Yesterday we sidetracked with ideology…
Our beef is with the negative gearing. It doesn’t make sense.
We argued our leaders should think about phasing it out – with a view to ending it all together. However, we know that decision won’t be a popular one.
We are not holding our breath for the simple reason there are over 200 politicians (holding an estimated $100M in property value) who have listed investment properties against their name.
Some even boast 9 properties!
Add to that the 1.3M Australians who claimed negative gearing benefits last year with their tax deductions.
Do you think they will vote to cause a material slide in their own wealth? I doubt it.
Personally I see very few positives with the policy – despite government rhetoric. For example, house prices continue to rise with rents… and yet many argue that additional supply (made possible by investors) makes housing more affordable?
Maybe if you live at the back of Bourke!
Anyway, investing and trading is my beat.
The reason I occasionally go off on these tangents is I am (clearly) passionate about the long-term economic future of our great country. And it pains me to to see how things are being (mis)managed.
Once upon a time things we were headed in the right direction… but that all changed in 2007.
Since then it’s been straight down hill… and accelerating.
Look no further than our position of debt (public and private). Disastrous by any metric (as a function of what we actually produce).
But hey… it’s not simply the government making dumb decisions (like negative gearing).
They are only half of the equation. The “enablers” are the Reserve Bank (RBA).
It’s my view they are the principle architects behind the greatest misallocations of capital we have ever seen; ie property prices and subsequent speculation.
My argument is property speculation would not have been so rampant if it were not for excessively cheap (dare I say ‘free’) money.
According to Deloitte today “gravity could catch the stupidity surrounding house prices“
The RBA (in their wisdom) have anchored the cash rate at 1.50%. That’s half the “emergency levels” of 3.0% we saw during the GFC of 2008.
But where is the “financial crisis”?
If you adjust 1.5% for inflation (ie what we call “real terms”) – they are effectively below zero.
But here’s the thing:
The RBA are now powerless to raise them. But keeping rates at such levels further mis-prices risk.
That’s an issue.
What happens is more speculative money is thrown onto the fire. Problem is at some point things ultimately ‘revert to the mean’ (that’s another word for “gravity”)
The higher things go – the bigger the reversion. And the more painful the adjustment.
Let’s explore further with a few metrics…
Anchored at Zero
Around the world central banks are changing their language.
Things are becoming slightly more “hawkish”; ie moving towards increasing rates (rather than reducing them).
For example, Canada’s central bank is shifting its tone…. as are the European Central Bank.
Mario Draghi has suggested that he can start to see the end in sight for QE… with various metrics pointing to improvement
Likewise we are hearing hawkish language from countries such as Norway and Sweden.
And of course the world’s largest economy – the US – is already well down the path.
There’s a movement going on… a positive one. Interest rate hikes are good news.
But not in Australia…
Here there is a distinct lack of movement and we will attempt to explain why.
There are many reasons as to why the RBA finds itself in this position…
For example, what we see in the property market (especially Melbourne and Sydney) is just one.
But let’s talk to three others…
First up commodities.
Unfortunately for the “lucky country”… most of our income is generated from this highly cyclical sector.
We dig “dirt” out of the ground… refine it… and then send it offshore (mostly to China).
And that’s a great gig when the resource cycle is in full swing (as it has been since the early 2000’s). But as we know – all cycles eventually end.
From the year 2000 to its peak in 2011… this was the money-printing machine of China in full swing. Infrastructure investment was the story of the day.
But with commodities coming off the boil the past few years (there are only so many ghost cities you can build in a short space of time) — ultra-low rates were “needed” to try and shift the focus on growth to the non-mining sectors.
All good in theory right?
But as we often remind readers – whilst central banks can alter the price of money – they can’t control where it goes.
You see, things hasn’t really worked out in terms of business investment. It’s close to a 15-year low and the trend suggests more ahead…
But that’s just one factor… albetit a crucial once in terms of job creation and wealth.
The second agenda from the RBA is currency… and specifically lowering the Aussie dollar.
Yes folks – we too want to participate in the global race to the bottom.
A lower dollar was desired (again) to help and rebalance how we secure longer-term sustainable growth (away from mining).
But as we know – with the AUD now trading above 78c – this also hasn’t worked out.
The third component (and perhaps most important) is what we see with local wages growth and underlying inflation.
No surprises here… these are also sitting near decade lows despite record low rates.
Yes… record low rates are working a treat (he says sarcastically)!
The slowdown in wages growth is partly the result of the long, drawn out, downturn in the mining industry.
Not hard to explain: over-paid mining jobs were lost and replaced by lower paid services jobs.
But a job is a job right?
Only if you are a government statistician.
Despite the very small recent uptick in equipment investment – the longer-term trend is not encouraging.
Now with less money in people’s pockets (eg lack of wage growth) – combined with a stronger Australian dollar – underlying inflation is now below the RBA’s 2-3% target:
Now you are getting a sense of the challenge(s) for both our central bank and government.
They are joined at the hip…
But as we said…. it’s a different tone abroad. Other developed economies are seemingly turning the corner. And non-Australian central banks are becoming more encouraged by what they see with global growth.
For example, in the US we see annualised GDP growth meandering along at ~2% YoY… and in Europe activity indicators have had a run of upside surprises.
So what’s different down under (apart from the pies and the footy)?
Australia… the Exception
Generally when we see global growth upswings… Australia is at the front of the curve opposite rate hikes.
Not this time… and it comes back to the commodity complex.
Despite global growth improving – commodity prices remain very low – evidence by what we see with things like iron ore, coal, oil and even copper.
This is not what we need – as it pressures our national income and in turn, tax receipts.
And whilst we need higher commodity prices — the balance of the developed-world does not.
Their economic growth engines tend to be far less commodity-intensive than China’s growth.
The United States, United Kingdom, Japan and Europe do not need higher commodity prices to enjoy economic growth. That’s something we (and many emerging markets) need.
Furthermore, the recent lift in global trade has also allowed China scope to tighten local financial conditions, to help deal with some of its own (credit) imbalances, again, softening growth in housing and infrastructure investment.
Again, that’s not something Australia want to see.
We have largely benefited when (a) China have adopted looser (credit favourable) policies; and (b) growth policies around infrastructure investment.
For example, if you map Chinese stimulus injections to iron ore price movements – you will see a direct correlation.
As such, Australia is in a very different position to its peers – as we wrestle with our commodity (Chinese) dependencies.
Market Says No Hikes from RBA
For a change, money markets are with me on this one – and they are not buying any hawkish rhetoric from the RBA.
For example, today the market believes the next hike will be Q2-Q4 2018.
That’s probably optimistic…
But I have no idea how accurate (or what the timing) will be… I don’t even try and guess.
However, I do agree that the RBA is in no position to consider hiking rates anytime in 2017. And that’s not a good thing… unless of course you name is Karen Edwards… the Australian politician with 9 investment properties.
Putting it All Together…
I would love nothing more than to see the RBA start to raise rates as early as next month.
But I know that’s not going to happen. Consider if you will:
- mining investment trending lower;
- car industry moving its manufacturing operations offshore (largely due to our excessively high wage costs);
- national income growth stalling;
- businesses failing to invest despite low rates (eg lack of tax incentive);
- increasing economic budget risk (falling tax receipts)
- house prices on the verge of rolling; and of course
- a very high Australian dollar.
How many nails in the coffin do you need?
Question: what do you think higher rates would do to each and everyone of these variables? Tell me what I am missing?
I don’t pretend to be an economist (far from it) — and am applying a layperson’s lens.
Again, I am more of a trader / investor than “interest rate forecaster”.
Therefore, it’s most likely that I end up being way off course and we see the RBA hikes rates “eight times over the next couple of years“ — as former RBA member (John Edwards) said recently. We will check back with this forecast in December…
Now it’s great if they do. Bring it on! Please.
But from my limited understanding… I don’t see how they can.
… trade the tape
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