Memo to RBA from former self

Former RBA senior economist Jeremy Lawson has delivered a gentle rap across the knuckles of his previous employer for the state of housing, albeit with the insistence that it wasn’t mendacity but rather an underestimation of the ‘investor pulse’ in Australia that led the RBA to sit by while housing market inflated. I have covered the rise of the Australian property investor here, so it goes without saying that I mostly agree with his appraisal.

Much has been written this week about Stevens’ ‘backflip’ on macpru regulation, centred on his somewhat flippant description of these tools as an international ‘fad’, just last month. What he actually said was;

As for what one does about (the boom in property investment in Sydney and to a lesser degree Melbourne), apart from just warning—and the warning is probably ignored—I think the next step is to then press through the supervisory mechanism for the lenders to know who they are lending to, take care, keep giving the message about leverage and take a close look at standards of lending. APRA already has been communicating with banks about those types of issues, and I imagine we can probably step up that scrutiny and make it a little bit more targeted if it is appropriate to do so over time. The strongest step would be the dreaded macro prudential tools—they are the latest fad, internationally. And I have said that I do not rule out the use of those or asking if APRA will use them, if needed. That would remain on the table as a possibility as well.

His choice of words was unfortunate. He wasn’t wrong that macpru policies have gained popularity in the international policymaking community in the wake of the GFC, however this was a necessary response to the catastrophic failure of conventional thinking on central banking and macroeconomic management that resulted in the crisis. So macpru is no fad, at least I certainly hope it’s not. But despite his seemingly dismissive tone, Stevens clearly had not ruled out the dreaded macroprudential tools.

Returning to Lawson’s comments, the one criticism I think can be fairly levelled at the RBA over its lackadaisical approach to housing is the failure to learn from recent history both here and abroad. As I have detailed previously, the past two decades have deeply implanted the notion in many Australians that property speculation is a low-risk, high return investment strategy, and understandably so. There have been persistent warnings of the dangers of leveraged property bets, and none of these ‘doom-mongering’ exhortations have been vindicated (remembering, of course, why this has been the case). Therefore, as the RBA pushed the real cash rate into negative territory, it should have been acutely aware of the high probability that this would ignite another investor surge in the property sector. It would have been entirely appropriate to deploy some manner of macpru tools before the cash rate was dropped as low as it was. Whether these would have worked, we do not know. But as Stevens has belated accepted, there was little downside in trying.

Shining lights in the darkness

Michael Pascoe and Adam Carr have both come out swinging as a mood of foreboding supposedly descends upon the nation. Carr is sounding increasingly unhinged as he lambasts everyone from ‘property doomsters’ to our esteemed policymakers. What can you say? Anybody who declares property investment a no-brainer under any and all circumstances has obviously done their credibility a disservice (remembering the extreme historical anomaly that Australia’s experience with property have been over the past two decades).

Both commentators are chiefly concerned with the ‘Hanrahan chorus’ wailing about imminent collapse. The point being, either Australian property is heading for a US subprime-style meltdown, or it’s fine. Reality is a little more nuanced than this simple bifurcation implies. As the RBA’s Financial Stability Review showed, Australian banks are not engaging in the scale of risky lending that has characterised other property bubbles. So the risk of a complete systemic meltdown seems remote. But this doesn’t mean that having a property market in which median prices are over 8 times incomes and investors account for over half of mortgage issuance, as in Sydney today, is a good idea. You can still seek to optimise economic policy outside periods of imminent doom.

Moreover, there are considerations regarding property that go beyond the threat to financial stability. Australia is in the grip of the most serious downturn in national disposable income in at least three decades, perhaps much longer. The household debt-to-income ratio is stable but high (having risen slightly in the past couple of years). This situation can easily deteriorate as incomes fall, however, either through loss of purchasing power if the nominal exchange rate keeps falling, or rising unemployment if it does not. So it ought not to be too controversial to highlight that it’s undesirable to have a seriously stretched residential housing market at this point in our economic cycle. 

Macpru is therefore an eminently sensible option. If it totally fails, and if the housing market continues to march inexorably higher, then we may have to countenance higher rates. But the hurdle is very high for higher rates, since as I have mentioned a number of times, nothing else aside from the speculative end of the property market argues for them.

Bounce in steel, iron ore to end the week

Better news in the steel-ore complex today, with futures up in China; a welcome end to another dour week.

Ugliest of all this week was news that growth in crude Chinese steel consumption in has ground a halt this year, for the first time since 2000. The mantra in the iron ore industry is that the 2014 rout has been a supply-side phenomenon; demand is fine. However, the assumption driving higher iron ore output was that Chinese steel consumption had much further to rise. So flat steel consumption, and therefore relatively weak growth in seaborne iron ore demand, is what has made the iron ore supply ramp-up into a problem.

Unless spot stages an almighty rally today, this will mark the 7th straight week of declines. China’s National Day ‘Golden Week’ holidays begin on Wednesday, running to the following Tuesday. There’s a fair chance we see a bit of restocking activity once that’s out of the way, but unless the government the signals a meaningful shift in policy that will reinvigorate demand for steel, the Q4 rebound is likely to be underwhelming this year.

Friday Muzak 

Because econ can wear you down after a while…