If you have been reading this blog the past 5+ years – you will know that Australian homeowners are the most exposed (second only to Switzerland) in the world to any increase in interest rates.

The thing is it shouldn’t be this way…

We have just come off the greatest (income) boom we have enjoyed in almost a century.

And it’s likely to be another 50 years or so before we enjoy a repeat.

Money was coming in faster than we could count it… all thanks to red-dirt and a Chinese printing press.

You ripper!

Be that as it may… here we are… swimming in unproductive debt.

As such, the “trillion” dollar question (quite literally) is whether our record levels of private debt and sky-high house prices (in Melbourne and Sydney) are a key risk to our economy?

After all, haven’t we been warning on the risks for what feels like a decade?

In a word, yes.

However, there has been one important factor (above all others) which has helped Australia avoid any major downturn.

Interest rates.

Record low interest rates throw speculators are life-line. And the lower the go – the less Aussie’s seem to fear about borrowing as much as 6x their income (or more in capital cities).

Frightening to think that some people owe this kind of money… but some do.

And worse still… many folks today see this is “normal”.

Bank for International Settlements Warns

Earlier this week (June 26) the central bank’s bank – the Bank for International Settlements – issued a warning to the lucky country.

In their view – a modest run-up in interest rates could leave many Australian households in a precarious financial position.

You don’t say Einstein.

Side note: this is why they pay the top brass at the B.I.S. the big bucks.

Readers will know our precarious situation… where household debt is now approaching double the level of household disposable income.

To put this in context — a quarter percentage point increase in rates would add more than $40 a month to a $300,000 mortgage.

But who has a $300K mortgage?

Maybe if you live beyond the back of Bourke?

Most Australian’s within an hour of cities such as Melbourne or Sydney are sitting on mortgages close the double that amount – where the average house price exceeds $1.0M.

According to the rocket scientists at the B.I.S — if interest rates increased in line with market expectations, then Australian debt servicing levels would have to double in a development that would crimp the spending patterns of many homeowners.

And if rates had to be pushed up even quicker, then debt repayment levels would treble — and go past the level homeowners experienced just ahead of the global financial crisis when standard variable interest rates climbed above 9 per cent.

Current standard variable rates are about 4.5 per cent.

Australia: 8 Rate Hikes in 2 Years?

Fresh on the heels of the grim warning from the B.I.S. — former (respected) RBA board member John Edwards came out the other day and said the central bank could raise rates as much as 2% if growth (and inflation) forecasts were to come to fruition.

Ahhh John… all due respect mate… that’s a big bloody “if”!

Dr Edwards felt our cash rate should be closer to 3.5% if we are able to return to 3% GDP growth in the next few years (as the RBA expects). I quote:

“It seems to me that something like eight quarter-percentage-point tightenings over 2018 and 2019 are distinctly possible if the RBA’s economic forecasts prove correct,” Dr Edwards wrote in a paper for the Lowy Institute think tank.

“If inflation does indeed return to 2.5 per cent, as the (Reserve) Bank now expects, if growth does indeed return to 3 per cent ‘within a few years’, as the minutes of the June board meeting predict, if the world economy is indeed picking up, then a policy rate of 1.5 per cent is too low.”

There’s four ifs in those two paragraphs!

Ahhh central planning forecasts! You got to love them don’t you.

Below is the trend for Australia’s GDP growth from 1990 to 2017… and the budget assumptions:

From my (limited) perspective — both the RBA’s forecast (and the government budget) repeat the mistakes of the past; ie they rely on optimistic forecasts.

That’s dangerous.

A significant uptick in GDP growth to 2.75% in the next financial year and 3% in 2018-19?!

On what basis? Greater government spending? The national credit card?

What exactly?

How Miracles Happen..

The gaps in their thinking (and assumptions) are so large – you could drive a truck through it.

So much for critical thinking!

For example, let’s start with household consumption (eg things like retail spend). They continue to struggle… and have done for almost 7 years:

So why is this important?

Australia’s economy is consumer driven. Regular readers will know that our household spending makes up around 60% of GDP.

Yes… 60%.

Now, based on the chart above, Aussie Mums and Dads are more reluctant these days to open their wallets.

Why?

Not hard to explain – most of what they earn (which is declining) – is going into paying off what they owe on the house (and to feed, clothe and educate ankle biters — which we are having less of).

But what does that mean for GDP? And inflation?

And most importantly – tax receipts?

You got it – they will be hit.

But let’s say these rosy forecasts of 3% GDP were to magically eventuate…. for shits and giggles.

What about our private debt? Is it magically solved?

Of course not.

The budget papers estimate that gross debt will reach $725 billion by 2027.

That’s like running up a mountain with a back pack full of rocks? And yet – we are forecast to accelerate up the mountain?

How exactly? Isn’t the idea to get rid of the rocks? I would have thought so…

But perhaps not.

Putting it All Together...

I would love nothing more than to see 8 (even 12) rate hikes in the next 24 months.

But I know there are two chances of that happening: (i) buckley’s; and (ii) none

In order for Australian economic growth to accelerate we need to see three key things:

(1) More disposable income to boost consumption (ie lowering our debt);
(2) Businesses to start investing; and
(3) Wage growth to turn around.

All three are important.

However, with respect to wage growth – this chart from Bloomy tells the (bleak) story:

Wage growth (purple line) has not been this low since the year 2000… and it’s trending lower.

Second, look at the savings ratio (blue-line).

Not surprisingly it peaked in 2008… from there it’s all down hill. However, what do we see with debt and speculative assets?

Enough said.

Connect the dots folks… and it gives the impression of a slow-motion train wreck.

… trade the tape

When investing in shares, you can lose you some or all of your money. The potential gains on my blog are based on investing in Australian and US markets and don’t include taxes, brokerage commissions, or other fees. It’s important you seek independent financial advice regarding your particular situation. For any investment, never invest more than you can afford to lose, and keep in mind the ultimate risk is that you can lose whatever you’ve invested. If in doubt – always seek independent financial advice.

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