposits. Last year there were few rallies on which to sell; this year there have been few dips on which to buy. Public interest has grown this year, but is still small compared to 1928 and 1929; “a market with a growing public interest is a dangerous market to sell short.” (Feb. 26th)
Yeah, right: in both 1930 and 1931, the belief was widespread–at least in the financial community–that the Depression was over, and recovery was just around the corner. As Australia’s Alan Kohler noted when he first discovered this blog, at least early on during the Great Depression, people didn’t realise that they were in it. They too, were declaring victory at what turned out to be not even half-time.
Ultimately, the debate over whether we’re in a complete recovery or merely a temporary recess from the GFC will only be resolved by time. But well-informed theory can also give a guide as to what we can expect, and here I regard Hyman Minsky’s Financial Instability Hypothesis and Irving Fisher’s Debt Deflation Theory of Great Depressions as the outstanding guides. However they are complex theories, especially when most economists have been mis-educated by neoclassical economics into ignoring money, debt, and disequilibrium dynamics. So the following numerical example might make it easier to understand their arguments:
- Imagine a country with a nominal GDP of $1,000 billion, which is growing at 10% per annum (real output is growing at 4% p.a. and inflation is 6% p.a.);
- It also has an aggregate private debt level of $1,250 billion which is growing at 20% p.a., so that private debt increases by $250 billion that year;
- Ignoring for the moment the contribution from government deficit spending, total spending in that economy for that year–on all markets, both commodities and assets–is therefore $1,250 billion. 80% of this is financed by incomes (GDP) and 20% is financed by increased debt;
- One year later, the GDP has grown by 10% to $1,100 billion;
- Now imagine that debt stabilises at $1,500 billion, so that the change in debt that year is zero;
- Then total spending in the economy is $1,100 billion, consisting of $1.1 trillion of income-financed spending and no debt-financed spending;
- This is $150 billion less than the previous year;
- Stabilisation of debt levels thus causes a 12% fall in nominal aggregate demand.
What about if debt doesn’t actually stabilise, but instead grows at the same rate as GDP? Then we get the following situation:
- In the first year, total demand is $1,250 billion, consisting of $1,000 billion in income and $250 billion in increased debt;
- In the second year, total demand is also $1,250 billion, consisting of $1,100 billion in income and $150 billion in increased debt;
- Nominal aggregate demand is therefore constant;
- But after inflation, real aggregate demand will have contracted by 6%.
This is the real danger posed by debt: once debt becomes a significant fraction of GDP, and its growth rate substantially exceeds that of GDP, the economy will suffer a recession even if the debt to GDP ratio merely stabilises.
A debt-dependent economy has no choice but to record rising levels of debt to GDP every year to avoid a recession. Unfortunately, this makes a debt-servicing crisis inevitable at some point, especially when a large fraction of the increase in debt is financing Ponzi-speculation on asset prices, since this adds to debt without increasing society’s capacity to finance that debt.
That is why falling debt levels caused the Great Depression, as Irving Fisher argued back in 1933, and the phenomenon is obvious in the empirical data. The next few charts illustrate this argument.
Private debt and GDP levels in the USA from 1920 to 1940:
The change in private debt, added to GDP to show aggregate demand as the sum of GDP plus the change in debt:
Now I calculate the proportion of aggregate demand that is debt-financed, by dividing the change in debt by the sum of GDP plus the change in debt: the formula for is:
The correlation of the fraction of demand that is debt financed (lagged one year since the data is end-of-year annual) with unemployment is minus 0.77. Roughly speaking, this tells us that when the debt-financed fraction of demand rises, unemployment falls, and the correlation of these two series accounts for 77% of the change in unemployment between 1920 and 1940:
Now let’s repeat the same exercise with the data from 1990 till 2010
Private debt and GDP levels in the USA from 1990 to 2010:
The change in private debt, added to GDP to show aggregate demand as the sum of GDP plus the change in debt:
The correlation of the fraction of demand that is debt financed (unlagged since we now have quarterly data on debt) with unemployment (the correlation coefficient is now minus 0.84):
This is why debt-deflation matters, and it’s also why we are barely at the half-time mark in the GFC. Though government spending has countered the fall in debt-financed spending to some degree, that fall has only hit 40% of the level that applied during the Great Depression, even though debt levels are substantially higher (relative to GDP) than they were back then.
The numerical example given above is, by the way, not too far removed from the empirical data for both Australia and the USA prior to the GFC. In the year before the crisis, Australia’s GDP was roughly A$1.1 trillion, and the increase in debt that year was A$260 billion, which was a 17% increase on the previous year; for the USA the comparable figures were roughly US$14 trillion, a US$4.5 trillion increase in debt, and a peak rate of growth of debt of about 10% p.a.
The example also illustrates why the rate of inflation matters, and why a low rate prior to a debt crisis is a serious danger. If inflation is high when the crisis hits (say 20% p.a.) then most of the decline can be taken by a fall in the rate of consumer price inflation itself. But if the commodity inflation rate is low, then the hit will be taken by asset prices and actual output as well as by a fall in the inflation rate.
The process can be countermanded to some degree by the government running a deficit, which counteracts the fall in aggregate demand caused by private deleveraging. But the government deficit would need to be far higher than current levels to return us to prosperity if nothing is also done about the astronomical level of private debt.
With the deficits that are being contemplated today, I expect the outcome to be that the rest of the OECD will “turn Japanese” and enter a long-running, low level Depression. Actions that limit those deficits–or even worse, force countries in crisis like Greece to impose austerity measures to reduce deficits back to zero–will turn this from a drawn-out Depression into a sudden and deep one.
Of course, at the same time that economic policy makers–misled by neoclassical economics–are imposing austerity programs on national governments, they are trying to restart the private debt binge mechanism that gave us the crisis in the first place. I’ll write more on this in a future Debtwatch, but in the meantime I recommend the post on this point on Vox by Peter Boone and Simon Johnson, “The doomsday cycle“.
Why has Australia done so well?
I’ve noted previously that government policy during 2009 boosted household disposable income dramatically, and Gerard Minack of Morgan Stanley recently pointed out just how much: “household disposable income increased by 10.1% over the year to the September quarter, while labour income – the biggest component of household income and traditionally the largest swing factor – increased by just 0.4%.” (Morgan Stanley Australia Strategy and Economics, February 24, 2010: The Odd Expansion). The primary factors driving household disposable incomes higher were the government’s stimulus package (which boosted incomes by about 4%) and the RBA’s rate cuts (which added another 5% to disposable incomes).
As Gerard commented when he first publicised this outcome (Morgan Stanley, Downunder Daily October 9, 2009: Antipodean Lessons), “If that’s recession, bring it on!”: it’s unheard of for household incomes to rise during a recession, and that’s a major reason why Australia avoided a downturn last year.
But it’s not the only reason: the other one, as my numerical example above illustrates, is what happened to debt levels. In our debt-dependent economies today, a recession almost always means a fall in debt levels relative to GDP (while a Depression results from absolutely falling debt). We began that process early in 2008, only to dramatically reverse direction in 2009 so that, once again, debt was growing faster than GDP.
The key cause of this was that other government policy, the First Home Vendors Boost, which enticed Australians back into mortgage debt in droves (both First Home Buyers who actually received the Boost, and the Vendors who sold to them who took levered the extra $15-40K The Boost added to the sale price into another $100-200K for their next house purchase). This policy gave us the fastest turnaround in debt levels in our post-WWII economic history.
Note that the period prior to 1965 had as many periods of the debt to GDP ratio falling as rising–which is the sign of a cyclical but non-Ponzi economy. Then from 1965 on, the trend was for debt ratios to rise faster than GDP except during the recessions of 1973-76 and 1990-94. The period of the Howard Government involved the longest sustained period of rising private debt ever–though notably this trend for rising debt began while Keating was still PM.
Then the GFC hit virtually as Rudd came to office, and the rate of growth of private debt plunged–a similar coincidence to the one that had done the Whitlam government in decades earlier (note that the debt bubble whose bursting brought Whitlam undone had also commenced under the preceding Liberal government of Billy McMahon).
Rudd deserves no blame for the bursting of the debt bubble–as I warned since December 2005, this was inevitable and when it happened, a serious global recession would begin (because the phenomenon was global and not merely limited to Australia). But his government does deserve whatever is deserved–credit or blame–for the rapid turnaround in debt. This wouldn’t have happened without the First Home Vendors Boost, since as is illustrated below, the only source of this increase in private debt has been rising mortgage debt.
Had this trick been pulled back in the 1990s, then Rudd would have received credit for it in the long run, since it would have set off a prolonged boom as debt to GDP ratios rose for many years and gave us a strong if illusory recovery from the preceding recession.
But this is 2010: household debt has risen from under 30% to almost 100% of GDP (the RBA has recently changed its statistics on this front–two months ago the figures in D02 yielded a ratio slightly above 100%), and I simply don’t believe there’s capacity for it to continue rising. So I expect that the trend will rapidly reverse itself back into a falling private debt to GDP ratio, and the recovery this rising debt has helped engineer will evaporate.
That will leave government spending as the one prop to keep the Australian economy afloat, and it is a prop that shouldn’t be underestimated, as the next chart illustrates: though the private debt to GDP ratio turned around from falling at 5% p.a. to rising at 2% p.a. courtesy of government policy, the increase in government debt added another 3% to the mix.
The sum of changing private and government debt thus substantially boosted spending in the Australian economy in 2009–enough to stop the GFC in its tracks here. But in 2010, it is highly unlikely that the private sector will continue re-leveraging. That will leave increased government debt-financed spending as the only boost.
If the government’s contribution remains at about the level of 2009–roughly a 3% boost–and the private sector continues the deleveraging it was doing before government policy kicked in–at a rate of close to 6% p.a.–then the net outcome will still be a falling debt to GDP ratio. While that is necessary in the long term to get us out of the Ponzi cycle we have been trapped in for the last 4 decades, it will still mean pain: private sector deleveraging will outweigh government sector pump-priming.
The reason is simple: so much debt has been taken on already by the Australian private sector that its capacity to take on any more is virtually exhausted. Even as households slapped on more mortgage debt under the influence of the FHVB, other personal debt was falling (until just recently) and the business sector has been rapidly deleveraging–and even so, business debt today still exceeds the peak it reached in 1990.
So the Australian gambit out of the GFC–get back into debt as fast as possible–may soon run its course. We should then find ourselves in the same situation as in the rest of the OECD–deleveraging. The fact that we are taking the “hair of the dog” approach to a debt-hangover (get drunk again on debt the next morning) is readily apparent in this comparison of Australian and US private debt levels: Australia actually began to delever before the USA did, but just as they hit deleveraging with a vengeance, our aggregate private debt started to grow once more.
Just like the “hair of the dog” approach to getting over a hangover, it works once or twice, but not forever: the ultimate destination is DA: “Debtors Anonymous”. Australia has merely delayed its entry into the club.
**
Further reflections on the Perennial debate
Chris in part attributed doing poorly in Sydney to a couple of personal mishaps that morning prior to the debate–and he did say that he expected not to speak as well as in Melbourne before the debate in Sydney took place. That would certainly have been a factor.
One other factor may be that I developed the numerical example used in this DebtWatch Report after the Melbourne conference. That gave the Sydney audience a clearer idea of why debt-deflation matters–and why the servicing cost of debt, which Chris insists is not high, is not the main problem with a debt-driven economy.
Of course, I dispute the argument that debt servicing costs are not particularly high today. As the next chart shows, even though the RBA’s rate cuts have reduced the cost substantially from its peak, interest payments on mortgages in Australia today consume 7.5% of household disposable income. This is 1.65 times the average from 1976 till now.
Yet this “average” itself is almost as high as the debt servicing costs in 1990, when mortgage rates were an astronomical 17%–2.5 times as high as today’s rates. The primary driver behind this extreme rise in debt servicing costs is the factor Chris loves to ignore, the ratio of mortgage debt to income. This is more than five times larger today than it was in 1990 (130% of household disposable income versus 25% in 1990).
In Sydney, the audience was advised (after our debate) to make a large change to its previous number if they were persuaded one way or the other; this may have made the final swing larger in Sydney than Melbourne.
Finally, Chris later argued later that financial planners are inherently bearish on residential property, since they want to advise people to get into stocks instead. That is an argument that I would prefer to take with a grain of salt. Whether that is true or not as a general proposition, it appears that the people “Mum and Dad investors” might rely upon for advice about where to put their speculative dollars are on average telling them not to put them into residential property, which is the opposite advice to that one sees regularly in the Australian media today (sourced from commentators who clearly have no pecuniary interest in whether house prices rise or fall…).
“there is no reason we couldn’t ride out at least another 5 years before global events started to hit home. By then the US economy should be on the road to recovery which would give us a boost – and potentially we could miss any major impact here.”
Yes I agree with you – it is possible for the government to sacrifice anything else and only look after the “wealth” of the housing bubble for a few more years. If there is no trade war between China and the US – the bubble may keep growing.
Then the natural limit of the growth of housing bubble will be the rising inequality between these who “have” and these who “will never have a chance to have”. Our country will be really screwed up and no fix will be possible then. I have repeated many times the story about over 2mln Polish “plumbers” who left the country after 2005 and will never come back. In fact these “plumbers” were often doctors and engineers. Try and find a good private medicine surgery in Gdansk… yes they are but only a few and you have to wait a few days. It is not a matter of paying more money for the consultation (as the salaries of doctors in Poland have already risen almost reaching the Western level but the persistent damage had already been done before). These people have simply left or no longer practice medicine. My classmate who was a heart specialist is obviously a well paid bank manager, she is really very intelligent, her husband did the same …
Imagine the situation when the US economy recovers and you can buy a house there for $250k and get a job paid 30% more than in Sydney. Sydney median prices will reach $1mln. Do you think that my kids will stay here? Yes there will still be some boat people wishing to settle in our lucky country. But not in Sydney any more I think.
This is the real end game. I hope that the bubble bursts soon and we avoid this scenario.
Brett – these are just my thoughts and anyone is welcome to tear them to pieces.
The External debt levels put Aus severely at risk. As long as China keeps booming?, there is no Bond crisis?, our interest rates are higher than the rest of the world and the rest of the world maintains a ZIRP?, we are willing to keep selling off the equity in our own resources (that’s a given) then you may be right.
But like all things with high debt this edifice may be a lot more unstable than the PTB and MSM think.
Bill Mitchell’s thoughts on the positive GDP numbers:
http://bilbo.economicoutlook.net/blog/?p=8399
With the RBA tightening monetary policy the sensitivity of household borrowing may be stronger now than in the previous recovery periods. This is because the households are still carrying record levels of debt and there has not been significant de-leveraging in the downturn evident. Some but not much! The probability of bankruptcy (at the margin) is now much higher than it was when the RBA tightened after the 1991 recession.
And Michael Pettis:
Stuck in neutral – what Japan’s rebalancing can teach us
http://mpettis.com/2010/03/stuck-in-neutral-%e2%80%93-what-japan%e2%80%99s-rebalancing-can-teach-us/
“I am not an expert on Japan by any means, even though in the past two years I have been giving myself a crash course on recent Japanese economic history, but my Asian-development-model story suggests at least one explanation of what happened. After many years of excess investment driving growth, Japan’s rebalancing process, which occurred after corporate, bank and government debt levels prevented the investment party from continuing, locked the country into many years of slow growth because it had to grind through years of debt-fueled overinvestment.”
Australia’s position is not secure as Flawse indicates. Counting on US recovery and a hopeful return to a pre-2007 world is not likely either.Further gvt priming may delay delay collapse, in 1 year or 5 years.
I think we all now agree that cheap debt is one of the root causes of Sub-prime and GFC. Now doubt China played an important role in supplying the cheap debt. Why? On the surface it is because of the imbalanced global trading, but deep down is the due to the severe imbalance of domestic income distribution and social injustice.
Generally imbalance global trading will be balanced by exchange rate movement. The surplus country will gradually become rich due to wealth accumulation, then domestic demand will pickup to compensate decline in export. However, this didn’t happen in China due to the obvious reason above. Therefore, the currently situation will continue as long as the richer or their agents are in power. So the bubbles (doesn’t matter the one in US or Australia or elsewhere) will continue to growth.
I guest most of you won’t believe this model will continue.
The ideal outcome, Chinese government with wisdom changes its policy to address the social issue above. The bubble naturally deflate and economic land softly.
The good outcome, the current situation hits natural resource limit. Rising resource cost cause rising product price. What will happen after the tipping point I think will match Steve’s model, but in a relative graduate way.
The ugly, the social problem will cause government change in China in its mild form. The conservatives take over through even like what happened back in 1989. Sudden policy change will cause bubble burst all over the world. Steve’s model will predict the rest.
The worse, power change happens in its violent form via up rising or civil war.
a. If US are not involved and conservatives win, the new government won’t be acknowledged, US will get away from the existing debt. However, inevitably the bubbles will burst because the sudden interruption of the debt supply.
b. If US are not involved and conservatives lose, the bubble will burst due to the sudden interruption. The world will bounce till hit resource limit.
Worst, US are involved and support the exiting government in order to protect its interests. I don’t know who will survivor the nuclear war.
All in all I don’t think the bubble in China will burst just by itself in natural course. Classic model may not always applicable in China. Chinese government has many unconventional methods (I can give you a long list, e.g. jail whoever not comply) to intervene and this is the reason that I think the ideal outcome can be achieved (technically, but very unlikely in reality)
Sorry, a bit off the topic and forgive me about all the bullshit above. Steve, feel free to delete this post if you think it is inappropriate. All I want to say is that to know when and what will happen to the bubble here, keep an eye on China.
If you ask, I put my bet on the ugly outcome at this moment.
From HQ@84,
I think HQ is on the right track.
Australia’s destiny is going to be governed by what’s going on overseas. There’s not much we can do here in Australia except to go along for the ride, whichever way that might be.
It is very easy for the world (esp. China, Japan, US etc) to pull the rug from under us.
But in the meantime, where is that Australian Federal Election? I reckon they better hurry up! There is an old chinese proverb that goes “delay has dangerous consequences”. I wonder whether Kevin will get in before a “double dip” occurs.
Kris Sayce in today’s Daily Reckoning (these blokes have declared war!)
Quote
Anyway, we thought it was about time we looked at the Transforming America’s Housing Policy conference that was held at New York University in February 2009.
And if you don’t believe me, watch for yourself. El Joye starts babbling on at about the 20-minute mark:
“Our research shows the single family home is a phenomenally risky investment. It’s around six-times the risk of a broad based property index. In Australia the single family home has around a 20% volatility, so volatility akin to equities and yet the average family invests 50% to 60% of all their wealth in the world in this highly idiosyncratic asset… The system [financial markets] had too much leverage, and particularly households had geared to high levels… They’re leveraging against what is an incredibly risky underlying asset.”
Got that? We nearly fell off our $99 Officeworks chair when we heard those words. We finally have an admission from El Joye that residential housing is a “phenomenally risky investment” and an “incredibly risky underlying asset
From Kris Sayce, Money Morning Editor, another little expose’ of Chris Joye that you could note and use Steve, or maybe asking him to explain in your next face to face, if ever….
Christopher Joye’s ‘Bookend’ Appearance on Insight
The Daily Reckoning Australia
Baltimore, Maryland – Melbourne, Australia
Thursday, 4 March 2010
———————————-
Dan Denning has a busy schedule in Baltimore today, so we are once again pleased to allow Money Morning editor Kris Sayce to take the stage:
You’ll remember this quote we relayed to you from one of Christopher Joye’s recent blogs at Business Spectator:
“There is an investment category out there that you likely have a large chunk of your wealth tied up in. The problem though, is that it is literally 11.6 times riskier than ‘cash’… Australian equities also don’t stack up relative to fixed income investments, such as bank bills and government bonds. I am pretty sure one could also add AAA-rated Australian home loans and A1+ corporate debt to the fixed-income outperformers…”
It was his ‘bombshell’ moment. The ‘revelation’ that investing in shares is a risky game. Thanks for the info!
Shares are risky, but not property. Investing in property and residential mortgages is much safer apparently. In fact, according to Joye’s ‘bookend’ appearance on the SBS show Insight:
“We had 11.1% house price growth in 2009. House prices have continued rising in the first month of the year – in January. Melbourne experienced 16% house price growth last year and then Sydney also experienced around 11% house price growth. The national housing shortage is estimated to be around 200,000 homes… ANZ project that will be 400,000 homes by 2015.”
And the price pressure is on the up:
“We will have a 62% increase in our population. We are looking at 7 to 8 million people living in Sydney and Melbourne individually. One of the concerns I have is the 36 million forecast is very conservative. It assumes our population growth rate today halves so it will place huge pressure on prices.”
It’s the typical spruikers mantra. A population increase means more demand for houses which means higher house prices, which means, ‘Buy now before it’s too late!’
By the way, we’ve referred to it as a ‘bookend’ appearance because El Joye was asked one question at the beginning and then one at the end. And that was it. But in just a few words he managed to express almost every property myth there is.
Hats off to him for having the argument so fine-tuned that it can be rolled out under any circumstances. Even on the occasion when you’re just asked two questions during a one-hour show.
Anyway, we thought it was about time we looked at the Transforming America’s Housing Policy conference that was held at New York University in February 2009.
We thought we’d look at it because it’s the conference that El Joye has banged on about ever since, usually with statements such as, “While presenting to the Obama Administration alongside Robert Shiller last year…”
It’s obviously an appearance he’s proud of. You can tell that by the number of times he mentions it.
It was Joye’s opportunity to show the Americans how fab the Australian housing market is. And how, if only they’d done things the same way as us then everything would be fine.
So, yesterday afternoon, we settled back to listen and watch the video recording of the panel discussion that included Robert Shiller (or ‘Bob’ as Joye referred to him), Raphael Bostic, Eric Stein, and of course Christopher Joye.
Click here to watch and listen for yourself. It’s discussion Panel 4.
Only a few minutes in and it was pleasing to hear Robert ‘Bob’ Shiller say:
“This financial crisis was caused by a failure to manage real estate risk. We put people… no matter how low income… into a leveraged position in local real estate. Highly leveraged, and if they’re low income, with their entire life savings. It’s hard to believe it, but that was the conventional wisdom… Larry White was saying… people had this strange idea that home prices only go up, and he couldn’t fathom how people would have thought that…”
Sound familiar? Ask any spruiker or property investor and they’ll tell you, you’ll always make money on property because prices always go up.
Even the feedback we received from yesterday’s Money Morning article, readers told us our example was wrong because we should allow for property doubling in value every ten years.
And that was from readers who class themselves as property bears. The idea that housing doubles in value every ten years and that it always goes up is brainwashed into almost every Australian.
We don’t take into account property doubling in the next ten years because we don’t believe it will happen.
The fact is, the idea that property is guaranteed to double in seven or ten years is a lie. Property is not a magical investment that can be detached from every other investment. It is inherently risky. But look, don’t take my word for it, just ask Christopher Joye how risky property is…
“What?” I hear you ask. Yep, straight up. Here’s a quote from El Joye I’ve taken from the video I mentioned above. And if you don’t believe me, watch for yourself. El Joye starts babbling on at about the 20-minute mark:
“Our research shows the single family home is a phenomenally risky investment. It’s around six-times the risk of a broad based property index. In Australia the single family home has around a 20% volatility, so volatility akin to equities and yet the average family invests 50% to 60% of all their wealth in the world in this highly idiosyncratic asset… The system [financial markets] had too much leverage, and particularly households had geared to high levels… They’re leveraging against what is an incredibly risky underlying asset.”
Got that? We nearly fell off our $99 Officeworks chair when we heard those words. We finally have an admission from El Joye that residential housing is a “phenomenally risky investment” and an “incredibly risky underlying asset.”
Well, well, well. Who’d have thought it? An admission that confirms everything we’ve said about residential property for the last eighteen months.
That residential property has been bid up to such a high level, and that the leverage is so enormous, it has burdened Australian households with a “phenomenally risky investment.”
It confirms exactly what we wrote a few months ago, that property is now at least just as risky as share investing – and we know how risky that is.
But because of our comments and our busting of the conventional wisdom myth, your editor has received a barrage of abuse from Joye and his property investing cronies. All of it claiming that your editor is a liar for saying that property investing is risky.
Yet all along, Christopher Joye was completely aware that in February 2009 he himself labelled the family home as a “phenomenally risky investment.” That’s taken the wordage even further than us.
And remember, he’s stating that a family home is a “phenomenally risky investment.” He’s not referring to investment properties or commercial real estate, he clearly states the “family home.”
And despite all this, El Joye and the other property spruiking bandits insist residential housing is a safe investment. An investment where prices always rise. An investment which according to his recent article, is less risky than shares.
But I’ll let you figure out what words you want to apply to someone who states one thing to an American audience and then states the opposite to Australian home owners.
If you ask me it’s a downright shameful disgrace.
All I can say is, how convenient it is to tell the truth when you’re trying to sell an idea to an American audience. An audience that has already experienced a housing crash and therefore the Joye solution will supposedly help prevent it happening again – or make it worse in our opinion.
Whereas to the Australian audience, well, the crash hasn’t happened yet. Joye wouldn’t want to ruffle anyone’s feathers. And besides, the money in the Australian market is to be made selling research to fund managers and the real estate industry.
Those customers won’t be best pleased if El Joye starts talking about housing being a “phenomenally risky investment” or a “risky underlying asset.” That’s not the way to keep dollars flowing through the door.
Look, I can’t believe it’s taken your editor over a year to come across this gem. Maybe others have spotted it, but we can’t say we’ve noticed.
Yesterday I said that Joye’s credibility was in negative territory, well, after viewing this video, in our opinion his credibility has gone off the scale and through the floor.
So far, Jason Clout at the Australian Financial Review (AFR) is the only mainstream journo to call Joye out for having soggy numbers. We can only hope that the mainstream journos really do start to take everything that Joye says with a gigantic pinch of salt.
The next time we see Joye interviewed we’ll hope to see the journo ask him to explain what he means by Australian family homes being a “phenomenally risky investment.”
It’s about time the mainstream press stopped thinking of Chris Joye as an independent objectively minded real estate analyst. The reality is that he’s a spruiker with a vested interest in keeping the property bubble going for as long as possible.
And then, when it pops, he’ll turn up like a white knight saying, “Have I got a solution for you!”
Can you trust another word Christopher Joye writes? And of equal importance, does the mainstream press have the balls to finally challenge what he says?
Let’s wait and see.
Kris Sayce
for The Daily Reckoning Australia
Link for the above Chris Joye video:
http://transformingamericashousingpolicy.org/panels#reclaiming
Panel n.4
Cheers
Hi Noah
Thanks for your post and i agree with you.
If you interpret my remarks as my thinking Australia’s position is in some way ‘secure’ I’d wish to inform you otherwise. I have an evergrowing sick feeling in the pit of my stomach! The solution for the country for the last 50 years has been to borrow more and sell more of the country off to foreign interests. We are now between a rock and a hard place and both are closing in.
I have tried very hard on various MSM blogs and the ABC to bring the dangers of our foreign Debt exposure and the degree we have sold out our future generation’s prosperity but I cannot get anyone to publicly print the numbers. I guess recognition of the problem would now precipitate the crisis!
I differ to Steve in that I don’t believe there is ANY way out of this. The policy solution, as stated by Glen Stevens, is for Australians to take on more debt, which also means more External debt. What a wonderful economic policy!!!!!
Flawse / Outback Oracle
Flawse…I think we share a similar outlook on this question and I did say not secure. The establishment running things aren’t capable and the only way to be published to get other views out in the media is to be an accredited expert. The MSM criticisms of Steve have mostly been over perceived status – not arguments, of which they are all too flimsy.
The world has faced worse positions before and if people lose 60% or more of their phony wealth, well… that means cutting back for a while. Its not the 14th century: Black Death, famine, war, and the first time England defaulted on sovereign debt. But if human nature is a guide, it will play out until there are no other options. Could be tight without a plan B.
Hats off to Kris Sayce!
I had noticed that CJ mentions that conference quite often, but gee that video really was quite interesting.
It is also worth noting the discussion about the options (CFDs) trading based on the Rismark\RP Data hedonic house price indices which CJ said would trade in May of last year.
(Note, the indices were viewable on the ASX website for a while around June last year but are no longer available and the product has not been launched even though I can recall a press release about them from around 2006.)
Here is the press release for the latest monthly data.
http://www.rpdata.com/press_releases/australias_residential_property_market_begins_2010_in_the_black.html
It is worth pondering whether the material within this press release is appropriate for the release of market sensitive data on which synthetic instruments will (one day?) be traded.
(The reader might also be interested to look back through other press releases, including from around 18 months ago when the market was under pressure.)
Ah…sorry Noah….it’s age…and stupidity….I read it as ‘not AS secure’!!!!
Thanks for the clarification
Hello Outback, ak and others.
This question of the external debt puzzles me. The neoclassical drongos say it is OK because it is “private” and not “government” and they never feel any need to explain WHY. Now as the banks are having trouble with their external solvency while rolling over their external debt the government is helping by selling government bonds (300 billion approved without mention with the stimulus package) these again for some odd reason are acceptable to the foreign lenders (is not government debt bad?). Of course here the net government debt gain is nominally zero as the debt is passed on to the banks, but the government effectively takes over the external risk from these marvellous private banks which are “too big to fail”. The flow with the current account is now a government backed magic pudding for the snouts in trough brigade.
Australia’s CAD has now been in deficit for fifty years it really took off on an exponential rise in 1974 and dipped with the start of the GFC but is now back to the level need for “growth” and to avoid “recession”. In reality it is approaching the 8.5% of gdp which seems to be the the same as the private debt level increase and this level seems to have triggered the 1890, 1930, and 2008 global financial crises.
Haven’t caught up on all the comments. Sorry guys been busy. Another good post Steve. Thanks.
Had a thought on China. Saw a story over at TAE about China’s property bubble. This made me think of the gold and silver bubble in the late 1970s and the peak in 1980.
As I remember it, the prices of gold and silver were artificially suppressed by government for 40 years. Then when that price fix was lifted the PMs began to rise in price. Their prices then went vertical before crashing back down in tulip bubble proportions.
I don’t profess to be an expert on China, but it strikes me that their property prices (and speculative juices) have been artificially suppressed due to communism. The flip to a free market over the last 10 years has probably unleashed new found speculation and a “can’t lose” phase where prices rise much further than anyone expects.
So I guess my conclusion is that their bubble could greatly exceed the size of any other country’s and the resulting crash will dwarf all other crashes.
Anyway just an idea.
Apparently the Qantas Credit Union has just reduced it’s maximum LVR to 80%. Not to reduce risk, but due to funding pressures. Presumably because deposits are leaking to other institutions that are offering better rates.
Symptomatic perhaps?
One question to ask is that if the Chinese buy investment real estate in Australia would this increase the supply of rental real estate here. Also how would this affect the Australian situation apart from making housing even more unaffordable.
I noted on a recent travel show on the ABC that, on a visit to one of the many ghost towns in China, a development called Thames Town near Shanghai the commentator revealed that a vast majority were sold but unoccupied. They were not occupied because they had been bought by investors and were being kept intentionally vacant. Apparently they depreciated on initial occupation which rendered them “second hand”.
Is this not indicative of a “bubble”.
BrightSpark1,
I believe you have asked a valid political question about the boundaries of sovereignty.
The foreign component of the private debt may be a problem if there is a wave of defaults here. It is interesting to see how foreign ownership laws will be applied to our banks and mining companies which are the main borrowers. As to exchange rates exposure – hedging is common but one may question how this is going to work if there is another global financial crisis.
http://www.rba.gov.au/publications/bulletin/2009/dec/1.html
The foreign component of the public debt if denominated in AUD does not matter at all in the context of Modern Monetary Theory. We can print our way out of debt. But the Modern Monetary Practice is a bit different. A small country without nuclear weapons but rich in natural resources may be forced to surrender the real assets – that is the mineral resources and agricultural land. We are more like Iceland or Latvia than Russia or Argentina. If the American influence wanes in our region – the eternal dream of Paul Keating of becoming an Asian country will become a reality.
The foreign debt denominated in foreign currencies can be very dangerous. Just check what happened to Ceausescu.
There is one more question almost nobody asks. Let’s assume that nothing bad happens and the foreign investment is used to expand mining operations in our country rather than fuels overconsumption binge and housing bubble growth. The investment indeed may increase our income even if there are costs associated with servicing the debt. I believe we have to surrender between 2 and 2.5% of GDP on servicing the foreign debt while net income deficit is between 3 and 4 % of GDP.
http://www.rba.gov.au/statistics/tables/xls/h05hist.xls
I don’t have numbers how much our GDP growth accelerates due to that factor.
So the question is – does it really make sense to dig out and exhaust all our easily recoverable mineral resources over the next few decades? Why shouldn’t we leave some of them for the more distant future? What is wrong in building an economy based on manufacturing and high technology? That it violates some of the sacrosanct dogmas of globalisation? Is our income really so low that we are desperate to sell off our non-renewable assets?
http://en.wikipedia.org/wiki/Economy_of_Nauru
re : #93
“The neoclassical drongos say it is OK because it is “private” and not “government” and they never feel any need to explain WHY. ”
Brightspark,
I don’t get that either. Gov’t debt is debt held on behalf of the citizens of the country. While some of them may be public workers , they’re all PRIVATE citizens. Thus gov’t debt is , at some level , private debt , of current as well as future generations of citizens.
On the other hand , every time there’s a financial crisis , debt that was clearly private originally finds its way onto gov’t balance sheets , and off the private balance sheets. Like magic.
Either we’re just running a big Ponzi-style , fiat money-printing scam , or we need to consider all debts equally as a first approximation. Distinctions about internal vs. external , class distributions of creditors vs. debtors , interest rate and maturity differentials between the private and public debt loads , etc. , are all worthy of consideration , but as a starting point, I think combined public plus private debt relative to GDP is the metric to use , viewed in the context of the historical debt levels of the particular country , as Steve’s work does.
Asset values should be given minimal countervailing weight over debt levels , IMO , as there is always mean-reversion. Private net worth/GDP levels tend to vary around a certain multiple historically , and only large deviations from that should even be considered. In the case of asset bubbles , the upward bias in net worth weighs negatively on the issue of current debt sustainability , since mean reversion should be anticipated. The opposite might apply for large net worth “troughs”.
BTW , “neoclassical drongos ” is a new one for me , and I intend to put it to good use here in the U.S.
Thanks for that.
re: #93 and #98
Because neoclassices think private sector will use the debt “wiser” as compare to public sector. I think this is general true. Private companies won’t brow if the debt is not going to generate any profit. What I can understand of Steve’s main concern is about personal debt which is fundamentally different than private debt. The personal debt(mortgage) seems picking up too quick. Personal debt is mainly used for consume not for productivities. The surged mortgage fuelled the property price increase in Australia.
Steve, thanks for your previous response (56). Time does appear to be the limiting factor.
In your example, I’m curious how you derived the statement: “But after inflation, real aggregate demand will have contracted by 6%.
I get the fact that Agg. Demand is flat, Debt is up 10% and GDP is up 10%. I just don’t see the derivation of the 6% figure. I’m going to give myself a little credit and assume it is an Econ 102 issue as opposed to 101.
Thanks for your efforts.
Will
Australia’s business investment grew in the last quarter 09 because they know to use the money wisely. On cars: passenger cars jumped 36 per cent between September and December. business purchases of four wheel drives soared 43 per cent.
Classified as business investment under the Australian Gvt’s program
The neo-classical cult is quasi moral/conservative politics rationalised in economic jargon.
If the external debt was on a much smaller scale then the fact it is ‘private’ debt MAY have some relevance…I’m undecided. However, the fact that the external debt is so enormous, when pressure comes on as it did last year, any default will sink the whole economy.
So on the scale we are at it doesn’t matter much what blessed label you put on it.
Re MMT just printing money and paying all the foreigners back their $A. This debt is gigantic now. By the time MMT get through with printing money and throwing it at the economy the foreign debt will be a whole lot bigger. The act of printing so much money will devalue the currency against just about any commodity or currency you like to think of.
So, yes, the foreigners would have to accept the devalued currency, however two things follow.
The price we pay for imported goods and capital items would automatically be somewhat higher.
Secondly, once they have taken a massive real loss on their loan to us, I doubt they will be too willing to part with too much of their savings to give to us in future.
AK at 97
You mean we could follow the sort of suggestion from te Germans being made to the Greeks in this morning’s SMH!!!
Cash for Corfu – Greece told to sell a few islands
http://www.smh.com.au/business/cash-for-corfu–greece-told-to-sell-a-few-islands-20100305-pmyn.html
Beats the hell out of having to drop para troops in and fighting for them!!!
Hi Flawse,
You said “Secondly, once they have taken a massive real loss on their loan to us, I doubt they will be too willing to part with too much of their savings to give to us in future.”
I agree with your sentiment, but look at Argintina. The defaulted in 02 and have recovered to be a hot economy with huge capital inflows a few short years later and are headed for another crash right now.
http://www.zerohedge.com/article/sovereign-default-time-capsule-what-people-were-saying-real-time-debt-and-currency-crises-pl
Don’t underestimate the power drawing people to short term profits, especially people that know if they screw up they are getting a bailout, ie bankers!!