For example as a crude way of showing this idea I did a numerical word search for both “income” and “debt”. The word income was used 33 times during the speech but debt was only used 7 times and two of those instances were with regard to the United States.
Governor Stevens said of his task with the speech:
…the description of consumers as ‘cautious’ has become commonplace. It is not one I disagree with. Indeed the RBA has made such references on numerous occasions over the past couple of years.
Nor do I wish to dismiss any of the concerns that people have. People want to make sense of the disparate information that is coming at them.
I want to suggest that to do that – to make sense of it all – it is worth trying to develop a longer-run perspective, particularly in the area of household income, spending, and saving. That is my task today
Now on the face of it that task he has set himself doesn’t exactly make my point does it? For a central banker who has clearly, given the utterance in the may SoMP and subsequent turnaround since, been blind sided with what is going on in the economy he is being upfront and open.
That is commendable and he offers this chart as an explanation,
Without rewriting all his words, what is apparent in the convergence of the disposable income and consumption lines is that they were converging as consumption outpaced disposable income and savings fell.
Crucially though, so that you can get a clear picture that Stevens is an unreconstructed ‘mining boom will drive incomes higher’ advocate he says,
From about 2006, real per capita income began to grow faster. Over the five years to the end of 2010, it rose by 2.9 per cent per annum. It may not be entirely coincidental that that period is when the terms of trade really began to rise in earnest.
My bolding but you get where he is going with the rest of the speech and why income is uttered 26 more times than debt during the speech.
Those of us who believe that it is the household debt burden, coupled with the near debt experience of the global economy of the past 4 years that is driving the consumption drought at the moment got excited when he mentioned that:
…lack of income growth is not the reason for lack of consumption growth. It’s not that the income is not there, it’s that people are choosing, for whatever reason, not to spend it in the same way as they might have a few years ago.
Why is that?
He goes on to look at the household balance sheet with the chart below:
Of this chart Governor Stevens said:
Using the Treasury’s series for private wealth, from 1960 to 1995 the annual average per capita rate of increase in total wealth, in real terms, was 2.6 per cent. That is, it was broadly similar to the per capita growth rate of real GDP, which is what one would expect. So the growth from 1995 to 2005 was at a pace well over double the average of the preceding three or four decades. A large part of the additional growth was in the value of dwellings. The extent of leverage against the dwelling stock also tended to increase, with the ratio of debt to total assets rising from 11 per cent at the start of 1995 to around 17½ per cent by the end of 2005. It has tended to rise a little further since then.
Had we really found a powerful, hitherto unknown route to genuine wealth? Or was this period unusual?
Looking back, it appears the latter was the case.
My bolding to highlight the impact of leverage on housing and wealth. But even Governor Stevens dismisses this as a path to genuine and sustainable wealth, so if he can see it doesn’t work why wouldn’t your average Australian household? I’d argue they do and that is why they are paying down debt.
But for the Governor it’s all about wealth and income.
Casual observation suggests that this change of trend in the growth of assets, or ‘wealth’, roughly coincided with the slowing in consumption spending relative to its earlier very strong trend. It seems fairly clear that these financial trends and the real consumption and saving behaviour of households were closely connected.
I don’t think there is too much argument with the link between consumption and wealth. There are many studies that show it. What I’d argue though is that “wealth” is a nebulous term, it is a stock, and for many Australians whose wealth is tied up in their houses and or superannuation it can be a stock that is hard to access. Certainly when house prices are rising steadily we are sitting on a cheque that we can cash through redraw and refinance. But when house prices stop rising, as they have recently, and look biased downwards, as they do now, coupled with poorly performing super accounts and global market instability I believe Australians are disaggregating their balance sheet in such a way as to focus on the here and now.
The here and now is the cost of living and paying down their debt. Sure a central banker or an academic can focus on net wealth, which is effectively net debt for many but the problem is that in my view Australians see the two as separate items. I’m fairly sure that the behavioural economists in and psychological testing that has been done in this discipline would back me up. Australians know they have super but that is years away and they also know they have debt which is here and now and must be repaid.
Who wants to pay off their debt with their super and then go on the pension? Not too many boomers or Xers would be my guess.
So we have a spending drought as the focus at present is not on income but debt and debt repayment.
You can see that Stevens has sympathy for this view when he explains the drivers of the excess consumption but he fails to extrapolate it to the next step in my view:
I would argue that the broad story was as follows. The period from the early 1990s to the mid 2000s was characterised by a drawn-out, but one-time, adjustment to a set of powerful forces. Households started the period with relatively little leverage, in large part a legacy of the effect of very high nominal interest rates in the long period of high inflation. But then, inflation and interest rates came down to generational lows. Financial liberalisation and innovation increased the availability of credit. And reasonably stable economic conditions – part of the so-called ‘great moderation’ internationally – made a certain higher degree of leverage seem safe. The result was a lengthy period of rising household leverage, rising housing prices, high levels of confidence, a strong sense of generally rising prosperity, declining saving from current income and strong growth in consumption.
I was not one of those who felt that this was bound to end in tears. But it wasbound to end.
End certainly, but why not reverse? Lets look at his check list.
It is clear that the so-called Great Moderation was academic premature extrapolation. It is clear that financial liberalisation and innovation has stopped and is being reversed by Basel III regulations and banks having to conduct business as usual as if it is a crisis, so the availability of credit too is reduced or will be. Crucially, where as households started the period of growth with little leverage the reverse is now the case as you can see in the chart below from the RBA’s chart pack.
No need for interpretation there – just look at the mountain of debt and the interest burden it carries with it. If we take Governor Stevens argument about the growth in incomes again we can see that even with rising incomes we have rising debt, thankfully it has halted recently, and rising interest burden. It’s not just about the outright growth in incomes.
Governor Stevens then goes on to discuss the mining boom and the structural adjustment that this is causing in the economy and I think it is fair to say he is taking an academic arms length view of things when he says:
…the change in the terms of trade, being a relative price shift, will itself occasion structural change in the economy: some sectors will grow and others will, relatively speaking, get smaller. That is particularly the case if the economy’s starting point is one that is not characterised by large-scale spare capacity.
But those pressures for structural change are also coinciding with changes in household behaviour that are associated with the longer-run financial cycles I have just talked about. Just as some sectors are having to cope with the effects of changes in relative prices – manifest to most of us in the form of a large rise in the exchange rate – some sectors are also seeing the impacts of a shift in household behaviour towards more conservatism after a long period of very confident behaviour.
That’s a bit like saying, its ok – it’s just a bit of skin off. It is also testament to how the RBA views the mining boom. Central tendency and its positive for them and I think they are happy that consumers are out-of-the-way.
How long will this spending drought continue, not too long according to the RBA because the savings rate has risen so far so fast:
So the adjustment in behaviour to what should be a more sustainable relationship between spending and income has in fact proceeded pretty quickly (which is presumably why it has become such a prominent topic of discussion). That in turn means that the time when more ‘normal’ patterns of consumption growth recur is closer than it would have been with a more drawn-out adjustment… It is entirely possible that, were some of the current raft of uncertainties to lessen, the mood could lift noticeably, so I don’t think we need to be totally gloomy.
I’ve bolded the bit that is the key point of difference I have with the RBA. That is, they still think it is all about the mining boom and income. They just don’t pay enough attention, in my view, the chart above of household debt and the interest cost of same. Why would it not be rational for Australian’s to reverse course, not just sit with the current leverage ratio or huge debt burden.
Indeed as proof, at least to me, that the governor and the RBA don’t get it, in answer to a question after his speech yesterday about consumption, Governor Stevens quipped that things can’t be too bad if we are still traveling overseas and spending online.
That may be true, but hasn’t he heard of a budget?
Australians are increasingly showing discretion in where and what they spend but in aggregate are spending less. Just look at the volatility in the cafe’s and restaurant section of the retail sales. If that doesn’t tell me people are saving up for a night out and then not going out again until they save up, then I don’t know what does.
Our grandparents would be proud, we are cutting our cloth to fit.