A New Sustainable Housing Boom?

Bank lending is on the increase again and the housing market is back in boom territory. My prediction  last year was that the housing market would boom and then crash. The question is how long this play will take to work itself out. Too long a delay means the prediction is almost worthless. My guess is that the boom will continue over most of 2014 before crashing in 2015 as the economy tanks due to declining demand from China and the difficulty of increasing credit as a percentage of disposable income.

From the RBA:

The renewed boom has been associated with increasing concerns about housing affordability for younger buyers. According to a report in The Australian, the wealthy account for a growing percentage of housing stock, with "the top 20 per cent of income earners owning 36 per cent of Australian homes".

Another question is whether increased home lending is 'crowding out' business lending. To answer this we would need to understand whether the problem is one of supply (the banks) or demand (small business). I'm guessing that if banks can make easy money lending for houses it decreases their willingness to lend to risky small business.

One simple solution that would help affordability and possible crowding out: get rid of negative gearing.

From Leith van Onselen at Macro Business:

While it is clear that the mining boom has ended, my conjecture is that a new housing boom is unlikely to have long legs. This view is reinforced by the high levels of household debt as a percentage of disposable income.  One possible mitigating factor could be foreign purchases of Australian houses. Although there are restrictions on foreigners buying houses in Australia, these seem to be regularly bypassed by foreign investors through a variety of means. According to Martin North:

One factor which is driving the residential property market, especially in the major centres of Sydney, Melbourne and Perth is a rise in overseas purchasers. They may be Australian residents, overseas purchasers buying property for investment through an approved development, or locals acting for overseas purchasers, who are attracted by the sustained house price growth and relative economic stability. China is often identified as a major source for potential purchasers.

The ratio of debt to income increased enormously over the 1990s and 2000s and it is hard to imagine it repeating these increases over the next 10 years. A similar level of growth would see household debt to income increase to well over 200 per cent. (Such a ratio is possible, however, as The Netherlands shows, but it does set a country up for an inevitable rebalance as debt becomes unsustainable.)

Australia has benefited from a virtuous circle as the credit boom interacted with the mining boom. This is likely to turn into a vicious circle over coming years as commodity prices, particularly iron ore prices, decline over coming years.

Australia has been lucky in the timing of various booms - credit, consumption, housing and mining - over the past 10-15 years and who knows what new factor could intervene to damn all predictions and continue the luck.

The major factor affecting Australia given our growing export dependence will be the trajectory and form of Chinese growth. A less investment intensive Chinese growth model will lead to lower demand for resources and have negative effects on Australia.

The left field factor that I think will be very important over coming years is the fossil fuel revolution that has already had significant impact in the United States, putting it on the path to energy independence.

Rising prices and new technologies have made previously economically nonviable sources of supply viable. These technologies will eventually have an impact throughout the world, lessening the prices Australia receives for gas. Increased demand increases prices, which in turn increases supply, which eventually leads to lower prices. We are approaching this stage for many of our key resources. What Australia needs is continuing and sustained demand to balance lower prices with increased export volumes.  Over the longer term, lower prices mean that further supply is less viable and the cycle begins again. However, given the sustained nature of this commodity super cycle and the massive increase in supply it has encouraged, it is likely that it will be a while before there is a new investment boom, especially given Australia's status a high cost country.

While it might seem a long shot to connect these factors to the housing market, lower prices for Australian resources, particularly gas, could lower Australian incomes and expose high levels of indebtedness.

The saving grace for households (as the chart above shows) has been low interest rates leading to a lower ratio of interest paid to disposable income. Given the low level of inflation and the uncertain prospects for the world and Australian economies, low interest rates are likely to continue for a while.

The major reason for the absence of a crash in the Australian property market has been the simple fact that we've avoided a recession and thus avoided the development of a negative spiral where increasing unemployment leads to declining demand and increased difficulty in households meeting debt repayments, which leads to further declines in spending and further declines in demand. And so on.

Graphs that Show a Little Pain: Mining, Manufacturing and Services

In my last post I included a graph showing the high level of mining investment past, current and prospective. The graph was from a speech the other day by Deputy Governor of the RBA Philip Lowe elegantly titled "The Changing Structure of the Australian Economy and Monetary Policy" 

The happy graph is this one. 

Mining investment is as high as its ever been in Australia, but this doesn't necessarily mean that all is fine in the Australian economy.

Lowe also discusses a range of other graphs that show how some parts of the economy are struggling.

The first graph below uses 2000 as its starting point and considers outcomes since that time.  Manufactured exports were growing substantially until the GFC, with the parts of the sector clearly becoming more export oriented (consider exports in ratio to output). Part of the cost of this transition was a gradual decline in employment. Since the GFC, exports and outputs have recovered somewhat although still well below the pre-crisis peak and well below the general recovery in world manufacturing trade, which has exceeded pre-crisis highs. Unemployment in the sector, meanwhile, has fallen in a hole.

It's harsh to say it, but the survival of the manufacturing sector (and remember that it's a remarkably varied sector) is probably dependent on more job losses as firms restructure and focus on higher value-added activities. Steel production, for example, is not going to survive in its current form. Car production is also probably dead in the water over the longer-term unless the government does something more than simply providing regular gifts to American and Japanese car companies to keep producing cars in Australia.

Just imagine the potential results for Australia's hi-tech manufacturing future if just 10 per cent of that largess delivered to American and Japanese investors had been put into research on new engine technology. Instead we paid the car companies to keep producing cars that fewer and fewer people wanted.

There is some indication that the manufacturing sector is restructuring in a good way in that a greater percentage of firms are embracing new operational processes than in other industries. Once again this means higher productivity and clearly fewer employees as a percentage of output. Currently manufacturing employs about 950,000 people and accounts for about 9% of output. As Lowe argues:

Realistically, Australia cannot hope to be a large-scale producer of relatively standardised, plain-vanilla, manufactured goods for the world market. But what we can be is a supplier of manufactured goods that build on our comparative advantages: our educated workforce; our ability to design and manufacture specialised equipment; our reputation for high-quality food; our research and development skills; and our expertise in mining-related equipment.

Inevitably, the high exchange rate means that the manufacturing industry has little choice but to move up the value-added chain in order to compete. This is, of course, a lot easier to say than to do. It means difficult changes for many firms and those who work for them. It also means ongoing investment in human capital and the latest machinery and equipment and constant attention to improving productivity. One piece of evidence that things are moving in this direction is in the ABS business characteristics survey, which asks firms a series of questions about innovation. In this survey the manufacturing sector clearly stands out as one where firms are actively reviewing their business practices and, over recent times, they have been doing this more frequently.

Two significant sub-sectors that have been growing are "professional and scientific" and "specialised machinery", while cars and metals and construction manufactures are in a dangerous decline. The problem for the car industry is that there is overproduction throughout the world and especially in Europe.

Another sector that has been doing poorly is tourism, although some sectors of the accommodation sector have not been doing so badly, highlighting that there is restructuring going on within sectors, not just between them (as in manufacturing above).

As those of us who live in Queensland will have noticed, tourism is in deep trouble. Sydney, however, is doing well as business travel remains high and as tourists seek city-based experiences rather than coast-based experiences. The floods and La Nina have probably not helped Queensland tourism.

Another sector that is going through a tough time is the real estate industry. Not only are prices in decline, but turnover rates have more than halved from their peak in the early 2000s. The fall over the last few years has also been significant. The trend is clear despite a couple of rises before and after the GFC. I live near a high street that must contain at least 6 real estate agencies on one side of the road over a distance of no longer than 200m. Might be difficult to maintain that sort of penetration of Logan Rd Holland Park if the turnover trend charted below continues.

As with accommodation, retail is a sector with varying fortunes. Clothing, footwear and accessories are doing poorly as are Department stores, but other retailers are doing quite well.

As I argued in The Internet and the Death of Retail the problem for the bricks and mortar part of the sector is not yet because of Internet sales, which are less than 5 per cent of overall sales, with o/s sales even smaller at about 25 per cent of total Internet sales.

Nevertheless, a recent study by the NAB reported that online retail had been growing rapidly, although the rate of growth slowed in the second half of 2011.

Australian retailers are not, therefore, powerless to take advantage of the Internet. Australian businesses, even those with stores, can sell online as well. But a little hint here to Rebel Sports and Super Amart, things have to be cheaper online.

After trying to find some running shoes in the US, I found that many of the cheaper retailers wouldn't sell directly to Australia, although there were companies that would provide you with a US address and then send the goods to your Australian address. This seemed more trouble than it was worth after I found an Australian site - myfootyboots.com - that sold shoes much more cheaply than the bricks and mortar retailers.

Undoubtedly we live in interesting times and clearly some sectors (and sub-sectors) are doing much better than others.

International House Prices: Australia Compared

The Economist has just released the latest version of its interactive global house price graphic. They explain it this way:

The Economist has been publishing data on global house prices since 2002. The interactive tool above enables you to compare nominal and real house prices across 20 markets over time. And to get a sense of whether buying a property is becoming more or less affordable, you can also look at the changing relationships between house prices and rents, and between house prices and incomes.

Whichever way you look at it - and it's worth moving the dates around to get a good idea of the changes - Australia has done 'better' than nearly anywhere else. But we too are now in decline.

If you push the date to start at Q1 2007, you get a real insight into how house prices have fallen in the rest of the developed world.

Going back to 2000, Australia has done well - if you think rising house prices is necessarily a good thing (and I don't). Japan has done particularly poorly (falling prices are not a good thing either)

Going back even further to 1990 and the country that stands out the most is South Africa with an amazing rise in house prices. Australia still stands out, but the most interesting figure is the gradual rise in house prices in Germany - no boom there, just a gradual orderly rise (the best of all outcomes in my view). And look at that fall in the Celtic 'tiger' - financialisation not looking like such a great idea now.

The Economist has been a long-time bear on Australian house prices arguing that:

SOME four years after house prices peaked in much of the rich world, housing remains over-valued, when compared to its long-run relationship with housing rents and income per person. Housing prices in Australia, Canada and France, which had only a slight wobble in 2008 before climbing to new highs, look particularly frothy. In contrast, prices in America have fallen so far that they now look cheap when compared against both rents and income. But given the huge stock of foreclosed homes that is yet to come on to the market, the chances are that they could yet fall further.

From this accompanying article The Economist reports:

Never before had house prices risen so fast, for so long, in so many countries. Yet the bust has been much less widespread than the boom. Home prices tumbled by 34% in America from 2006 to their low point earlier this year; in Ireland they plunged by an even more painful 45% from their peak in 2007; and prices have fallen by around 15% in Spain and Denmark.

The suggestions from the overvalued nature of house prices against income increases and rent changes is particularly bracing.

The ABS and other private sector organisations argue that house prices have fallen further than the 2.2 per cent listed here.