Why Australia’s Housing Bubble Will Only Get Worse

Today’s Money Morning is brought to you by regulatory failure. It seems that Australia has spent the last six months so focused on lamenting the rise of Donald Trump, that we’ve ignored the utter ineptitude of our own state of politics.

Where to start?

How about with the Victorian State Government, led by Daniel Andrews.

From news.com.au…

VICTORIA has thrown a lifeline to young people struggling to get on the property ladder by axing stamp duty for first homebuyers.

From July, the controversial property tax will be abolished for any first homebuyer in Victoria whose property costs less than $600,000.

There will also be discounts for properties worth between $600,000 and $750,000, regardless of whether they are new or existing.

Premier Daniel Andrews will formally unveil the plan today, which is expected [to] save 25,000 first homebuyers an extra $8000 a year, as a part of his government’s cost-of-living package.

More realistically, the government has thrown a noose to young people to hang themselves with.

Why? You could say that the government’s move is idiotic, and argue convincingly that this move will simply push prices up by the amount of the stamp duty cut.

But it’s much worse than that.

Do you think these politicians are ignorant of the fact that any stamp duty cut will immediately capitalise into higher land prices?

I think they know full well how this will play out. They just don’t really care. When it comes to politics, it’s all about style over substance. It’s about looking like you’re doing something, while getting the maximum political benefit.

In this case, the government wants to look like its helping first home owners by cutting the expense of buying a house. But it’s well known that this saving will immediately translate into higher prices for houses in that price range.

As the Financial Review reports:

“The idea of the initiative is well-intended but I think it’s going to be a disaster,” said Wakelin Property Advisory’s Paul Nugent.

“It’s going to lead to tremendous capital growth in that sub-$600,000 sector. It basically becomes a grant to the vendors more so than the purchasers.”

Pushing prices up means more housing stock will rise above $750,000, increasing the government’s overall tax take.

It’s a win-win for the government. The only losers out of this are the people the government pretended to help in the first place.

It’s pure — evil — genius!

Housing Bubble

Meanwhile, the major housing markets of Sydney and Melbourne continue to bubble over. Thanks to ultra-cheap money, demand isn’t going to pull back anytime soon.

To really put a dent in the housing market, the RBA would need to raise interest rates a couple of times. That’s just not going to happen while official inflation measures remain subdued.

Remember, our venerable central bank caused the boom by lowering interest rates to unprecedented levels. This caused Australian households to take on record levels of debt, increasingly the fragility of the economy.

As I’ve argued previously, at the moment the economy looks strong…and it will more than likely continue that way for the remainder of the year, at least. That’s because strong commodity prices have, in effect, given Australia a pay rise.

Get this: Nominal economic growth for the December quarter came in at 3%! It’s up over 6% for the past 12 months. This ‘nominal’ rate takes into account the higher prices received for exports, and is a more realistic measure of the strength of the economy.

In a highly leveraged economy, this kind of income boost works very well.

But if the RBA thinks the big rise in commodity prices, particularly coal and iron ore, is fleeting (and I think they do at this point), then they will resist the urge to raise rates until visible evidence of inflation emerges.

I’ve argued before that the RBA should not have cuts rates twice last year. There was simply no need to keep cutting when the commodity market had started to turn. As such, official interest rates should be at 2%. If that were the case, house prices in Sydney and Melbourne would be more subdued.

Instead, we have state governments compounding errors made by the central bank.

If you’re hoping for a collapse in property prices, you could be waiting for some time. For a bubble to pop, it needs a catalyst. Usually, that catalyst is rising interest rates.

In my view the RBA will err on the side of caution this year and raise rates only very gradually, if at all. They know they’re created a housing market monster. Apart from export led growth (which contributed 0.2 percentage points to the December quarter growth rate of 1.1%) nearly all of Australia’s growth comes from interest rates sensitive sectors.

That is, households spending strongly based on the wealth effect of higher house prices (the sector contributed 0.5 percentage points to growth in the December quarter) and housing construction (which contributed 0.1 percentage points to growth.

If they raise rates too aggressively (and by that I mean by more than 50 basis points — two increases of 25 basis points each) it will impact growth considerably.

So while I think house prices in the big cities of Sydney and Melbourne are crazy, the nature of bubbles is that they can go on for much longer than most people believe possible.

When trying to analyse asset prices of any kind, you can’t allow your personal beliefs to get in the way. Just because you think prices are outrageous doesn’t mean they have to immediately conform to your beliefs.

When the US housing market blew up in 2007/08, it was the result of the Federal Reserve raising rates 17 times (25 basis points each time) from 2004 through to 2006.

The RBA will do nothing like this. More than likely, with the politicians we have in Australia, the bubble will just keep getting bigger and bigger.


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