Thanks Wayne !!
Late last year I bought an investment property on Sydney’s North Shore. With the recent turmoil in the markets and the rapid run-up in mortgage rates, i was starting to get a little nervous about whether my purchase was such a wise decision. Fortunately, Treasurer Wayne Swan has just bailed me out of a tight corner.
As part of the government’s five-point plan to “fight inflation, promote private savings and place downward pressure on interest rates”, he’s offering a tax break for aspiring first home owners.
God bless you, sir 
“This is a modest long-term measure to assist more young Australians to achieve their dream of home ownership. Young Australians saving for their first home will attract a government contribution equivalent to 15% discount on their marginal tax rate.”
Housing Minister, Ms Plibersek, said the plan would work alongside several other schemes designed to “improve housing affordability”.
Err, how?
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I think the turmoil in the share markets might actually help property prices. If 2008 is going to be bearish, investors are going to be looking for alternative investment vehicles such as investment properties. Sydney hasn’t had much growth either in the last couple of years compared to the other states.
winston
possibly but property prices are in retreat the world over. i don’t see why australia should be immune.
Pommy, because you are a recent immigrant I’ll explain it to you.
When the Liberals are in government, first home owner grants feed into the market and increase house prices.
Under Labor governments, house prices are unaffected so that the grant increases the ability of first home owners to buy them.
If you studied for your citizenship exam, you’d know this. Or at least whether Don Bradman had said it.
A question for any economists out there.
I watched the PM on the 7.30 Report tonight and he blamed the previous govt for the current acceleration in the inflation rate. In his words:
“If you look at the consistent set of warnings from the Reserve Bank, they were consistently critical of the Howard government’s performance on the supply side.
That is, through their warnings if you like on skills shortages and infrastructure bottlenecks over many years, 20 successive warnings, each of them ignored, the result being a succession of interest rate rises.”
So is it true that inflation is caused by a lack of govt investment in infrastructure and education/training?
David – my exam’s not til June. And i know that ‘the Don’ needed 4 from his last innings to average 100. But i don’t know how increasing demand can lower prices. Maybe that’s why everyone keeps failing.
E.D – inflation can be lowered by improving the supply side of the economy, for instance removing infrastructure bottlenecks, reducing red tape etc. Ironically, one measure that would have greatly improved productivity of the economy was WorkChoices which Mr. Swan is against.
It is basic redistribution. If the government gives a handout to one group they get an advantage in the market place over other groups. If you give first home buyers a tax break it may push up house prices on average but it won’t push up prices enough to negate the benefit of the handout.
Sometimes I give my kids money to increase the affordability of lollies. All indications are that it seems to work because they usually have more lollies after such an initiative.
Terje, I work in tax, I have studied the effect of subsidies (especially on property prices) and let me tell you, the tax break feeds straight into higher property prices. UK Governments have often tried scrapping SDLT (that takes up to 4% out of the purchaser’s budget and this thus reduces the price he can pay) in ‘deprived areas’ and all that happened was that property prices went up by exactly 4%. The tax break benefitted the vendor (in this case, Pommygranate) and not the purchaser. And one man’s tax break is another’s tax burden. And so on.
Better to have LVT that reduces purchase price and increases tax receipts, which allows other more damaging taxes to be cut (cont. p 94).
“Inflation is always and everywhere a monetary phenomenon” — Milton Friedman
I’m not sure what all this talk about infrastructure & skills is about. You could have low inflation with no infrastructure in the economy at all. Or you could have high inflation even if the entire country was covered in bridges, dams, ports and fiber optics.
Interest rates are managed by the RBA to control inflation, but it’s underlying drivers are (1) the savings rate; and (2) investment opportunities. If there are more investment opportunities, then interest rates should go up. As interest rates are controlled by the RBA, the actual mechanism is more complex…
More investment opportunities lead to more demand for loanable funds, which will lead to an increase in the supply of loanable funds (through an increase in the credit multiplier and/or velocity) which leads to an increase in effective money supply, which leads to inflation. This triggers the RBA to increase interest rates which helps bring the supply & demand of loanable funds back into equilibrium. A stable inflation rate is the sign that interest rates are at the right level to clear the loanable funds market.
Anyway — the long and the short of it is that interest rates are going up because Australia is a relatively good place to invest. This is the same reason that our dollar is appreciating.
As for infrastructure & skills investments — I don’t see the link. Insufficient infrastucture or skills will increase the price of some things, but decrease the price of other things. That’s not inflation. I thought the idea of “cost-push” inflation died along with Keynes.
Thanks John,
This idea that the govt needs to spend, err ‘invest’, more money on physical infrastructure and education looks suspicious to me. If the ports are choked, then why can’t the private sector build bigger ones? If there is a shortage of higher education or TAFE student places, then why not allow education providers to charge higher fees?
E.D. – the Howard government was in charge of the regulations that prevented the private sector from expanding port capacity and providing better education options. Whether you believe the government should be responsible for providing infrastructure or education is irrelevant as to whether it is responsible for a lack of it.
John, what would insufficient infrastructure decrease the price of? And why would increasing the skills of the 4% of Australians who are currently unemployable lead to anything else but deflation?
LS is right. Whether the govt ‘should’ release the bottlenecks for the mining companies is irrelevant. They are the only ones ‘allowed’ to. Hence they must either permit private investment or sort it out themselves.
John – productivity increases lead either to lower inflation or higher wages. Surely productivity can be improved by supply side measures? e.g. WorkChoices.
Pommy,
I do hope you actually voted for Mr. Swann. Otherwise, won’t you be hypocritical if you take up his electoral bribe?
Nicholas
I’m not able to take it up as it’s only aimed at first home buyers but as an existing homeowner i certainly will benefit from it.
A good piece of legislation for wealthy older landlords. Not so great for younger, poorer first home buyers.
Surely the people it disadvantages are those that were already good at saving, which seems a little unfair.
Slightly off topic and minor historical nitpick.
The port of Newcastle is controlled by the NSW State Labor govt. And the equally struggling ports of Gladstone and Dalrymple Bay are controlled by the Qld state govt ( with some private sector operators ).
And Qld Rail – owned by the State govt runs all the freight trains up there. Slightly different situation in the Hunter Valley.
Coal exports on the east coast are bottlenecked NOT because of the former Coalition govt regulating away opportunity – at least in this area.
The industry was in over supply for years, prices reflected that causing massive shareholder losses for decades – and there was no willingness to bang in extra capacity that was not being called out.
Demand lifted sharply and supply simply wasn’t in place to respond. Hence bottlenecks. And while the private sector operators have had a few challenges, state govt indifference is where any responsibility should lie, not heaping every malinvestment at the feet of the former feds.
Rant ends.
I thought the port bottlenecks were mostly due to state regulation rather than federal regulation.
Hmm…if regulation of ports is mostly a state government responsibility, the federal Liberal party never bothered to explain to the public why they were unable to help much.
Mark W,
I have no doubt that a tax rebate for first home buyers will feed into higher home prices however if the rebate is restricted to a small subset of buyers then it will benefit that subset even if at the expense of other home buyers from outside the subset. We are talking about a targeted subsidy that is generally means tested and is not available to the bulk of home buyers. If the aim is to benefit the small subset of qualified buyers that it will be effective.
Regards,
Terje.
LS — I don’t know exactly what prices would go down and which will go up. The economy is an amazingly complex thing and far beyond the power of any person or group to micro-manage (hence the failure of socialism). But I’ll explain the mechanism through a rambling example:
Just say we have a skills shortage in doctors. Lower supply will lead to higher price for going to the doctor and fewer people going to the doctor. For the people who pay an extra (say) $50 on the doctor, they now have $50 less and so they don’t buy that gym membership they were going to get. Demand for gym membership decreases, which leads to lower gym prices and fewer people going to the gym. Consequently, one gym shuts and five people lose their job. Those people then can’t afford to continue having their weekly lunch at the Thai restaurant down the road… and as a result the Thai-restaurant owner can no longer afford his planned holiday to Tasmania. Meanwhile, the doctor who is getting an extra $50 spent his extra money on new shoes for his son, so the demand for shoes increased, leading to higher shoe prices and higher shoe production. To expand production, the shoe manufacturer employes the ex-gym workers who spend their extra money on a trip to Perth. Prices increased for doctors, shoes & perth holidays. Prices decreased for thai food, gym membership & tasmanian holidays.
Prices go up and down all the time. As they should. But for the price of everything to go up it is necessary to actually have more money floating around the system. That is why sustained inflation can only be caused by the excessive growth in effective money supply.
If a loaf of bread costs $1 today, and the average wage is $10 an hour, but in 5 years’ time a loaf of bread costs $1.10 and the average wage is $20 an hour, then there’s no inflation – that’s just currency deprecation, and obviously caused by a growth in money supply.
But if a loaf of bread costs $1 today, and the average wage is $10 an hour, but in 5 years’ time a loaf of bread costs $1 and the average wage is $9 an hour, then surely that’s inflation, by any useful definition of the concept? And yet the money supply may well have decreased.
(Oops, I meant to retype the above as a question, rather than a statement, but hit Enter accidentally).
Pommy — You’re right. I agree that productivity can be improved by supply-side measures. Indeed, that’s the only way.
But I’m not sure about your conclusions about inflation given our monetary system. Higher economic growth with constant monetary supply growth would lead to higher interest rates and lower inflation. But we don’t have constant monetary supply growth.
Under our system the interest rates wouldn’t immediately go up because they are controlled by the RBA. Instead, the market would match the demand of loanable funds by increasing the supply of loanable funds… which would increase the supply of effective money. Without higher interest rates the supply would increase too fast, leading to inflation. The inflation is then the signal to the RBA that they need to increase interest rates.
Perhaps I’m missing something — but I still can’t see how productivity bottlenecks contribute to inflation in Australia. Our inflation is being caused by strong growth, not the lack of it.
No LS — that’s not the definition of inflation.
First, inflation is about the total price level, not the price of one thing. But if we make the simplifying assumption that bread is the only good in an economy, then the price going from $1 to $1.10 is inflation… and the price staying at $1 is not inflation.
If the price stays at $1 and your income decreases from $10 to $9 we call that a recession (ie the economy got smaller). This is also a bad thing… but not all bad things have the same name.
LS
Unlike Mark and John, i’m not an economist but someone explained it to me like this,
wages growth = inflation + productivity
Hence wages can grow faster than inflation and yet not elevate the rate of inflation because of productivity improvements. This is why US productivity was one of Greenspan’s most closely watched numbers.
John – Our inflation is being caused by strong growth, not the lack of it.
Sure. Which is why i never quite understood why Howard and Costello failed to ram this point home during all the rate rise debacle last Novemeber. Would Oz voters really prefer a US economy in recession but nice juicy low rates of 3%?
Pommy — I don’t think it would have been a good political move to tell people that they should be happy about a rate rise.
The problem for the Liberals is that they took credit when interest rates were low… even though they didn’t really cause it. Consequently people assumed the government controlls the interest rate and wanted to blame them when it went up.
In realty, the supply and demand for loanable funds (ie savings rate and investment opportunities) are the real driver of inerest rates. The RBA and government can stuff things up, but they can’t defy the laws of economics.
Ok, but let me rephrase…if wages are growing faster than inflation, does it matter all that much what the inflation rate is? Or does that basically never happen, so nobody worries about it?
Yes, no (it does) yes (it is a worry).
Refer back to Okun’s Law.
Inflation will increase costs, real wealth and wages will decrease and this will weaken the demand for products, and both will drive up unemployment.
By inflation I assume you mean “high inflation”? Or do you think we could manage fine with a fixed supply of money?
(BTW does anyone really believe that “shoe leather” costs and menu costs are a significant problem for inflation in today’s word?)
No, inflation. No, having a fixed supply of money under economic growth is deflationary. Yes and yes. The higher and more volatile the inflation rate the worse they will be.
So why does the Reserve Bank have a target range of 2-3%? Why not a target of zero?
Agreed that shoe leather and menu costs will go up as inflation goes up, the key word was “significant”.
Even with no inflation, people would exchange cash for non-cash assers at a rapid rate, and advertised prices would change frequently on the basis of suppliers constantly to achieve optimum sales. If it jumped to 4%, would it really modify behaviour that much?
That is there political prediliction. The policy that is in vogue these days is outcome based GDP maximisation, but I can’t see how inflation helps and I think it also suffers from time inconsistency problems. There is also a weak argument that CPI measurements overstate inflation.
On time ionconsistency:
http://en.wikipedia.org/wiki/Time_inconsistency
No. It is predictability and variability that matter.
Some people think the RBA should target 0%. The reason they target 2-3% is because:
(1) Some prices are nominally sticky. That is, they need to go down but human pychology is such that people don’t want to put a lower price on things. Inflation allows the real price to decrease while the nominal price remains the same.
(2) The measure we have for inflation (the CPI & GDP deflator) is imperfect and generally considered to slightly over-state inflation by not fully factoring in quality improvements. That is, if a phone gets more expensive because it has a better camera in it… that’s not inflation. That’s a product improvement.
One big problem with inflation is that it occurs in different parts of the economy at different times, and so can significantly distort investment decisions. This leads to something the Austrian economists call “mal-investment”, which contributes to booms and busts.
Another problem is that inflation can create a dramatic re-allocation of wealth from savers to borrowers. Imagine you loan me $100 and I am supposed to pay you back $110 next year. During that year we have 100% inflation. When I pay you back the $110 it is only worth $55 in your old dollars.
And for dramatic effects of hyper-inflation — see Zimbabwe. It’s cheaper to use money as toilet paper than actually buy toilet paper. People there buy all their beers before a game of golf, because when they get back from their game the beer price has doubled!
LS,
If all trade was done via spot markets then inflation would be largely irrelevant. However much trade is done via contract. In my business for example I have contacts with employees that specify their wages and benefits, contracts with a landlord that specifies the rent and various contracts with suppliers and customers. Such contracts have a temporal component where by various parts of the offer are delivered at different times as are associated payments. An office lease for a small business for instance generally entails a contractual commitment of 3-5 years. When the value of the “unit of account”, the yardstick by which such agreements are made, changes in unexpected ways then either the buyer gets screwed or the seller gets screwed. When people expect to get screwed commerce becomes more difficult.
As an analogy imagine working in the lumber business and using the meter as your primary unit of measure in contracts. Now imagine how confidence in trade would go out the window if the length of a metre changed from time to time. You agreed to sell fifty metres of lumber last week but now suddently that entails a lot more timber than it did at that time. What is true in commercial terms for a standard unit of length is also true for a standard unit of value. Good standards offer a fixed point of reference.
Regards,
Terje.
John,
I get the impression (perhaps wrongly) you don’t subscribe to the view that the RBA’s monetary policies have been too loose.
Growth in the money supply rarely rates a mention in the media, and certainly the RBA never mentions it.
However, there is at least one commentator (Gerard Jackson) who has continuously argued that the RBA has allowed the money supply to grow too fast.
From the RBA’s website, 12 month growth to Dec 2007:
Credit – 16.5%
M1 – 11.9%
M3- 23%
Broad Money – 19%
Aren’t these numbers worrying?
Further bad news from ‘Henry Thornton’:
“While official figures released last month revealed inflation was running at the fastest pace for 16 years during the final three months of 2007, an unofficial measure released yesterday indicated the first three months of this year could prove even worse.
“The TD Securities/Melbourne Institute inflation gauge rose at an annual pace of 3.9% in January, the second highest on record. The gauge’s underlying measure of annual inflation was 4%, the strongest on record”.
ED… I agree those numbers are worrying. It would be interesting to see the annual monetary growth states going back over the last few years.
The RBA is a slow-acting organisation and there are lags in monetary policy. They quite rightly don’t want to over-react, which can mean they move too slowly sometimes.
I think the RBA has done a fairly good job, as evidenced by our acceptable inflation statistics over the last 20 years. As an economist, I think they made the right move today, though as a home-owner I’m not happy.
However, as Terje likes to point out, the slow responses do lead to volatility in the commodity markets. This is one of his arguments for a gold standard, and after much pestering I think he might have a point.
Some people believe that excess money has been stored in asset bubbles (primary housing). Personally I disagree. I think high house prices have been caused by limited supply, high incomes and population growth.
I do believe in the Austrian Business Cylce Theory…mostly. But it is more nuanced than the populist version and it should consider recent developments in orthodox monetary and general macro economics.
A good starting point is “The Capitalist Alternative: An Introduction to Neo-Austrian Economics by Alexander H. Shand, G. L. S. Shackle ”
I think the excess money contributes to high property prices, but not because of bubbles. As the hurdle rate for investment is artificially lowered, the resulting malinvestments change the structure of production in a deleterious way which lowers real wages (falling derived demand for labour as the demand for the project dissipates and as the capital-labour ratio falls in aunderinvested sectors of the economy)and alters relative commodity prices (as there is more investment in one sector more strongly relative to the rest of the economy). Such an example can merely begin by investing in property being as an inflaiton hedge, leading to deceptive price signals. We can have strong economic growth based on quality investments and a malinvestment cycle occuring at the same time.
I think optimising monetary policy it is a little more complicated than just reducing changes in the price level (preferably to zero) which is the main issue, but I also think that volatility and liquidity matter. A little bit of inflation or deflation here or there isn’t bad if it is predictable and can dampen financial consolidation such as the recent bank recapitalisations.
John: “It would be interesting to see the annual monetary growth states going back over the last few years.”
You can download an RBA Excel spreadsheet containing the full time-series of monetary aggregates from here:
http://www.rba.gov.au/Statistics/Bulletin/D03hist.xls
In annualised terms, M3 is at its highest in almost 19 years.
Broad money is at its highest on record (records go back to the late 1970s).
Currency, however, appears more benign and M1 is trending downwards though is above historical trend growth.
“I think the RBA has done a fairly good job…”
Has it? I wonder.
Now, my understanding of the earlier Friedman quote was that the money supply is not simply ‘a’ cause of inflation, but ‘the’ cause. In other words, inflation has nothing to do with limited land supply, high incomes, population growth, capacity constraints, Govt spending, transportation bottlenecks, droughts, floods, tax cuts, Labor Governments, commodities booms, high oil prices, skill shortages, self-fulfilling prophecies (Turnbull’s latest sound-byte) etc. etc.
@ John Humphries:
The current house price bubble is by far the worst in Australia’s history. To put it in perspective, the median house price here is almost twice that (PPP-adjusted) than in the US (USD240,000 [Apr.07]/AUD475,000[Oct.07]). See the history of US house prices over the last 120 years or so, compiled by Yale economists Robert Schiller here:
http://tinyurl.com/ysedde
Schiller’s thoughts on the potential direction of the US housing bubble, of which the sub-prime fiasco really was just the first domino piece to fall, was recently covered by The Australian:
http://tinyurl.com/2odjju
Some of his statements ring so very true here in Australia, also – like “Americans have fuelled the myth that prices would never fall; that values could only go up.”
There exists a modified Schiller chart, showing Australian housing values super imposed over the US ones. Alas I can’t remember where I last saw it – suffice it to say it is scary!
It is clear that the Australian bubble is now substantially more inflated than the US one ever was. Rental yields, while improving somewhat, are starting to level out because increasing numbers of tenants cannot afford to pay what is being asked. Still, the rental equivalents of P/E ratios are still very poor in historical terms.
We also have our own version of sub-prime here (called “lo-doc” loans) and, worryingly, while you are correct about the restricted supply (at least some areas), the majority of the housing inflation has been driven by loosening of the prudential lending standards and a subsequent massive increase in personal debt – which again is a lot worse than that in the USA. As can be seen here:
http://tinyurl.com/2kxk9o
I am actually a financial adviser dealing predominantly with clients with at least $1 million in investable assets. I have been advising consistently over the last couple of years to steer clear from property, as the prices have got so far out of whack with wages growth and the yields are so poor they will at some stage have to come crashing down. The talk in the US is about declines of 40% or more – I believe in Australia it will be even worse. Once the economy slows down or dips into a recession, the house of cards will come crashing down the same way overgeared investors have recently seen their margin loan holdings sold from under them by panicky lenders.
It is truly sad that politicians of all stripes are only too intent on pouring further fuel on the fire by offering still more incentives for people who cannot afford to buy now to put their neck on the line and stretch themselves dramatically to buy their “dream”.
It has ended in tears before (late 80s/early 90s) and it will again this time; even more so.
John Bayley
Actually, here’s the house price comparisons I mentioned in the post above:
http://tinyurl.com/239gqj
See it and weep.
ED — I agree with your interpretation of Friedman’s quote. However, the actual monetary mechanism can be quite complex and proves us with other indicators.
Bayley — I disagree that we’re having a housing bubble, especially in s/e Qld (where I live). Australia is in a very different position to America. We are getting thousands more immigrants to s/e Qld than houses being built, and rents are going through the roof. We have far fewer people on lo-doc or no-doc loans. And it doesn’t seem like we’re heading into a recession.
John, did you have a look at the long term, inflation-adjusted home values comparisons I provided above? Or the personal debt levels?
These relate to *all of Australia*, not just a few boom areas.
Every single one of Australia’s capital cities is classed as “severely unaffordable” on the world scale. In fact, we are leading the unaffordability stakes. So are now almost any regional coastal areas anywhere in the country.
Furthermore, median house prices Australia-wide are now only about $70,000 (or 13%) below those of Sydney. Keep in mind those figures include the likes of Birdsville and Winton.
The other day I was around the Atherton Tablelands outside of Cairns. Old, unimproved queenslander-type residences in Atherton itself, on ~900 square metres blocks, have asking prices of around $360,000.
In Cairns itself and the coastal areas around, the median house price is pushing close to half a million dollars. Yet the average wage is around $40,000.
You don’t think we have a housing bubble? — Well, I guess lots of people thought there was no dot com bubble either – it was the “new economy”, hey?
And with regards to whether we are heading into a recession: The sharemarket certainly thinks so. We don’t even need to go into a full-blown recession for the debt-fuelled problems to snowball, just like they have done in the USA. Our debt levels are worse than those in the US.
All we need is a slowdown and a jump in the unemployment rate. Then you just watch.
John Bayley
From the Fourth Annual Housing Affordability Survey (data for 3rd quarter of 2007):
Australia (with New Zealand) has the most unaffordable housing in the surveyed nations, with an overall Median Multiple of 6.3, more than double the Median Multiple
ceiling. There are no “affordable” markets in Australia and there are no “moderately unaffordable” markets. Twenty-five (25) of the 28 markets are rated severely unaffordable.
All of the large capital cities (Sydney, Perth, Melbourne, Brisbane and Adelaide) are rated “severely unaffordable.” The best ratings are “seriously unaffordable” in three smaller markets, Maitland (New South Wales), Ballarat (Victoria) and Bendigo (Victoria).
In comparison, another mineral-rich country with a mining/oil boom under way, Canada, “… there are 13 ‘affordable’ markets and 8 ‘moderately unaffordable’
markets.
The across-the-board affordability median is 6.3 for Australia, 3.1 for Canada and 3.6 for the USA. This has resulted in outcomes like this one:
“In Perth (Australia), 35 percent of the median household income was required to pay the median mortgage in 2000. By 2007, 70 percent was required.”
Anyone who thinks this can continue should really think again.
John Bayley
Surely if wages keep rising faster than the price of goods and services, there’s no in-principle reason we couldn’t devote 99% of our income towards a mortgage, and 1% towards other goods and services, and still enjoy a high standard of living.
The problem of course is that it makes ability to keep paying your mortgage highly sensitive to job losses or wage reductions.
Either way, it’s unlikely the best solution is more regulation. Some people really only do learn after getting burnt. The difficulty is containing fall-out: it’s not reasonable that the rest of my family should have to suffer unduly from my own poor judgement on how much mortgage debt I could safely take on.
I don’t really know what you mean above LS in your first paragraph.
I think I might but perhaps you should break it down.
Historically, most goods and services have been going down as a percentage of wages, no? Food, clothes, electric appliances, etc. Even petrol until recently.
On that basis, the fact that we now spend a higher percentage of our incomes on mortgages isn’t necessarily a problem. And there’s no reason the trend couldn’t continue for quite some time.
That is correct.
The problem is that we know there are causes for the lack of affordability, and removing these bottlenecks will have a net benefit. Clearly they should be removed.
Consequently, this would address some vertical equity issues you care about.
(Mostly I disagree with you about these issues because you have been citing them as a cause, and not an effect of policy and other economic determinants).
John
We are getting thousands more immigrants to s/e Qld than houses being built
And that’s what they said in England too…
Bayley is right – Oz property is the last great asset bubble.
I don’t doubt that housing is over-priced in some places.
But it is no suprise that it is “severely unaffordable” to live in our capital cities — they are great cities, and we’re not building any new land in the middle of Sydney. And for some reason, we’re not building many new houses in the major population growth corridors in s/e Qld.
If demand goes up significantly and supply stagnates — what would you expect to happen?
There is nothing wrong with having higher debt. We also have higher incomes and therefore a greater capacity to finance that debt.
As for the “new economy”, I can’t see how anybody can doubt that. The fact that there was a dot com bubble doesn’t mean there weren’t also dot com successes. Indeed, there were many.
When I entered the property market there were many people predicting the dramatic collapse of the “bubble”… and they have predicted that every year for the last 8 years. It reminds me of religious people who keep predicting the end of the earth and when it doesn’t come true, they just predict it again.
Of course, there will be property market fluctuations and the market will go down at some stage. But this doesn’t prove the nay-sayers correct. If I predict rain every day then I’m going to be right eventually… but I’m not going to be very useful.
John, it must be said plenty of people correctly predicted the end of the US housing bubble, as early as 2005 (predicting that it would start to deflate in late 2006).
I would think it premature to deny that a significant element of the recent rise in property prices (certainly in the last 4 years) is artificially inflated by a certain amount of speculative fever.
There is nothing unique about the Australian property market. Houses are a product of interest rates, price/wages ratios and supply/demand. The latter can change quickly causing a rapid adjustment in the former.
LibSoc – who? to my knowledge, the only people who made money out of the US housing debacle were Goldman Sachs. Every one is a good hindsight trader.
Robert Schiller in mid-2005 said:
“So a very plausible scenario is that home-price increases continue for a couple more years, and then we might have a recession and they continue down into negative territory and languish for a decade.”
http://www.nytimes.com/2005/08/21/business/yourmoney/21real.html
Also, apparently some physicists predicted it:
http://physicsworld.com/cws/article/news/22421
I agree with John. THe housing situation in America is much different to that in Australia. The US has seen a massive increase in the housing supply as people tried to cash in on the boom, this resulted in a massive over-supply.
Australia has not seen a massive increase in building new housing, partly because other industries are price competiting for labour, partly because of regulation of housing development (I blame the later more than the former).
Brendan, agreed, however that doesn’t mean that the current wage to property value ratio can be maintained much longer. Hopefully wages will keep going up strongly and property values will just gradually plateau out until a more reasonable ratio is obtained.
LS – how do you define “maintained”? Who is maintaining high property prices?
The solution to property prices is releasing more land for development and reducing regulations on land use, together with reductions in transaction taxes. First homeowner schemes simply pump more money into chasing the same (or only slowly growing) housing stock, they do not address the supply side at all. More houses mean lower prices, more money chasing the same houses means higher prices.
Generally, speculators maintain bubbles…until they can’t.
And yes, there are a bunch of supply-side solutions that need to be looked at.
How do speculators maintain bubbles?
Speculation better aligns current and future prices.
I would be surprised to see an argument that would show how that they maintain bubbles.
Note that I implied my take on the Austrian cycle means you can have different sectoral trends of economic growth and recession without necessarily having an overall bubble at all.
I’m not against speculation per se, but plenty of speculation is clearly irrational.
No it isn’t. Specualtion is stabilising as it gives a market more liquidity and more information regarding a theorectically correct price.
Mark if you’re denying that there is plenty of irrational speculation that goes on in various markets, then may I politely suggest you pull your head out of the sand.
Let’s agree that speculation is a net good. And that there’s probably nothing that could productively be done to reduce bad speculation.
Successful speculation is good. Unsuccessful speculation is just disruptive. Now if you could work out ahead of time which specualtion was going to be successful and which speculation was going to be unsuccessful well then wouldn’t that be good.
No, you need to be less ambiguous. “Plenty” – can imply a large proportion or too much.
Most speculation is to some degree irrational, as there can only be one correct price for an asset. The more we have, the better the guessing becomes and smoother the price changes are. You are right, there is no way stopping it with a net benefit. What I am implying is that you don’t want to get rid of it because it has benefits anyway.
You can’t necessarily work it out ahead of time, but you can definitely provide better education and information.
The sort of regulation I think is *most* likely to be effective is that which prevents the dissemination of wrong information (fraud) and the deliberate withholding of correct information.
The regulation (or any extra regulation) isn’t necessary. It is mostly already there (fraud) and having an open market creates a derived demand for research on securities, property etc.
Ending mispricing of credit and equity due to monetary policy, cpaital controls and moral hazard would be more worthwhile.
John Humphries:
But it is no suprise that it is “severely unaffordable” to live in our capital cities — they are great cities, and we’re not building any new land in the middle of Sydney. And for some reason, we’re not building many new houses in the major population growth corridors in s/e Qld.
But John, as I said above – it’s not just the major cities. It is pretty much everywhere. The Demographia report (actually great reading – very much recommended states for example that Adelaide has had very low population growth, and yet it is also severely unaffordable.
Ultimately when prices get way out from their long term trend relationship with wages, something has to give. Given the massive level of personal indebtedness and the stress this is already causing now, at historically still very low interest rates, it is not hard to see where this is likely to lead should the economy slow or interest rates increase further.
I read recently that at present mortgage levels, should interest rates rise to their average levels attained over the last 30 years, the average family would have to find extra $800 a month! It won’t have to get anywhere near that level before many of these people go broke.
There is nothing wrong with having higher debt. We also have higher incomes and therefore a greater capacity to finance that debt.
Real incomes apparently have on average increased by about 88% since 2000. Debt levels have over the same period increased by some 250%. What will happen if this debt can no longer be serviced?
As for the “new economy”, I can’t see how anybody can doubt that. The fact that there was a dot com bubble doesn’t mean there weren’t also dot com successes. Indeed, there were many.
When the housing bubble bursts, it won’t mean everyone will go broke. Many investors will have made a packet. That still does not excuse the fact this is a bubble – like the dot com one was – and even more investors/mums and dads will lose their shirts.
Every time a bubble arises, it is said that “this time it’s different”. One can understand that – even though not agree with – when it comes from the average punter.
However, how it is not possible for someone with economics training to ignore all the warning signs painted by fundamental data is beyond me. People are prepared to borrow what amounts to telephone numbers to buy property, believing it will continue to always go up; with no regard to serviceability or general affordability.
The other day I spoke to a client, who is a 37-year old single female, on $85,000 annual salary. She is interested in purchasing a unit in Palm Cove (Cairns Northern Beaches), which she can buy for $700,000 plus costs. She has saved $100,000, so would need to borrow approximately $635,000 to complete the purchase. She has, believe it or not, secured a lender who is prepared to forward this amount – provided the loan is taken on an interest-only basis. She will therefore have to pay at least $54,000 p.a. in interest (assuming 8.5% commencing interest rate). The unit can apparently be let for $550/week (a gross yield of around 3.9% – net yield is likely to be closer to 3%). The client would then have a shortfall of at least $26,000 (or over $17,000 after allowing for the tax deduction) to cover from her own pocket.
Is this a wise strategy? — On her income, it can be said it is affordable.
However, what happens if the unit is not rented for some time? What happens if the value drops? What happens if – as is likely – there is no capital gain of note over the next decade? Wouldn’t it be more prudent to invest elsewhere, with less debt?
The fact that somebody in that situation is seriously contemplating borrowing such large sum of money, and that she can actually obtain it, is to me enough of a proof that this is the worst property bubble/some of the most loose lending standards I can remember.
And John, you are correct – many people have been predicting that this bubble would burst for a while, and it hasn’t happened yet. Alas, bubbles can inflate to sometimes spectacular proportions – witness the original tulip mania in the Netherlands several hundred years ago. Eventually though they must collapse. This happened in the late 80s/early 90s and it will happen again.
John Bayley
Sorry about the formatting of the above comment – I quoted John’s statements before replying to them, but my quote tags disappeared.
Hopefully those who are interested in reading it can still follow it.
I also provided a link for the Demographia report, which has disappeared!
I’ll have to get used to the quirks of this blog!
Here it is again for those who want to have a read:
http://www.demographia.com/dhi.pdf