The Warning Signs in the Australian Economic Growth Model

Illustration of australian real-estate development

Stocks had a decent rally overnight. The Dow rose 0.27% while the S&P 500 was up 0.28%, to 2105 points. That’s the highest level since last November.

The US rally should give Aussie stocks a boost today following a few nasty sessions.

Earlier this week, I mentioned 5400 points being an important level for the ASX 200. While it poked its nose through here on Monday and Tuesday, there was no follow-through buying. That was a warning sign…

Three days later and the index had lost 130 points. You’ll see a bounce today, but it will take some more work to get back to 5400. What we need is some poor economic data to put a near term rate cut back on the agenda!

The irony of this week’s ‘strong’ economic growth data was that it took the wind out of the prospects of another rate cut.

The market rallied on the back of the early May interest rate cut. But it wasn’t just about one move by the RBA. The market assumed it was the start of another rate cutting ‘cycle’, and that we’d get one or two more before the end of the year.

Now that assumption isn’t looking so good. That’s thanks to the economy growing faster than expected in the March quarter. Although, as I pointed out yesterday, it’s a questionable claim.

GDP measures production, and while production might be up, the prices received for that production are way down. It’s like a business that churns out more goods but generates lower and lower profitability from the increased production.

In such a scenario, the business would come under pressure. The board might get external consultants in to look at the business. Or shareholders might boot the board and management and get new blood in.

Shareholders (the electorate) have a chance to boot Australia’s managers (politicians) in July. Will they take it? And if they do, will there really be much difference with a new management team?

Unfortunately not. No party has a comprehensive plan to wean Australia off its debt-dependent economic growth model. Since the peak of the resources boom in 2011, we’ve managed to increase our net foreign debt levels by more than 60%, to over $1 trillion.

Most of that debt has gone into Australia’s housing market. It was soon after the 2011 resource peak that interest rates fell sharply and house prices took off.

The wealth effect from rising house prices might feel good for those of us who benefit, but, in the aggregate, it doesn’t benefit the economy. That’s because the increase in house prices comes at the expense of another part of the household sector taking on more debt.

The effect of leverage makes it look as though the country is better off. But the bottom line is that Australia now has significantly more debt to service without anywhere near a commensurate rise in income to help pay for it.

That might not matter in the short term, but it will in the long run. The risk is that we simply don’t know when our foreign creditors will turn off the lending taps.

But warning signs continue to flash that our growth model does have issues. The latest is from ‘external consultant’ OECD, a Paris-based economic think tank that specialises in giving their opinion on economic matters.

I’m not sure anyone really listens to what they’re saying. But they need to publish reports and have a media presence if they are to continue receiving funds…and invitations to various economic blabber sessions.

Their latest on Australia is a warning about the housing market (join the queue!). From the Financial Review:

Australia may be on the cusp of a “dramatic and destabilising” end to the housing boom rather than a hoped-for soft landing because of the apartments building boom, the Organisation for Economic Co-operation and Development said.

In its latest assessment of the threats to the economy, the Paris-based think tank said jitters over the federal election are adding to risks, and called for an increase in the goods and services tax.

Somewhat paradoxically, the OECD appears particularly worried about how to interpret changes in the housing market – even as it notes simultaneously that risks of a boom appear to be receding which, it argues, provides leeway for even more official interest rate cuts.

What horribly confused analysis. So they’re saying the housing boom could come to a destabilising end…but risks of a boom appear to be easing, which could provide room for more interest rate cuts.

Got it?

I published the comment to highlight the sort of gibberish that passes for economic analysis. The warnings on Aussie housing are de rigueur these days. They aim to get headlines and publicity, rather than disseminating genuinely useful economic ideas.

Based on fundamentals, nearly everyone knows that Aussie property is very expensive. And with the recent construction boom in apartments, nearly everyone knows it poses a risk to the industry and broader economy.

To be useful, any research on the housing market needs to be more nuanced. I’ve said before that you’ll find the best research on Aussie housing in Cycles, Trends and Forecasts. It goes beyond the headline grabbing claims to tell you what you won’t read anywhere else.

If you’re a property investor, or thinking of becoming one, it’s simply a must read. You can check it out here.


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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