US inflation falls, Personal Consumption grows

A dip in the latest consumer price index (CPI) growth figures brings the inflation measure back in line with the Fed target of 2.0%. Inflationary pressures appear contained, easing Fed motivation to implement restrictive monetary policy.

Consumer Price Index

Personal consumption continues to grow at a modest pace. The down-turn in expenditure on services would be cause for concern — this normally precedes a recession — if not for a strong rise in expenditure on durables.

Personal Consumption

Manufacturers new orders for capital goods display a similar recovery.

Manufacturers New Orders: Capital Goods ex-Defense

The housing recovery continues at a modest pace.

Housing

Construction spending as a percentage of GDP remains soft, suggesting that the recovery still has plenty of room for improvement.

Construction/GDP

RBA stuck

Great slide from the NAB budget presentation:

RBA Interest Rates in a Cleft Stick

The RBA is in a cleft stick:

  • Raising interest rates would increase mortgage stress and threaten stability of the banking system.
  • Lowering interest rates would aggravate the housing bubble, creating a bigger threat in years to come.

The underlying problem is record high household debt to income levels. Housing affordability is merely a symptom.

There are only two possible solutions:

  1. Raise incomes; or
  2. Reduce debt levels.

Both have negative consequences.

Raising incomes would primarily take place through higher inflation. This would generate more demand for debt to buy inflation-hedge assets, so would have to be linked to strong macroprudential (e.g. lower maximum LVRs for housing) to prevent this. A positive offshoot would be a weaker Dollar, strengthening local industry. The big negative would be the restrictive monetary policy needed to slow inflation when the job is done, with a likely recession.

Shrinking debt levels without raising interest rates is difficult but macroprudential policies would help. Also policies that penalize banks for offshore borrowings. The big negative would be falling housing prices as investors try to liquidate some of their investments and the consequent threat to banking stability. The slow-down in new construction would also threaten an economy-wide down-turn.

Of the two, I would favor the former option as having less risk. But there is a third option: wait in the hope that something will turn up. That is the line of least resistance and therefore the most likely course government will take.

Australia: Financial Stability | RBA

Extract from the latest Financial Stability Review by the RBA:

….In Australia, vulnerabilities related to household debt and the housing market more generally have increased, though the nature of the risks differs across the country. Household indebtedness has continued to rise and some riskier types of borrowing, such as interest-only lending, remain prevalent. Investor activity and housing price growth have picked up strongly in Sydney and Melbourne. A large pipeline of new supply is weighing on apartment prices and rents in Brisbane, while housing market conditions remain weak in Perth. Nonetheless, indicators of household financial stress currently remain contained and low interest rates are supporting households’ ability to service their debt and build repayment buffers.

The Council of Financial Regulators (CFR) has been monitoring and evaluating the risks to household balance sheets, focusing in particular on interest-only and high loan-to-valuation lending, investor credit growth and lending standards. In an environment of heightened risks, the Australian Prudential Regulation Authority (APRA) has recently taken additional supervisory measures to reinforce sound residential mortgage lending practices. The Australian Securities and Investments Commission has also announced further steps to ensure that interest-only loans are appropriate for borrowers’ circumstances and that remediation can be provided to borrowers who suffer financial distress as a consequence of past poor lending practices. The CFR will continue to monitor developments carefully and consider further measures if necessary.

Conditions in non-residential commercial property markets have continued to strengthen in Melbourne and Sydney, while in Brisbane and Perth high vacancy rates and declining rents remain a challenge. Vulnerabilities in other non-financial businesses generally appear low. Listed corporations’ profits are in line with their average of recent years and indicators of stress among businesses are well contained, with the exception of regions with large exposures to the mining sector. For many mining businesses conditions have improved as higher commodity prices have contributed to increased earnings, though the outlook for commodity prices remains uncertain.

Australian banks remain well placed to manage these various challenges. Profitability has moderated in recent years but remains high by international standards and asset performance is strong. Australian banks have continued to reduce exposures to low-return assets and are building more resilient liquidity structures, partly in response to regulatory requirements. Capital
ratios have risen substantially in recent years and are expected to increase further once APRA finalises its framework to ensure that banks are ‘unquestionably strong.’

Risks within the non-bank financial sector are manageable. At this stage, the shadow banking sector poses only limited risk to financial stability due to its small share of the financial system and minimal linkages with the regulated sector, though the regulators are monitoring this sector carefully. Similarly, financial stability risks stemming from the superannuation sector remain low.

While the insurance sector continues to face a range of challenges, profitability has increased of late and the sector remains well capitalised.

International regulatory efforts have continued to focus on core post-crisis reforms, such as addressing ‘too big to fail’, as well as new areas, such as the asset management industry and financial technology. While the goal of completing the Basel III reforms by end 2016 was not met, discussions are ongoing to try to finalise an agreement soon. Domestically, APRA is continuing its focus on the risk culture in prudentially regulated institutions and will review compensation policies and practices to ensure these are prudent.

Reading between the lines:

  • household debt is too high
  • apartments are in over-supply and prices are falling
  • we have to maintain record-low interest rates to support the housing bubble
  • APRA is “taking steps” to slow debt growth but also has to be careful not to upset the housing bubble
  • the Basel committee has been dragging its feet on new regulatory guidelines and we cannot afford to wait any longer

Source: RBA Financial Stability Review PDF (2.4Mb)

Why we need to worry about the level of Australian household debt

From Elizabeth Knight:

The balance sheets of Australian households with a mortgage are dangerously exposed to any fall in house prices.

It isn’t just that household debt relative to disposable incomes has reached a record high of 189 per cent, it’s that households’ ability to service that debt is potentially a ticking time bomb…..

A recent Digital Finance Analytics survey found that of the 3.1 million mortgaged households, an estimated 669,000 are now experiencing mortgage stress.

“This is a 1.5 per cent rise from the previous month and maintains the trends we have observed in the past 12 months,” it found. “The rise can be traced to continued static incomes, rising costs of living, and more underemployment; whilst mortgage interest rates have risen thanks to out-of-cycle adjustments by the banks and bigger mortgages thanks to rising home prices.”

Source: Why we need to worry about the level of Australian household debt

ASX 200 faces bank headwinds

The ASX 300 Banks Index continues to test support at 9000. Declining Twiggs Money Flow warns of selling pressure and reversal below 8900 would warn of a correction.

ASX 300 Banks

The ASX 200 continues its advance towards 6000, with rising Twiggs Money Flow signaling buying pressure. But it is vulnerable to a correction in the Banks Index, the largest sector in the broad index.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

The economy is still exposed to a property bubble and APRA is likely to keep the pressure on banks to increase their capital reserves, which would lower their return on equity.

Sorry folks, this ain’t no property bubble

I have been predicting the collapse of the Australian property bubble, so feel obliged to also present the opposite view. Nothing like confirmation bias to screw up a good investment strategy.

Here Jessica Irvine argues that the property bubble will not burst:

Believe me, no one is keener than me to see a property bubble burst.

But sadly – for would-be buyers, at least – I just don’t see it happening.

Sure, there are risks.

If it turns out that banks have been lending to people who really can’t afford it, then we have a problem when interest rates start to rise.

Experts have been calling the end of the property market for years. But banks insist they stress test customers for a 2-percentage-point rise in interest rates and require “interest-only” borrowers to prove they could afford to repay principal too, if required.

More worrying is the mortgage broking channel, where a recent ASIC investigation found most of the high loan-to-value loans are written. If there is a weakness in the housing market, it’ll be in this area of lending standards and so called “macroprudential” policies when interest rates start to rise. The recent clamping down on investor loans is welcome.

But ultimately, the defining thing about bubbles is that they inevitably must pop.

But where is the trigger for a widespread home price collapse?

In a world of low inflation and growth, the Reserve Bank is likely to raise interest rates very gently, cushioning households.

Widespread job losses would be a trigger, but there is no talk of that. With record low wages growth, labour is hardly expensive at the moment.

Bubble proponents point to very high household debt levels relative to incomes. But the structural lowering of interest rates in the late 1990s and again after the global financial crisis has increased the amount of debt households can afford to service from a given income.

Lower rates have also helped many households build significant “buffers” against future rate increases, in offset accounts and other forms of saving.

Bubbles form when asset prices disconnect completely with market fundamentals.

But there are very good reasons to expect housing to be so expensive.

Forget the Cayman Islands, housing – owner occupied and investment housing – offers the best tax shelter around, from negative gearing and the capital gains tax discount on investment housing to the complete exemption of the family home from capital gains tax AND from the pension asset test.

Meanwhile, rapid population growth has been met by sluggish increases in housing supply. Incompetent state governments have created a premium for inner-city housing, where buyers can avoid paying the indirect costs of long commutes.

In the aftermath of World War II, home ownership rates skyrocketed as governments focused on supply.

But since then, governments have instead implemented policies that boost only the demand side of the equation, with tax concessions and cash bonuses for buyers that only increase prices.

Absent any trigger for widespread forced property sales, home owners will always respond to sluggish market conditions by sitting on their properties for longer. Lower volumes provide a cushion against falling prices.

In such a market, the best a first-time buyer can hope for is that future price gains might come back into line with income growth.

Indeed, that’s exactly what happened after the early 2000s property boom when Sydney prices stagnated for almost a decade.

It’s less exciting, but more likely.

Jessica makes a good point about offset accounts which may cause real household debt to be overstated. This warrants further investigation.

But she seems too complacent about market fundamentals:

  • an oversupply of apartments;
  • negative gearing and capital gains tax advantages that could be removed by the stroke of a pen (or a tick on a ballot paper); and
  • prospective sharp cuts to immigration (again dictated by the ballot box)

Interest rate rises seem unlikely in the near future as inflationary pressures are fading. But I doubt that new homebuyers could afford a 2 percent rise in interest rates, that would amount to an almost 40% increase in monthly repayments for some. Even if they survive, repayments will take a big bite taken out of other household consumption and hurt the entire economy.

Also, the RBA may plan to increase rates gradually, to cushion the effect on homeowners, but Mr Market could have other ideas. And if you think central banks act autonomously from markets, think again.

Source: Sorry folks, this ain’t no property bubble

3 Headwinds facing the ASX 200

The ASX 200 broke through stubborn resistance at 5800 but is struggling to reach 6000.

ASX 200

There are three headwinds that make me believe that the index will struggle to break 6000:

Shuttering of the motor industry

The last vehicles will roll off production lines in October this year. A 2016 study by Valadkhani & Smyth estimates the number of direct and indirect job losses at more than 20,000.

Full time job losses from collapse of motor vehicle industry in Australia

But this does not take into account the vacuum left by the loss of scientific, technology and engineering skills and the impact this will have on other industries.

…R&D-intensive manufacturing industries, such as the motor vehicle industry, play an important role in the process of technology diffusion. These findings are consistent with the argument in the Bracks report that R&D is a linchpin of the Australian automotive sector and that there are important knowledge spillovers to other industries.

Collapse of the housing bubble

An oversupply of apartments will lead to falling prices, with heavy discounting already evident in Melbourne as developers attempt to clear units. Bank lending will slow as prices fall and spillover into the broader housing market seems inevitable. Especially when:

  • Current prices are supported by strong immigration flows which are bound to lead to a political backlash if not curtailed;
  • The RBA is low on ammunition; and
  • Australian households are leveraged to the eyeballs — the highest level of Debt to Disposable Income of any OECD nation.

Debt to Disposable Income

Falling demand for iron ore & coal

China is headed for a contraction, with a sharp down-turn in growth of M1 money supply warning of tighter liquidity. Falling housing prices and record iron ore inventory levels are both likely to drive iron ore and coal prices lower.

China M1 Money Supply Growth

Australia has survived the last decade on Mr Micawber style economic management, with something always turning up at just the right moment — like the massive 2009-2010 stimulus on the chart above — to rescue the economy from disaster. But sooner or later our luck will run out. As any trader will tell you: Hope isn’t a strategy.

“I have no doubt I shall, please Heaven, begin to be more beforehand with the world, and to live in a perfectly new manner, if — if, in short, anything turns up.”

~ Wilkins Micawber from David Copperfield by Charles Dickens

APRA fiddles while housing risks grow

From Westpac today (emphasis added):

….With the Reserve Bank sharing our caution around 2018, along with ample capacity in the labour market (unemployment rate is 5.9% compared to full employment rate of 5.0%) and stubbornly low wages growth, there is only scope to cut rates. But as we have argued consistently, a resurgent housing market disallows such a policy option. Indeed, the minutes refer to “a build- up of risks associated with the housing market”. A tighter macro prudential stance seems appropriate.

Indeed, as we go to press, APRA has announced new controls, restricting the “flow of new interest-only lending to 30 per cent of total new residential mortgage lending” with a particular focus on limiting interest only loans with a loan-to-value ratio [LVR] above 80%. Currently, “interest-only terms represent nearly 40 per cent of the stock of residential mortgage lending by ADIs”, so this policy will restrict the terms at which a marginal borrower can access credit (investors and owner-occupiers). APRA also noted that they want banks to manage growth in investor credit to “comfortably remain below the previously advised benchmark of 10 per cent growth”. This is not a hard change to the target as had been mooted recently in the press (some suggesting the 10% limit could be as much as halved), but it does suggest lending to investors will continue to grow at a pace meaningfully below 10%. Looking ahead, the next RBA Stability Review (April 13) may provide more clarity on the macro prudential policy outlook and potential triggers for further action. For the time being though, the 2015 experience offers an understanding of the potential impact of this further tightening.

To head off a potential bubble burst, the RBA and APRA need to drastically slow house price growth. I am sure the big four banks are urging caution but they would be the worst hit by a meltdown. What APRA is doing is fiddling around the margins. To make housing investors think twice about further borrowing, APRA needs to cut the maximum LVR to 70%. And half that for foreign borrowers.

Confidence in housing falls to lowest level in 40 years

From Eryk Bagshaw & Peter Martin at SMH:

Confidence in the housing market has collapsed, with the number of Australians describing property as the wisest place to put their savings falling to its lowest level in more than 40 years.

The Melbourne Institute of Applied Economic and Social Research has been asking about the wisest place to store savings since it began its consumer confidence survey in 1974. Real estate has been one of the most popular answers, often eclipsing bank deposits and paying down debt as the wisest place for savings.

Australian Housing Confidence

Westpac’s Bill Evans: “There is no doubt nervousness about the sustainability of prices.”

Lack of confidence is a vulnerability rather than sign of an imminent collapse. It may also reflect consumer nervousness about record low interest rates (lowest in more than 40 years) and the impact on affordability, and house prices, when rates eventually rise.

Source: Confidence in housing collapses to lowest level in 40 years: survey

Chinese real estate bubble “slows”

Elliot Clarke at Westpac reports that home price growth in tier-1 cities “slowed materially” in January 2017:

From 29%yr in September 2016, tier-1 new home price growth has slowed to 23%yr. Similarly for the tier-1 secondary market, price momentum has slowed from 33%yr to 26%yr since September.

Tier-2 and tier-3 cities have far lower annual growth rates: 12% and 9% respectively for new homes and 9% and 6% for existing dwellings.

When we compare tier-1 price growth to Sydney and Melbourne, the Chinese bubble is in a different league. From CoreLogic: “Sydney home prices surged 15.5 per cent and Melbourne’s 13.7 per cent over the year [2016]”.

It is hard to imagine a soft landing when property prices have been growing at 30% a year.

Even 15%….

Australia & Canada in 4 charts

RBA governor Phil Lowe recently made a speech comparing the experiences of Australia and Canada over the last decade. Both have undergone a resources and housing boom. Four charts highlight the differences and similarities between the two countries.

Australia’s spike in mining investment during the resources boom did serious damage to non-mining investment while Canada’s smaller boom had no impact.

Australia & Canada: Mining v. Non-Mining Investment

Immigration fueled a spike in population growth in Australia, adding pressure on infrastructure and housing.

Australia & Canada: Population Growth

Both countries are experiencing a housing bubble, fueled by low interest rates and lately by export of China’s property bubble, with capital fleeing China and driving up house prices in the two countries.

Australia & Canada: Housing

Record levels of household debt make the situation more precarious and vulnerable to a correction.

Australia & Canada: Household Debt

Hat tip to David Llewellyn-Smith at Macrobusiness

Seven Signs Australians Are Facing Economic Armageddon

Economics advisor John Adams warns that Australia faces “economic Armageddon” because of “significant structural imbalances” not seen since the lead up to the Great Depression in the 1920s.

Here are his seven signs:

Seven Signs Australians Are Facing Economic Armageddon

Sign 1: Record Australian Household Debt

According to the Reserve Bank of Australia, Australia’s household debt as a proportion of disposable income now stands at a record high of 187%.

The two closest episodes were the 1880s and the 1920s, which both preceded the only two economic depressions ever experienced in Australian history in 1890 and 1929.

Sign 2: Record Australian Net Foreign Debt

Australia’s net foreign debt now stands at more than $1 trillion and as a proportion of Gross Domestic Product was at a record high of 63.3% in June 2016.

This makes Australians much more vulnerable to international economic developments such as higher global interest rates, international financial crises or major government or corporate bankruptcies.

Sign 3: Record Low Interest rates

Australia has its lowest official interest rates on record with the Reserve Bank of Australia’s cash rate sitting at 1.5%. The current low rate of interest is not sustainable over the medium term and will inevitably rise.

Australians, particularly in Sydney and Melbourne, who have borrowed record amounts of money are very susceptible to higher interest rates.

4: Australian Housing Bubble

The expansion of credit by the Reserve Bank of Australia has been pumped into the Australian housing market over the past 25 years. Credit, which has been directed to Housing as a proportion of Australia’s GDP, has exploded from 21.07% in June 1991 to 95.06% in June 2016.

Over the same period, credit which has been directed at the business sector or to other personal expenses has remained relatively steady as a proportion of GDP.

5: Significant Increases in Global Debt

The General Manager of the Bank for International Settlements stated on 6 February 2017:

“Total debt in the global economy, including public debt, has increased significantly since the end of 2007 … Over the past 16 years, debt of governments, households and non-financial firms has risen by 63% in the United States, the euro area, Japan, the United Kingdom, Canada and Australia, 52% in the G20 and 85% in emerging economies. Heavy debt can only leave less room for manoeuvre in responding to future challenges.”

Sign 6: Major International Asset Bubbles

There are significant asset bubbles in bonds, stocks and real estate in major economies such as the United States and China, which has been fueled by the significant increases in global debt.For example, the Shiller PE Index in the United States which measures the price of a company’s stock relative to average earnings over the past 10 years is now at 28.85. This is the third highest recorded behind the Tech Bubble in 1999 and “Black Tuesday” in 1929.

Sign 7: Global Derivatives Bubble

According to the Bank for International Settlements, the value of the over the counter derivatives market (notional amounts outstanding) stood at US$544 trillion.

Much of these derivatives contracts are concentrated on the balance sheets of leading global financial and banking institutions such as Deutsche Bank. The concentration of complex derivative contracts on bank balance sheets poses significant risks to both individual institutions and the global financial system.

Veteran Investor Warren Buffet has repeatedly warned that derivatives are “financial weapons of mass destruction” and could pose as a “potential time bomb”.

Household debt is too high. Rising foreign debt and record low interest rates are fueling a housing bubble. Global debt is too high and rising, while stocks are over-priced. Throw in the global derivatives “bubble” with some truly terrifying numbers just to scare the punters out of their wits.

Nothing new here. Nothing to see. Move along now. The global economy is in good hands…..

Or is it? Aren’t these the same hands that created the current mess we are in?

John Adams is right to warn of the dangers which could have a truly apocalyptic effect, that makes the global financial crisis seem like a mild tremor in comparison.

Some of the risks may be overstated:

The derivatives “bubble” is probably the least of our worries as most of these positions offset each other, giving a net position a lot closer to zero.

Defensive stocks like Consumer Staples and Utilities are over-priced but there still appears to be value in growth stocks. And earnings are growing. So the stock “bubble” is not too alarming.

Global debt is too high but poses no immediate threat except to countries with USD-denominated debt — or Euro-denominated debt in the case of Greece, Italy, etc. — that cannot issue new currency to repay public debt (and inflate their way out of the problem).

But that still leaves four major risks that need to be addressed: Household debt, $1 Trillion foreign debt, record low interest rates and a housing bubble.

From Joe Hildebrand at News.com.au:

Mr Adams called on the RBA to take pre-emptive action by raising interest rates and said the government needed to rein in tax breaks like negative gearing as well as welfare payments.

This, he admitted, would result in “a mild controlled economic recession” but would stave off “uncontrolled devastating depression”.

The problem is that the Australian government appears to be dithering, with one eye on the next election. These are not issues you can “muddle through”.

If not addressed they could turn into the four horsemen of the apocalypse.

Source: Apocalyptic warning for Australian families

Why the establishment were clean-bowled by Trump

Forget private email servers and sex tapes. Forget men versus women. This election was decided on the following three issues:

1. Globalization.

Currency manipulation by emerging economies like China and consequent offshoring of blue-collar jobs has gutted the US manufacturing sector. Accumulation of $4 trillion of foreign reserves enabled China to suppress appreciation of the Yuan and maintain a competitive advantage against US manufacturers.

China Foreign Reserves ex-Gold

Container imports and exports at the Port of Los Angeles (FY 2016) highlight the problem. More than 57% of outbound containers are empty. Container shipping represents mainly manufactured goods, rather than bulk imports or exports, and the dearth of manufactured exports reflects the trade imbalance with Asia. Even the container statistic understates the problem as many outbound containers contained scrap metal and paper rather than manufactured goods, for processing in Asia.

Port of Los Angeles (FY 2016) Container Traffic

Manufacturing job losses were tolerated by the political establishment, I suspect, largely because corporate profits were boosted greatly by offshoring jobs and low-cost imports. And corporations are the biggest political donors. Corporate profits as a percentage of GDP almost doubled over the last two decades.

Corporate profits as a percentage of GDP

2. Immigration

This is a similar issue to that highlighted by the UK/Brexit vote. Blue collar workers, losing jobs to globalization, felt threatened by high levels of immigration which, among other problems, stepped up competition for increasingly-scarce jobs.

3. Wall Street

Wall Street bankers with their million-dollar bonuses were blamed for the global financial crisis and collapse of the housing market, the primary store of wealth for middle-class families. While there is no doubt Wall Street had their snouts in the trough, the seeds of the GFC were laid years earlier when Bill Clinton repealed the Glass-Steagall Act with backing from a Republican congress. Failure to prosecute or otherwise punish even the worst offenders of the sub-prime mortgage debacle was seen by the public as collusion.

The Democrats in 2015 recognized that Hillary had been damaged by the private email server controversy and did their best to maneuver the election into a Trump-Clinton stand-off. Their view was that Hillary would be beaten by either Rubio or Kasich. Even the reviled Ted Cruz was seen as a threat. Hillary was seen as having the best chance against a flawed Trump who would struggle to unite the Republican party behind him.

Hillary Clinton and Donald Trump

Hillary Clinton was presented as the ‘safe’ candidate in the election, representing the status quo and stability. But that set her up for a fall as their strategy underestimated the anger of American voters and the risks they were prepared to take to bring about change.

While I am relieved that we can “close the history book on the Clintons”, to use Trump’s words, I viewed him as a lame-duck candidate, too flawed to hold the office of President. Fortunately there are many checks and balances in the US political system. It survived Nixon and should be able to survive this too. Especially if Trump takes a hands-off approach, along the lines of Reagan who was reputed to doze off in cabinet meetings. A lot will depend on his appointees and the next few months will be critical in setting the direction for his presidency. Expect financial markets to remain volatile until they have grown accustomed to the change. It could take a year or even longer.

Australia weeks from a housing collapse, US report warns

Washington-based International Strategic Studies Association warns that Australian banks’ crackdown on foreign investor lending may precipitate a collapse in the apartment housing market:

“The banks clearly believe Australian real estate values will decline, so they are attempting to avoid that risk. They’ve learned from the US collapse that seizing real estate collateral is a no-win scenario when the volume is great and the market slow.”

“In so doing, they precipitate the market collapse but are less exposed to it.”

It comes after Australia’s richest man, billionaire property developer Harry Triguboff, warned that a “very significant” number of Chinese buyers were now failing to settle their off-the-plan units and urgent action was needed.

But Mr Triguboff, founder of Australia’s biggest apartment builder Meriton, warned the real risk was looming in the new wave of developments. As apartment price growth stalls or goes backwards, the risk of buyers walking away from their deposits grows.

Source: Real estate: Property price crash ‘six weeks’ away, US report warns

Hat tip to Macrobusiness.

The high-rise boom is over

From The AFR:

Macquarie Bank is planning to hit the brakes on lending to high rise and high density apartment dwellings in up to 120 postcodes around the nation amid growing fears about falling demand and oversupply. A confidential memo from the bank to brokers announces that from May 23 it will require a maximum loan to value ratio of 70 per cent, which means buyers will have to stump-up another 10 per cent deposit…

Leith van Onselen:

Macquarie’s latest actions, of course, also follows curbs by other major lenders aimed at mitigating exposure to high-rise developments, including:

  • tightening of lending criteria….
  • increased mortgage rates for investors; and
  • refusing to lend to overseas buyers…..

Every tightening of criteria by Australia’s mortgage lenders represents another nail in the high-rise apartment boom’s coffin.

Source: Macquarie joins high-rise lending crack-down – MacroBusiness

APRA gives the RBA some wiggle room | Business Spectator

Robert Gottliebsen predicts further rate cuts from the RBA:

Given that Australian interest rates are higher than other countries of similar standing, money is now flowing Down Under which works to boost the currency and some are forecasting that the exchange rate could rise as high as US80c.

Thanks to APRA, the Reserve Bank can now attack the currency with lower rates without the risk of putting a rocket under house prices.

Source: APRA gives the RBA some wiggle room | Business Spectator

Hat tip to David Llewellyn-Smith at Macrobusiness

Axe negative gearing for a healthier property market | Saul Eslake

Thanks to Ody for posting this on IC forum. I feel it is worth repeating here because of the current debate around negative gearing.

Axe negative gearing for a healthier property market
Apr 25, 2011: Saul Eslake

The property market would look a lot healthier without it, writes Saul Eslake.

For almost a quarter of a century, successive Australian governments have, with varying degrees of enthusiasm, sought to promote higher levels of participation in employment, and higher levels of personal saving.

These are both worthy objectives, ones which public policy should seek to promote. It’s therefore surprising that successive governments have not merely been content to maintain a tax system that taxes income from working and saving at higher rates than those at which it taxes income from borrowing and speculating, but have either increased the extent to which income from borrowing and speculating is treated more favourably by the tax system, or explicitly rejected sensible proposals to balance incentives between the two as Wayne Swan did in May last year when ruling out recommendations made by the Henry Review.

Under the taxation system, income from working – that is, wages and salaries – is taxed at higher marginal rates than any other kind of income: 31.5 per cent for most Australians with full-time jobs (earning between $37,000 and $80,000 a year), 38.5 per cent for those earning over $80,000 a year and 46.5 per cent for those earning over $180,000 a year.

Income from deposits in banks, building societies and credit unions is taxed at the same marginal rates.

For those contemplating entering, or re-entering, paid employment (say, after a period of caring for children or aged parents) the impact of tax on income from work can result in effective marginal tax rates of close to, or even over, 60 per cent, on what are quite modest levels of income. The Henry Review concluded that ”some people [are] likely to reduce their level of work as a result” of these very high effective marginal tax rates. This may be one reason why the workforce participation rates of women with children, and older people, are lower here than in other OECD countries.

By contrast, income from most forms of investment, other than interest-bearing deposits, is typically taxed at lower rates than similar amounts of income derived from working. Income from saving through superannuation funds, and from ”geared” investments (that is, the purchase of assets funded by borrowing) is especially lightly taxed.

The review calculated that, for a top-rate taxpayer, the real effective marginal tax rates (after taking account of inflation assumed to average 2.5 per cent per annum, and the time at which tax is payable) on income earned from superannuation savings or highly-geared property investments are actually negative, while the real effective marginal tax rate on interest income from deposits can be as high as 80 per cent.

Very few other ”advanced” economies are as generous in their tax treatment of geared investments as Australia is. In the United States, investors can only deduct interest incurred on borrowings undertaken to purchase property or shares up to the amount of income (dividends or rent) earned in any given financial year; any excess of interest expense over income (as in a ”negatively geared” investment) must be ”carried forward” as a deduction against the capital gains tax payable when the asset is eventually sold.

In Australia, by contrast, that excess can be deducted against a taxpayer’s other income (such as wages and salaries) thereby reducing the amount of tax otherwise payable on that other income.

The Howard government’s decision in 1999 to tax capital gains at half the rate applicable to wage and salary income, converted negative gearing from a vehicle allowing taxpayers to defer tax on their wage and salary income (until they sold the property or shares which they had purchased with borrowed money), into one allowing taxpayers to reduce their tax obligations (by, in effect, converting wage and salary income into capital gains taxed at half the normal rate) as well as deferring them.

As a result, ”negative gearing” has become much more widespread over the past decade, and much more costly in terms of the revenue thereby foregone. In 1998-99, when capital gains were last taxed at the same rate as other types of income (less an allowance for inflation), Australia had 1.3 million tax-paying landlords who in total made a taxable profit of almost $700 million.

By 2008-09, the latest year for which statistics are available, the number of landlords had risen to just under 1.7 million: but they collectively lost $6.5 billion, largely because the amount they paid out in interest rose almost fourfold (from just over $5 billion to almost $20 billion over this period), while the amount they collected in rent only slightly more than doubled (from $11 billion to $26 billion), as did other (non-interest) expenses. If all of the 1.1 million landlords who in total reported net losses in 2008-09 were in the 38 per cent income tax bracket, their ability to offset those losses against their other taxable income would have cost over $4.3 billion in revenue foregone; if, say, one fifth of them had been in the top tax bracket then the cost to revenue would have been over $4.6 billion.

This is a pretty large subsidy from people who are working and saving to people who are borrowing and speculating. And it’s hard to think of any worthwhile public policy purpose which is served by it. It certainly does nothing to increase the supply of housing, since the vast majority of landlords buy established properties: 92 per cent of all borrowing by residential property investors over the past decade has been for the purchase of established dwellings, as against 82 per cent of all borrowing by owner-occupiers.

For that reason, the availability of negative gearing contributes to upward pressure on the prices of established dwellings, and thus diminishes housing affordability for would-be home buyers.

Supporters of negative gearing argue that its abolition would lead to a ”landlords’ strike”, driving up rents and exacerbating the existing shortage of affordable rental housing. They point to ”what happened” when the Hawke government abolished negative gearing (only for property investment) in 1986, claiming that it led to a surge in rents, which prompted the reintroduction of negative gearing in 1988.

This assertion has attained the status of an urban myth. However it’s actually not true. If the abolition of ”negative gearing” had led to a ”landlords’ strike”, then rents should have risen everywhere (since ”negative gearing” had been available everywhere). In fact, rents (as measured in the consumer price index) actually only rose rapidly (at double-digit rates) in Sydney and Perth. And that was because rental vacancy rates were unusually low (in Sydney’s case, barely above 1 per cent) before negative gearing was abolished. In other state capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed.

Notwithstanding this history, suppose that a large number of landlords were to respond to the abolition of negative gearing by selling their properties. That would push down the prices of investment properties, making them more affordable to would-be home buyers, allowing more of them to become home owners, and thereby reducing the demand for rental properties in almost exactly the same proportion as the reduction in the supply of them. It’s actually quite difficult to think of anything that would do more to improve affordability conditions for would-be home buyers than the abolition of ”negative gearing”.

There’s absolutely no evidence to support the assertion made by proponents of the continued existence of ”negative gearing” that it results in more rental housing being available than would be the case were it to be abolished (even though the Henry Review appears to have swallowed this assertion). Most other ”advanced” economies don’t have ”negative gearing”: yet most other countries have higher rental vacancy rates than Australia does.

I’m not advocating that ”negative gearing” be abolished for property investments only, as happened between 1986 and 1988. That would be unfair to property investors. Personally, I think negative gearing should be abolished for all investors, so that interest expenses would only be deductible in any given year up to the amount of investment income earned in that year, with any excess ”carried forward” against the ultimate capital gains tax liability. But I’d settle for the review’s recommendation, which was that only 40 per cent of interest (and other expenses) associated with investments be allowed as a deduction, and that capital gains (and other forms of investment income, including interest on deposits) be taxed at 60 per cent (rather than 50 per cent as at present) of the rates applicable to the same amounts of wage and salary income.

This recommendation would not amount to the abolition of ”negative gearing”; it would just make it less generous. It would be likely, as the review suggested, ”to change investor demand towards housing with higher rental yields and longer investment horizons [and] may result in a more stable housing market, as the current incentive for investors to chase large capital gains in housing would be reduced”.

Sadly, these recommendations were among the 19 that the Treasurer explicitly ruled out when releasing the review last year. That makes it hard to believe that this government (or indeed any alternative government) is serious about increasing the incentives to work and save – or at least, about doing so without risking the votes of those who borrow and speculate, in effect subsidised by those who don’t, or can’t.


Saul Eslake is a Program Director with the Grattan Institute. The views expressed here are his own.

Saul’s suggestion of carrying forward losses rather than writing them off against other income is a good one. But I would go a lot further with tax reform:

  • a 10% flat rate of tax on all income;
  • 10% corporate tax rate;
  • 10% tax rate for super funds;
  • no capital gains discount and no inflation adjustment;

While a comprehensive 10% tax on all income and capital gains would raise a substantial sum, there is bound to be a shortfall compared to the current system. My solution would be a land tax (similar to local council rates), excise taxes (alcohol, petrol and tobacco), and a flat rate of GST on all goods (including basic foods and medicine) to balance the budget.

Some would argue that this would increase the tax burden for the poorest families, but that could easily be addressed through food stamps or “rent stamps” for families on welfare. Land tax is a highly progressive (the opposite of “regressive”) tax that is closely correlated to wealth rather than income. The overall aim would be to encourage GDP growth by removing the burden of a complex income tax system with high marginal rates that serve as a disincentive to create additional income. Simplicity would improve fairness, minimize avoidance and reduce the cost of reporting and administration.

….Don’t hold your breath.

Can ‘New’ Keynesianism Save the Chinese Economy? | The Diplomat

Excellent summary of China’s growth dilemna by Dr Yanfei Li, Energy Economist at the Economic Research Institute for ASEAN and East Asia (ERIA) [emphasis added]:

To conclude, national capitalism, which aims to help the Chinese economy move up the global value chain through technological catching up, can be considered part of the essence of the “new” Keynesianism – in other words, the Chinese approach to intervention in the current economic downturn. It will certainly continue to make significant progress in certain well-targeted areas, given enough time. However, there are two key dimensions to measuring how successful the strategy will be. One is the timeline: how long it takes for such efforts to be translated into significant productivity gains for the whole economy. Second, whether or not these selected areas, especially AI and robotics, can bring about a major productivity boost as seen with the IT boom in the 1990s and early 2000s.

In addition, national capitalism, a centralized strategy, is an intrinsically high-risk approach to technological development. Even with well-informed decisions, such as the case of Japan in developing HDTV, there are always surprises. The Chinese government can only hope that it has chosen the right technologies to pursue.

Finally, it is worth mentioning that the other part of China’s “New” Keynsianism, namely the One Belt One Road initiative, which is about exporting the products and services of over-capacity, infrastructure-related industries overseas, also seems riskier than usual. Put another way, if these proposed infrastructure projects in targeted developing countries were attractive and low risk, they would have been financed and done. The fact that they are not itself implies higher risks are involved.

At this point, policymakers must look inward: They must identify and implement all necessary reforms to improve the micro-level efficiency of the Chinese economy. And this always implies the importance of truly open, competitive, transparent and fair markets for all industries. That is a vastly superior approach to the Ponzi game of emphasizing ways to manipulate the property market to keep prices climbing ever higher.

Source: Can ‘New’ Keynesianism Save the Chinese Economy? | The Diplomat