Back in December, David Murray, Chairman of the Future Fund and former CEO of the Commonwealth Bank, issued a stern warning on Australia’s high level of net foreign liabilities, which had reached nearly 60% of GDP:
…the assumption that Australia could maintain a high level of foreign borrowings because the economy was underpinned by the mining boom and demand from Asia was worrying. “That’s a very risky position”. Australia’s foreign debt position relative to the size of the economy is higher than that of the United States or France.
Mr Murray admonished politicians for glossing over the risk posed to Australia’s economy from foreign indebtedness. Instead, he said, they had chosen to focus voters’ attention on abolishing government debt. “The debate is all being run at a level that completely ignores this vulnerability”.
If Australia’s economy were to slow, the ability to service those foreign borrowings could be affected. There is also the risk that the cost of foreign capital could rise further, which would be felt by many through higher domestic mortgage rates. Banks’ foreign borrowings have funded Australia’s housing boom…
Now Mr Murray is warning that Australia’s high house prices make the economy vulnerable to overseas events, particularly a sharp fall in commodities prices. Here’s an extract from today’s Business Day:
Australian house prices are high by world standards and have made the economy vulnerable to overseas events that may cause a sudden decline in their value, the head of the Future Fund says.
Future Fund chairman David Murray said younger Australians in particular had been prepared to devote a large portion of their incomes to loan repayments, even at a cost to their living circumstances, and that had helped propel house prices higher.
‘‘The relationship between house prices and incomes is uncomfortably high,’’ Mr Murray said in a televised panel discussion, hosted by The Australian newspaper and Sky News.
The comments by Mr Murray, a former chief executive of Commonwealth Bank, came as a major ratings agency said that more Australians were falling behind with their mortgage repayments and the situation could worsen with interest rate rises.
Mr Murray said that Australia was vulnerable if interest rates rose around the world, which in turn would prompt commodity prices to fall and leave the country exposed with high house prices.
A fall in commodity prices would cut the income flowing into Australia, reducing the pay of many, and make it more difficult for people to service home loans.
‘‘Hopefully that won’t happen and we can work through it,’’ Mr Murray said. ‘‘But by any set of normal measures, house prices in Australia are high”.
As I said back in December, it’s heartening to hear these views being expressed publicly by Mr Murray, even if he is one of the people responsible for Australia’s housing/debt addiction. When Mr Murray was at the helm of the CBA in the late 1990s, he ignited a price war amongst the banks by slashing CBA’s variable mortgage rate (remember ‘equity mate’?). Let’s also not forget that the CBA is the second largest issuer of offshore wholesale debt as well as Australia’s second largest mortgage lender behind Westpac.
Nevertheless, Mr Murray is right to be concerned. Australia’s over dependence on China and rising housing values are its key vulnerability.
Over the past ten years, Australia’s ‘miracle’ economy has ridden on the back of twin booms: the debt-fuelled housing market and the China-led commodities market. This dynamic is illustrated by the below chart, which shows the rapid growth of household debt levels, real house prices and the terms-of-trade (ToT) since 2000. Whilst other economies experienced hardship in the wake of the technology stock market crash of the early 2000s and the recent Global Financial Crisis, Australia’s economy continued to march onwards and upwards.
But to expect the ToT to remain at 60 year highs and household debt levels and house prices to rise further from their current high levels is wishful thinking. The fact is, sooner or later China will slow and households will deleverage, bringing asset prices down, reducing consumer spending, and increasing unemployment. In short, much of the good fortune that Australia has experienced over the past decade would unwind and a painful recession would likely follow.
I hope for Australia’s sake that the commodities market can defy history. Although I don’t like our chances.