Is the property bubble about the burst, with a rippling effect across the economy?
Possibly, warns the Reserve Bank.
This week the Reserve held a seminar on what to do about the seemingly uncontrollable boom in property prices. It made the papers public.
The Reserve has been treading on eggshells over interest rates in the past few months. On one hand, it should lower them to cope with the poor international outlook. Other nations have lowered their interest rates so if Australia’s stay high, money rushes into Australia and our currency goes up quickly, hurting exporters. But if interest rates are lowered, it will add further fuel to the property boom. Indeed, some argue that the Reserve should raise interest rates to put an end to the boom.
But it cannot both raise and lower interest rates.
Monetary policy – adjusting interest rates – is exercised by the Reserve to keep inflation under control. And it is a moot point whether the Reserve should exercise monetary policy to prick property bubbles or any other sort of bubble. Some economists say that would be part of controlling inflation so fair enough. Others say that because interest rates affect the whole economy they should not be used to prick a bubble in one small part of it.
But it seems that the Reserve is being quite clever with interest rates. It seems it has introduced a third weapon in its monetary policy armoury in the past few months. This is to (ital) talk (end ital) about rates without actually moving them. It has been threatening to increase rates unless the property boom comes under control. It seems to be hoping that this will be enough to frighten investors into curbing their borrowing and cause bankers to tighten their lending.
Among this week’s papers, for example, was an argument from the Governor of the Bank of England, Charles Bean, that it is perfectly acceptable for reserve banks to jack up interest rates to control an asset boom like the current property boom in Australia. Message: watch it you lot. If you borrow too much you might find your interest rates going up, forcing you on to a diet of sausages and mash.
Another paper by the Reserve’s John Simon looked in detail at three major bubbles in Australia’s past – the Melbourne property boom of the 1880s, the Poseidon nickel boom of the late 1960s and the share and property boom of the 1980s.
The message from these was that after the booms come the crashes. So watch it you lot.
It is a subtle message. The Reserve would reject any idea it is deliberately using academic papers to issue warnings. Fine. We do not want any crass “banana republic” warnings. The warnings themselves can be more damaging than the effect they are trying to cure.
Even so, the public pronouncements from the Reserve seem aimed at getting all the advantages of an interest rate rise without actually doing it, because a rise would visit harm other sectors of the economy. Reserve has learned from the “recession we had to have” of the early 1990s.
And here follows the next observation (of mine, not the Reserve’s) about the property boom.
People are making comparisons with the tulip mania in Holland in the 1630s where idiots paid the equivalent of $50,000 for one bulb; the South Sea Bubble of the 1720s; the crash of 1929; the Japanese stock market crash and so on.
But if a South Sea Bubble was threatening in Australia’s property markets, surely all the talk and threats in the world would be useless. Isaac Newton, the great physicist who gave us the laws of motion and gravity, should have known that what goes up must come down. He bought South Sea stock for 3500 pounds and sold shortly afterwards for 7000 pounds. But then he entered the market at the peak and lost 20,000 pounds – an enormous fortune then.
“I can calculate the motions of the heavenly bodies,” he said, “but not the madness of people.”
So if a South Sea were threatening, warnings would be useless. But there is no South Sea situation, precisely because these days warnings are at least partially effective. Humans are learning. Their “madness” in economic behaviour is becoming less mad. It is just that the process has been slow.
The bubbles of the past show a trend upon which some bright economist might base a PhD thesis. As time goes on the asset bubbles and their burstings are getting smaller. The bubbles before 1900 – tulips, South Sea, the French Mississippi land bubble of 1719 and Melbourne property boom and so on – ran till the assets were six, seven or eight times the original value and after the bursts the values went to nothing.
As you enter the 20th century the values seem to only go up three or four times before the burst, and the collapse when it comes usually does not drive prices much below the original value. The crash of 1929, Poseidon, the NASDAQ crash of the 1990s and the 1980s property bust, occurred well before madness of South Sea proportions took hold. People are better informed. Economies are better managed and better understood.
This property boom has not even seen a trebling of prices. It is no bubble. And when the boom ends it will end with a whimper. Prices will come back, but not catastrophically.
This boom has not been driven by a madness. Rather it has been driven by a combination of half a dozen factors – especially the liberalisation of credit and deregulation of the financial system. They will not all crash together. Household debt in Australia has doubled in proportion to GDP since 1995. People can borrow, so they do. They may be slightly exuberant, but they are not mad and the rise in property prices is not a bubble – empty inside, getting larger and waiting to burst. It is an adjustment to a freer economy and demand driven by immigration and a desire to live in the capitals and the coast.
We may get a levelling but not a bust.