Is debt financed prosperity real?
Today’s Daily Reckoning Australia is full of questions.
Not the sort you can get right or wrong.
The sort that reveal choices.
Did you know Callum is leaving The Daily Reckoning Australia?
It was news to me. Probably because I’m flitting between London and Japan.
I was relieved to hear he’s not going far. He’s setting up his own free daily e-letter, Profit Watch, devoted specifically to tracking, identifying and playing the hottest market-moving trends in the world today.
He’s identified four such bull markets for 2019. And he’s written a compelling report on all four, identifying ways to play each of them.
Like Profit Watch, this report is free. The only ‘cost’ is that you sign up to it. Bargain if you ask me.
I’d do so now, because after this coming week is done, you’ll no longer see Callum in the DR.
Probably a good thing, too, as Shae, Jim and I have a whole lot of ‘big picture’ questions to ask and ponder.
But you don’t have to answer them. Instead, take a guess at how your neighbours would answer them. Because Australians as a whole will soon be confronted by those questions in their day-to-day lives. They’re about the nature of our wealth.
The only people wealthier than us are the Swiss. The only people more indebted than us are the Swiss.
The link between debt and wealth appears obvious at first. Debt allows you to buy things. It improves your living standards enormously. It allows you to gain wealth faster by leveraging up your business or investment. It allows you to expedite consumption – you get the car today and pay for it thereafter.
A young investor might look at the wealthiest Australians and conclude that borrowing a huge amount of money is the key to success. It’s very difficult to become extraordinarily wealthy without using the leverage that debt gives you.
But is that the right conclusion to draw for a whole generation of investors? Do they fail to see all those for whom debt went badly wrong?
Let’s contrast Australia and Switzerland with a ‘poor’ country.
In 2012, Germans registered the lowest median household net wealth of the 15 euro-area members for which data was available when the Peterson Institute compared them. That’s the opposite to what most people would expect.
The reason why German households are less wealthy is well understood. Germany didn’t have a property boom in the 2000s. And homeownership rates are low, thanks to a reluctance to get into debt. Not to mention tight lending standards – the sort that Aussie banks used to claim they had.
In 2012, things began to change in Germany. Property prices began booming. But let’s leave that for another day.
Were the Swiss and us Aussies really wealthier than the Germans in 2012? Is debt-based prosperity real?
In the one sense, it obviously is. Even if Australia has a financial crisis and house prices tumble, the houses remain there. They don’t disappear when people default on their mortgages.
It’s an interesting thought experiment to explore further. Let’s say house prices fall 99%. Everyone declares bankruptcy. And then sells each other their houses for a few dollars. We’d be living in the same houses, without the debt. Would we be more wealthy, less, or the same?
What about the argument that, without debt, few could buy houses. Let alone build them.
Well, that’s a circular argument.
Without debt, houses would have to become affordable. They’ve been bid up to unaffordable levels by the availability of debt. That’s why house prices are affordable in Germany. The reluctance to be in debt and to lend to people who secretly can’t afford the debt holds back prices.
Debt is not wealth
In another sense, debt-based prosperity is not real at all. Debt is a liability. Plus interest.
Every default on unaffordable debt destroys wealth – that’s the problem with the thought experiment above. If you own bank shares, mass mortgage defaults don’t sound so good.
But consider, for a moment, where you’d prefer the burden to lie. Do you favour the creditor or the debtor? The lender or the borrower?
Because, once house prices begin to fall, someone has to pay up. Either the lender loses out, or the borrower has to repay regardless. In most countries in 2008, the borrower got stuck with their debt.
In Australia and some American states, the banks are left with the burden instead.
Australians who can prove their mortgage application was fudged by their banker or mortgage broker can apply for their debt to be cancelled, but they get to keep their home. It’s the Aussie version of jingle mail – the American practice of mailing your house keys to your bank and thereby becoming debt-free in the process.
I think the Aussie and jingle mail systems are preferable to what happened in places like Ireland and Spain because it discourages lenders to lend unaffordable debt.
Stability or complacency?
Few Australians fear a financial crisis that would make borrowing and lending problematic. So perhaps the debt bloom we’ve seen is due to stability. Stability encourages debt.
Property rights, a helpful central bank and economic growth all make it safe to borrow.
But if stability encourages more debt, is that really a good thing? It’s not entirely clear given the above discussion about debt and wealth.
The problem is that borrowing becomes a punt on stability lasting.
The Japanese held the previous record of the longest period of uninterrupted growth. Since it ended, they’ve had a miserable time. At least by the measures we consider important in the west. House prices tumbled alongside the stock market.
And yet, having lived in Japan for the last four months, I don’t hear people bemoaning the issue.
The only people in trouble are those who bought in the latter stages of the boom. They’re repaying unaffordable mortgages based on house prices that have since tumbled. They’re stuck, unable to move anywhere without having to pay off their debts.
The property ladder became a ball and chain cemented into outer suburbia.
I think Australia is on the cusp of having to answer all these questions about wealth and debt. The Royal Commission has exposed that need.
Europeans had to answer the questions in 2008. Each nation responded a little differently. And it determined the nature of their recovery.
The Australian solution
In this month’s Strategic Intelligence, Jim Rickards, Shae Russell and I discuss how all this debt leads to inequality and the problems that go with it.
There is something very specific you should do if you’re worried about the wealth gap.
But what should we do as a nation? The Royal Commission has exposed plenty of Australian banking’s dirty secrets. But what will our political response be?
Submissions to the Royal Commission close this week. There has been plenty of talk about extending it.
The Commission has, at no point, pursued a line of questioning intended to uncover just how widespread the problems are that it has uncovered. In each example and case brought up, bankers have pointed out the uniqueness of the situation. Nobody questioned them or argued their outrageous actions are common.
Just how many loans were made possible by manipulating loan applications? Just how much Super was lost by investing in low-interest accounts? Who trained mortgage brokers to fudge figures? Why did the regulators do nothing despite everyone in the industry being aware of the problems?
Can we even deal with the Royal Commission’s discoveries without undermining the property bubble and the banks – the two most important investments Australians have?
I doubt it.
Australians are going to have to choose between their wealth and their beliefs about right and wrong. How will we answer the difficult questions?
Until next time,