In purely economic terms, the upcoming Federal election is extremely unusual. The shut down of the Australian economy for almost two years because of health measures really has no precedent in our history. Only war can produce that type of shock.
The Federal government’s financial response was as extreme as the state of emergency measures, including a sharp increase in Australian government debt. It remains to be seen, however, if the government gets much credit for injecting so much free money into the economy. It is unlikely. When Labor prime minister Kevin Rudd did something similar during the financial crisis of 2007-08 with his so called ‘cash splash’ he got little recognition for acting fast and keeping Australia, uniquely in the developed world, out of recession.
The economic focus is instead likely to be on two types of inflation: asset inflation (especially rising house prices) and consumer price inflation. For most of this century the Australian economy has been a battleground between those two forces, with asset inflation winning easily.
For about two decades CPI inflation has been quiescent, allowing the Reserve Bank to bring in steadily lower interest rates. There were many reasons for this, one of which was the efficiency of cross-border supply chains. In the aftermath of the pandemic those supply chains have started to come apart and it is not clear if they will return in the same form.
Thus the game came to an end when the country recorded the largest quarterly and annual increase in inflation since 2000. The CPI rose 2.1 per cent in the March quarter and came in at 5.1 per cent annually. The Reserve Bank has responded by increasing interest rates by 0.25 per cent, the first jump in over 11 years.
'Australian households are amongst the most indebted in the world. In the third quarter of 2021, Australia’s household debt-to-GDP ratio was 119 per cent.'
For those with large mortgages, a return to interest rate levels more like the historical average is a chilling prospect. The current rate of 0.35 per cent is still very low but it is likely to be heading higher, as indicated by the fact that the Australian 10 year bond rate has hit 3.56 per cent. Last August it was only 1.06 per cent.
Australian households are amongst the most indebted in the world. In the third quarter of 2021, Australia’s household debt-to-GDP ratio was 119 per cent, second only to Switzerland’s 131 per cent. The ratio of housing debt to household income is over 140.5 per cent and residential housing is worth almost five times the stock market and five times the nation’s annual economy.
That indebtedness is heavily skewed to younger generations. Only about a third of the population has a mortgage (a third rent and a third own their homes). So the most indebted are younger people who had to buy when prices had already soared. They have had little or no experience of the risks of higher interest rates and many have borrowed at six times their income. If rates rise sharply they are at risk of default.
Labor is proposing a Help to Buy scheme, in which it will take up to 40 per cent equity in a house for those who qualify. This idiosyncratic project will probably only reinforce the high prices that are making housing unaffordable for young people; it will not solve the core problem and could easily have unintended consequences. It is probably a good thing that it will be capped at 10,000 homes a year, which is only about 1.7 per cent of the total turnover in houses.
The political parties and regulators have largely ignored asset inflation and the distortions it has caused for two reasons. One is that Australian banks, which have $2 trillion in housing loans, have enormous political influence and going against them is risky, especially as the economy depends on their being healthy.
'The politicians, instead of using sops like the First Home Owner Grant, which are either ineffective or counterproductive, could have changed the tax system to make it less attractive for investors to gamble on house prices – otherwise known as negative gearing.'
The second problem is that economists have difficulty measuring asset inflation. Consumer price inflation is easy to calculate because the products are constantly being transacted but asset prices can rise with few, or even no, transactions taking place. A house, for instance, can be worth more even if it is not being sold.
Faced with that measurement problem economists have tended to throw up their hands. They resort to circular arguments, such as claiming that assets are justifiably worth whatever people are prepared to pay for them so the price therefore must be fair and not inflated. QED.
It is a leadership betrayal. Just because something is hard to measure does not mean it does not exist. It just means a different approach is required like, I don’t know, using common sense. Any fool can see that house prices are out of control, just not the fools in Canberra.
The Reserve Bank could have addressed the problem when setting interest rates but it did not. The politicians, instead of using sops like the First Home Owner Grant, which are either ineffective or counterproductive, could have changed the tax system to make it less attractive for investors to gamble on house prices – otherwise known as negative gearing.
At the very least there could have been an effort to educate younger people about the dangers, and how to assess and manage risk. None of that has been done, and it will not be sensibly addressed during this election campaign. There are almost certainly some hard lessons to come.
David James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.
Main image: An auction outside a residential property Strathfield in Sydney, Australia. (Lisa Maree Williams / Getty Images)