So Australian house price growth is slowing? Yesterday, the Domain Group, formerly known as Australian Property Monitors, reported quarterly growth of 1.2% at the national capital level. Sydney accounted for most of the rise, with median house prices rising by 3.8%. Melbourne was up 1% in the quarter, while Darwin registered a 2.7% increase.
All the other state capitals recorded price falls over the quarter. With Darwin actually down 1.7% over the past 12 months, its quarterly rise was a bit of catch-up so you could argue that the latest ‘housing boom’ in Australia is really a tale of two cities…Sydney and Melbourne.
And that’s because it’s the investor market driving prices higher in these cities. Investors now account for 45% of all new housing loans, which is a record. Sydney, and to a lesser extent Melbourne, is the home of this ‘investor speculation’, to coin a nonsensical term.
I’ve written here before that I think this latest bout of price rises is a blow-off top in a 25 year bull market. The latest round of speculation was a product of the global search for yield and the Reserve Bank of Australia’s dramatic interest rate cutting cycle from 2011 to mid-2013. That saw the official cash rate fall from 4.75% to 2.5%, a cut of 225 basis points.
Add to that a crazy disregard for risk around the world, which lowered the borrowing costs of the big banks (they source about 40% of their borrowing needs from offshore) and you get an easy money driven price boom.
But interest rates haven’t moved in about 14 months. The boost from lower rates has all but washed through the system. That’s why house price growth is slowing, or even falling in some cities.
This is what happens to an economy with deep structural problems. It gets a one-time boost from monetary policy and when it wears off, the ‘economy’ goes looking for more. There’s nothing sustainable underpinning the Australian economy right now. It needs constant monetary stimulus to retain facade of health.
The mining construction boom is now starting to slow rapidly. That is, some very large projects employing thousands of people move into production phase this year, meaning the construction and engineering jobs will go.
The Bureau of Resource and Energy Economics (BREE) will soon provide an update on the state of large resource projects and employment in Australia…I’ll let you know what the findings are when it comes out in the next week or so.
But the point to keep in mind is this…when a project moves from construction to production, employment on those projects can fall anywhere up to 90%. Rising unemployment is on its way. More worryingly for Australia, when the asset begins producing, whether it’s a new iron ore mine or a large gas project, much of the returns on capital flow to offshore owners. That is, Australia doesn’t benefit, apart from royalties, that politicians will predictably blow on getting into a Middle Eastern punch-up it has no business being in…but I digress.
This profit loss will show up in an increased outflow of ‘net income’ in the current account deficit. And despite just experiencing the biggest terms of trade boom in Australia’s history, we’re still not able to run a consistent positive trade balance.
The chart below shows the balance of trade since 1971. Yellow represents deficits and blue, surpluses. As you can see, since 2008 the situation improved on the back of the iron ore boom and China’s one-time credit/construction explosion.
But with iron ore prices now reverting to the mean, we’ll struggle to maintain trade surpluses into the future.
So what, you may ask?
Well, the balance of trade feeds into the current account deficit (CAD). This is hardly ever important to markets except in a crisis. Then it becomes very important. (This is a big topic. I’ll go into it more detail in tomorrow’s Markets and Money.)
Below is a chart of the CAD over the same time frame. Except in the early 1970s, the current account has been in perpetual deficit. In short, it means that as a nation we consume more than we produce. We make up the difference by borrowing from offshore…from nations that produce more than they consume.
The cumulative result of these decades of deficits is a foreign debt load (as at June 30, 2014) of $865 billion. That’s a lot of interest to pay. In fact, we pay about $40 billion per year in interest on that debt. And that’s with interest rates at a record low!
Now, let me bring the story back to where we started. A large part of that debt is sitting on the balance sheets of the big four banks. That’s a result of our voracious borrowing to finance speculation in the property market.
This ‘investment’ provides very few productivity benefits. That is, it produces no innovations or new sources of income for the country…hence our chronic trade and current account deficits.
And that is the reason why Australia is addicted to low interest rates. It’s because we’ve punted our national wealth on an unproductive asset that needs constant stimulus to stay afloat.
Over the past decade, the stimulus has been plentiful: low interest rates, a terms of trade boom, government handouts and a beneficial tax structure.
However, all those benefits are now in the price. The terms of trade is in rapid decline and the government doesn’t have the fiscal room to provide more grants or more support for property in general.
That leaves interest rates.
But don’t expect anything from Glenn Stevens…not in the short term anyway. He’s on record saying there is only so much low interest rates can do. Fiscal policy, he says, must play a larger role.
And he doesn’t mean another round of first-time home owner grants.
I’ll continue this conversation tomorrow. In the meantime, keep in mind that the great Australian property bubble is slowly, but surely, starting to burst.
For Markets and Money