Gerard Minack: “A recession in Australia is becoming more likely”

By Leith van Onselen

Independent economist Gerard Minack has released a report explaining why he thinks “a recession in Australia is becoming more likely”.

In the report, Minack notes a number of downside risks, including:

  1. The accelerating decline in dwelling values;
  2. The accelerating decline in building approvals;
  3. Leading indicators of employment are weakening; and
  4. The negative wealth effect.

While these factors are nothing new to readers of MB, it’s Minack’s analysis of the household savings rate that is most alarming:

The evidence from other economies is that household saving rates typically keep falling for around a year after house prices peak relative to income. The adverse wealth effect – when household saving starts to rise – normally hits a year or two later.

Exhibit 7 shows the change in household saving rates around the house price/income peak for Australia and a selection of economies that saw significant house price declines in the GFC. On average, the household saving rate increased by 3½ percentage points over an 8 quarter period, starting one year after the peak in house prices.

Australia is toast if it follows that pattern. Exhibit 8 shows what would happen to real consumer spending if the household saving rate rises by 3½ percentage points over the next two years. I have assumed that real household disposable income continues to rise by 1½%. Of course, that would be too optimistic: income growth would weaken if consumer spending – which accounts for over 55% of GDP – started to weaken as this scenario implies.

This illustrates the point that the wealth effect alone is capable of causing recession. The uncertainty is whether the wealth effect kicks in as powerfully as in this simple example. If the recent pattern of macro weakness – in house prices, building approvals and hiring intentions – continues, then I will make the bet that the wealth effect will cause a recession in Australia, most likely later this year.

The below chart shows the four drivers of real final demand:

As at September 2018, these drivers were:

  • Household Consumption: 57% share;
  • Dwelling Investment: 6% share;
  • Public Demand: 24% share;
  • Business Investment: 13% share.

Dwelling investment is now falling, and will subtract from growth over the next few years:

Whereas infrastructure investment to peak at $40 billion this year and then fall into 2020:

However, as pointed out by Minack, the big kicker is household consumption. Consumption has so far held-up by falling savings amid weak income growth, which is clearly not sustainable:

As the savings rate normalises, it will necessarily drain on household consumption, removing Australia’s key growth driver and raising the real prospect of recession.

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Leith van Onselen
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  1. But, but, savings don’t matter! Lower da rates and borrow more money ! Deficit spending is where it’s at, bro!

    – Signed the entire Economics establishment.

    What a joke.

    • Housing values were based on real values, house prices couldn’t crash unless we saw a rise in interest rates or unemployment and the fundamentals are sound they said?

      • So all that their ‘models’ said couldn’t / wouldn’t happen …. is happening. Funny that.

        Will that cause them to reflect? I doubt it. The models are right, dammit!

    • Don’t exactly know how this disaster will pan out but here’s my 2 cents worth: Too many vested interests in ZIRP and NIRP and continuing the current deficit spending bonanza despite evidence in regions like the EU and countries like Japan it does not work, it’s actually a giant policy failure of the economics industry. Europe’s best survival will be to decentralise (oh dear that taboo word….decentralise) and return to it’s respective nation-state currencies and I believe Italy will be the first to follow this pathway during some sort of debt moratorium (that no vested interests want to discuss) during the next few years. The vested interests will do whatever they can to retain the status quo (as Draggi has already alluded to) and attempt to prevent “populism”. However, the vested interest status quo are backed into a corner because (as has already been proven) NIRP and ZIRP increase inequality of income and actually cause & increase populism. Populism demands a return to the long-term interests of ordinary voters…..and that my dear Watson’s….require a change of monetary system. So those advocating for lowering our already emergency low interest rates further in Auz may like to view the disaster of that policy begin to play out in Europe this year. Politics will now begin to determine the outcome of failed economic policies…hence the rise of populism.

    • CaptainFeatherSwordsGhost-TheHaunting2

      and where exactly does all the money come from to pay for said infrastructure ?? Oh, taxation. Tell me more about your circle jerk economics.

  2. Interesting chart, that comparison between Australia and GFC-hit economies.

    I wonder though, if those other economies saw savings rates increase more promptly because everyone there KNEW there was a crisis. It was all over the news and the politics.

    Whereas here it’s not at all clear many people think we’re in a crisis. Could take many more months before the herd even accepts that house price falls are not going to rebound fast.

  3. As another tidbit of information – Treasury forecasters say that they don’t really model household debt and savings rates. It’s more a residual/plug number in heir models.

    Those blokes will be really blindsided once we run out of rainbows and cop a good firm jab up the butt.

  4. The wife and I have made a more concerted effort to save recently, say over the past 6 months or so, no defining moment it just came about – prevailing winds maybe. We don’t budget per se, just watch what we spend and amazingly we’re getting by without daily cafe coffees and weekly Westfield trips. Interestingly several friends have started doing the same, fewer coffees and restaurants, dropping gym membership etc. – I feel like discretionary spending is going to fall hard. It is funny how subliminally we’re influenced by events

    • I went to Westfield yesterday in Burwood NSW. It seemed quiet compared to other times. Saw cooking stuff like pots and pans for $200+ and knife sets for similar. No wonder retail is dead. It looked like a closing down sale. This stuff was $500-$600 before mark down of 70% or so.. still too much for my liking. I’m no chef, but seemed over the top to me.

      I’m saving as much as possible right now. Have been for ages.

      • Same down in the shire. Plenty of parking at 11 am, not too many annoying kids running around, got a seat at the cafe and noticed people mainly drinking coffee and juice, not indulging in a $20 big brekkie … rough times ahead indeed.

      • MMM bought a habitable house for like $70k and retired to live off investment earnings. Unpossible in Straya. 70k doesn’t even get on a caravan park spot.

        I think MMM later un-retired, for the heck of it. good bloke, I liked his stuff when I read it back i the day.

      • I did it in Australia, “retired” in 2010. I know people doing it now. Its actually probably easier now because you can arbitrage your house. If you bought a house 10 years ago, you can sell it for $1-2M and go retire in a small town where you can buy a house for $300k and put the rest into income producing investments and never need to work again.
        PS. “Retired” doesnt mean sitting around doing nothing, it means being free to do whatever you feel like doing, without worrying about whether you are going to be paid enough to do it 🙂

      • Thanks Kiwikaryn, I’ll give it a read, I agree retirement from working for others doing things you don’t like in order to pay the bills is different to being completely retired. I still want to work myself, but doing things I enjoy doing because I feel like doing them and also having more time for leisure.

      • It’s a movement called konmari as well. Throw out all your old stuff, realise you have what you need, shop less. I’m sure retailers are quite annoyed at the worldwide craze.

      • Mining BoganMEMBER

        Read that blog a lot before I dropped out of slavery back in 2015. I hadn’t noticed it but I had been living my life much like that anyway…even down to the target of saving 25 × spending. Part time work and a bit of luck since has turned that into 30 times…plus I enjoy the job because I know I can walk away at any time I like.

        Everyone should have it saved to favourites.

      • Great KK. It’s a great idea if you can buy yourself a house… 20 years ago and make $2m out of it.

        Lololol. How about some more practical tips?

      • Sometimes; the best investments are the ones that you don’t make.
        Particularly with the likes of a wife, long term girlfriend and/or kids.
        Not only are they expensive to service but should she decide that she doesn’t love you anymore, a court can decide that half of your hard earned stuff is now hers.

        As they say in the classics; if it floats, flies or, you know … hire, don’t buy.

  5. Surprised Gerard took this long to pick this point up. I’ve been making it in my PowerPoint presentations to clients since Jan-18. It’s obvious and simple arithmetic. My argument has been less dire than this. All you need is household savings to stabilise while real disposable income remain 1.5%y/y and you have a really big problem.

    RBA forecasts have been illogical for a long, long time.

  6. Gavin HegneyMEMBER

    One persons spending is another persons income is timeless . Don’t forget the reset of interest only loans to Pand I on top of this . Seems the only $ coming the other way are wage increases ? and interest rates down ?

  7. You cant ignore the possibility that credit growth will accelerate again.

    Royal commission is finished, banks may slowly lower their lending policy requirements and money will start flowing again to home buyers.

    • ASIC will need to drop this talk of legislating against HEM first.
      Generally speaking, I think the banks are feeling a need to let the heat die down before they open the credit floodgates again. Can’t see it happening before the election has pushed them out of the news good and proper (and I think there are a few law suits coming, so that might need to be dealt with also).