Pete Wargent blogspot
Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.
4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.
"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.
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Tuesday, 8 January 2013
Does the RBA believe in creative destruction?
I was in Darwin the other day, the Northern Territory city formerly (and confusingly) known as Palmerston. The city is now named for Charles Darwin who is remembered for his theory of evolution or “the survival of the fittest”.
Darwin believed in natural selection. In 'science speak' he argued that members of populations are replaced by the progeny of those who were best adapted to survive. In simpler English, the weak die out.
There are similar theories in economics, variously known as Schumpeter’s Gale or creative destruction. These hold that while free markets can be brutal, they ultimately serve to create stronger economies as weak, uncompetitive and unprofitable companies are weeded out of existence, while those that survive are the strongest and most resilient.
Joseph Schumpeter argued this point vehemently and believed that economic cycles are vital for the long-term health of an economy.
While this is a strong argument in favour of free markets, most of us of more moderate tendencies tend to believe that free markets are only healthy to a point and, like ebullient school-children are a little prone to misbehaviour when not watched carefully. This was evidenced by the malpractices of unscrupulous lenders during the recent sub-prime crisis.
In his great post-subprime text Capitalism 4.0 Anatole Kaletsky argued that the next era of capitalism will encompass free market economies but with a more watchful eye and perhaps tighter restrictions around banking practices and lending.
Those familiar with Keynesian economics will know that while recessions are sometimes inevitable, Keynes argues strongly that deep recessions or depressions should be avoided at all costs. The long-term effects thereof can cause devastating levels of unemployment and confidence, and can destroy economies for decades.
The Great Depression
Schumpeter contested that where investors had profited from investments during periods of boom they should equally be allowed to suffer in the bust. Allowing companies to fail and investment markets to collapse should eventually allow the economy to recover end be reborn stronger than before.
Schumpeter’s ideas were allowed their reign during the Great Depression through 1930s America, where the government allowed hundreds upon hundreds of banks to collapse with devastating consequences. The US economy shrank by a third and took decades to recover in full.
In fact, several trillion dollars of the US government debt is directly attribuitable to stimulus spending in an attempt to fire up the economy following the financial crisis fall-out.
Unsurprisingly, Schumpeter’s ideas fell out of favour somewhat and now governing bodies generally do attempt to avoid full blown recessions or depressions at all costs.
Should central banks “lean against the wind”?
Investment markets such as securities exchanges and housing markets tend periodically to become irrationally exuberant and over-valued. Should central banks allow booms to run or temper them by increasing interest rates.
Former Chairman of the Federal Reserve in the US Alan Greenspan was one who argued that bubbles can form naturally in a flourishing economy, and that central banks should not always attempt to “lean against the wind” by hiking up rates.
This is partly because bubbles can bring some benefits such as increasing investment and consumer spending, but mainly because ratcheting up interest rates tends to see collateral damage in other ‘innocent’ parts of the economy which are experiencing no such bubble.
This prevailing viewpoint seems to have been altered or at least tempered by the financial crisis. It is now more widely accepted on a global basis that central banks may need to play a greater role in the controlling and deflation of asset price valuations.
This can be difficult to do for bubbles are often only apparent in retrospect, and because bull markets can often run for longer and far higher than we ever expect.
What will the RBA do?
With share markets only trading at moderate valuations, the Reserve Bank in Australia will have no worries in respect of equity valuations. Property markets are different because Australian housing has generated a lot of column space which talks of a credit bubble.
Many, many commentators forecast a housing crash but they were wrong. Instead over a period of two years dwelling prices have fallen by around 6% from their peak. If it was a bubble, it certainly didn’t burst, instead we just heard the gentle hiss of deflation. The Reserve Bank deserves some credit for its role in that.
There are many in Australia who believed that we would have been better served by prices dropping by 40% in a matter of months, which indeed is what many of them confidently predicted. However, on balance, they were wrong.
While on the face of it a crash would have been beneficial to those trying to get on the housing market ladder, the collateral damage of housing market corrections can be vast, from unemployment to crucified consumer confidence. The effects of property crashes in some other developed countries have been far-reaching and very painful. After all, you will find it very hard to buy a house – low-priced or otherwise - with no job and no income.
The RBA has shifted its view
Does the RBA want to play a role in massaging the housing market gently back towards sustainable growth? It definitely does, and those who predicted massive and instantanteous asset class price corrections in 2008, 2009, 2010, 2011 and 2012 seemingly underestimated that. The RBA, the major lending institutions and the Government each have a vested interest in avoiding a crash.
Where do I get my evidence from? Well, take a read back through the RBA Board Meeting Minutes through 2012 – the Minutes practically read like a month-by-month commentary on the movements in housing market prices and confidence, which they would surely not do if the Board did not rank these factors as important to them. Listen to Board members talk to the press about the return of moderate but sustainable price growth.
Perhaps most conclusively of all, the RBA went to considerable lengths to produce data which showed that while Australian dwelling prices are far from cheap, insofar as any such conclusions can be drawn, on a global level we are very much back “in the pack”.
All of the evidence points very much towards an Australian central bank which is protecting the downside when it comes to the housing markets. It will be interesting to see whether sentiment begins to turn in early 2013 due to the historic low interest rates or whether the moderate price slide continues.