Pete Wargent blogspot

Co-founder & CEO of AllenWargent property advisory & buyer's agents, 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.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

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Tuesday, 14 May 2013

The Keynesian multiplier

The Keynesian multiplier

The Keynesian multiplier was an idea conceived in the 1930s which aimed to demonstrate that government spending itself can result in further cycles of spending which in turn increases employment.

The basic idea is that if a government spends heavily on projects then perhaps half of the money spent on the project will take the form of labour costs. So the theory goes, those labour costs (after income taxes are deducted) less the saving rate will in turn be spent on elsewhere with new businesses.

All being well, the new businesses will thus have more money to spend and can afford to hire more staff creating employment, and so the cycle continues.

This was one of the arguments in favour of heavy welfare state spending – the government expenditure would eventually make a country better off as a whole.

If the theory worked perfectly then an economy should have full employment and we should all be merrily spending away, which is one of the reasons Keynesians argued in favour of taxing savings – to encourage yet more spending and discourage the hoarding of cash.

Does the multiplier theory hold true?

 Well, yes in part, but it’s hardly perfect.

For one thing, governments have to raise the capital to spend from somewhere in the first place.

Of course, a government could raise money through taxation but this to some extent defeats the purpose by pulling money back out of the economy it is attempting to stimulate.

The alternative is for governments to raise funds through bonds and going into debt, which can be effective but risks inflation over the longer term as governments become incentivised to devalue their currency in order that they may pay down their debts more easily.

It has since been understood by economists that both investing and saving have a role to play in the multiplier effect, without the debt downside, and therefore a more balanced approach may be preferable.

The housing ‘wealth effect’

One of the more controversial discussions around in Australia is the ‘wealth effect’ of rising house prices.

That is, as house prices and stock market valuations rise, households feel wealthier and thus more inclined to spend on consumer goods.

Despite the hype, house prices are still some way below their previous peak in most areas outside Sydney, and it appears that the Reserve Bank (RBA) is prepared to risk a rising or even an overheated housing market in order to benefit from the supposed wealth effect.

However, after the financial crisis new credit will not be some easy to come by for households so any wealth effect in the current property cycle is likely to be somewhat diminished. 

Last time around we saw 100% mortgages freely available and a proliferation of ‘low-doc’ loans which added fuel to the fire.

Australia’s great rebalancing

It’s unquestionably a tough balancing act to pull off for the RBA.

While the Reserve will no doubt be pleased with the trends towards new jobs being created, and financing for construction and new home sales also increasing, it will also be aware that low interest rates introduce a risk of debt-fuelled speculation by investors in some markets blasting prices on to new peaks.

While governments and central banks can become addicted to the wealth effect, salutary lessons should have been learned from certain other countries where property markets became overheated and then tanked.

Naturally, if one is a believer in the ‘wealth effect’ of rising house prices, then there must be a corresponding opposite effect when prices fall.

So far, in particular with unemployment remaining at 5.4% and consumer sales trending reasonably strongly upwards through both February and March, the Reserve is not too badly placed.

However, the annual trend in the unemployment rate still raises concerns and despite a promising rise in the number of employed persons, the RBA will remain wary.

Retail Trade
Graph: Monthly Turnover, Current Prices, Trend Estimate
Graph: Unemployment Rate
Employed persons
Graph: Employed Persons

Source: ABS

But these are uncharted waters for Australia as it goes over the edge of an unprecedented boom in mining construction – the rest of the economy needs to pull itself into shape.

The outcome is likely to be lower interest rates for longer and scant rewards for savers and investors in fixed income products. 

Source: ASX