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 "Again the question: "Is the property bubble going to pop...or will it just gradually let off some of the excess gas and gently deflate?" The US economists are watching the Australian market closely hoping that it will serve as an early warning signal for their markets." - Mark |
| US hears the pop of our housing bubble |
| by The Weekend Australian |
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July 16, 2005 WHEN you are at the nether end of the world - to put it more politely than Paul Keating's pungent anatomical description of Australia's whereabouts - it can take a while for the global metropolis to catch up with what's going on. But on Thursday we made it on to page one of The Wall Street Journal. The reason is that Wall Street is worrying about a US housing bubble and the consequences if it bursts. The heading explains the interest in Australia: "Safe Shelter Australia Suggests End of Home Boom Needn't Be Dire." The article says Australia's experience suggests the end of a housing boom doesn't necessarily lead to widespread economic distress. It isn't the first time Australia's housing boom has attracted international attention. A bit over a year ago Morgan Stanley's chief Asia economist Andy Xie suggested the bursting of our housing bubble could be the trigger for a global crash. Not yet, thankfully, not even a local one. However, the WSJ article is right to say it's too early to declare our experiment in bubble popping a success. The example it chooses to reinforce this caution is Japan: "Japan's central bank raised interest rates in 1989 and 1990 to pop a real estate and stock bubble. For a while the economy seemed destined for a soft landing. Then it plunged into a decade-long malaise, from which Japan is only now emerging." However, Japan is not a particularly good example. The grounds of the Lodge, unlike those of Japan's Imperial Palace, were never valuable enough to finance the purchase of California. And Australia doesn't have Japan's banking system. Even a much larger fall in housing prices than we have had to date wouldn't threaten bank balance sheets. Nevertheless, Australian households are highly indebted, and if falling, or even stagnant, house prices change households' spending and savings behaviour, it could have a more damaging effect. This week the Reserve Bank held a conference on business cycles, and there was some interesting discussion that touched on this question. Australia is one of a group of OECD economies that has enjoyed a remarkably long economic expansion, now entering its 15th year. According to analysis by the OECD, reported in a conference paper, behind this have been comprehensive and ambitious economic policy reforms. More recently their economic performance has been helped by rising housing prices, an associated rise in wealth and a willingness to borrow against this wealth to sustain consumer spending. In discussion, one of the central bankers present - there were several from around the world and locally - raised some highly relevant issues about business cycles and household spending and saving behaviour that are of central importance to monetary policymakers and investors. If, as seems to be the consensus of economists, the business cycle is now much less volatile than it used to be, both in terms of economic growth and inflation, then gearing up their balance sheet is a sensible response for many households. Less volatility suggests lower future inflation and hence lower interest rates, and more stable growth means less risk of a recession and loss of employment and future income. But what if this balance sheet behaviour, induced by the reduced volatility of the short period growth cycle, is actually setting up a much longer cycle of lower frequency but elevated risk? What if households have been over-optimistic about their future income, or an unexpected economic shock hits the system that means they can't cope with their higher leverage, and have to suddenly stop spending and start saving? What looks like a rational response to lower business cycle volatility then turns out on a longer time scale to be dangerously and painfully imprudent. In a speech last month, Reserve Bank governor Ian Macfarlane noted the slowdown in the growth in domestic demand in Australia - from around 6 per cent to 3.5 per cent - which he attributed directly and indirectly to developments in the housing sector and which he described as "orderly" and "a healthy correction". An important part of this correction he attributed to the fact that - after several years when borrowing was much higher than housing investment, meaning Australians were withdrawing equity to fund consumption - it appeared that housing equity withdrawal had ceased. So far this has meant that consumption has been cut back to match the rate of growth of income. There has been no major scaling back to build up savings, but it could be coming if housing prices remain flat or fall further. According to Macfarlane, "it is early times yet and the situation bears close watching". It certainly does, because how households manage their balance sheets from here on can make the difference between good growth, a prolonged slowdown or a recession. Reference: The Weekend Australian 
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