I’ve been pretty kind to the Reserve Bank of Australia over the years of this blog. I’ve criticised and praised at different times, on balance more of the latter. But now it’s time to deliver a serve.
One of reasons that I have been supportive of the bank is that I have been of the view that deep down it understood the challenges facing the country and was wrestling with them in its own slow, institutional way. The appearances of Glenn Stevens in 2010 in which he described the end of the credit boom era, warned against house price speculation, and clearly articulated banking architectural evolution were an intellectual and economic breakthrough for the country.
At the time I wrote a piece in which I offered a new definition for the credit reckoning process that the RBA was beginning. I titled it The Great Disleveraging and it argued that the lackluster credit growth of the period was:
…what the RBA wants to see. They have engineered interest rates to produce just this result. Australia’s new normal is that it can no longer rely on the accumulation of offshore debt to boost asset prices and consumption. The GFC proved that international markets can and will shut down. To persist with a large external imbalance is imprudent.
In short, despite there being to date no bust in housing, Australia’s economy is in a post-bubble adjustment.
Normally, such adjustments are achieved through a long a painful process of deleveraging and growth out of the debt through increased competitiveness, generally via a falling currency (or, in Europe’s case, general deflation).
To date, Australia has rather been able to outgrow its bubble because of the income flows and business investment emanating from the iron ore, coal and LNG booms.
To describe this as lucky hardly seems to credit it.
Where the rubber really hits the road for the RBA, however, is in mortgages. The great experiment, of outgrowing a huge bubble without having to deleverage, hinges ultimately on the housing market.
There is never a stasis point for capital-growth asset markets. Or so they say. Such markets are either going up, as more people borrow ever more amounts, or they are going down as fewer people do so and price falls beget selling on capital loss capitulation.
…Counter intuitively, this blogger has been of the view that a plateau in property prices is possible, for the reason that the bubble psychology in Australia is so entrenched that, supported by strong employment from the commodities boom, investors will look through weakness in the mistaken belief that they will make later gains.
There is evidence here that to date this is happening. In 34 years, mortgage credit growth only briefly dipped beneath 10% in the eighties. Yet it has now sat below that level for nearly three years without collapsing. Let’s call this disleveraging.
There is also evidence at the macro level that this disleveraging is working. At the conclusion of the 06/07 financial year Australia’s debt to GDP ratio was 164%. The next near it was 171%. The last two years it has shrunk first to 160% in June 08/09 and at the end of last financial year was 153%. You might choose a different data mix but the trend is clear.
The RBA did do well. It used the mining boom to contain credit growth and interest rate management to rebuild the liability side of the banks’ balance sheets without blowing them up. It was an episode of spectacular economic management; a soft landing for both a housing bubble and a spectacular current account vulnerability.
But they overdid it. They left rates too high for too long, egged on by a local flerd of bullhawks and spooked by inflation they let the dollar run riot. And when their rosy mining boom forecasts began to unravel at the end of 2011, they still didn’t get it, supporting the high dollar for months and months while ignoring what common sense was telling those who could listen, that the capex boom was going to go bust as the Chinese slowdown became permanent.
Ultimately they slashed interest rates with no effect on an economy moribund under the weight of a super-high currency. Finally, mid last year, much deeper into an easing cycle than we’ve seen before, housing began to take off. Later, far too late, the RBA began to focus on bringing down the dollar. Eventually they cut rates enough and a jawboning campaign that should have begun eighteen months earlier worked superbly late last year.
This year began with the hope of more. However, the bank’s two most recent documents – the Statement on Monetary Policy and yesterday’s minutes – show diminishing concern about both credit growth and the dollar. What’s been unleashed in credit is rapidly reversing the great achievement of the great disleveraging, yet the bank has offered white-washed housing analysis that only the vested interests believe. I take no comfort from the argument that credit is growing more slowly than past booms and only responding to low interest rates as planned. House prices are rapidly approaching record highs on affordability multiples and the asymmetric risks building in the nation’s two largest housing markets via intensive investor borrowing are exactly the same as those that the RBA itself described as a bubble in 2003.
Worse, the RBA’s 2014 communications have expressed a fatal complacency about the dollar. In committing to vague forward guidance about long term stability in rates they’ve removed the barrel over which they had speculators bent. There’s no need to fear playing a simple risk on, risk off game in the Aussie any more. It was a major blunder.
The RBA will counter that I am furnishing it with too much agency, that they only respond to signals in the economy, obeying the rules of their charter and economic theory. They will claim transcendence, a mindless machine, not responsible, only reactive. It’s the economy that makes the decisions, don’t you know?
There’s a little truth in it, especially in the sense that Australia’s warped tax and planning regimes favour certain assets, but only a bit. We all know that interest rates determine investment flows and the RBA controls them. They could have installed macroprudential tools like many other central banks around the world and ensured their rate cutting cycle was tipped more towards the dollar than local assets and prevented the headlong rush into risk we are currently witnessing.
But they didn’t and now I fear it is too late to do so. Any move to rein in asset markets over the next three years (via rate rises or MP) will simply deprive the economy of its only source of growth and expose it fully to what lies beneath, collapsing business investment and ongoing tradable carnage. Asset markets are quickly running too far ahead while the still strong dollar robs us of the stimulus that we really need.
We’ll get there in the end, an overly strong currency ultimately guarantees the reverse, but at that point it will be extraordinarily expensive and painful to rebuild what we’ve lost and the RBA will be to blame.
