The Link Between China and Australian Property Prices

Signs aren’t too good in the property market. According to this article in the SMH, credit ratings agency Standard and Poor’s (S&P) has stated the blindingly obvious by saying a slowdown in China will hit residential property hard.

It reckons that if China’s growth rate drops to 5 per cent, Australian property prices could drop more than 20 per cent. S&P quickly distanced itself from such a scary prediction by saying such a fall is unlikely. But even Chinese growth of 7 per cent would result in a 10 per cent fall in Australian house prices.

So what is the link between China and residential property? In a word – commodities. Below, we join the dots between China, commodities and house prices. But first, check out the chart below, which will help you understand the explanation that follows.

We found it on the Sober Look blog. It shows the under or overvaluation of house prices for various countries based on the house-price to disposable-income-per-capita ratio. To get the level of under or over valuation, today’s incomes are measured against the 1990-2011 average.

house prices to disposable income per capita

On this basis,

Australian houses are overvalued by around 40 per cent. The key input here is the average per capita income for 1990-2011. Back in the 1990s (and for probably the first half of the 2000s) Australia’s average income levels were much lower.

Inflation counts for some of the difference. But the biggest boost to national income – and therefore individual incomes – in the past five years or so has come from the massive boost to the terms of trade. And rising commodity prices – specifically iron ore and coal – are the reason for the jump in the terms of trade.

Now the terms of trade do not have a big effect on the headline economic growth figures you read about in the paper. The effect seeps in gradually via other means.

But in reality, the terms of trade have a major impact on incomes. Check this out from the ABS’s recent release of the National Accounts (emphasis ours):

Real Gross Domestic Income

The real purchasing power of income generated by domestic production is affected by changes in import and export prices. Real gross domestic income adjusts the chain volume measure of GDP (the headline economic growth rate – ed) for the Terms of trade effect. In seasonally adjusted terms, during the December quarter, Real gross domestic income fell 0.6%, while the volume measure of GDP increased by 0.4%, the difference reflecting a decrease of 4.7% in the Terms of trade.

Terms of Trade

The Terms of trade represent the relationship between the prices of exports and imports. An increase (decrease) in the Terms of trade reflects export prices increasing (decreasing) at a faster rate than import prices. The Terms of trade fell 4.7% in seasonally adjusted terms in the December quarter following a 3.2% increase in the September quarter. This is the first fall in the Terms of trade since September quarter 2009.

Real Net National Disposable Income

A broader measure of change in national economic well-being is Real net national disposable income. This measure adjusts the volume measure of GDP for the Terms of trade effect, Real net incomes from overseas and Consumption of fixed capital

During the December quarter, seasonally adjusted Real net national disposable income decreased 0.9%. Growth over the past 4 quarters was 4.9% compared with 2.3% for GDP.

There’s a fair amount of economic jargon in there. But the point is that the terms of trade make a big difference to national income and national economic well being, even if they don’t show up in the headline number.

Now, before we confuse you even more, let’s get back to the chart. We would guess that Australia’s per capita disposable incomes are much higher today than they were based on the average level from 1990-2011.

So if you think we’re in a new paradigm or a permanently higher plateau for commodity prices, the level of overvaluation of Australian property as shown by the chart above is clearly misleading. (Permanently) higher commodity prices mean a higher than long-term average level of income…meaning property prices are about right.

But if you think China’s credit boom has inflated Australian incomes via the terms of trade, then we could be in for a bit of ‘mean reversion’ in the coming years. We made a similar argument to this a few weeks ago. Mean reverting household income levels would send Australian property prices much lower.

It may happen in a few years or over a decade, but our guess is that it will happen.


Greg Canavan
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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7 Comments on "The Link Between China and Australian Property Prices"

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But Michael Pascoe tells us today in Fairfax papers that Standard and Poor’s is wrong and everything is peaching in the ‘lucky’ country. According to Pascoe the worlds ‘best treasurer’ Wayne ‘Black’ Swan will seamlessly steer Australia out of any economic headwinds or storms for that matter. It seems he has unlimited ‘ammunition’ on hand to fight off the forces of darkness that will dare try and make a heroin house in Redfern worth less than $1 million. Isn’t it funny though that the US had unlimited ammo and handed out 1.4 trillion dollars in bailouts during the GFC. What… Read more »

Of course Swan will inject stimulus and lower intrest rate, dont you know you can do anythink you like to the australian public as long as you don’t let the price of there housing fall, if you do that you will be out on your ear come the next election. better to run up the national dept and keep brand labour in power, after all Swan will be long gone and sitting on a beach when the poop hit the fan. Thanks to articules like this we can get ready for what lies ahead.

Jan Schmidt

Thanks for this report Greg. I agree with the 2 commenters above too. The government should not try to manipulate house prices at all. Please can we have small government! Stay out of our lives.

Andy "Battler"
You guys are talking from your “treasure chest” and little ‘castles” which is fair enough, as I would. I do not doubt your “loyalty and patrioticism” to your personal wealth and almighty dollar. You may may be a potentially welcomed candidate to the “multinationals”. Tell me what you got out of a higher interest rate?…does not affect you as it is written of as costs…does not affect you as you do not need bridging finance…There are many battlers in this country who are not so ‘gifted’ or lucky as you are. We live in a democracy with the implied social… Read more »
Charles Ponzi

We need land value tax.


You forgot to mention or compare interest rates in comparison to previous decades and other countries.

GC: “But even Chinese growth of 7 per cent would result in a 10 per cent fall in Australian house prices.” So, conversely, increased growth would drive Aussie property prices higher? How simply these journalists link highly complex economic events, drawing fanciful conclusions to suit the sales pitch. In fact, Australian property prices are dependent on a host of interrelated factors. At the moment, housing supply might well be included among them. Rental shortages are just beginning. Rental agents are pushing six-month rent reviews harder than we’ve seen in decades. And property bears _stimulate_ the shortage: * There’s an… Read more »
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