Glenn Stevens Says Australia’s Economy Has Been Travelling Better Than Others


The ASX 200 has tacked on just over 11.5% in the last eleven trading days. Not a bad little run at all. But it looks to be coming to an end today. And you can blame Glenn Stevens for it!

Actually that’s not fair. Rallies don’t last forever. If you go back to March 6th, the ASX 200 closed at 3,145. It’s up over 1,000 points since then-or 32.5% if you’re trading at home. You’d expect a correction or consolidation at some point. We may be at that point.

But let’s not leave Mr. Stevens out altogether. The Governor of the Reserve Bank of Australia gave a fascinating speech yesterday in Sydney. The market reacted to the speech by pushing up the Aussie dollar. It did so because Mr. Stevens said that Australia’s economy and financial system have, “been travelling rather better” than other industrial economies.

This leads some people to believe the next move for Aussie interest rates is up, which is bullish for the currency (given that interest rate differentials to the U.S dollar and the Japanese yen are currently the big driver for the Aussie). Another way of looking at it is that interest rates are rising because the economy is healthier than we all thought.

We’ll see about that. Stocks are certainly pricing in a profit recovery (about which we have our doubts). But Mr. Stevens also had a bit to say about credit markets and balance sheets, in comments that were not as widely reported as his comments on Australian housing. More on housing in a second.

But what about our claim this week that corporate cash flows are headed back to early 20th century level growth rates because of the burst credit bubble? Does the Governor of Australia’s central bank agree? Judge for yourself.

Stevens writes that, “The pace of global growth, and the easy availability of credit, seen in the period up to 2007 was not the norm. It is unlikely to be seen again any time soon.” So far so good?

“The path to economic health for the major countries of the world will still be a difficult one, because the legacy of the crisis will cast a shadow for some time.” Could he mean that the destruction of bank collateral (commercial and residential real estate loan books) is still a problem restricting the availability of credit, or will restrict future lending?

“Major international banks will remain diminished in stature and balance sheet capability, and will be required to devote more capital to their strategies in the future. If global regulators have their way, the world will be characterised by less leverage and more expensive credit, than in the earlier period. We here in Australia have to accept that fact and accommodate it in our thinking.”

Bravo! We reckon that means that Aussie bank profitability-indeed the profitability of the whole real estate, finance, and insurance sectors-will never again reach the 2007 highs, or not at least for a very, very long time. And if that’s the case, it means that income investors used to counting on dividends from safe bank stocks may need a new game plan.

One other non-housing note from the Governor, this one on debt and the changing nature of global capital markets (due to the massive destruction of global capital). “Government and government-guaranteed debt of one form or another is rapidly increasing globally…Certainly people will worry, longer term, about increases in long-term interest rates potentially ‘crowding out’ private borrowers. To date, though, long-term rates remain historically low for public borrowers, despite the prospect of very large debt issuance.”

The important words in that sentence are “to date.” If historically low interest rates do not stay historically low, the cost of government-guaranteed debt is going to rise along with interest rates. And if the government itself maintains and increases its role as middle-man lender in the capital markets, we can’t see how government borrowing wouldn’t crowd-out borrowing by smaller businesses and even households.

We all know how efficient the government is at spending money and allocating capital to productive enterprise, don’t we? This puts Aussie banks in a tough spot. They can use the government-guarantee to borrow. But who are they going to lend to? Households?

“The prominence of household demand driving the expansion from the mid 1990s to the mid 2000s should not be expected to recur in the next upswing,” Stevens said. “The rise in household leverage, the much lower rate of saving out of current income, and the rise in asset values we saw since the mid 1990s, are far more likely to have been features of a one-time adjustment, albeit a fairly drawn-out one, than of a permanent trend.”

Now that’s a bit of a bomb shell. Stevens describes the whole model of getting rich in the Western world for the last twenty years and says it was a one-off, not to be repeated. But if you can’t borrow, leverage, and spend your way to wealth as your stocks and houses go up in price, how are you going to get rich and retire?

Stevens says that, “The households of the Western world are currently feeling that they can no longer consume as they did, in part because the earlier spending is now seen to have been based on an unrealistic set of assumptions about long-run income and wealth. To that extent, there is no real way around a period of adjustment involving lower consumption for awhile.” What about lower standards of living too? Hmm.

This is remarkably frank talk from a central banker. Stevens paints a picture in which business confidence has recovered. But he also shows that systemic leverage will have to be reduced and that the economy will enter a period where households lower their consumption “for awhile”-even as the government is forced to withdraw its support for “aggregate demand” through cash giveaways s mis-directed stimulus splurges.

All of that leaves us with a question about the Australian economy: who is going to be borrowing and who is going to be spending? What is going to drive the growth? If banks have to repair balance sheets by being more guarded with capital, and if consumers tighten their belts because their real net worth is falling (along with their real wages), why would a business borrow for demand that isn’t there, assuming it could even get a loan from a bank reluctant to lend?

Our guess is that Aussie banks don’t want to lend to businesses because there’s too much risk in that. Besides, Aussie corporations have successfully tapped the equity and bond markets for new capital in last year, leaving the banks out of the loop. But one asset class Aussie banks are keen to lend to is residential housing. Why?

The destruction of bank collateral is what’s behind the shrinking of bank profits and balance sheets. The largest part of Aussie bank collateral is in property, especially residential property. If banks don’t keep lending to the property market to support demand and prices, prices will fall, damaging bank collateral and forcing the banks to tighten credit (housing finance) which leads to even further house price declines. Vicious circle. Feedback loop. Take your pick.

We were discussing just this subject earlier in the week over lunch with Phillip J. Anderson. Phil is the author of a new book called “The Secret Life of Real Estate.” He’s also one of our panellists for this Friday night’s Debt Summit and the State Library of Victoria. He had some forecasts about the Aussie housing and stock markets that some investor might find…surprising.

Incidentally, if you can’t make the Debt Summit, Phil is signing copies of his book tomorrow between noon and 1:30 pm at the Educated Investor Bookshop at 500 Collins Street. We recommend dropping in if you’re in the area. It’s a great book shop. And Phil’s written a book about the real estate cycle that Aussie investors can’t afford to miss.

Glenn Stevens says now is the perfect time to build more houses in Australia and hopes that the “ready availability and low cost of housing finance is translated into more dwellings, not just higher prices.” He seems to be arguing that the Aussie property market could be in strife if someone doesn’t start building more homes ASAP.

“If all we end up with is higher prices and not many more dwellings-then it will be very disappointing, indeed quite disturbing. Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over-leverage and asset price deflation down the track.”

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. On one hand our man from Goldman Sachs, the esteemed RBA governor, says “The pace of global growth, and the easy availability of credit, seen in the period up to 2007 was not the norm. It is unlikely to be seen again any time soon.”

    On the other he says “Now is the perfect time to build more houses in Australia” and hopes that the “ready availability and low cost of housing finance is translated into more dwellings, not just higher prices.”

    Is he hedging his bets or something?

  2. Of course..he is an economist :)

  3. Dan:
    “If banks don’t keep lending to the property market to support demand and prices, prices will fall, damaging bank collateral and forcing the banks to tighten credit (housing finance) which leads to even further house price declines. Vicious circle. Feedback loop. Take your pick.”

    Exactly. So the banks keep on lending at cheap rates…whilst their credit costs soar, availability drops and they are trying to repair their balance sheets. Does anyone see an issue here?

    For the banks to continue lending to avoid the vicious cycle that Dan mentions, it would mean significant profit haircuts and possibly even losses by the banks. And as I mentioned this is at a time when the banks need more capital than ever. It is not a balancing act, but rather a completely exclusive contradiction – the banks will not be able to manage both competing needs at the same time.

    Ironically either approach will lead to the same conclusion.

    As far as I understand, the following things may influence the outcome:
    – bank nationalisation (last resort)
    – extreme Government regulations/legislation
    – a favourable economic environment (banks recapitalise)
    – loosened lending requirements for overseas borrowing
    – a strong AUD*
    – inflation (I believe this impact would mostly be negative)

    *I will admit to not completely understanding how forex complicates an economy, besides basic import/export controls and cost of overseas borrowing. It appears a strong AUD would relax overseas lending strains, but negatively affect the general export economy at the same time. If the RBA puts up rates, this appears to boost the AUDs value, but constricts credit in the internal economy. If the RBA reduces rates (I have previous posts on that) then the AUD falls, which is worse for the export economy and inflation/bubbles.

  4. Oops, in the last sentence I meant that if the AUD falls it is better for exports and overseas borrowing, but worse for imports and inflation/bubbles.

  5. Hmmm. Stevens coming clean on the truth of our credit system/property bubble/economy. Probably more likely a way of nudging the government for a considerable hike in FHBG stimulus. Kind of like, “Pay up now Wayne or I’ll spill the beans, in public. I’ll do it you know.”
    It may seem wrong headed and down right irresponsible which makes it more of a possibility.

  6. It says to me that if global regulators get their way, the world will be characterised by less leverage (CDs are bad) and more expensive credit. (I suspect they’ll get their way?) But irrespective, Oz housing will continue to be the principal beneficiary of the cheapest and easiest credit that our banks can possibly give it. (Which amongst other things, points out a lack of diversification in the economy; Even a structural weakness? But there we have it anyway.)

    And having looked at Stevens’ speech, he hopes that with the lessening of labour shortages and reduced price pressures on raw materials, that we can add to the dwelling stock “without a major run-up in prices”. But he obviously accepts that this may not happen (Looked at that way, I’m tempted to agree?) because he feels to do the RBA’s usual trick and warn of risks “down the track” if it doesn’t.

    Big picture: Our export industry is minerals. Our domestic industry is housing. We are going to sell our minerals and spend the money on our houses. (Because we’re Aussies and that’s how we like it.) The RBA’s job is to make sure that the exchange rate and domestic interest rate remain balanced within ranges that are supportive of both. And Mr Rudd’s job is to be nice to China (and Japan Greg – Smile!) and make sure the money gets shared round so that everyone can spend money on houses. Think I’m starting to get a handle on this! Double Smile!!

  7. Ned S, if domestic industry is housing , I hope that means housing construction and not housing speculation.

  8. Ned I just reckon some government aid to real estate (of some description) has to be forthcoming soon even though I dont agree with it of course. Shops in my region are emptying out very quickly though residential stuff seems to be holding up a little better in high density areas. Rudd is not averse to irresponsible deficit spending and at this time the kitchen (credit/mortgage/economy/bank sector relationship) must be getting a little hot (judging on Stevens language).

  9. Ned S – I think you have summed it up nicely. Glen Stevens was stating the obvious, Australia will chug along okay if commodities do okay. Personally I think this is a dangerous strategy and we should have a Plan B (e.g. develop some high tech sector)but everyone seems happy to rely on iron ore exports so I guess we are going along for the ride.

  10. Nirvan, I was actually thinking of housing construction. But every little piggy who ever went to parliament or ever sat in council chambers has probably experienced the joy of realising how they can milk money out of the land and infrastructure side of things. As to punters having a punt – I’m not sure why they’d bother in a game that is so obviously rigged to only ever go one way – Just buy and hold I think?

  11. True Ned S and I think universities should stop teaching most courses like the sciences . What use will that come to when you can buy land and sit on it. 18 year olds get into debt early these , not HECS debt but property debt (negatively geared) while they stay with parents. Yikes Australia will need to import some transport technology , surely we will need to link up the ever expanding sprwal. Maybe a cottage industry around fixing up some tired trains plus the housing/finance industry and mineral exports can be the three pillars for this genious economy.

  12. Agree with many of these thoughts. (Yep, [all] speculation is BAD, guys!) :) But, seriously, you cannot simply buy land and ‘sit on it’and expect to prosper in this market. You need to add value… and get a weekly dividend. That actually does help Oz, because the housing industry is vital, regardless of how much one disapproves ;)

    Biker Pete
    July 29, 2009
  13. Yes “add value to land” that is the one specific science we should reserve as a grad course at the unis.

  14. Universities are teaching far less science (ie establishing truth through deduction) and are replacing it with creating/asserting the truth where it supports political whim.
    Developing a high tech sector…wouldn’t that be like stimulating real growth in GDP….like to affect a genuine recovery….as in not giving out cash so we can buy imported plasmas, or FHBG’s so we can get the new $400K house we’ve always deserved (at the tender age of 21).
    Maybe the real solutions will get looked at further down the track as the situation becomes more critical…or after the system is broken.

  15. Think you misread me Nirvan? Buy and hold rental property is generally best. Although I’ve seen very significant capital gains made from vacant blocks of land too. Just depends what’s happening at the time in the market and who wants to buy what.

  16. Lachlan..yes sorry, I was talking about aiming for long term growth and increased productivity…not popular topics these days. Better to hand out cash so we can all buy imported products and provide grants so we can get the home with the double garage that is our right under the constitution :)

    But seriously, is it just me or have we missed a golden opportunity to really shift the Australian economy up a gear? We are going to be billions of dollars in debt and maybe at best we will end up with a broadband network in a decade that might deliver what is available in Japan today.

  17. Well, I can’t argue with the premise that technology may help lift us out of the mire, Greg. The Tech Wreck occurred because the machine revved along faster than the consumers… . Seven years later, there might have been less carnage. Yes, the ‘necessity’ for a double garage IS a joke. It’s what the tenants demand, however. (We actually have a ‘two cars only’ rule.) Here in New York, I’m reminded again why you choose not to drive! It also supports our son’s contention that he’s better off without a car in Vancouver… .

    Biker Pete
    July 30, 2009
  18. Gidday Greg. Had no idea Japan was so up to speed on the net. There would no doubt be a benefit from faster internet. I just cant help thinking we could maybe achieve that at lower cost than Wayne has allowed for. But Australia and the US could so easily use a new technological revolution as a major plank in a grass roots (GDP inclusive) recovery. So much potential really but alas…not yet. The powers that be arent finished fixing the unfixable…and getting a new life. I dont see the world financial crisis in itself as the problem but rather short sighted leadership as the real problem. Australia, with honest leadership could grow, prosper and dominate any old time with the people and resources we have.

  19. We should be doing everything we can to be the most technologically advanced nation on Earth. Technology is where the real wealth is made. Natural resources are a finite windfall. Hard work is OK, but by itself can only produce limited wealth. Technological advancement creates massive, unlimited wealth, both for the originator and for the whole world. Its a no-brainer.

    Its tragic that Australia doesn’t use our current wealth to become a technological super-power. Its the understatement of the century that we are lucky to have such enormous natural resources per capita, but instead of “riding on the sheeps back” we should be improving the farm.

    Either we continue spending this windfall on living it up like a lottery winner destined for the poor-house, or we invest it ways that create wealth and diversify our economy. Its obvious that technological innovation is the only way to go. That starts with all levels of education, but it is also crucial to grow our culture of research, incubation and venture capital institutions.

    Education also helps keep us relatively politically sensible compared to places that don’t value education like the USA. Get the institutions and the funding right and Australia could become a world super-power. Its either that or become China’s quarry.

  20. Xoc for PM!

  21. On Ya Xoc! A focus on funding Education & Research (and Health I might argue) will see us prosper in the future. With a well educated, healthy population of youngsters we could see Australia innovate its way to the top of the line and ensure our wealth. USA style poor education standards and health care for the rich will drag us down like a lead weight. Digging holes in the ground won’t feed us forever…. Our brains and ideas will save us, not holes in the ground.

    Cyber Cynic
    July 30, 2009
  22. Lachlan at home here in Japan I have a 100 Mbps fibre internet connection which also delivers Pay T.V and handles two IP phone connections. I am in southern Japan so it is not like I am in the middle of Tokyo…and who provides this fibre connection? The good old private sector. The whole package is around $100 a month and remember this includes everything. IP calls even back to Oz are as cheap as chips and the quality is as good as a landline.

    In 2005 there were 370,000 robots working in factories across Japan and the target is to have 1 million in place by 2025. I wonder what high tech goal Australia is aiming for by 2025?

    I ranted on about this a while back in:

    My point was and is that we as a nation could have spent the economic stimulus money on far more beneficial projects than school gyms, pink bats and ipod docking stations at community centres.

    It is a bit like having that pie and kebab after a big night out, sure they tasted great at the time but you really didn’t need them and they won’t help with the hangover the next day :)

  23. Here we go? All this today.
    “Oil Inventories Up” (in US Summer no less)
    “Commodity Futures Trading Commission aims to rein in speculation”
    “Oil Jolt”
    “AUD Down”
    “USD up on safe haven buying”

    Let’s see how much hedge fund money comes out of Australian resource equities and how many points come off the ASX XMJ and XEJ today.

  24. I recall the RBA raising interest rates just before reversing course. So we know they are not able economists but are bureacrats with qualifications so they use the correct big words!

    He is trying to provide more housing for economic activity and to keep the asset appreciation grounded in reality. I suspect they have re-learned their economics and appreciate the dangers of malinvestment.

    I would give them 4 out of 5.

    Good article Dan!

    Pat Donnelly
    July 30, 2009
  25. The RBA did a better job than most is my take on it. Not their fault if the rest of the world wouldn’t bite the bullet and keep their interest rates at half sensible levels. If ours had been low before the crisis we’d have a burst housing bubble on our hands and be printing money now too. Of course they were way more fortunate than most in having the minerals boom backstopping the economy. But that isn’t really something we can hold against them.

    My main criticism of them is that they didn’t raise interest rates higher than they did during the boom. (Although John Howard wasn’t seeing it that way at the time.) But battling bubbles was not, and still is not, part of their mandate. And they don’t have the tools. Plus heck, who wants to take on a bubble that is of extreme national significance once you have one – Here fix this – Sounds like thankless work to me.


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