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In tackling the oft debated question as to whether a real estate bubble exists in Australia, the answer you get is highly dependent on whether you think that asset prices are largely determined by global macroeconomic forces, or whether you think that local market forces dominate.

The claim that global macroeconomic forces can be considered of minor importance or even irrelevant means that local forces, namely those influencing supply and demand, determine real estate asset prices. For asset prices are allegedly predominantly driven by local forces of supply and demand — and, the market, in the neoliberal view, is an oracle that is always right. That is the position taken by Joe Hockey, who ironically dismissed ideas about an Australian property bubble as being based on a “lazy analysis”:

It is just an infinite mantra for international commentators, for analysts based overseas to say ‘well, you know, there’s a bit of a housing bubble emerging in Australia’.

That is rather a lazy analysis, because fundamentally we don’t have enough supply to meet demand.

Federal Treasurer: Joe Hockey

The biggest problem with this is that already in 1875, Baron Meyer Carl von Rothschild had noted that: “the whole world has become a city”.


Freiherr Mayer Carl von Rothschild (1820-1886)

Rothschild’s observations were in response to the way stock market crashes in the US would spread a wave of adverse economic contagion to the rest of the world. Just as we had the dotcom technology bubble, there were similar manias driven by speculation in the technological innovation-driven railroad stocks of the 19th century. The effects of a crash in American railway stocks would be rapidly felt in Europe.

In our digitally connected age, the world has become immeasurably more tightly interconnected than ever it was in 1875. Failure to recognise this deeper interconnectedness of the global economy lead German finance minister, Peer Steinbrück, to make an abject fool of himself on the eve of the Global Financial Crisis in 2008. “The financial crisis is above all an American problem”, Steinbrück confidently proclaimed, adding that “the other G7 financial ministers in continental Europe share this opinion”. Days afterwards the European banking system collapsed.

Steinbrück’s fatal error was failing to realise that “the whole world has become a city”. Things that occur at a local level must also be seen as the result of global macroeconomic forces.

One common fallacious argument put forward to suggest that no real estate bubble exists in Australia is that American styled subprime lending practices are not rampant in Australia as they were before the American property bubble burst. Therefore the American real estate asset deflation process, we are told, is entirely a local American problem of no further relevance to Australia.

In this view, the bursting of the American real estate bubble teaches us nothing about global macroeconomic forces — of relevance to all countries — but only about local American issues. It is just as Steinbrück asserted: “the financial crisis is above all an American problem”.

Anyone who believes that, sadly risks making as much of an abject fool of themselves as Steinbrück did back in 2008. It is exactly as Nouriel Roubini says:

the crisis was less a function of subprime mortgages than of a subprime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

Roubini: Crisis Economics

As Roubini says, it is a catastrophic mistake is to dismiss the GFC, like Steinbrück did, as being purely a local American problem, rather than as a problem reflective of much broader global macroeconomic forces and trends. It was hardly possible to ignore global macroeconomic forces back in Baron von Rothschild’s day, and to do so in the 21st century reflects a degree of ignorance bordering on the comical.

The best illustration of the fact that subprime lending practices were not the singular cause of the bursting of the American real estate asset bubble is the example of the Japanese real estate bubble. Nobody claims that subprime lending practices alone drove the Japanese bubble to burst back in 1990. The trigger for that was that the Japanese central bank deliberately spiked the bubble by pushing up interest rates.

The Japanese bubble deflated with less of a bang than the American one. There was no collapse of the global banking system. The country did not go into recession overnight. Yet in the long term, the effect was hardly any less severe. It resulted in a lost two decades struggling to overcome stagnant deflation, while lurching from recession to recession.

The difference in the velocity between the collapse of the Japanese and American asset bubbles is worth studying:


You can see that the velocity of the American bubble deflation was much greater than the Japanese bubble. Yet, the macroscopic structure of the deflation process remained remarkably similar in both cases.

The relative velocity of property asset deflation, however, can be understood in terms of localised differences. The principle difference between Japan and America is that America has a much greater degree of income inequality than Japan. Thomas Piketty, in Capital in the Twenty First Century, tells us quite rightly that if Americans had all been guaranteed good wages, there would never have been such a demand for subprime mortgages in the first place.

All the subprime element of the crisis did in America was to accelerate the velocity of bubble deflation, to the point it engendered a massive financial shock of huge proportions as the bubble popped with an abrupt bang. The Japanese experience shows that bubbles can deflate much more slowly without anything like a bang of sufficient violence as to take the world economy down with it, yet still have crippling long term economic consequences.

And this is how the Australian real estate bubble looks like compared to the American one:


You can see that it has grown bigger than the American one — or even the Japanese one.

What Australia has to learn from this is that it is utter nonsense to suggest that real estate asset deflation can only occur with a bang produced when subprime mortgage defaults prick the bubble. We are deluding ourselves if anyone thinks that property bubble deflation cannot occur as long as local lending practices do not embrace American styled subprime lending.

The assumption that absense of grossly subprime lending in Australia confers immunity from a property bubble-bust cycle represents a hubris that cannot be justified in global macroeconomic terms — a hubris engendered by myopia. Especially given the rapid rise in Australia of interest only mortgages, and 95% loans

The whole trend towards real estate asset bubble formation, followed by asset deflation cycles culminating in stagnant deflation, is a global phenomenon. All advanced economies that went through the neoliberal reform process leading to easy lending practice, to the point that private households ended up to the eyeballs in debt, are going through this worldwide deleveraging process. Only a fool could conclude that property price cycles seen within nations are purely the product of local economic forces of no relevance to Australia.

I quote from Harry Dent:

Everyone focuses on the now out-of-control $17 trillion [US] government debt that has mushroomed from $5 trillion in just 2000. But the private sector accumulated far more debt since the 1980s boom started. At the peak of the debt bubble in 2008, private debt racked up $42 trillion, which includes $14.2 trillion of consumer debt — mostly mortgages.

Then we hit a wall. A slight increase in interest rates and millions of Americans could no longer meet their monthly mortgage repayments. Then they could no longer make their credit card payments. Then they could barely get food in the house.

Dent: How to Profit Through the Coming Safe Asset Slaughter

Australians are going through the exact same process of debt accumulation:


It is only a matter of time before Australia hits a wall and the deleveraging process begins, resulting in a deflationary cycle from within a recessionary environment.

For even without subprime lending practices, grotesquely inflated house prices and rents inflict immense hardship on those least able to afford it. There is a reason why poverty and homelessness are on the rapid rise in Australia, even if the minimum wage here is far more reasonable than America. High housing costs are one of the main reasons for this financial stress. Yet for every person living in poverty there will be someone else struggling to meet mortgage payments.

Even those in higher income brackets have most of their income disappear into mortgages. That means equity ends up trapped in real estate — a hopelessly unproductive aspect of the economy. That means that there is less money going towards the service and sales sectors of the economy. Nobody can afford to spend money on anything other than rent, mortgage payments, and bare essentials.

Industry, too, comes under pressure to increase wages to keep up with the price of the ballooning cost of housing — an inescapable cost of living. That increases the cost of manufacture. Everybody loses out.

The trouble is that winter is coming. The Australian Indian summer, extended by the Chinese driven mining boom, will soon end. Australia’s 24 year recession-free run has to come to an end some time after the mining boom ends. That means even more mortgage stress, and less money going to the service and sale sectors, as Australians are left with no other discretionary income, because the mortgage eats up the entire income.

When the mining boom ends, Ross Garnaut warns that Australia will have to shift from mining to a productivity driven economy. However, with all of that equity caught up in real estate, and unable to be freed to stimulate the productivity based sectors of the economy, the result can only be disaster for Australia.

At some point, the property asset bubble deflation simply has to occur to allow equity trapped in the dead-end of real estate to flow back into productive sectors of the economy. Housing will become affordable again, manufacturing costs will go down and national productivity will increase.

It is furthermore a delusion to think that property asset prices only ever rise. Nor is it plausible that real estate prices can reach a “permanently high plateau”. That phrase was used by economist Irving Fischer, who, when stock prices stopped climbing, predicted that the stock prices had reached a “permanently high plateau”. Almost the next day in 1929, the markets crashed plunging the world into the apocalypse of the Great Depression. It is almost as comical as Steinbrück’s sweeping assertion that “the financial crisis is above all an American problem” on the eve of a European banking collapse.

Far from the idea that there exists a global real estate cycle involving Australia being a “lazy analysis”, the breathtaking myopia belongs on the side of those who ignore complex systems wide macroeconomic analysis in favour of a “lazy analysis” based on simplistic local supply-demand issues.

Baron Rothschild would be turning in his grave.