Cracks in the Australian Housing Edifice…

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So Australian house price growth is slowing? Yesterday, the Domain Group, formerly known as Australian Property Monitors, reported quarterly growth of 1.2% at the national capital level. Sydney accounted for most of the rise, with median house prices rising by 3.8%. Melbourne was up 1% in the quarter, while Darwin registered a 2.7% increase.

All the other state capitals recorded price falls over the quarter. With Darwin actually down 1.7% over the past 12 months, its quarterly rise was a bit of catch-up so you could argue that the latest ‘housing boom’ in Australia is really a tale of two cities…Sydney and Melbourne.

And that’s because it’s the investor market driving prices higher in these cities. Investors now account for 45% of all new housing loans, which is a record. Sydney, and to a lesser extent Melbourne, is the home of this ‘investor speculation’, to coin a nonsensical term.

I’ve written here before that I think this latest bout of price rises is a blow-off top in a 25 year bull market. The latest round of speculation was a product of the global search for yield and the Reserve Bank of Australia’s dramatic interest rate cutting cycle from 2011 to mid-2013. That saw the official cash rate fall from 4.75% to 2.5%, a cut of 225 basis points.

Add to that a crazy disregard for risk around the world, which lowered the borrowing costs of the big banks (they source about 40% of their borrowing needs from offshore) and you get an easy money driven price boom.

But interest rates haven’t moved in about 14 months. The boost from lower rates has all but washed through the system. That’s why house price growth is slowing, or even falling in some cities.

This is what happens to an economy with deep structural problems. It gets a one-time boost from monetary policy and when it wears off, the ‘economy’ goes looking for more. There’s nothing sustainable underpinning the Australian economy right now. It needs constant monetary stimulus to retain facade of health.

Consider this…

The mining construction boom is now starting to slow rapidly. That is, some very large projects employing thousands of people move into production phase this year, meaning the construction and engineering jobs will go.

The Bureau of Resource and Energy Economics (BREE) will soon provide an update on the state of large resource projects and employment in Australia…I’ll let you know what the findings are when it comes out in the next week or so.

But the point to keep in mind is this…when a project moves from construction to production, employment on those projects can fall anywhere up to 90%. Rising unemployment is on its way. More worryingly for Australia, when the asset begins producing, whether it’s a new iron ore mine or a large gas project, much of the returns on capital flow to offshore owners. That is, Australia doesn’t benefit, apart from royalties, that politicians will predictably blow on getting into a Middle Eastern punch-up it has no business being in…but I digress.

This profit loss will show up in an increased outflow of ‘net income’ in the current account deficit. And despite just experiencing the biggest terms of trade boom in Australia’s history, we’re still not able to run a consistent positive trade balance.

The chart below shows the balance of trade since 1971. Yellow represents deficits and blue, surpluses. As you can see, since 2008 the situation improved on the back of the iron ore boom and China’s one-time credit/construction explosion.

But with iron ore prices now reverting to the mean, we’ll struggle to maintain trade surpluses into the future.


Australia balance of trade

So what, you may ask?

Well, the balance of trade feeds into the current account deficit (CAD). This is hardly ever important to markets except in a crisis. Then it becomes very important. (This is a big topic. I’ll go into it more detail in tomorrow’s Daily Reckoning.)

Below is a chart of the CAD over the same time frame. Except in the early 1970s, the current account has been in perpetual deficit. In short, it means that as a nation we consume more than we produce. We make up the difference by borrowing from offshore…from nations that produce more than they consume.


Australia current account

The cumulative result of these decades of deficits is a foreign debt load (as at June 30, 2014) of $865 billion. That’s a lot of interest to pay. In fact, we pay about $40 billion per year in interest on that debt. And that’s with interest rates at a record low!

Now, let me bring the story back to where we started. A large part of that debt is sitting on the balance sheets of the big four banks. That’s a result of our voracious borrowing to finance speculation in the property market.

This ‘investment’ provides very few productivity benefits. That is, it produces no innovations or new sources of income for the country…hence our chronic trade and current account deficits.

And that is the reason why Australia is addicted to low interest rates. It’s because we’ve punted our national wealth on an unproductive asset that needs constant stimulus to stay afloat.

Over the past decade, the stimulus has been plentiful: low interest rates, a terms of trade boom, government handouts and a beneficial tax structure.

However, all those benefits are now in the price. The terms of trade is in rapid decline and the government doesn’t have the fiscal room to provide more grants or more support for property in general.

That leaves interest rates.

But don’t expect anything from Glenn Stevens…not in the short term anyway. He’s on record saying there is only so much low interest rates can do. Fiscal policy, he says, must play a larger role.

And he doesn’t mean another round of first-time home owner grants.

I’ll continue this conversation tomorrow. In the meantime, keep in mind that the great Australian property bubble is slowly, but surely, starting to burst.

Greg Canavan+
For The Daily Reckoning Australia

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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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6 Comments on "Cracks in the Australian Housing Edifice…"

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slewie the pi-rat
Guest

great needle-point idea:

~~~Home Sweet Home~~~
~an unproductive asset that needs constant stimulus to stay afloat~

Ross
Guest
any crack in that edifice is a crack in the stamp duty edifice… which is a crack in the state and Federal budget edifice “The booming property market continues to provide a stamp duty windfall for the government. Total value of housing sales in Sydney this year will exceed $100 billion.” http://smh.domain.com.au/real-estate-news/26-per-cent-jump-in-nsw-home-loans-20141020-118vbh.html remember how Aussie economist luminaries beholden to the establishment told you that the sovereign surplus …. cough cough …. small sovereign deficit …. cough cough …. well the its still not as bad as Greece’s deficit yet – rendered the current account deficit a marginal concern …. cough… Read more »
Craig
Guest

Should I sell my house? I live in western Sydney about 45 mins from the CBD and look set to make a very tidy profit if I sell now, but that will mean going back into the rental market. Not sure what I should do..

Rick
Guest

I wouldn’t worry too much Craig. The next newsletter these jokers put out will be telling us we’re in for another property boom. You might as well save time and flip a coin.

Paul
Guest

“Investors now account for 45% of all new housing loans”.
Add to that the people who are paying cash for properties and the number of overseas land bankers (sorry investors!) would be a much higher proportion of all sales.

Mark
Guest

I live in Qld. I get tired of real estate commentary that is always based on Sydney/Melbourne markets.
Most of Australia’s wealth is not produced in these cities yet they continue to dominate Australia’s monetary policies. Craig sell your Western Sydney property and invest in a house say in Cairns.
Think I read somewhere that the Cairns rental yield is one of the best in the country at the moment.

wpDiscuz
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