Well you have to give RBA governor Glenn Stevens credit (no pun intended). He is no Alan Greenspan. He got on the idiot box yesterday and told anyone who would listen that speculating on house prices is crazy. Specifically he said that, “I think it is a mistake to assume that a riskless, easy guaranteed way to prosperity is just to be leveraged up into property. It isn’t going to be that easy.”
There are two reasons why it’s not going to be easy, although we don’t speak for the governor. The first is that he pretty clearly telegraphed his intention to raise interest rates to what the RBA considers more “normal” levels. “We can’t assume rates will remain low,” he told Seven. “The relationship between the cash rate and what they pay for mortgages or small business loans is what we think is useful.”
Useful for what? For predicting where mortgage rates are headed. And that would be higher if the relationship between the cash rate and mortgage rates persists. “If you look back when the economy was stable and we had low inflation, the cash rate, that is the rate we decide on, the rate has been in the average of 5 per cent.”
So if Stevens thinks the economy is pretty normal now with low inflation, then you’d expect the cash rate to rise from 4% now to at least 5% by the end of the year, beginning as soon as April 6th when the RBA meets again to rig the price of money (we mistakenly said they meet today in yesterday’s edition.) In February, Stevens said there was a good chance rates were headed up in the first half of this year.
When the man who sets interest rates tells you that you’re rising, it would be wise to at least hear him out. Whether you take him at his word is up to you. But if you’re making financial plans – say, like you’re going to buy a house and are trying to figure out if you can stand a few extra points rise in the interest rate – the man has told you what is going to happen.
Of course there is the chance, mentioned last week, that bank interest rates have decoupled from the cash rate. This was the possibility raised by NAB execs when they said Australia’s dependence on wholesale borrowing from overseas meant that the foreign cost of capital would determine the local cost of capital, not the RBA’s price for money. We’ll see about that.
In the meantime, Stevens has also said the RBA is watching whether or not “the role of foreign purchases [in the Australian housing market] is an important one.” We’d submit that it is. This is the second reason it won’t be “easy” for Australians to get risklessly rich in leveraged property investments. They’ll be outbid!
It’s obvious now that the Rudd government has opened the Australian property market wide open to overseas investors in order to keep the housing market bubbling along. The stamp-rich gorging state governments have not objected. The end result is a huge spike in prices that locks out Australians hoping to enter the market at the bottom end of the property ladder.
Some people might call this the government selling-out the interests of its citizens in order to prevent the bubble from popping on their watch. In fact, we just muttered that aloud to ourselves. And we’re not even Australian. But as an American, we’ve seen these desperate attempts to keep the good times rolling before. It always costs the little guy the most.
To be fair, there isn’t much data yet on how much of last year’s national price surge was fuelled by foreign buying. And let’s face it. By “foreign,” most of the media accounts mean Chinese. And you know, from a Chinese perspective, buying real Australian houses with money not subject to Australian interest rates is probably a great investment.
But whether it’s such a good thing for Australians depends on who you ask. If you’re a Baby Boomer with 3.6 investment properties that you’re counting on to fund your comfortable retirement, the influx of cashed-up foreign buyers is just what the doctor ordered. If you’re a first home buyer…well…you’re going to need a bigger grant…or be willing to live in an outer suburb…or rent for the rest of your life.
Can you see now that we have the confluence of two bubbles? The first is Australia’s fevered national pastime of speculating on property. It’s all good as long as it’s making someone – property spruikers or investors – rich. But what if it makes the Chinese rich? And what if the Chinese investment in Australian property is itself a product of China’s massive lending bubble?
As always, all bubbles come back to excessive credit growth. You have to prune away at the flowers these bubbles are decorated with. They make it look pretty, desirable, and natural. But beware!
In a great article we read over the weekend by GMO’s Edward Chancellor we found this quotation from 19th century economist John Mills: “Panics do not destroy capital; they merely reveal the extent to which it has previously been destroyed by its betrayal in hopelessly unproductive works.”
Has Australia over-invested in higher house prices at the expense of other national investment and productive possibilities? Let us know what you think at firstname.lastname@example.org
And if you think we’re making up the idea that China has exported its property bubble to Australia, well, that’s alright. Free thinking is encouraged here at the Markets and Money. But according to today’s Wall Street Journal, “China’s banking regulator banned new property loans to 78 companies owned by the central government in an effort to control risks in property credit and curb asset bubbles, which pose a threat to the country’s strong economic recovery.”
Urban property prices rose 11% in February compared to the same time last year. In fact, there’s a way of seeing the performance of the entire commodity sector – and by extension Australian resource stocks – as a function of China’s retreat from the U.S. T-bill market and into tangible asset markets like copper, iron ore, coal, and high-rise flats in Melbourne.
We’re taking these concerns and questions to a meeting in an hour with Diggers and Drillers editor Alex Cowie. Alex sent us a note yesterday that one of his gold stock recommendations has nearly doubled. But he hinted that there are some decisions he’s made regarding the rest of his recommendations. He’ll share those with D&D readers when he’s made them. But tomorrow, I’ll let you know what he thinks about the big picture and the China risks highlighted above.
for Markets and Money