We’ve been banging on the property bubble drum for some time. As the old movies will tell you, you’re safe until the drums stop beating. Well, we’re going to beat them for a bit longer because the bubble is still expanding, but I’ll get back to that in a moment.
First I want to explain the secondary reason why we’ve focused so much attention on the property bubble. Sure, when house prices fall and the unemployment rate rises even further, things are going to get pretty bad, but…
It will be nothing compared to what the property market is showing us about the effects of inflation.
In recent months many commentators, economists and analysts have scoffed at the idea of government stimulus programmes being inflationary. They’ve trotted out some fairly typical reasons why it couldn’t possibly lead to inflation.
They’ve said the economy is moving into recession and therefore prices will fall not rise. They’ve said that with all the money that has been lost in investments any increase in money supply will be inconsequential. And they’ve said “inflation? That’s just ridiculous, it’s not important right now, we’ll worry about that in a couple of years.”
Their clear argument is that you can increase the amount of money in the economy and that it won’t increase demand or prices. If you accept that argument then you must also accept that increased demand for the same product leads to lower prices and decreased demand for the same product leads to higher prices.
Such an argument turns the laws of supply and demand on its head. It doesn’t work that way. In any market where there is more money it must necessarily lead to higher prices for goods.
Proof of that is in the housing market. The extra supply of money by government to first home buyers has pushed up house prices in the low to mid range of the market. If sellers know there is more money around they will demand a higher price. And buyers will have more money in which to bid a higher price.
It’s nonsense to suggest that if someone is given free money that they won’t use it to their advantage to pay extra for the goods they are bidding for.
It is exactly the same in the rest of the economy. As the government borrowers to spend, and borrowers to bribe, it is adding more money into the market than there otherwise would have been.
You see, when an economy contracts people will generally spend less. Because of this, companies have to cut costs, lay off workers and inevitably they will not produce as much.
But if while that is happening you suddenly have a government interfering in the market to spend money which others have saved it distorts the demand. Because there is less supply but now an excess in demand, the government spending will only succeed in pushing up prices.
Everyone else with limited resources will find they will have to compete against the government with its unlimited resources. Prices will rise even though the economy is in recession, and the knock-on effect will cause even more hardship to those having to pay higher prices.
This then has a self perpetuating effect on the economy and inflation, as buyers see prices rising and rush to buy before prices rise even further. And it may not necessarily lead to more employment either. If businesses are also faced with rising costs of production, their ability to hire new staff to meet the demand for their products is also limited.
It is perhaps unthinkable that such extreme consequences could happen in a modern economy. However, policy makers, backed up by mainstream economists are succeeding in making the kind of mistakes that are inevitably leading us down that path.
Property Bubble Close to Bursting Point
Quickly back to the topic of the first home buyers bribe. There were two charts in the Fujitsu/JPMorgan Australian Mortgage Industry report that haven’t received much attention in the mainstream press.
People in the survey were asked two important questions:
- Can you afford to enter the market? And…
- How important is the first buyer grant?
Below are the charts comparing the answers given in February 2009 to those given in June 2008…
There’s the shocking evidence. Many property spruikers have tried to argue that it is the fall in interest rates that has attracted first home buyers, and that the government bribe is just a bonus.
If you take the first chart in isolation, then you could reasonably come to that conclusion. After all, the repayments on a $300,000 mortgage twelve months ago would have been around $2,500 per month. Today they are closer to $1,800 per month.
That’s a $700 saving. Although it isn’t really is it. Because twelve months ago, these first home buyers didn’t have a mortgage. They were either renting or living at home. So they aren’t ‘saving’ $700 per month at all. They are taking out mortgages on property values that have yet to fall in the low to mid range of the market.
Plus, as the recent numbers from the Australian Bureau of Statistics revealed, while the average mortgage across all borrowers has decreased slightly, the average mortgage for first home buyers has increased by 6%.
In other words, they are paying top dollar and borrowing as much as they can.
But it is the second chart that blows away the argument that the bribe is just a ‘bonus.’ Nearly 60% of respondents say the bribe is “vital.” And if you take ‘vital’ and ‘very’ combined, it tells you 80% of respondents are relying on the bribe in order to buy.
Or, to put it another way, without the bribe they most likely wouldn’t be in a position to buy at all.
But it doesn’t look as though the bubble will burst just yet. With all the spending and bailing out going on, it’s unlikely that the government will completely abandon the topped up grant. That should give the property market a little more of a kickalong.
But just like any ponzi scheme that is built on a distorted supply and demand, the eventual effects will be a massive slump in demand and price.
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