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19-04-2015, 10:39 AM
The mother of all housing bubbles?
Christopher Joye - Christopher Joye is a leading economist and director of Smarter Money Investments.
804 words
17 Apr 2015
Financial Review Smart Investor
FRSINV
English
Copyright 2015. Fairfax Media Management Pty Limited.
OPINION
The key lessons from the GFC were to speculate less and invest in the real economy but Australia is seemingly headed in the opposite direction, writes Christopher Joye.
The Reserve Bank’s governor Glenn Stevens is trying to unravel a Gordian knot created by his institution’s inconsistencies. The RBA is blowing the mother of all housing bubbles to defl ate an overvalued exchange rate. It is replacing one asset pricing conundrum with another, arguably more dangerous, one.
The RBA has introduced unprecedented monetary policy settings in the form of the cheapest borrowing rates in history to put downward pressure on the Aussie dollar.
Relative to the greenback and our key trading partners’ currencies, the exchange rate is well above the RBA’s estimate of fair value, which is about US70¢.
When the RBA cut rates in February it judged the housing market to be cooling.
Much like it thought rate cuts in 2013 would not fuel an unsustainable housing boom that would force regulators to introduce macroprudential rules to slow credit growth running at three times the rate of incomes. On all counts the RBA’s forecasts have been wrong.
It has probably been blindsided by housing dynamics over the past couple of years as it has never confronted these conditions. In 1991 the value of housing debt divided by disposable household income was 35 per cent. Today it is more than 140 per cent, and climbing daily. Australia has never had to contend with home loan rates of less than 4.3 per cent. And home buyers have never seen more expensive house prices, either in absolute terms or compared to their incomes.
The bad news for the RBA is the asset class is heating up again, with national house prices infl ating at about 12 per cent annualised over the three months to March 25.
With so much more leverage in the household sector, small changes in interest rates can have a bigger impact on participants’ behaviour. However, the exact size of this sensitivity is hard for the RBA to anticipate because it is in uncharted waters.
It has never had to deal with a cash rate as low as 2.25 per cent.
The RBA has been explicit in admitting it is already an active combatant in the global “currency wars”, declaring it is battling the overvalued Aussie dollar by crushing interest rates. The problem is that this is a very blunt tool which is infl icting far-reaching collateral damage by infl ating asset-price bubbles across interest rate-elastic areas of the economy and forcing retirees to assume untenable capital risks that could decimate their future living standards.
It is not clear that borrowers – especially the record 40 per cent taking “interest-only” loans – will be able to service the repayments in an infl ationary world. We’re talking mortgage rates at more than 8 per cent –a touch higher than their average level since 1993.
So one crucial question is why the RBA is not using its formidable balance-sheet powers to lean against, or actively sell, the exchange rate, as it has done in the past?
The RBA’s reluctance to tackle these distortions is ironic, given its two most senior leaders – Stevens and Phil Lowe – made their policy bones advocating that central banks should “lean against” asset prices that were far removed from fundamental values if they threatened the economy’s overall wellbeing.
The Aussie dollar falls into this camp. Indeed, that has been the RBA’s offi cial assessment.
Lowe and Stevens made this case in the context of their critique of the US Federal Reserve, which they suggested contributed to a house price bubble by leaving rates too low for too long before 2007. The worry is the Aussie house price bubble today is much bigger than its US equivalent before the GFC.
Australia does not need cheaper money – it would be detrimental to long-term productivity. The lesson from the GFC was that we needed to take on less leverage and redirect scarce resources away from overvalued banks and homes into real-world businesses that contribute to productivity. In Australia, we have done the opposite.
I pay heed to the RBA’s Guy Debelle, who, in October, said he found it “somewhat surprising that the market (in aggregate at least) is willing to accept the central banks at their word and not think so much for themselves”.
Put differently, the central bankers’ BS is not likely to last. There will eventually be a reckoning when freely functioning fi nancial markets reassert themselves at radically different prices. No one knows when, but it will happen. And you’ve been warned.
Fairfax Media Management Pty Limited
Document FRSINV0020150416eb4h0000a
Christopher Joye - Christopher Joye is a leading economist and director of Smarter Money Investments.
804 words
17 Apr 2015
Financial Review Smart Investor
FRSINV
English
Copyright 2015. Fairfax Media Management Pty Limited.
OPINION
The key lessons from the GFC were to speculate less and invest in the real economy but Australia is seemingly headed in the opposite direction, writes Christopher Joye.
The Reserve Bank’s governor Glenn Stevens is trying to unravel a Gordian knot created by his institution’s inconsistencies. The RBA is blowing the mother of all housing bubbles to defl ate an overvalued exchange rate. It is replacing one asset pricing conundrum with another, arguably more dangerous, one.
The RBA has introduced unprecedented monetary policy settings in the form of the cheapest borrowing rates in history to put downward pressure on the Aussie dollar.
Relative to the greenback and our key trading partners’ currencies, the exchange rate is well above the RBA’s estimate of fair value, which is about US70¢.
When the RBA cut rates in February it judged the housing market to be cooling.
Much like it thought rate cuts in 2013 would not fuel an unsustainable housing boom that would force regulators to introduce macroprudential rules to slow credit growth running at three times the rate of incomes. On all counts the RBA’s forecasts have been wrong.
It has probably been blindsided by housing dynamics over the past couple of years as it has never confronted these conditions. In 1991 the value of housing debt divided by disposable household income was 35 per cent. Today it is more than 140 per cent, and climbing daily. Australia has never had to contend with home loan rates of less than 4.3 per cent. And home buyers have never seen more expensive house prices, either in absolute terms or compared to their incomes.
The bad news for the RBA is the asset class is heating up again, with national house prices infl ating at about 12 per cent annualised over the three months to March 25.
With so much more leverage in the household sector, small changes in interest rates can have a bigger impact on participants’ behaviour. However, the exact size of this sensitivity is hard for the RBA to anticipate because it is in uncharted waters.
It has never had to deal with a cash rate as low as 2.25 per cent.
The RBA has been explicit in admitting it is already an active combatant in the global “currency wars”, declaring it is battling the overvalued Aussie dollar by crushing interest rates. The problem is that this is a very blunt tool which is infl icting far-reaching collateral damage by infl ating asset-price bubbles across interest rate-elastic areas of the economy and forcing retirees to assume untenable capital risks that could decimate their future living standards.
It is not clear that borrowers – especially the record 40 per cent taking “interest-only” loans – will be able to service the repayments in an infl ationary world. We’re talking mortgage rates at more than 8 per cent –a touch higher than their average level since 1993.
So one crucial question is why the RBA is not using its formidable balance-sheet powers to lean against, or actively sell, the exchange rate, as it has done in the past?
The RBA’s reluctance to tackle these distortions is ironic, given its two most senior leaders – Stevens and Phil Lowe – made their policy bones advocating that central banks should “lean against” asset prices that were far removed from fundamental values if they threatened the economy’s overall wellbeing.
The Aussie dollar falls into this camp. Indeed, that has been the RBA’s offi cial assessment.
Lowe and Stevens made this case in the context of their critique of the US Federal Reserve, which they suggested contributed to a house price bubble by leaving rates too low for too long before 2007. The worry is the Aussie house price bubble today is much bigger than its US equivalent before the GFC.
Australia does not need cheaper money – it would be detrimental to long-term productivity. The lesson from the GFC was that we needed to take on less leverage and redirect scarce resources away from overvalued banks and homes into real-world businesses that contribute to productivity. In Australia, we have done the opposite.
I pay heed to the RBA’s Guy Debelle, who, in October, said he found it “somewhat surprising that the market (in aggregate at least) is willing to accept the central banks at their word and not think so much for themselves”.
Put differently, the central bankers’ BS is not likely to last. There will eventually be a reckoning when freely functioning fi nancial markets reassert themselves at radically different prices. No one knows when, but it will happen. And you’ve been warned.
Fairfax Media Management Pty Limited
Document FRSINV0020150416eb4h0000a