This Will Make the Property Lobby’s Head Explode

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The craziness in the oil market continued overnight. Brent crude was up around 6.5%. No one can really explain why of course, although the Financial Times had a crack:

Iran on Wednesday cautiously welcomed an initiative to freeze oil output by the world’s largest producers — even though Tehran itself is rushing to increase its own exports.

The Iranian response to a plan backed by Saudi Arabia and Russia helped oil prices to a 7 per cent gain on the day as traders discarded some of their scepticism about the first big effort to reverse the 18-month oil price slide.

I see. So the fact that Iran ‘welcomed’ a production freeze led to a huge rally, did it? Even though Iran itself wants to increase production and you can’t really rely on any other nation to curb output, despite what they promise in public.

As the saying goes, markets make opinions…

But opinions don’t matter, price action does. The fact that oil rose sharply overnight motivated global stock markets too.

US stocks jumped more than 1.5% while European stocks soared more than 2.5%.

The European banking sector, the source of much of the world’s recent problems, jumped 3.3%. But the rally is nothing more than a bounce back from oversold conditions.

The chart below, which shows the STOXX Europe 600 Banks Index, still looks very bearish. It could continue to rally for some time and still look bearish. So don’t be lured into thinking that the worst is over.

It is for now, but the bear is by no means back in hibernation.

Source: BigCharts

One reason for the positive market sentiment recently has been China. Since coming back from the lunar New Year holiday, Chinese markets have behaved well.

But don’t let the lack of news fool you. The Middle Kingdom still has some very big issues to deal with. Like its out of control debt situation.

A few days ago, China announced that total credit growth jumped by a record $525 billion in January. So much for deleveraging…

However, analysts say some of the jump in new loans is a result of refinancing from US dollar debt into yuan-denominated debt.

This is all well and good for short term growth, as it takes the pressure of firms servicing debt in a strengthening US dollar. But it stores problems for down the track. It creates even more yuan in the financial system that will potentially want to get out of the Chinese economy when things turn south again, as it undoubtedly will.

That means the issue of capital flight hasn’t gone away, it’s just resting for a while. China expert and adviser to UBS, George Magnus, has it about right. In an interview with Bloomberg, he said:

“I’m not anticipating an imminent meltdown, but we’ve got a lot of warnings going on that should make us cautious about how we see the situation developing for the course of this year.”

If Australia’s economy is already struggling, then imagine how it’s going to be when China cannot keep pumping record amounts of debt into its economy?

China’s huge credit surge over January goes a long way towards explaining the rebound in the iron ore price. It’s gone from around US$37 per tonne in mid-December to about US$46 per tonne now.

Still, it’s not much of a bounce given the half-a-trillion debt expansion in January. It suggests a lot of the new debt is going towards paying down old debt, rather than going into new construction.

Which means the iron ore bear market isn’t over. Which means Aussie governments still have to come to terms with structural budget problems.

This week, Labor had a stab at addressing the budget issues by promising to shake up the negative gearing tax perk if it wins the next election. This policy brought about a hysterical response from the property lobby, as they know that negative gearing and capital gains tax concessions fuell and price gains and speculative behaviour.

This lobby group, which includes real estate and building associations, as well as listed property companies with big land banks, has the power to bring down the reforms even if Labor wins the election and carries out its promise.

Here’s the issue: if Labor restricts negative gearing to new builds only, which is a sensible policy and a better use tax incentives, the property lobby will counter by restricting supply.

Companies sitting on massive land banks will simply not release enough land to satisfy the demand. This will push up prices and allow them to play the ‘high prices for new home owners’ card. They will say ‘I told you so’ and try to get the new rules repealed.

So the message for Labor, if they want this policy to work, is to look at the supply issue. Work with the states to release enough land to absorb the shift in demand to new homes. If they don’t, the property lobby will win and Australia will be forever locked into a high land price regime.

The other option is to bring in a land banking tax. Put a tax on companies excess land holdings to increase the cost of land banking. This would immediately encourage greater supply.

But who am I kidding? The property lobby’s head would explode if Labor (or any political party) tried that on. Making easy gains from land price rents is a rite of passage in Australia.

If you want to know how land rents work and affect you and the economy, start 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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