The “negative gearing” mania in Australia is largely a symptom of a bigger problem as without an expectation of excessive capital gains few would be getting excited about negative gearing ‘Oz Style’ (aka losing money operating an investment property in the hope that capital gains on the land will make the exercise profitable).
The economic model whereby the Australian economy is driven with RBA ‘bait rates’ and growing household debt is the core of the problem as that has driven and is continuing to drive the excessive capital gains on land/residential housing.
In short, land prices have been rising much faster than they should simply because rising land prices is the fundamental mechanism by which households are induced to take on debt and households taking on lots of debt is how the RBA drives economic activity.
The household debt “bubble” or “binge” was the great ‘invention’ of politicians on both sides of politics over the last 20 years – Howard and Costello discovered the ‘seam’ but both sides have mined it like “miner 49’ers” ever since. The process works as follows – households run themselves into the ground with larger and larger levels of debt (from circa 30% of household disposable income in the early 90s to circa 160% now) while the pollies skim off the cream (some of the debt taken on by households) and use it to run surpluses or small deficits.
The economy bubbled along nicely on all that household debt until 2007 and the pollies got to have photo ops as ‘deficit hawks’ and ‘fiscal conservatives’ – again both sides (after all Mr Rudd invented that particular phrase).
The pollies simply loved milking the household debt cow (e.g. “first user pays all” model for the costs of developing new land, stamp duties, GST on new builds etc) and RBA “bait rates” were (and remain) the single most powerful stimulant of the process.
Remember that Howard line “...interest rates will always be lower…” . Well that was a brilliant strategy as it encouraged households to bury themselves in debt and made it easier for Costello to run surpluses (helped by a pile of asset sales). It also made it politically very difficult for anyone to recommend an approach to interest rates that would discourage excessive household debt. Low interest rates were seen as a fundamental human right – a bit like getting a credit card when you turn 18. Just a shame those low interest rates depended on building a mountain of foreign debt.
Ever wondered why our politicians don’t talk about the massive amount of household debt? If they did – that would probably kill the desire of many Australians to load themselves up on massive amounts of personal debt and bet on perpetually rising land prices. And if households stop borrowing and start paying down their debts our hopeless political class would then have to take responsibility for economic management that does not rely on someone racking up massive debt. In short the politicians outsourced public sector debt to the balance sheets of the households of Australia. How nice of them!
Of course the tax rules regarding negative gearing and capital gains discounts also gave the process a solid push, along with the incompetence of the NIMBY / BANANA whipped land supply authorities who choked off land supply as migration numbers exploded, but those factors would not have produced the land asset price mania we have experienced (right around the world) without the RBA (and their central bank buddies) administered ‘bait rates’ and the swelling mountain of household debt driven by those “bait rates”.
Now we are reaching the end game of the model because an economy running on expanding household debt will collapse if the household debt mountain stops growing – deleveraging (paying down debts) is simply the reverse of endogenous money creation by the private banks. Australia is getting the news later than the rest of the world because China and our mining boom gave us a “get out of gaol” card. But like gooses we spent it instead of using it to ……get out of gaol.
The RBA is on the path to ZIRP (zero interest rate policy) simply because the ‘bait’ required to induce heavily indebted households to take on massive personal debts – when asset prices are already highly inflated – must be made tastier and tastier. The RBA is certainly trying to dawdle on the path to ZIRP as much as it can by cutting rates just enough to keep household debt growing slowly but not enough to make the problem of excessive debt any worse than it already is. The foaming Sydney property market is playing havoc with this strategy as an attempt to cool Sydney risks the rest of the country slipping into deleveraging mode. APRA is trying to handle the problem with very quiet cups of tea with its banking buddies – good luck with that Wayne – those buddies of yours have a taxpayer guarantee!
Governor Glen in his understated way recently flagged that the days of relying on “monetary policy” were numbered but he was typically vague on what he thought the alternative might be.
The problem of course is that keeping the household debt model alive means making the situation worse. Sadly, the vast majority of our economic commentators in the media do not even understand the danger that falling interest rates are signalling and they buy the line from our army of bank economists (that our compliant media dutifully report as news) that cutting rates is about providing “stimulus” and supporting ‘demand’ – yep demand for their No. 1 ‘product’ – i.e. more debt.
The government is scared stiff of fiddling with ANY of the secondary factors contributing to the problem or keeping the model on life support:
- thus the repeated assurances by Joe and Abbott that they will not touch negative gearing,
- thus going slow on FIRB reform and limiting foreign and temporary resident purchases of existing property,
- thus the FTA agreements that facilitating flogging assets off shore,
- thus no signs of action on real macro-prudential – i.e. restrictions on the off shore borrowing by our banks that enables a CAD country to run a “bait rate” program.
- no leadership federally on solutions to end the “first user pays all” gouge fest by state, local and federal governments that drive up new land prices,
- thus the population ponzi still going strong while housing supply is still not making much of a dent in the rental vacancy rates.
but the ONE factor they need to talk about – driving the Australian economy on debt based money produced by the private banking sector – is the one they are not talking about.
Eventually they will have no choice – the current model is broken.
Someone somewhere is going to have to bite the bullet and start supplying economies with money that is not debt based. I doubt it will be Australia as our pollies – both sides – are just not up to the job of resolving the failures of 20 years of bi-partisan policy. Perhaps it will be Iceland – if they proceed with the reforms being promoted by Frosti. Sure this is no magic pudding and if overdone inflation may be a problem but it certainly beats trying to dig yourself out of a debt hole with more debt.
What IS likely in Australia is that our hopeless pollies will try to ignore the problem by first running up a mountain of public debt and selling it to off shore central banks and by making it easier to sell off any remaining Australian assets that are not already in foreign hands. This is exactly what Andrew Robb’s FTA/TPP agreements are about, what Joe is doing (while claiming it is the ALP’s fault) and now Abbott seems keen on the idea as well.
End result – the model remains broken but we will have a mountain of private AND public FOREIGN debt when we finally do something about it. Yes – foreign debt is the nasty form of debt you get when you spend decades importing more than you sell.
The dumbest excuse currently being trotted out is that we “should make use” of all those cheap off shore savings (i.e money printing by off shore Central Banks) to build “infrastructure” white elephants.
Building infrastructure would certainly be better than simply consuming our borrowings but we DO NOT need to borrow off shore to build the infrastructure that we need.
Depressingly – none of the above is complicated or controversial but very few are talking about it. Australia truly is the land of lotus eaters.
To read the original version of this comment in the original context at Macrobusiness.com.au click this link. (link maybe locked – but there is a free trial available)
“Blame the policy makers. To drive economic growth, boost living standards, and manage growing inequality, policy makers have used debt and monetary tools to create economic
activity. This has resulted in excessive borrowing and imbalances in global trade and capital.”
Saying exactly the same thing but from a global perspective. I can hear flawse teething now.
Ultimately 3d, with that Zen quality I so enjoy, makes a tedious but compelling refrain; namely that 20 years on and Globalization is the world we have. Supra-national entities and cross-border tax regimes are the norm not the exception. We the little people are still tied to a domicile, more or less, and more frequently less, but corporations have become “global citizens” and care little for whatever monetary and tax structure you attempt to setup here in you coral, they’ll just go somewhere else and make you irrelevant ….
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No surprise that while the prevalence of the current debt driven model of economic activity is disturbing, I don’t share the 3d sense of resignation and belief that nothing will ever change.
Things do change and often it does not require anyone to successfully promote the change that occurs.
A lot of stuff that just happens seems so very logical and pre-ordained – but only after the event.
The heavy tilting of the system towards monetary policy and reliance on household debt is relatively recent (1980s) and at the time it all made sense and appeared reasonable. Public debt had been discredited in the 1970s and switching to private debt seemed like a good alternative. All those rational individual private debt decisions must stack up to a brave new world.
Skip would argue that it was not just a mistake and it was the result of the fiendish plans of a cabal but the idea that individual borrowing decisions was a better idea than the decisions of public servants is not implausible. There was no cone of silence stopping people from talking about a monetary system not based on debt – the need for it just wasn’t apparent. Why not leave the money creation to private banks and ‘manage’ the process by fiddling with the price of credit.
All that is happening now is that the heavy switch to monetary policy exposed the fundamental flaw in trying to cure the fraud of 19th century fractional reserve banking with central banking as the lender of last resort. By going whole hog the structural flaw has been exposed.
The problem is not whether the debt is public or private – the problem is a monetary system based on debt. They tried public sector debt and that did not work and then they tried private debt and that does not work. Now we have plenty of countries who have maxed out both.
The solution now, is the thing that has not been tried – a monetary system not based on debt – public or private.
I think it is a forgone conclusion that it will happen – as there is little choice.
All it will take is some politician who understand the issue to give the idea a go and before you know it everyone will be doing it. “Go Frosti”
Sure they will have to overcome the hysterics who reckon we will end up like Zimbabwe or Weimar etc but the road we are on seems a more likely route to those locations than placing the (fiat) money supply fully under public control for the first time – possibly ever. By that I mean I don’t think there has been a fully publicly controlled money supply since the rise of central banking.
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Yes well said, in my more melancholic moments I tend to regress to pondering the rigidity of the current system, ignoring how brittle and ready to splinter it all is.
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I have plenty of those moments :).
It really isn’t necessary that we spend quite so long exploring all the wrong options before giving the right ones a go – or even just thinking about them.
I guess that is a feature of evolution – change can kill you so don’t do it unless you have no alternative.