RBA and interest rates, August 2017
Rate hikes to come say the pundits following the latest RBA minutes. The Aussie dollar hits $US 78.20. Yet for the past few years the mighty RBA has been cutting rates for two reasons: (1) to support a weak economy; and (2) to get the currency lower.
Please recall the following contribution, gentle readers. 'Monetary policy revamp'.
In the late 1980s, that article assets: ' The net effect was a single policy attempting to do two things – suppress the currency hikes and contain inflation. Like the policy of the US Fed in 1928 and 1929, this approach failed, and produced an overall monetary policy that was inflationary. The consequence was a later sharp hike of interest rates, the ‘recession we had to have’ and great, unnecessary misery for many Australians'.
I pointed out that no lesser authority than Milton Friedman said that 'monetary policy cannot serve two masters'. The bottom line was: 'The only sensible answer is for the Reserve Bank to introduce a higher cost for international investors seeking to buy Australian assets. This will be achieved with implementation of a tax on capital inflow'.
Those who do not learn from history are condemned to repeat it. Should the RBA fail to find a way to moderate the value of a floating dollar, the dollar will continue to rise, doing further real damage to our trade exposed industries.
Eventually a government will step in and remove the RBA's much valued 'independence'.
Australia's housing markets, 20 August 2017
The best account of the rise and fall of asset prices is by Hyman Minsky. His 'financial instability hypothesis' is the best way to understand why modern economies have self-contained booms and busts. In modern economies, an often long period of 'Tranquility' with sound finance is followed by a period of financial excess and severe asset inflation. The asset boom is followed by an asset bust that in a severe case leads to deep depression, certainly recession.
Australia's east coast housing markets have certainly seem a period of powerful house price inflation. One reason for this is cuts in interest rates designed to keep the economy moving and as part of this to help an overvalued exchange rate falls to levels that give traditional manufacturing industries a chance to survive. The fallacy in all this is that monetary policy, meaning manipulation of official cash rates, cannot serve two masters. Extreme house price inflation is the net result.
General considerations point to the high likelihood of a crash in East coast house prices. Naturally, the real estate boosters deny the possibility of a crash in the hope that markets can continue to defy the economic equivalent of gravity. The most optimistic comment I have seen recently says 'House price inflation will be half its recent level'. Other so called experts say there will be a period of 'tranquility' with prices stable at current levels.
Any sophisticated observer is holding off buying in expectation of a substantial fall. Unit markets have been oversupplied and are clearly falling, with downward momentum added to the many stories of shoddy construction method producing leaks or other clear defects, including use of fire-prone cladding - what were the building inspectors doing one naturally asks.
Evidence about house prices in mixed. In both Melbourne and Sydney recent data on house price levels show recent months of fall and rise - perhaps pointing to the 'flat price' hypothesis.
More anecdotal evidence suggests future falls are more likely. The first pointer is less auctions, although this is a regular winter experience. Many auctions report 'passed in on vendors bid'. But even successful auctions less often report prices well above the indicative level. One recent property in a desirable inner city suburb was advertised as 'price reduced'.
These clear indications of a change of attitude indicate the start of a new, downward, trend in house prices. So called 'prudential policy' such as instructions to banks to reduce 'interest only' loans support this trend. (The evolution of 'prudential policy' shows the monetary authorities have accepts the need for new instruments of policy, in this case a so far small return to direct controls over the banks.)
So far, the Reserve Bank of Australia has been sitting on interest rates that are too low for comfort, especially as official cash rates in other countries have began to rise - the USA and Canada most obviously. In Australia, banks have begun to raise lending rates despite the stability of RBA cash rates.
There has, however, been much discussion of the exploding ratio of household debt to household income, most recently to 189 %. Perhaps a third of households have no debt to speak of. That says on average the debt ratio of indebted households must be far larger, you do the math. Even now there are stories of how many households, some 'owning' houses (with large mortgages), are just clinging on.
What happens when official rates begin to rise, dear readers? I greatly doubt that the mighty RBA can cut rates further, or ignore the global tendency to raising rates of interest. The firestorm when cash rates are doubled is hard to imagine. But it will not be described as 'tranquility'. The good news for our children will be that house prices on Australia's East coast will be substantially lower than current prohibitive rates.
There will be a substantial reevaluation of Australia's monetary policy which may extend to removal of the RBA's much vaunted 'independence'.