The Aussie Housing Slump. Gee, Thanks Banks!

The latest in US interest rates

Jerome Powell, who’s head of the US central bank, the Federal Reserve, said rates will be steady. The Fed is going to be patient about any future decisions.

Powell talked about economic cross currents. You know, stuff like trade tensions, government shutdowns and what not.

As a result, there is ‘no pressing need’ to change or rush on what might happen next. Powell basically told the world: let’s take a break and see what happens from here.

Why is this important?

Some might view it as important because of its implications for financial assets. Things like stocks, bonds and real estate are all sensitive to interest rate changes.

The common thought is that when interest rates rise, it’s bad for prices and when rates fall it’s good for prices. It’s got something to do with the amount of encouraged borrowers in the economy.

It’s why when Powell said rates will remain steady (and not rise like we all expected) stock and bond prices went up.

But what if I told you Powell and all the other central bankers have little to no effect on asset prices? What if the mainstream financial media has it completely wrong about what makes people borrow and invest?

It wouldn’t be the first time I guess…

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What do changing interest rates mean?

Small changes in the interest rate don’t mean a damn thing!

It’s not lower interest rates that encourage people to borrow and invest in an economy. It’s the level of perceived risk and uncertainty that either encourages or discourages those borrowers and investors.

Former Columbia Business School Professor, Bruce Greenwald, sums it up (my emphasis):

When you look at firms, I think, one of the things that we teach people, and will continue to teach people, is that interest rates matter.

There is enormous discussion of interest rates. They do matter for the distribution of income but nobody has ever been able to detect an interest rate effect on demand for investment or household savings.

That risk perceptions dominate among institutions, their concerns in making investment decisions.

What that means in turn is that when you talk about monetary policy you cannot talk about it in the abstract. Monetary institutions matter a lot. The institutional form of banking systems matter a tremendous amount.

I think it’s fair to say that across the world, whether it’s Abenomics, the European Central Bank or the US Fed, there is no significant evidence that they’ve had a positive effect. In fact, how they defend themselves is “ohh, if we hadn’t done this we would have had a depression”.

But again you can look at countries that didn’t do it and they didn’t have depressions. Successful monetary interventions with the institutions we now have in place do not look like traditional monetary policy.

They look like what the Swedes did in the middle 1990s when they had a tremendous problem, what the Koreans did in the wake of the Asian crisis, which is direct recapitalization of the banks.

What matters a whole lot more than central bankers are commercial bankers. The Big Four in Australia are responsible for a large majority of the money creation down under. And make no mistake, this is newly created money they’re handing out. Not cash from depositors.

The sad thing is these commercial banks have the privilege to create money. Yet they were never given any guidance on what constitutes good money creation.

I think you’d be hard pressed to find anyone that doesn’t believe banks shape an economy. The creation of money plays an integral role in what businesses and investments get funded.

But when newly created money is given to homebuyers, market speculators or debt-laden companies, it does more harm than good. That’s because these are consumption loans, not value-adding loans.

By value-added, what I mean is an activity that creates new goods or services.

The latter is what makes an economy grow. The former just creates too much money racing after a fixed amount of goods or services. It’s how we get inflation.

Then you get someone like Brian Hartzer, CEO of Westpac Banking Corporation [ASX:WBC], saying the banks are not to blame for the housing slump.

If I can borrow a line from McEnroe…

You cannot be serious Brain!

Last year, housing prices in Sydney and Melbourne dropped 9.5% and 8.2%. With even tougher serviceability standards about to come in, Aussie property might fall 25–30% from their peak, according to the Australian Financial Review.

And why is that?

Because banks created far too much money for consumption activities. Stuff like buying houses and other fixed assets.

It’s why from 2011–17, Aussie property seemed like a sure thing. Prices in Sydney and Melbourne jumped 75% and 55% in that time.

Where were the first home buyers and investors getting all that coin to buy these houses?

From banks like Westpac, Brian!

As long as borrowers passed the standard serviceability test, banks continued to create money for non-productive means. They’d get their interest payments either way, so what did they care?

What comes next?

A possible solution to this is actual direction.

I’m not talking about Soviet Russia or Mao’s communist China. The last thing I’d want to do is limit peoples’ freedom and tell them what to do.

But if we’re going to have a market for money creation, one that shapes our economy, why not have some helpful rules? Surely, we don’t want anarchy down under?

One of those rules could be a ratio. Define value-added and consumption activities. Then, put a rule on banks and say they have to create money in a ‘3 for 1’ deal.

Three parts value-added and one part consumption.

As you can guess this is a pretty loose rule I’ve thought up on the fly. But something like it could potentially lead to far more good money creation, the stuff that makes economies grow and living standards skyrocket.

Your friend,

Harje Ronngard,
Editor, Money Morning

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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