“We were much luckier because we were an old economy,” said the old man of the hour, former director of the Reserve Bank of Australia Ian Macfarlane.
We went to the archives this morning to figure out how an economy can go fifteen straight years without a single recession. It seems unnatural to us to defy the normal rhythms of boom and bust for that long, like drinking for 15 hours straight without showing any signs of inebriation. In a gentleman, that would be called holding your liquor and admirable. In an economy, it’s got to be bad for the kidneys, not to mention the bladder.
Macfarlane was at the helm for ten of Australia’s 15-year, no bathroom-break run, and on his way out, he predicted a recession ahead. But what will cause it? A Big Red Bust in China, or a soft, slow-motion crash in Australia’s property market?
For the first half of the current 15-year expansion, Australia followed the model of other Anglo-Saxon economies like the U.K. and the U.S. Inflation reached new lows with the help of dramatically cheaper imported goods from China. Wage growth was strong but not strong enough to tip the economy into inflationary growth. Unemployment ran at historic lows and capacity ran at nearly full tilt. Low-inflation. High employment. Strong growth. And, of course, cheap credit.
It sounds too good to be true to us. Prosperity makes us suspicious, just as sunshine makes us think of rain. But there it is all the same. And here we are, in what Macfarlane calls “a favourable position.”
“We were in a very favourable position in the second half of the 19th century. For a large part of the 20th century we sort of lost our exclusiveness—the things we were good at producing went down in value…I think around about 1985 that long period ended and we are now in a period where our position in the world and our resources and the institutions that we’ve created are going to become increasingly valuable.”
Still, it looks to use like the country faces a Dr. Jekyll and Mr. Hyde moment. The respectable aspect of the growth (Dr. Jekyll) is the industrial “old economy” part. China needs Australian resources. Until Chinese demand drops, Australian growth will continue, at least in the north and the West. What’s more, Australia needs more Dr. Jekyll, more investment in infrastructure to expand capacity. But there is also Mr. Hyde to worry about…
“Home loan defaults, repossessions and mortgage insurance claims are all up as property prices go nowhere,” reports Jason Bryce in today’s Herald Sun.
“First home buyers now need a household income of more than $87,000 and a disposable income of $73,000 to qualify for a loan to buy the median-priced first home of about $350,000….Property price forecaster Australian Property Monitors believes if rates rise again, as expected, property prices could fall by another give percent this year.”
–“Personal debt a major worry,” reads another headline. “Housing slump to continue,” reads a third. Yet despite this gloomy news, interest rates are almost certain to rise. And therein lies the problem for new RBA chief Glenn Stevens.
Inflation destroys real wealth. But rising interest rates destroy paper wealth in the housing market by putting highly leveraged homeowners and debtors into financial distress. Between a bad option and a worse one, what should he do?
We recall the helpful advice of baseball great Yogi Berra, “When you come to a fork in the road, take it.”
Our prediction is that the Reserve Bank will raise rates next week, but by more than the standard 25 basis points. It will do the predictable thing in an unexpected way. By doing so it avoids having to raise rates again in a month, right before Christmas. And Mr. Stevens can demonstrate to markets that he’s determined to keep the Australian expansion from overheating.
Of course we’ve been wrong before, and will surely be wrong again, perhaps as soon as next week! But if the RBA doesn’t take any action, one of two things will happen anyway. China’s growth will slow down because of domestic policy changes within the Middle Kingdom, or the housing slowdown here in Australia will become a housing bust, not a slowdown.
On the first point we cite an article from London’s Sunday Times which reveals that “Two new documents from the Chinese government, disclosed officially but little noticed abroad, left no doubt that ‘leftist’ factions have won the argument to rebalance economic policy after two decades of a dash for growth at any cost….The state news agency Xinhua, said the new policies responded to ‘rampant pollution, growing wealth disparity and complaints about the high costs of education, housing, and medical services.”
So the Reds are taking a turn to the Left? Shocking. Yet it shouldn’t surprise anyone that inflation and economic growth in China have been massively destabilizing, even while some people have become gloriously (perhaps through a bit of corruption here and there.)
This also confirms one of Bill’s essential observations that rich and powerful institutions must, almost by nature, find a way to destroy themselves. Entropy, decay, waste, whatever you want to call it, you see it over and over. The natural course of man-made things is to find a way to hasten their own destruction, like a built-in self-destruction button.
If China wants to cease getting wealthy by adopting some of the same lunatic policies that impoverished it and Russia for seventy years, we shouldn’t be shocked. Success drives whole countries mad and forces them to find the quickest way to squander what they’ve gained.
In economic terms, it was bound to happen sooner or later. China’s huge competitive advantage for the last twenty years has been its willingness to run its people and its environment into the ground in order to gain global manufacturing market share. This has made some people rich, and left millions of others with broken bodies and growing resentment. It will be interesting if China’s lurch to the left produces the desired “social stability,” or, if the inequality in growth produces more social unrest, which would, of course, dampen Chinese demand for Australian iron ore.
By the way, we don’t mean to suggest we’re big fans of economic equality, especially if it means freezing economic growth. We are big fans of inequality. It makes the world more interesting to have exceptional success and exceptional failure. Besides, average standards of living in China, like anywhere else, are lifted, even when the richest twenty percent of the population control eighty percent of the wealth.
But trying to alter the distribution of wealth in any given society is like trying to argue with the tide. This power law of wealth distribution is true nearly everywhere and all the time in history. Not everyone can be rich, just like not everyone can be beautiful, or thin, or Nicole Kidman. Trying to change this by lurching to the Left is yet another mass exercise is stupidity, something in which the Chinese have recent experience.
But even if the Chinese don’t manage to sabotage their own success and by extension, Australia’s, the local housing market may expose the dirty little secret that has kept Australia’s growth going abnormally long without a correction.
Up to now it’s been assumed Australia’s house price correction was mild and manageable. But bear markets it property are not like bear markets in stocks. Real estate bear markets are gradual and last years, like the one in Japan that went a full fifteen years.
Rising rates at the end of this year may just ignite the second leg of a more wealth-destroying property bear market in Australia. We know there are all sorts of demographic arguments for the boom. And we know the old mantra that real estate never goes down. But we also know this is not true. Real estate, like any asset class, can go down for years—especially if it went up thanks to a bunch of funny money and silly incentives in the mortgage market.
Finally, we are spending our nights and weekends making our way through Robert Hughes’ “The Fatal Shore,” a history of Australian settlement. “In eighteenth-century strategy,” Hughes writes, “pine trees and flax had the naval importance that oil and uranium hold today. All masts and spars were of pine, and flax was the raw stuff of ships’ canvas; neither could be had in quantity in the Far East.”
It was argued by some that the British navy, in need of pine trees and flax, decided to settle Australia as a strategic resource base, in addition to its destination for thousands of jailed Englishmen. Hughes argues that Botany Bay was ultimately too far away from everything else of importance to be of real strategic value. But we did find his observation somewhat comforting.
Pine trees and flax…oil and uranium…Empires are always dependent on key resources to maintain and extend their reach. “Trade had brought territory, territory war, war an Empire. With this had come immense problems of security as well as trade.” Doesn’t sound so different from today does it? Different empire, different strategic resources.
Today, the American Empire needs two things to maintain the status it has achieved through trade: money and energy. The money comes in the form of credit or the reinvestment of vast pools of petro-dollar and trade surpluses recycled into American financial assets. This keeps interest rates low and American debtors solvent. The energy comes from cheap oil, which comes mainly from the oil-rich Middle East, especially America’s good and trusted friend, Saudi Arabia.
Debt and the cost of war eventually sunk the British Empire and drained the crown of its gold, the capital stock of the nation’s money supply. America’s reliance on foreign credit and foreign energy are sinking it. Where will the next Empire form?