The RBA airbrushes history

Deputy Governor of the RBA, Guy Debelle, yesterday delivered an analysis of Australia’s recent financial history that left a few things out. Let’s take a look:

Over much of the past two decades, demand for credit outpaced the growth in deposits, so that banks accessed wholesale funding markets to support growth in lending. This outcome reflected a number of factors.

Australia’s relatively high level of investment, and the sustained growth momentum of the economy over the past two decades, underpinned the demand for credit. While the source of the demand for credit shifted between household and business sectors, from the early 1990s recovery until the financial crisis, aggregate credit growth was sustained at a rate of over 10 per cent per annum.

At the same time, on the supply side, the importance of superannuation in Australia has, for much of the past few decades, constrained the growth in household deposits. Superannuation funds have historically tended to invest in wholesale bank paper rather than hold bank deposits. So, compared with other countries, more of the savings of the Australian household sector has tended to end up in wholesale bank paper rather than in deposits, with the superannuation sector as the intermediary.

More recently, however, the demand for credit from households and businesses has slowed in tandem. For businesses, the reduced appetite for debt was initially due to a desire to strengthen balance sheets. More recently, strong profitability, most obviously in the mining sector, is ensuring many segments of the business sector have sufficient internal funding to meet their investment needs.

As has been discussed in much recent RBA commentary, for households the slowing in demand for credit appears to be driven by a more cautious approach to debt. There are a number of factors contributing to this. One is that the increase in household leverage that occurred through the 1990s and first half of the 2000s in response to the downward shift in the nominal structure of interest rates has run its natural course. The slower growth in household wealth, and particularly the large negative shock to equity wealth at the height of the crisis, has also contributed to the cautiousness, even though equity wealth has recovered and household income growth has remained robust.

This growing caution of households in the past few years has seen the household saving rate pick up substantially, and much of this saving has been in the form of deposits, given the attractive yields on offer. The strong cash position of many businesses is also contributing to stronger deposit growth. As a result of these factors, deposit growth has outpaced credit growth for the past two years.

You’ve got to love the framing of the issues here. Invisopower! is hard at work. There’s no sense at all that there was ever any excess debt accumulation or misallocation of capital into housing. It’s all just twenty years of a “relatively high level of investment”.

This is the old deposit shortage argument, generally promulgated by the banks. That superannuation unfairly sucked away the banks’ natural funding source and, to meet the demand for credit, they had to go for wholesale debt. Poor things.

What about the supply of credit? What about the banks’ historic plunge into offshore wholesale debt (which doesn’t even rate a mention) from the late nineties? What about the banks’ innovation in the use of derivatives that enabled them to manage the credit and currency risks of borrowing offshore? What about the dramatic expansion of non-bank lenders, which did much the same thing? Both of which happened to coincide with Australia’s great asset inflation? What about the clear evidence in the chart that in the latter years of the boom, the banks were channeling rapid deposit and wholesale debt growth?

What about the fact that bank asset growth, profits and bonuses all went parabolic from the turn of the millennium? The same binge which later left them facing insolvency in the GFC.

And if the debt accumulation that inflated asset prices to extreme levels wasn’t in some way misallocated, why is the RBA so determined to see it flatten out now? And why have debt-loving paradigms such as the Pitchford thesis been consigned to history? That’s where we can return to Debelle:

So banks have experienced a slowdown in asset growth and have funded the assets with a greater share of deposits. A consequence of this is that wholesale debt issuance by financial institutions has declined to its slowest pace since the mid 1990s. The most pronounced slowing has been in the issuance of short-term debt as banks have sought to lengthen the average maturity of their funding by increasing the share of long-term debt in total funding

There are reasonable grounds to expect these trends may be sustained for some period to come. In particular, if one thinks about the composition of growth in Australia in the period ahead, it is likely to be investment-intensive. But much of that investment is likely to be funded by companies which are cash-rich or tap global capital markets directly. This means that the growth in the economy in the period ahead may be associated with less growth in business credit than has been the case in the past. It is also likely to boost deposit growth. So banks may be seeing a prolonged period of faster deposit growth but slower asset growth.

Which, as I’ve argued before, means you shouldn’t buy their stock.

There’ll be nobody happier than I if the trend of increased deposit growth continues. I’m on board with the grand experiment of disleveraging. The attempt by the Stevens RBA to backfill the bubble is a ground-breaking endeavour in the history of central banking.

Airbrushing history discredits the project. Not to mention that it sets us up for a repeat episode.

David Llewellyn-Smith
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  1. “The attempt by the Stevens RBA to backfill the bubble is a ground-breaking endeavour in the history of central banking.”
    Has this endevour been ever tried before or has succeeded elsewhere?
    That said, Stevens deserves a Nobel prize in economics IF he succeeds in disleveraging.

  2. Where in the RBA’s graph is the $170bn of deposits that is sourced offshore? The deposit line is specifically titled “Domestic Deposits” Is this another example of very loose labeling to make the position look more acceptable?

    • I assume it is hidden in the two categories “long term debt” and “short term debt”. The sum of the two is greater than the banks’ offshore borrowings, so I guess it includes both offshore and onshore borrowings (but mostly offshore).

  3. You could argue that it was tried and succeeded in Sydney from 2003 to 2009. It’s a little reported point that the median house price in Sydney was lower in June 2009 than December 2003. It was one almighty boom (in Sydney at least) from ’98ish to 2003, so it was a good effort to bring about the original soft landing. At the time, I recall plenty of talk about the RBA engineering a soft landing. This article from 2004 seems to confirm that:

    It was all doom and gloom in that article – much more so than now! Yet by the end of the year there was no talk of house crash in Sydney or elsewhere. For many, the party had only just begun…

    But you could also argue that the Sydney market shouldn’t be viewed out of context of the overall Australian housing market. That is, the soft landing experienced in Sydney only came about from the ability of investors to switch to other markets, like SEQ and Perth.

    My personal opinion is that Australia truly would be the lucky country if it happens again. This time, there’s precedents for investors to see – US, Ireland, Spain to name just a few, and it looks like it is far more wide spread. But if China keeps paying too much for our rocks, then the RBA might just get away with a miracle. What better time to deleverage than during the midst of a mining boom?

  4. Stevens needs to get his finger out of his azz and raise interest cash rate towards 10% and give cash some value before commodities and food prices do it for him and he looks like a bitch.