China's Gift To Australia: Inflation

Reddit

With the US markets shut down for Thanksgiving and a game of football, there is no Wall Street ‘lead’ for the local bourse to follow today. Just as well then that RBA Governor Glenn Stevens has given investors something to focus on.

In his ‘Opening Statement to House of Representatives Standing Committee on Economics’ Mr Steven’s told the assembled bureaucrats that the price of money in Australia is just about right. The vibe of the speech was that rates would stay where they are for the time being, but further increases down the track were still on the cards.

Stevens is concerned about the cost of labour, which has a major bearing in the cost of money. ‘Growth in labour costs, however, is no longer declining, but rising. The overall pace could not be described as alarming at this stage, but the turning point is behind us.’

Wages are a big deal in the inflation equation. Price rises without compensating wage increases are actually deflationary. If the price of your electricity bill goes up (and it certainly has in NSW lately) for a given disposable income you have less to spend elsewhere. That’s not inflationary.

But if you bargain for a wage increase and do not increase your output, THAT is inflationary. Wages are the biggest expense for businesses so wage pressures are generally followed by price rises. Hence Stevens’ legitimate concerns.

So if the unions, the great protector of the worker, continue to have success in fighting for higher wage claims without offsetting productivity gains, you can expect to see inflationary pressures strengthen, and interest rates to rise again next year.

Speaking of productivity, or lack of it, we should point out that the government is contributing heavily to the upward pressure on wages. The latest figures from the ABS show that full time adult total earnings for the public sector rose a hefty 6% for the 12 months to August 2010 on a trend basis. This compares to private sector growth of 4.3%.

The problem is, government workers to not produce anything of value. The productive part of the economy, the private sector, sustains the public sector via the taxes they pay. The fact that wages are rising faster in the non-productive part of the economy is troubling.

What’s also troubling for Stevens and his mission of guessing the right level for the price of money in Australia is China. What happens there is the wildcard for interest rates.

Credit conditions in Australia are very weak and do not call for interest rate tightening at all. Credit growth is down to an annual rate of 3.3% (all due to housing, by the way) while growth in M3 money supply is 5.8%.

The inflationary impetus is coming from China. While Stevens didn’t mention China directly, he mentioned its proxy, the ‘terms of trade’ on a few occasions. ‘Measured in nominal terms, the rise in GDP is running at about 10% per annum just now, because of the rise in the terms of trade.’

China’s credit boom (where growth in bank lending reached 33% in late 2009 and is still buzzing along at around 18%) is clearly spilling over into Australia via record high iron ore and coal prices.

As Stevens’ points out, this is due to very strong demand for steel.

We all know the emerging economies are growing strongly/industrialising, hence the demand for steel.

But what is really causing it? If the developed economies of the west are struggling to recover from the credit crisis and experiencing below average levels of demand, why are the developing nations growing so fast? After all, isn’t the west meant to be the buyer of the emerging markets’ goods?

In China at least, the answer comes down to the lending binge that kicked off in late 2008. This was an unprecedented attempt to reflate the Chinese economy during the deflationary shock of the credit crisis.

It certainly worked. Get a load of this. In 2009, China’s banks lent out a whopping 9.6 trillion yuan, equivalent to around US$1.44 trillion. The lending target for this year is 7.5 trillion yuan (US$1.13 trillion) but that looks like being exceeded easily.

As the Chinese bureaucrats are now finding out, once a credit boom takes hold it is very hard to stop.

The majority of these loans are going into ‘fixed asset investment’. According to an article in Fortune: ‘Fixed-asset investment accounts for more than 60% of China’s overall GDP. No other major economy even comes close. And of that fixed investment, slightly less than a quarter is attributable to new real estate investment.

Fixed-asset investment means buildings, road, property. Tangible, ‘fixed’, objects. There’s your steel demand right there.

That’s certainly good for Australia now and it is giving Stevens plenty of food for thought when it comes to setting interest rates. But surely he must be wondering what happens when the Chinese lending and fixed asset boom ends, as it surely will. (or is it different, this time, in China?)

One thing is for certain. The bureaucrats in Canberra wont be asking Stevens about Australia’s very heavy reliance on China’s ongoing boom. More than likely they’ll be playing politics (it’s what they do) and asking why banks cant make the price of money for housing cheaper than it should be.

After all, no one wants to see the end of a boom, especially politicians.

By the way, the next instalment in my ‘Sound Investing’ series is out today. So if you want to sign up to receive this free report, click here.

To give you some context, I am the editor of a report called Sound Money. Sound Investments. It’s part macro stuff, like you have just read, and part stock recommendations.

My view is that the world’s monetary system is undergoing fundamental change and will move towards a ‘sound money’ footing in the years ahead. Understanding how this evolution will impact equity markets is crucial for you to preserve and build your wealth. It will lead to increased volatility. I believe that by following ‘sound investing’ principles, you will greatly enhance your chances of growing your wealth in what will be a very challenging decade.

If this sort of thinking appeals to you, sign up for your free report today.

Greg Canavan
for The Daily Reckoning Australia

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.
Reddit

Leave a Reply

35 Comments on "China's Gift To Australia: Inflation"

Notify of
avatar
Sort by:   newest | oldest | most voted
masalai
Guest
“China’s Gift To Australia: Inflation” – AND the most important “OTHER” being the Western Economic SYSTEM” it is, by its nature, INFLATIONARY, – and then, “USA carry trade” and “domestic market mismanagement/manipulation” and “speculation and players interested in FALSE capital gains” and all the other players want to play “Me too”… The latest figures from the ABS show that full time adult total earnings for the public sector rose a hefty 6% for the 12 months to August 2010 on a trend basis. This compares to private sector growth of 4.3%. The problem is, government workers to not produce anything… Read more »
Biker
Guest

“Establish rules and laws to ensure fair and open transactions in business dealings”

Jeez, you’re right there, son. Did you know there’s an ‘Aussie’ website claiming that Australian houses are 61% overpriced? The clear intent is to have unsuspecting Australian families quit their homes and buy this spruiker’s product. WA Office of Fair Trading is examining their claims right now, to ascertain whether this constitutes misleading advertising and a breach of Fair Trading laws.

Maybe public servants _are_ useful after all!~ ;)

Ned S
Guest

“The ancient (Jewish/pre Christian) practice of periodically forgiving ALL debts should be re-introduced…”

All that ever meant was that Jews borrowed (or stole) from Philistines and Hittites and Amorites. And Christians borrowed (or stole) from Jews. Etc …

So that the ‘rules’ wouldn’t apply. You can change the rules, but there’s no changing human nature I’m afraid.

Ned S
Guest

61% overpriced? It’s one thing to be bearish; But another thing to be silly about it I think. And yes, I do know that The Economist made some sort of similar claim not that long back.

What are these people expecting? A full on deflationary crash??? In which case they’d simply be advising “You’re effed; There’s nowhere to run and nowhere to hide; Buy a gun; Shoot your neighbour; And eat long pig all next week!” Effing fruit loops … :D

Fred
Guest
@Ned. Consider your typical first home owner punter with a $50k deposit (probably much lower than $50k) thinking about whether to rent or buy a $500k apartment. The buying scenario: $450k loan @ 8% = $36k pa Strata levies ~ $5k pa Ongoing repairs and maintenance $1k???? Total = $42k. The renting scenario: Rent ~ $24k pa ($460pw) Interest on $50k deposit at 5% = $2500. Let say $1500 net. Total = $22500 When the illusion of forever increasing property prices and the wealth affect disappears. How much do you reckon this apartment would need to fall in value before… Read more »
Ned S
Guest
@Fred. One can do the maths and come up with an attention grabbing headline. But when one starts throwing figures around saying housing is 60% overpriced, some seem to take that to mean there is a good chance they’ll be able to buy it at 60% less sometime soon. Which is not a very realistic expectation IMO. As to the potential FHB with $50K saved up, if it was me, I’d probably keep renting and keep saving and see what the wind blows. And wouldn’t be targeting a $500K property as entry level. Unless living in such a property conferred… Read more »
Biker
Guest

‘Fred’, your hypotheticals are utter nonsense. Answer Ned’s rejection of the claim that Australian properties are worth 39% of their current values.

Your mathematics offer nothing to address this.
Your final ‘ifs’ are as irrelevant as quoting strata levy and maintenance costs.

“Effing fruit loops … :D ” is a pretty good call.

Lachlan
Guest

Holy livingcostamoley…460/wk rent for an apartment coop. No wonder I’m becoming more bushed/feral with age.

Fred
Guest
@Biker. It wasn’t a hypothetical. The apartment in that example is actually the apartment I currently live in, with the rent I currently pay, etc. Not sure why you wouldn’t factor TCO when considering buying a property. http://www.sciencedaily.com/releases/2010/11/101110073336.htm @Ned. I am not suggesting property prices are overpriced by 61%. Just using a real-life scenario highlighting the massive gap between rents and property prices. The only thing sustaining that gap is the expectation of further property price increases. For property to be overvalued by 61% is also suggesting rents are too high relative to wages and that rents may drop as… Read more »
Lachlan
Guest

I dont know whether true but I hear banks here are starting to go towards non-recourse mortgage lending.

Biker
Guest

‘Fred’, apart from the fact that you don’t begin to factor in a host of important considerations such as the generous tax concessions available to your landlord, including annual capital depreciation on the actual building, as well as strata fees, etc, etc, etc, you’re citing one aspect of the property market: rentals.

Ned’s summary is appropriate. I’d only add ‘naive’, between ‘effing’ and ‘fruit loops’. Naive is the kindest term of quite a few I considered… .

Fred
Guest
Biker, I know the maths for the landlord. Negative Gearing implies a loss is occuring. Lanlords have accepted this loss so long as they are in a safe environment where those losses are offset by Capital Gains. Where we differ is you believe the environment will always remain safe for investors. Whereas I believe we are nearing our debt capacity and there are few if any more capital gains to be had. Even the “soft landing” scenario of flat prices means that those Negative Gearing losses are real losses and not offset by any capital gains. No investor would enter… Read more »
Stillgotshoeson
Guest
Comment by Fred on 27 November 2010: @Ned. Consider your typical first home owner punter with a $50k deposit (probably much lower than $50k) thinking about whether to rent or buy a $500k apartment. The buying scenario: $450k loan @ 8% = $36k pa Strata levies ~ $5k pa Ongoing repairs and maintenance $1k???? Total = $42k. The renting scenario: Rent ~ $24k pa ($460pw) *Interest on $50k deposit at 5% = $2500. Let say $1500 net. Total = $22500 $50000 worth of a share that is set to at least triple in price over the next year or so…… Read more »
Biker
Guest
‘Fred’: “Lanlords have accepted this loss so long as they are in a safe environment where those losses are offset by Capital Gains.” We lanlords know a little more than you teningts, ‘Fred’. Your word ‘implies’ says it all. :D Euan, salary sacrifice has a better return than most punters can make through shares or property. Salary sacrifice now has a low(er) limit. In the days when we could max it out to 75% each… and when CFS was returning over 50% on Super, we killed the beast. Those days are gone. We can still roll CGT into Super, though:… Read more »
Stillgotshoeson
Guest

I imagine you have reconsidered your house purchase. Was that a small quick voice I heard: “…oooo I can’t sell, I will have to pay CGT…

Not at all… I am not adverse to paying taxes…
I may be a capitalist at heart by I also have a social conscience.. ;)

Primary purpose for me in regards to propety would be a steady income stream, not capital growth….

Fred
Guest

Biker, other than personal insults you are yet to make a single statement which counters the argument that houses are overpriced relative to rents and wages.

Maybe house prices won’t crash because “landlords know more”. It didn’t work for lanlords around the rest of the world but we all know Australia is “different”.

Biker
Guest

Pleased to hear you’re not averse to paying taxes. What percentage do you pay with your SMSF?

Sure and a social conscience, like a steady income stream, is a fine thing to have. ;)

Stillgotshoeson
Guest
Comment by Fred on 27 November 2010: Biker, other than personal insults you are yet to make a single statement which counters the argument that houses are overpriced relative to rents and wages. Maybe house prices won’t crash because “landlords know more”. It didn’t work for lanlords around the rest of the world but we all know Australia is “different”. My concern with “property investors” is that many (enough to influence the market) are not what you call astute investors, but just naive people that have jumped on the property always goes up, you can’t go wrong with property wagon… Read more »
Biker
Guest

Excellent point, ‘Fred’. Australia is different.

Even Euan, once the doyen of bears, is considering an investment property.
In a very flat market, cashed-up, he hasn’t yet been able to convince his seller that a crash is coming.

No matter how loudly he squeeks “you’re going to come unstuck!” they just don’t listen. Try ‘Fred’s argument, that it’s different here.
Hasn’t worked for ‘Fred’ but an accent with a special lilt may work… . ;)

Biker
Guest

And, BTW, ‘Fred’, while I didn’t personally call you an effing fruitloop (that was Ned’s excellent observation about folk whose website claims their spruiker has “a Godlike power” :D ) if that cap fits, wear it backwards, son.

My personal insult (?) was to add ‘naive’, quite a kindness given your strange contribution… .

Stillgotshoeson
Guest

Comment by Biker on 27 November 2010:

Excellent point, ‘Fred’. Australia is different.

Even Euan, once the doyen of bears, is considering an investment property.
In a very flat market, cashed-up, he hasn’t yet been able to convince his seller that a crash is coming

Oh I am still a bear… people that have bought property are going to get burnt.
The naive, the greedy and the “lazy” will come unstuck and the newspaper column “comments” section will be filled with “the government must do something”

Biker
Guest

Sour grapes, son. You made them an offer, they turned you down.

Your Gaelic curse? “Them that bought property are going to be toast!”

Biker
Guest

Apologies for my omission: “Them that bought property are going to come ‘unstuck’, then be toast!” Think that was the correct order of The Curse.
Of course the Irish Mafia would probably throw a horse’s head in there somewhere… . ;)

Still have your Mafia ‘connection’, Euan?

Stillgotshoeson
Guest

no sour grapes… No difference to me one way or the other… House is not listed yet..

Biker
Guest

Every property I’ve ever seriously considered ‘made a difference’ to me.
Things are different in Australia.

Seriously, if you think you’ll become unhinged and roasted by buying this house, don’t walk away from it. R U U U N N N N N N N N N N N N N N N N !~

Stillgotshoeson
Guest
Comment by Biker on 27 November 2010: Seriously, if you think you’ll become unhinged and roasted by buying this house, don’t walk away from it. R U U U N N N N N N N N N N N N N N N N !~ Property IS probably going to go through some sort of correction.. However long term it will recover and grow again… You yourself have said over the last 30 or 40 years have seen ups and downs and and financial crisis of sorts.. being in your 60’s you most likely don’t have another 30 or… Read more »
Biker
Guest
Stay with what you know, Euan. If shares work for you, stay with shares. With the prospects of reduced construction, boom times in WA, rising rents (our kids both pay $600+pw for apartments, now) we see property as a steady source of good income. Yes, we’ve seen flat spots in the last forty years. Honestly can’t ever recall a crisis. Perhaps post-’87, generated by the October ’87 stockmarket crash. I’d sold in September, so we were in a strong situation similar to yours. We bought land and houses actively… . But in 40 years we’ve only ever _made_ money from… Read more »
Ned S
Guest
RBA and Treasury seem to be feel we have a minerals boom coming. They are running scared of high inflation, labour constraints and wage blowouts. Which they’ll use higher interest rates to combat. It’s also pretty obvious they are concerned that out housing prices have reached a point where an unwinding in them could happen and impact the overall economy negatively. From what I can make of it, should the minerals boom go ahead, they’ll probably be very happy to see house prices stay flat for a significant period. And they’ll probably see it as a plus if high interest… Read more »
Ned S
Guest
Glenn Stevens: “If you think back, between 1970 and 1990, Australia had CPI inflation that averaged 8 per cent a year. At 8 per cent a year, the price level doubles in nine years. So if you had a dollar in 1970, by 1990 it’s worth 21c in purchasing power.” “If you think about that, [you see] how corrosive that is to the value of people’s savings. So retirees, people on fixed income, all these people have their wealth eroded by rising prices.” http://www.theaustralian.com.au/business/markets/governor-shakes-off-his-reserve/story-e6frg926-1225848222483 So, for a long term investor with cash in bank, who suspects that any instability this… Read more »
Biker
Guest
And consider, since the 1980s (on average) mortgage rates have halved, offsetting an almost doubling of the ‘house price to income ratio’ ie., what you can buy vs what you earn. WA? We have the fastest growing population in Australia and the number of people employed in WA increased 3.6% in the twelve months to October. ABS data released this month shows Perth house prices rose 9.4% during the last twelve months. You’d be a pretty competent share trader to match this after-tax gain. Hats off to all here who managed that feat… . My thanks to that belle of… Read more »
Lachlan
Guest
Gidday Ned. In response to your quote…Stevens says mining boom coming etc well crumbs I hope he’s right. I heard him on the car radio Friday arvo saying that. Now you know I’m no Keynesian either but fact is, thats the world as it is. And our our regime here in Aus has more gas in its Keynesian fuel tank than most of the others. If the boom continues I’ll have a basis to save for my property. With some GDP maintaining and income from abroad we may be able to sail through a property correction without too much social… Read more »
PETER
Guest

Has anyone stopped to think that the government might decide to change the rules relating to negative gearing! After all, it does disadvantage genuine home buyers against investors. Negative gearing has not always been around and could be revoked at any time. I wonder what is in the “secret” Henry Tax Reform report?

SteveNG
Guest
“If you think back, between 1970 and 1990, Australia had CPI inflation that averaged 8 per cent a year. At 8 per cent a year, the price level doubles in nine years. So if you had a dollar in 1970, by 1990 it’s worth 21c in purchasing power.” “If you think about that, [you see] how corrosive that is to the value of people’s savings.” Huh? Only if you DON’T think about it. Or maybe they stuff their cash under their mattress. Of course, if they had it in a bank, they’d be earning interest which (for the record) averaged… Read more »
Ned S
Guest

Asian growth story Lachlan? Yes, wouldn’t know what if any figures to trust these days. But the big picture stuff might just start with the question Is Asia likely to continue to be able to outcompete the West for many years. With my answer to that being Yes.

Anon for this one
Guest
“61% overpriced? It’s one thing to be bearish; But another thing to be silly about it I think” Wages * 3.3 is the global standard. Here in Sydney’s inner west I see just about every single person borrowing around 90% with also a 9:1 \ 10:1 income to purchase ratio. So, at least in those area’s that’s pretty close. What happens in laws on negative gearing change? What happens if China stops buying and our national income decreases, banks have to purchase debt at higher prices, which they of course will pass on? What happens if something else like china’s… Read more »
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au