Every Investor Should Watch This

The foreign money is still coming into Australian real estate. In fact, overseas investors account for one in six residential purchases, according to a survey the Australian Financial Review reported on this morning. If you’ve been following the DR you know the reason: a lower Australian dollar, and the security of Australia’s property rights.

This overseas money is flowing primarily into Sydney and Melbourne. The AFR says:

The figures confirmed anecdotal evidence that foreign investors are relatively modest investors and are not responsible for price surges, with 41 per cent spending between $500,000 to $1 million on homes and almost a third spending less than $500,000. Only 5 per cent bought property costing more than $5 million.

Maybe. What the article doesn’t make clear is how many properties each investor owns. And just because you buy at a modest price point doesn’t mean you are a modest investor.

Perhaps I’m quibbling. Maybe they are the notorious ‘mum and dad’ investors everyone loves to spruik about here. I don’t know. The potential is certainly there.

The OECD is forecasting that the global middle class will more than double to 4.9 billion by 2030. That’s a lot of demand that could continue to filter into our cities.

Of course, there’s plenty of demand right now. Real estate buyer’s advocate Catherine Cashmore, who was on Markets and Money Podcast recently, was at an auction in Victoria on Saturday. The property sold for half a million dollars above the reserve.

The suburbs where Asian migrant communities are flourishing are sizzling. That’s one reason NAB chief economist Alan Oster calls the demand from Asia a ‘Sydney and Melbourne story.’ But it’s not so true for the rest of the country. For all the talk of a housing boom, most of the country is fairly flat. Anyone in Perth right now can attest to that.

That’s a dilemma for the RBA when it comes to monetary policy. One side of the debate wants to cut rates further to foster demand. The other doesn’t want to spark a speculative frenzy in the housing market.

The transmission of interest rate cuts to the rest of the economy is not as clear cut as the mainstream media and economists would have you believe. It’s not an accelerator. You can’t just push down rates and watch the economy rev up.

If rate cuts did act like this, mainstream economists would have a much easier time explaining Japan. The Bank of Japan cut interest rates a dozen times in the 1990s and the economy still stagnated. This gave rise to Japan’s ‘lost decade’ (now actually three decades) and is still a perennial mystery to mainstream economists. They keep pushing their foot down on the accelerator, and expect Japan to go faster.

The most important factor to watch in an economy is not the interest rate, but the level of credit creation. That’s because the private banking system creates 97% of the money supply. If credit is rising, the economy will expand.

But there’s an important distinction to be made here that very few people understand. When the commercial banks create credit, that credit can either be used for productive investment or speculation. It’s vital to know which is happening.

If you follow the indicators mainstream economists use, you’ll never know. This is one reason they miss the build up of risks in the economy that bring on busts like 2008.

One example is GDP. GDP is a totally flawed way to measure the value of transactions in the economy. Here’s the problem: it totally ignores asset transactions, not to mention capital gains. That includes the majority of real estate buying and selling.

If you take out a business loan and buy tools, it will show up in nominal GDP growth. If you take out a mortgage to invest in property, it won’t.

The world’s premier banking expert, Richard Werner, put out a paper in 2012 explaining why, as an investor, you need to be aware of this. He wrote at the time:

The fact that asset prices are in aggregate determined by bank credit creation yields another important insight: the extension of credit for non-GDP transactions, if large and sustained enough, will produce a Ponzi scheme, whereby early entrants (those buying the assets that are driven up by bank credit creation) have a chance to exit with profits, while the late entrants (usually the broader public, buying at close to the peak of an asset bubble, as the media comes to focus on the phenomenal profits made by earlier entrants) will lose.

The reason why credit for non-GDP transactions must be a Ponzi scheme is that only GDP transactions – as national income accountants know – generate the value added that can yield income streams to service and repay loans.’

This is why over at Cycles, Trends and Forecasts we created our own indicator to track this. As far as we know, no one else in the world does this. You know when to be in the market and out of it. It should be on every investor’s dashboard. Put it on yours here.

Callum Newman+,
for Markets and Money

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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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