ECONOMY: by Colin TeeseNews Weekly
The housing boom: history repeats
, August 23, 2003
Question? What's the difference between inflated US share prices and the Australian housing boom? Answer: Almost nothing.
What is happening in Australia with housing prices and our government's response to the boom is eerily similar to what has happened in the US with escalating share prices.
More needs to be said on these issues, but first let's understand what has happened in the US following the boom and bust in share prices. That particular bubble was allowed to proceed unattended to bursting point.
After two years, the consequences of the bust are yet to fully work themselves out of the US economy. The immediate result was a savage collapse of the price of shares.US$7 trillion in losses
How about the fallout? Well, the value of US stocks has already fallen by some US$7 trillion, and most experts are convinced that the bottom of the market is yet to be fully tested. To put the figure into perspective, that amount represents the biggest setback to US wealth in the nation's history. It is, for example, an amount greater than the country's outlays on World War II.
But that is not the end of it. In one sense, it could be said that shares losing the inflated element of their value is no bad thing. Some investors, especially those who borrowed heavily, will be badly burned, but will there be any adverse fall-out for business?
Unfortunately, yes. Those burned by crashing share prices will necessarily become cash strapped consumers. And the shrinking of their buying power will flow on to business.
Overall, the effect will be to slow growth in an economy which - like ours - depends utterly for its sustained growth on healthy consumer spending.
Business can't escape the fallout. Those companies which have borrowed heavily against the inflated value of their shares will find trouble in servicing their loans as consumer demand slows. The US Central Bank's response has been to keep interest rates low, allow the US dollar to drop in value, thereby hoping to trigger an economic recovery.
The thinking goes like this. A lower US dollar will make US manufactured exports cheaper, create jobs in the US and thereby help the economy offset the fall in consumer spending occasioned by the collapse in share prices.
The trouble is that - again like Australia - the US has allowed its industries to run down as US consumers became addicted to more and ever cheaper imports financed by offshore borrowing.
The fundamental problems for the US is that new industries cannot be created overnight; moreover, their success depends upon investment now to realise returns some years later. And while the dollar may be low now thus making imports dearer and US output more competitive overseas, two years from now can business be certain where the dollar will be? What company, in a down market, will gamble investing against the prospect of such an uncertain future?
In any event, will US consumers come to the party? The low dollar condemns them to paying more for their consumer needs - whether US made or imports. US companies may indeed be more competitive with imports, but part of the reason for that will be that imports are more expensive.
So US consumers, already over-stretched on borrowings, may be forced to further draw in their consumer horns.
It's hard to see how any of this can do much to improve the health of the US economy.
So what about Australia? For reasons which we need not consider here, what the US has done with share prices, we have done - and are continuing to do - with housing prices. The only difference is that the bubble on our house prices has not yet burst. There are those who insist it will not burst, and still others who say, "Even if it does, so what? The market created the bubble, leave the market to correct it".
At one moment these positions retained a ring of credibility - certainly in the US. Those views are precisely what the Chairman of the US Central Bank, Alan Greenspan, is on record as proclaiming, while the share bubble was in full flight. He didn't believe, he said at the time, that he could or should do anything about it.
Understandably, he has retreated from that position in recent times, as the full impact of the burst share bubble eats its way into the US economy. Greenspan is now saying, "We don't know as much as we would like about the operation of financial markets".
What he is really admitting through the back door is that markets can fail, but we don't know whether they have until after the failure becomes obvious.
Greenspan's experience is a lesson Australia's over-exuberant defenders of free market economics might well heed. The free operation of the market does not always - or even usually - deliver long-term equilibrium or stability. Mostly it needs the help of a steadying, intervening hand.
As things stand - and based on the US experience - we need to relearn the basic economic proposition: too much money chasing too few goods pushes up prices, as much in housing as it does in cars or toothpaste.
The vexing problem for policy makers wrestling with our housing problem is that their sole instrument of choice - interest rate movements - is not open to them.
If our Reserve Bank puts up interest rates to contain the housing boom, it could plunge the rest of the economy into a downturn. Equally important, growth generally might itself be heavily dependent on a continuing housing boom. So just like our US cousins, Australian policy makers are all out of suitable levers to pull.More dependent now
Our situation is very interesting. Despite all the talk about our industries being driven to international competitiveness by the removal of industry protection, we are as much - or more - dependent upon domestic consumer spending for the generation of economic growth as we were 30 years ago. Then, as now, we measure our economic health in terms of increases in housing starts, car sales and retail spending.
The real difference between then and now is how we fund this consumer demand. Once we used imports of both goods and capital to fund our own manufacturing sectors, and used our export sector to generate the foreign exchange needed to pay for necessary imports. We bought what we produced with borrowings we could afford.
We now run our economy on an entirely different basis. Our manufacturing industry has been run down to the point where it is among the lowest of the developed world.
Consumer spending - still the backbone of our economic growth - is now funded, not by our own productive efforts, but by foreign borrowings. On one of the most recent counts, we were borrowing A$38 billion each year to fund consumption.
Substitute shares for housing and our situation is strikingly similar to that of the US - except for the fact that their growth sustaining boom has burst and ours is still bubbling.
There are two other important differences. US foreign borrowings - admittedly excessive, are denominated in US dollars - a currency they control. Ours, too, are similarly denominated in $US. The difference is the US can print money to pay its debts, we must earn $US to pay ours.
So where are we at right now? Well, the warning signs have hit the Government with an election on the horizon. An inquiry has been called by the Treasurer, not so much to find solutions, but to turn blame away from the Commonwealth Government.Deflect blame
The inquirers have been invited to consider, in particular, the impact of State taxes on housing costs. In this way our Treasurer hopes the outcome of the inquiry might give him the chance to deflect blame onto the States. He is unlikely to succeed.
By far the better solution would be to face up to the problem of housing price inflation and deal with it. But that is not easy. It will require a return to measures relating to the amounts of lending available for housing.
Moreover, other consequential regulatory measures would also be needed. Maybe something could be done in terms of taxation, though not, in this writer's opinion, by fiddling with negative gearing arrangements. Perhaps it would be better to revisit the issue of capital gains?
But all of these measures would be palliatives. Longer term, the fundamentals of our economy might have to be rethought. At the very least we will have to consider measures to re-establish manufacturing industry as a driver of economic growth and job creation. With such a large body of unemployed, it is asking too much of employed consumers - and their consumption of cheap imports - to sustain the entire economy.