The Reserve Bank of Australia (RBA) is keeping a close watch on household debt.
As they noted in this month’s meeting minutes (emphasis mine):
‘Members held a detailed discussion of the high level of household debt in Australia, informed by a special paper prepared for this meeting. Household debt has increased by more than household income over the preceding three decades in many countries, but particularly so in Australia. Two key drivers of this trend across countries have been the decline in nominal interest rates, predominantly reflecting lower inflation, and financial deregulation, both of which have increased households’ access to finance.
‘Household assets in aggregate are valued at around five times the value of household debt and total assets exceed the value of debt for most households. Members noted, however, that most household assets are housing and superannuation, and that both of these are illiquid.
‘Members noted that high levels of household debt could affect economic outcomes. For example, households with high debt levels are more vulnerable to economic shocks and therefore more likely to reduce consumption in the face of uncertainty about their future income. Members also noted that changes in interest rates have a larger effect on disposable income for households with high debt levels, but that these households may be less inclined to borrow more at times when interest rates fall. Accordingly, members agreed that household balance sheets continued to warrant close and careful monitoring.’
Household debt to income in Australia has soared to nearly 200%. Much of that debt has come about because of soaring property prices.
Australian Property Market Growth
The property market in Australia has had impressive growth in recent years. In fact, they have risen much faster than Australian’s earnings. As you can see in the graph below, property prices have diverged from salaries in the last decades.
Source: Business Insider
This year, the property market started to reverse. As you can see below, dwelling values this year decreased by 1.6% in the capital cities. This is a much different picture from last year, when dwelling values grew by 11.1%, driven mainly by Sydney and Melbourne.
Higher property prices have created a sort of ‘wealth effect’ in recent years. That is, as asset prices increase, households feel that they have more money, so they spend more.
Yet as the ABS pointed out recently, household wealth has recently fallen. The average per capita net worth in March was $410,708. Lower than the December quarter estimate of $414,277. And, as they noted, mortgage debt grew faster than the value of properties.
‘Household liabilities outgrew assets during March quarter 2018, resulting in a decrease of 0.4% in household net worth, falling from a 2.0% rise last quarter…
‘The mortgage debt to residential land and dwellings ratio rose to 26.6% from the December quarter 2017 result of 26.4%, indicating that mortgage debt grew faster than the value of residential real estate owned by households.’
If higher prices made households feel like they were sitting on a lot of money, lower prices could have the opposite effect. That is, households start spending less.
Households may be feeling less rich. Especially because, as the RBA pointed out above, they are mostly asset rich.
The thing is, they haven’t accumulated much cash.
We Need Salary Growth
Salary growth is still-non-existent. Yet households have been facing higher costs as costs of living have kept growing.
That’s why, while households have been accumulating debt in recent years, the savings ratio has also collapsed.
High debt makes households more vulnerable to any shock like unemployment, or rising interest rates. But it will also take a toll on consumption.
Household consumption spending makes up almost 60% of the Australian economy. It is also one of the key drivers of Australian growth, as you can see below.
Source: AMP Capital
Less disposable income and consumption will slow-down the economy.
You may temporarily replace it with higher government or business spending. Or you can keep on fuelling debt taking by decreasing interest rates. Or boost people’s incomes by lowering taxes.
But, these are only temporary solutions.
There is no replacement for consumers. In fact, that’s what much of the economy is, the production and consumption of services.
Consumers and salaries are stretched. Property prices are falling.
At some point we will need to have salary growth…or things will slow.
Editor, Markets & Money