Newsletter for the Rotary Club of Western Endeavour - Issue No.: 881 Issue Date: 20 Oct, 2019

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The Banking Royal Commission, The Housing Crisis and Related Issues

It would be news to no one that after a long period of steady increase, house prices in Australia have been falling for the last 24 months.  But is this due to the recently completed banking royal commission, or was it the bubble bursting we had to have?  And have we seen the bottom already or is their further to go?  And finally, have the economists now got their stories straight about what is happening?

These were the matters addressed on the 4th of June 2019 when Curt McDonald gave a brief presentation to the Western Endeavour Rotary Club entitled, "The Banking Royal Commission, The Housing Crisis and Related Issues.

After a few remarks on his background and what economists actually do, Curt took everyone on a flying tour of these important economic developments and their implications for the future, particularly in light of the recent election results.

A few highlights:

  • The reason most economists missed the GFC ten years ago is because they are too focused on high-level, economy-wide matters to pay much attention to (or even understand) what is going on at ground level - in this case in the financial industry.
  • The scope of the Banking Royal Commission was too wide - and its mandate to politicised -  to really do a good job of fixing anything specific.  There were many piecemeal recommendations which will mostly be ignored.
  • The big banks were already starting to make it harder to borrow as the commission got going.  Damaged by the negative publicity surrounding the commission, they are now hunkered down, focused on improving customer relations - and their own image.   They will likely continue to significantly trim staff numbers. 
  • The cherished view of housing in Australia - borrow as much as you can and pay whatever they are asking, and (if you are an investor) negative gearing will save you from any mistakes - is over.  With almost the highest house prices (as compared to income levels) in the world, this was inevitable.  The only question now is how far do property prices have to fall?
  • While property industry spruikers and the media are heralding the imminent return of rising house prices, Reserve Bank research suggests that prices will continue to fall over the next few years - ie, we are only about half way to the bottom.  This is mainly because the most important driver of house prices THIS year is house prices LAST year.  This single rear-view mirror factor is many many times more powerful than interest rate cuts in driving house prices.
  • The recent election outcome was largely a vote for the status quo, namely that Australians are as yet unwilling to give up the notion that their weatlh - and this country's prosperity - are driven by borrowing and higher house prices.

What does the future hold? 

Although economists often know WHAT is going to happen, they even more often don't know WHEN.  Curt readily defers to this fine tradition.

There IS one thing we know with 100% certainty:  Interest rates over the next 20 years cannot fall again as they have over the last 20 years.   This is as true for Australia as it is for the rest of the world and this has major implications for housing and just about everything else in Australia's economy. 

The Reserve Bank's decision to lower the cash rate to historic lows mere hours after Curt's presentation may indicate his influence on contemporary economic thinking in Australia.  More likely is that people think the RBA is trying to prop up house prices. 

However, the real reason the RBA cut rates is because it knows that Australia's welfare rests critically on household spending, which amounts to roughly 2/3 of our economic activity in this country.  As households go, so goes Australia, and lower interest rates are meant to help households through a tough period as we find our economic way post the global mining boom.

At the moment, consumer (household) spending is weak.  Households have started to tighten up right around the place, spending less and saving more.  Unemployment is not that bad at the moment, but wages have not been growing in recent years.  If unemployment rises further, household spending will decline further, with the expected effect on house prices and many other aspects of Australia's economic performance.

The calvary is coming, though. 

State and Federal Governments are starting to help out the economy with major public works projects, as you may have noticed.  And the really good news is that Australian government debt at the national level is so low that the federal government has plenty of dry powder to do more. 

Exports have also started to increase, courtesy largely of higher iron ore prices, but also due to a softening of the AUD in the background.  This will also help offset lower household spending.

But with interest rates almost as low as they can go, the RBA has essentially run out of ammo.  All that is left for the RBA to do is help the AUD down further to incentivize more exports.  Hence Curt's prediction that we will see the AUD at 60 cents in the next few years, and quite possibly lower.

And so as always we are left with the bigger picture.

Will Australian bear the brunt of a global trade war?  Will China have a soft landing or crash and burn? Will Europe emerge from its post-GFC debt morass?  Will the US lead the global economy forward or will its own recovery stall?  These are the issues economists will be watching in the months and years ahead, which will in turn determine the fate of Australia.

Dwelling on these matters might confirm once again that economics is all gloom and doom.  However, economics is rather more about dealing with significant uncertainty in the most rational way possible.  As ever, the economic landscape we are travelling through is full of hills and vallies, opportunities and pitfalls.  Our mission - as economists and householders - is not to look in the rear-view mirror wishing we could go back, but rather to look forward realistically and pragmatically, and be ready to meet the challenges of each phase of the economic cycle, both long and short.

Forewarned is forearmed, and we must all get ready.

Finally, if you have not watched the movie "The Big Short" do it now, and get everyone you know to watch it, too.

Author: Curt McDonald

Published: 6 June, 2019

 


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