This week we issued the following posts for subscribers: 

  • Is it time to sell the Aussie Dollar at 80c?
  • What a difference 40 years has made in terms of housing affordability (and debt);
  • The trend for crude and a potential trade on VLO;
  • 4 plays on a higher gold price (however tread carefully);
  • Why there is no US boom nor bust; and earlier this morning
  • Weekly Review for the XJO and S&P 500

Today I am sharing “What a Difference 40 Years Makes” 


Over time interest rates will naturally rise and fall.

Most financially literate folks know this.

Typically they reflect the ebbs and flows of the business cycle. Problem is these are not normal times.

For example, what’s not normal is for interest rates to remain unusually low (ie zero in real terms) for an extended period.

Those who have borrowed money the past decade or so (especially for the first time) have not lived through these ebbs and flows.

In fact, we have not had a recession in 25 years.

With interest rates anchored at zero for an extended period (combined with record amount of income) — this has led to many folks thinking they can afford to take on excessive leverage (eg more than 6-7x their annual gross income).

This is not normal.

For example, during the 1980s, most people paid an average multiple of 3x their income to buy a house. As such, when interest rates hit 19% in the early 1990s… it didn’t cause too much stress.

But that was then…

What a Difference 40 Years Makes…

Australia is a very different place to 1975.

Some may say for the better… and some may say for the worse.

I miss the one-day cricket outfits… and the cast of characters! Another discussion…

But one thing is for sure, things were not a less “financialised” in 1975. Now when putting this missive together tonight – I found this telling graphic

1975 to 2015 in Australia

In 1975 – the average income was around $7,618.

If you lived in Sydney – you were having to pay around $28,000 for a house – just under 4x your income. However, if you lived in say Melbourne or Brisbane, it was less than 3x.

Fast forward to 2015. The average income is around $72,000.

However, if you choose to live in Sydney today — you are now paying (on average) 11.8x your annual income. In Melbourne that drops to more affordable 8.5x

Note: these figures are 2015… we have seen double digit rises in house values over the past 2 years and virtually zero income growth (so 2017 multiples are likely higher).

This gives you an idea of how crazy things have been.

The question is how? And why?

Simple: with rates being at zero in real terms (by real terms I am taking the official cash rate of 1.50% and then subtracting inflation) – we have taken this as “free licence” to borrow obscene amounts on the belief “we can afford it”.

Wrong. Dead wrong.

And cracks are gradually beginning to appear…. 

And “now” we are worried… 

Today when I saw this headline in The Australian – I could not help but chuckle… 

As an aside, it immediately reminded me of Ernest Hemingway when he was asked about going broke.

He said it happens in two ways: “Gradually. Then suddenly”

Great line!

Let’s read what the Australian reported:

A rising minority of households also say they will not be able to meet their debt repayments, according to the Household Financial Comfort Report from super fund-owned bank ME.

Almost one in two households with a mortgage — or 48 per cent reported feeling worried about their debt over the past month.

The stress is taking its toll in the east coast capitals, with 40 per cent of all households in Sydney and 39 per cent in Melbourne feeling worried about the amount they owe.

Some 31 per cent of households said they would be worse off if the Reserve Bank lifted the cash rate 1 per cent.

ME consulting economist Jeff Oughton said high household debt would be in focus for the Reserve Bank alongside a pick-up in inflation and support for sustained growth.

“Australian wealth on average is at a record level, but the flip side of that is so is gearing,” Mr Oughton told The Australian.

“Household debt is at a record level, and interest rates are starting to rise from a record low level and that’s one of the balancing acts that the Reserve Bank will have to manage over the next few years.

Interesting – 48% of all households expressed concern over their debt levels the past month. And 31% said that they would be worse off if the RBA lifted rates just 1%.

Just a rise of 1%!!

Typically this would be statistically irrelevant. For example, for most folks 1% may mean about $300 month… if borrowing say $500,000.

Here’s a little test I did using NAB’s online calculator for at both a 1% and 2% difference:

Impact of Small Rates Rises on $500K Loan

Imagine the survey results if the question was a 3% increase!

Again, we are talking about a cash rate of just 2.50%.. which would most likely translate to commercial rates of around the 5.3% mark (give or take).

As an aside, the article says “Australian wealth has never been higher”.

My first thought: how are we measuring wealth?

For example, if it’s cold hard cash in the bank (or gold bars) – then sure. That’s no-one else’s liability. But if it’s a measure of the debt we carry against an asset – that’s not wealth. That’s paper wealth.

That asset could drop 50% in value in the span of a few short years… just ask the folks in the US, UK and Europe. I digress…

Struggling to Make Payments…

Earlier this week I referenced Coles’ CEO about shoppers choosing “cheap food” over “fresh” (more expensive) options.

He talked to things such as higher education fees, health premiums, utility bills, fuel and child care costs as impacting consumer choices.

He has a point.

All of these services are growing well in excess of incomes and inflation (eg 7% per annum plus). They are the goods and services we simply cannot be exported to China for $2 per hour.

But he did not talk to household debt… which I think is the real killer (or soon will be).

Here’s the thing:

If rates were to rise by a tiny 1%, this would also severely crimp consumer spend.

I often like to say that “7% is now the new 18%”

Remember, Australia’s GDP (ie 60% of it) largely depends on consumers spending more (typically with money they don’t have).

Now on this, the June ME Bank survey found a lift in the proportion of households who think they cannot meet the minimum required payments on their debt over the next six to 12 months, from 5 per cent six months ago to 9 per cent.

On the revenue side of the equation, the survey found household income growth was subdued, adding to the pressures in meeting housing costs.

About a third of households said their annual income had increased, 40 per cent said their income had stayed the same and 27 per cent reported their income had fallen.

Don’t you find that interesting…

Here we have 67% of folks who have not received any type of income growth… and yet borrowing for properties continues to grow.

How does that work?

Again, it “works” if rates are held artificially low.

The survey also found about half of Australians have no spare cash at the end of the month and the cost of necessities such as petrol, electricity and groceries was ranked as households’ biggest worries.


As a complete aside — we shared this graphic from a telling PBS documentary last week where middle-Americans were asked a similar question. This was their response:

I said it would be interesting if that was put to Australians… it looks like I have my answer.

Oh… and do you still think the RBA will raise rates this year?

Putting it All Together… 

We are going to see more headlines like this over the coming few years.

I have little doubt.

Welcome to a period where Australian incomes stagnates after a once-in-a-generation boom – as we wrestle with the decision to take on excessive debt (to afford our lifestyles).

Was borrowing 5x my income really the right thing to do? What if my house value drops 20%? What if rates normalise back to 5% over the next 5 years? What if I lose my job? What if we go into recession?

In recent times, cheap debt has fooled (or encouraged) many people (perhaps half) to live well beyond their means.

But nothing is free…. everything comes at a cost.

We are in the very early stages of a grand new cycle… perhaps one that lasts 20-30-years? I don’t know.

I don’t say that lightly – as we have wave of folks (baby boomers) depending on increasing amounts of welfare (not sure how we can afford that); we have excessive debt (that we can’t pay back); and at some point we will have to begin the deleveraging process.

It will be painful. There are no simply solutions.

But it’s yet to start… and may not start for another 2-3 years.

This is why I was telling folks to do everything they can to pay back what they owe today. It’s your “golden window” (ie whilst rates stay incredibly low).

But I also realise that is hard given most folks don’t even have “$300” spare each month to cover the necessities (according to the survey).

Interesting times ahead from my lens. As I say “7% is the new 18%”.

And I am not sure some of us are ready (or prepared) to accept the unintended consequences of their decisions.

… 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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