Australian Economy Fuelled by Housing Debt

Illustration of australian real-estate development
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It’s the first Tuesday of the month. That means the Reserve Bank of Australia meets to guess what the price of credit should be.

My guess is that they will guess to do nothing. The strength of the Aussie dollar since the last meeting — it has increased by 5 US cents since the start of March — means there has already been a form of monetary tightening.

Despite the RBA’s generally upbeat view of the Australian economy, there’s no way that will translate into an interest rate increase today, or anytime soon.

And because they don’t want to put any more heat into the Australian housing market, there’s no way they will cut either.

The only thing of interest to come out of today’s meeting will be to see whether the RBA has anything to say about the recent strength of the Australian dollar. While no doubt an unwelcome development, the RBA really is a bit player in the global currency wars.

If the US, China, Japan and Europe are going hard at it, the best Australia can do is keep its head down and hope it doesn’t get hit.

The one thing our currency has going for it is its perceived exposure to China. And try as China might to stimulate its economy back to some sort of balance, it’s just not happening with any degree of conviction.

This lack of conviction will likely see the Aussie dollar rally roll over soon enough. It really depends on how long China can sustain its recent economic ‘bounce’.

In a recent report, the International Monetary Fund (IMF) pointed out how economic news out of China increasingly influences the rest of the world.

‘[T]he IMF found that China appears to have a special ability to trigger market moves in other countries based on the release of economic news and data. With a fragile global expansion, twists and turns of the world’s second-largest economy often appear to be more consequential on Wall Street than what is happening on American main streets.

Yes, China matters. Thanks for that, IMF.

And China matters to Australia’s economy more than any other country. China’s attempts to boost growth at the end of 2015 are now bearing fruit, even if it’s half-rotten and pecked at by birds. This quest for renewed growth pushed the iron ore price and the dollar higher, providing a false sense of security about Australia’s economic performance.

On the surface, the Australian economy is indeed in good health. Everything is relative, and relative to many other major economies, we’re doing well.

But there is a cost to the relative outperformance. And the cost is not only in increasing household debt, but in a growing reliance on foreign capital to fund that debt.

You’ll notice that this is a recurring theme in The Daily Reckoning. That’s because, at some point, it will come back to bite us. Anyone can live the good life while they’re racking up debt…and when they have enough income to service the debt.

But when more income goes toward debt servicing, debt growth must inevitably slow. When that happens, economic growth slows too.

How far away are we from that point?

Don’t ask me…Australia’s debt appetite just gets bigger with every passing week.

While private sector credit expanded at a strong 0.8% in September 2015, and then slowed to 0.4% in November, it bounced back to 0.6% monthly growth in February this year. In the year to February, private sector credit expanded at a very healthy 6.6%.

While these amounts might seem small, they are coming off a $2.5 trillion-plus base. The current growth rate corresponds to around $165 billion of new money flowing through the economy each year.

Think of this as a source of new purchasing power. As banks create this new credit, it ‘gets spent’ in the economy. That’s why, if you see credit growth beginning to slow, it means economic growth will slow too.

Also think about how this money flows though the economy. Most of the growth in private sector credit comes from the Aussie housing sector, which has outstanding debt of around $1.5 trillion. Business debt is around $850 billion, while personal credit is only around $150 billion.

Growth in housing credit stimulates all the sectors involved in housing transactions: banks, mortgage brokers, real estate agents, legal services, etc. It also pushes up the value of the housing stock, increasing the ‘wealth’ of home owners.

Such growth changes an economy’s structure, as it creates employment opportunities in some areas at the expense of other sectors. But you have to ask whether creating employment to facilitate transfer of land ownership is really all that productive.

The fact that 6.6% private sector credit expansion is only producing around 3% economic growth tells you it’s not.

But governments love it. They reap massive inflows from stamp duty, which increases the reliance on housing (and housing debt) as a form of economic growth. No one wants to kill the golden goose.

Although they will talk about it…

For example, PM Malcolm Turnbull, in an attempt to look thoughtful while doing nothing, is asking the states to overhaul their tax systems. From the Financial Review:

Prime Minister Malcolm Turnbull will insist the states overhaul their tax systems before asking Canberra for more money, including possibly replacing stamp duty with land taxes, a change the federal Treasury calculates will deliver a big economic boost.

Treasury modelling confirms, at a cost of around 70¢ for each dollar collected, state-based stamp duties on property as the biggest drag on economic growth. Axing them would produce a 1.5 per cent increase in GDP, or $24 billion, without directly changing the amount of tax raised.

Stamp duty is a horribly inefficient tax. It is the states’ main form of revenue, and goes towards spending that everyone benefits from. Yet only a small percentage of people pay the tax. That is, those buying a house.

Let’s say 5% of the housing stock turns over each year. That means roughly 5% of the people contribute a large part of the tax that everyone benefits from. If you have to move often for work purposes, you’re paying more than your fair share.

Stamp duty puts a large cost on labour mobility. A broad land tax is a much more efficient tax. But it’s unlikely to ever become law.

Ken Henry, as head of Treasury, advocated a land tax in 2010. The politicians ignored it. A land tax would go a long way towards ridding the land market of speculative excess. It would ensure that the ‘economic rent’, currently captured by the landowning class, would be distributed more evenly throughout society.

But, as you know, dear reader, there are just too many vested interests that benefit from this speculative excess. A land tax is very unlikely.

No one knows this more than Cycles, Trends and Forecasts editor Phil Anderson. Having studied the history of land bubbles and written a book on it, Phil is adamant that politicians will never enact a land tax.

I highly recommend you get acquainted with Phil’s work. In Australia, where land ownership is a religion for many, he is a must read.

Keep an eye out for something from Phil later this week…

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning 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 The Daily Reckoning for free here. If you’re already a Daily Reckoning 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 Daily Reckoning emails. For more on Greg go here.
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