GAFFNEY’S LOOKING GOOD

Gaffney

 

An acid test of a hypothesis is its success in forecasting. The “Real Assets Model of Economic Crises”, published in March, 2015, seems so far (up to August 21, 2015) to have passed the test, with respect to China. It is likely that “standard brand” economists and other forecasters, their visions narrowed by the same blinders that have kept them from foreseeing so many major downturns since at least (and probably before) 1720, will ignore this forecast and its rationale. Anticipating that response, I take the liberty of circulating this material.

– Mason Gaffney

FORECAST

“For a number of years, it seemed that the Chinese miracle of rapid economic growth based on massive public investment would somehow steer clear of the economic distress caused by land speculation and marginal investment in capital projects. Because of the backlog of latent demand in that economy for better housing, it was possible to construct thousands of projects in mid-size cities without exhausting the ability of China to make efficient use of those investments. By 2014, however, it became clear that China’s economy had reached a limit of productive investment in housing and other fixed investment and would be subject to the same constraints as other economies. There were voices in China that began warning of this fate as early as 2006, but they were ignored. It now seems likely that China will face several years of sluggish growth as land prices fall, defaults rise on marginal projects, and the loss of liquidity of the state-owned banks forces the central government to cut back on its investments. At the same time, as house prices fall in the major cities, the urban middle class will respond to its reduced nominal wealth by cutting back on consumption. The combination of these effects will reduce growth further and increase the rate of unemployment.

The one ray of hope in this otherwise gloomy picture is that some of the top leadership of China is at least aware that rising land prices need to be controlled by means of taxation. This is the first sign that any national government has recognized the use of land value taxation as an instrument of macroeconomic policy. Although that recognition came too late to prevent the present crisis in China, it could be used to prevent future repetitions of the present situation. If China can learn that lesson in its first experience with a boom-bust cycle in land values, it will be far ahead of Western governments that have ignored the signs for centuries.”

  • Mason Gaffney, American Journal of Economics and Sociology, March 2015, p.355

FULFILLMENT 

“Stocks tumbled worldwide Thursday (August 20 2015) … as investors fretted about China’s slowing growth … . … reasons to avoid stocks start… with ongoing concerns about the cooling of China’s huge economy. China devalued its currency, the yuan, last week, and its stock market has suffered a massive sell-off in the last two months despite government attempts to stem the drop. … The overarching concern for the (world) markets is just how much China’s economy is going to slow down.”

– James Peltz,, “Stocks sink globally on China fears”, L.A. Times 21 August 2015, p.C1

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WELL, AT LEAST THE SHARE MARKETS ARE OK [NOT!]

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TAX REFORM INACTION CONTINUES ….

under-the-carpet

 

 

 

 

 

 

 

 

 

 

 

 

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HUDSON: IT’S *PRIVATE* DEBT THAT’S THE BIG WORRY

– and *public* debt that’s spent on banks!

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PROFESSOR MIRANDA STEWART TO GIVE HENRY GEORGE ADDRESS

Stewart_E2A9186_1

 

 

Tax and Law expert Professor Miranda Stewart is to give the 124th Henry George Commemoration Address at the Royal Society of Victoria in Melbourne on 2 September 2015.

Further details and ticket applications are located here on the Prosper Australia website.

 

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LF ECONOMICS PROVIDES EVIDENCE TO HOUSING INQUIRY

Friday, 7 August 2015 House of Representatives Page 31

ECONOMICS COMMITTEE

DAVID, Mr Lindsay, Co-founder, LF Economics

SOOS, Mr Philip, Co-founder, LF Economics

CHAIR: Welcome. I remind you that, although the committee does not require you to give evidence under oath, the hearings are legal proceedings of the parliament and warrant the same respect as proceedings of the House. The giving of false or misleading evidence is a serious matter and may be regarded as contempt of parliament. Would you like to make an opening statement before we proceed to questions?

Mr David: Yes, we would. Representatives, good afternoon, and thank you for allowing Philip and me to express our frank concerns, noted in our submission, to this inquiry. To ensure objectivity in the quality of research we deliver, LF Economics is not influenced by any stakeholder of Australia’s finance, insurance or real estate sectors. This independence guarantees our ability to foster an open discussion regarding our concerns related to homeownership and the financial risks associated with residential investment.

To be frank, the evidence suggests that, on the back of irrational exuberance, Australia is experiencing what can only be described as a classic, debt-financed, speculative housing bubble, with every metric that evidenced the bubble in the United States and Ireland present within our economic system today.

To put things into perspective: between the June quarter of 1996, when real house prices first began to rise, and the December quarter of 2014, real housing prices rose by approximately 131 per cent. But, over the same period, inflation rose by 60 per cent, our population grew by 30 per cent, real GDP by 79 per cent, real rents by 21 per cent and real household income by 39 per cent. In short, the growth of housing prices has completely outstripped all economic fundamentals except for the expansion of household debt. Over the same period, total household liabilities boomed from 54 per cent relative to GDP to 118 per cent, and today Australian households owe creditors close to $2 trillion, and rising. Never has our household sector been as indebted as it is today.

Between 2002 and mid-2015, the mortgage books at the big four banks—NAB, ANZ, the Commonwealth Bank and Westpac—grew by 388 per cent, 435 per cent, 475 per cent and 554 per cent, respectively. In 2002, the size of the mortgage books at the Commonwealth Bank and Westpac combined was equivalent to 18 per cent of GDP. Today, it stands at 44 per cent of GDP and continues to rise. The mortgage book of Westpac in 2002 suggests that for every dollar it had lent to an owner-occupier, it had lent 45 cents to property investors. By April 2015, the proportion rose to 81 cents.

It is truly surprising that these patterns of rapid growth have not been of profound concern to the RBA, APRA or Treasury over this 13-year period, as the data is freely available and states the blatantly obvious. Australia has spent the better part of 15 years avoiding the primary reason why house prices have boomed above fundamentals such as rents, incomes, inflation and GDP, which happens to be debt-financed speculation. Our grossly undercapitalised, overleveraged, foreign-funds-reliant banking system has artificially stimulated demand for real estate in what is an unaffordable market, by consistently lending irrational sums of debt to owner-occupiers and investors. The public is also caught up in a mania of irrational exuberance which, combined, explains why housing prices across Australia are as high as they are today. The evidence outlined in our submission suggests that this is the case.

To put into perspective how expensive land is across Australia, you can find cheaper blocks of land per square metre on the hills of Malibu, California, with a view of the Pacific Ocean, than you can find in locales like Alice Springs or St Marys. Representatives, this is not normal and, quite frankly, it would be laughable if the matter was not so serious. For too long Australian policymakers with authority and regulatory power have ignored all the warning signs pointing to a credit-fuelled housing bubble. Over the years they have invented various policies to stimulate the price of housing and the rapidly growing risk that homeowners and property investors accumulate in order to keep house prices abnormally high, whilst making various interventions that stick out like a sore thumb every time household credit expanded above a perceived comfort level. Thank you for your time. Philip and I are happy to answer any questions you may have.

CHAIR: Thank you very much. The picture that you paint is quite dire for investors. We know that some investors are expanding their property holdings. We have nurses, school teachers, firemen and police now entering the investment market. I understand that they are not necessarily negatively geared—they could be neutrally geared or even positively geared. Homeowners are exposed because the lowest rates of interest have allowed them to buy proportionally more expensive properties. There seems to be some awareness of concern in that APRA has asked that banks only lend 80 per cent to investors. They are also asking that homebuyers must be able to demonstrate that they could fund a seven per cent interest rate even though they are borrowing at about four per cent the moment. How would you characterise those actions of APRA in regard to the gravity of the situation which you say we are confronting?

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Mr Soos: The horse has truly bolted from the stable a long time ago. APRA was founded in 1998 in the midst of an exponential boom in private sector debt, specifically mortgage debt. APRA has pretty much sat on its hands, pontificating about how best to regulate the market while not doing much of anything. In December 2014, it suggested that it was implementing regulations to limit the annualised growth of investor debt to 10 per cent a year, but it is unclear on what basis it has chosen this metric. Even so, that is still too high a figure, because if investor debt is rising at 10 per cent a year and overall household mortgage credit is rising at seven per cent a year, but incomes are only rising at about two or three per cent a year, that implies a rising debt to income ratio.

Also, given that nominal GDP, generously, will rise perhaps three per cent this year, that implies a rising debt-to-GDP ratio, which indicates that mortgage debt is still rising exponentially. As we have shown in our submission, Australia, at the time of submission, had the world’s third most indebted household sector. We had just recently surpassed the Netherlands. We are 80 basis points behind Switzerland. We are about 500 basis points behind the world’s most indebted household sector, which is Denmark. Given the current rates of debt growth over the last several quarters in Australia, we will likely surpass Switzerland within the next quarter or two. Perhaps by late 2016 at the earliest, definitely by 2017, we should surpass Denmark, especially as that country continues to deleverage. That means that Australia will have the world’s highest household sector debt burden. Unlike a gold medal at the Olympic Games, this is not something that we should be proud of.

APRA could have taken action well over a decade ago to stem the growth of housing credit, which is the real reason why prices have ballooned since 1996 on the back of debt-financed speculation. But I do not see this rather weak approach by APRA doing much to stem current credit growth. The best data we have is the monthly releases by the ABS for owner-occupied and investor credit. Especially in Sydney, but also in Melbourne, we are still seeing an exponential blow-off. It will probably take a couple of months to see whether these APRA regulations can stymie this growth, but so far it looks like it has not done much of anything.

CHAIR: The investor is threatened; the homeowner is threatened; the lender is threatened; and I guess our economy is threatened. Is that fair?

Mr David: Yes.

CHAIR: We have the RBA, who set interest rates that impact on property prices. They also have in their charter a condition to maintain the economic prosperity and welfare of the people of Australia. Many Australians have their wealth and their prosperity represented by ownership of housing, whether it is renting as an investment or owner occupation. We have the Treasury, who set tax policy, and we have APRA. How should these bodies be working together? We have looked at cure—you are saying that it is too little medicine too late. In our terms of reference the final term is ‘opportunities to reform’. So we obviously have to repair, but would it not be wise to look at what we can do in the future to stop these booms and busts that can be so devastating to all involved?

What would you suggest be done?

Mr David: We made a lot of recommendations in our submission. At this point in time across Australia house prices are incredibly high. Home owners are incredibly leveraged. You have Sydney and Melbourne—or Sydney at least that I know of—where in the last 12 months I believe house prices grew into the six figures in just one year. It is the most unusual approach by a bank. When they see 37 per cent of Australia’s total population living in two housing markets and see house prices rise as fast as they have, the normal approach that you would see historically is that a central bank would raise interest rates. The approach by our Reserve Bank has been to lower interest rates. On various different occasions throughout history every time the market seemingly looked like it wanted to deleverage there have been incredible policy bailouts to try to protect the housing market and, more importantly, the lending market from falling.

To put it into perspective, between 1996 and 2014 there have been only two economic quarters where household credit has expanded at a rate of less than one per cent, and both of those were around 0.9 and 0.9 per cent respectively. Both times we saw household credit expand at that rate. Clearly back in 2008 we saw that, and we saw the Reserve Bank slash interest rates. We saw the Australian government launch a lot of stimulus packages—the bailouts, mortgage backed security bailouts, bans on short selling bank stocks and various stimulants—to stop things from going further down. Had that happened you would have found that we would have seen a significant deleveraging event in 2008.

Combined with the good fortune that we had a lot of iron ore in the ground and we assumed that China would, by all mathematical accounts, consume all the iron ore we could dig from the ground, we had luck that no other Western country was able to have at that point in time. But in saying that, mathematically, 2008 seemed like the last time Australia would have been able to have a coordinated deleveraging event to make homeownership a

Friday, 7 August 2015 House of Representatives Page 33

ECONOMICS COMMITTEE

better reality for a lot of younger Australians. Since then, the choice made by government and the RBA and various other policymakers was that we would save the housing market at all costs rather than letting things deleverage, become cheaper and move back to some sort of median.

CHAIR: In that last answer you said that 37 per cent of people live in Sydney and Melbourne. Do you have the value of the real estate that they live in as a percentage?

Mr Soos: As in the value of the total housing stocks of the capital cities?

CHAIR: You have 37 per cent of the people living in Sydney and Melbourne. As the cost of real estate is so high in both of those cities, what would be the percentage value of the housing that those people are living in compared to the rest of the country? For instance, if it were double the cost, it would be therefore equivalent to 74 per cent. Do we know what the percentage is? I would think it is probably upward of that, because housing in Sydney, as opposed to that in Wagga, would be maybe five times the price.

Mr Soos: I know that the ABS may keep some quarterly statistics on the total value of the stock of housing in the capital cities, but we had not looked at it for our submission.

CHAIR: Is it a destabilising factor that more properties are held by fewer people?

Mr David: Yes and no.

CHAIR: Put it this way. You have investors who are buying unbridled because they are not restricted by negative gearing. When interest rates were 10 per cent and rental returns were four per cent, they were limited in how many properties they could buy. We have heard that, at the moment, the smart investor is going as far as Geelong, Glen Innes and various other places to get six per cent returns and borrowing money at four per cent, so they are unbridled in the amount of property they can buy up. Earlier today, I think we had an example of a 20-year-old owning 10 properties. But the problem, when you have people holding large numbers of properties like that—and it might also apply to nurses and schoolteachers buying properties—is when the interest rate goes up. It might only go up two per cent, but on top of four per cent, the current rate, that is a 50 per cent increase. So those people who are holding large numbers of properties—

Mr David: I would say that if—

CHAIR: cannot fund a loss of that magnitude. They would have to sell, would that—

Mr David: Yes, that is correct. A commonly used way of building a property portfolio here is through finance. The financing method shares the same risk profile as a Ponzi scheme. Basically, they keep using newfound equity in their existing real estate holdings to borrow against. If the tide turns and the value of their properties goes down or they get hit with high interest rates, then they would be forced to sell. Whether it is a large chunk or a small chunk of their property portfolio would obviously depend on their individual circumstances. Let’s just assume they would have to sell everything. If there is someone with 40 houses in one particular neighbourhood, and they are forced to sell all their houses, and there are another 15 or 20 people in their neighbourhood doing exactly the same thing, then you could find very quickly that there you have a lot of extra housing stock in one particular area. If you also include all the individuals who own one investment property, it can accumulate very quickly and, before you know it, you have a lot of houses for sale and no buyers.

That is something that we saw in the Northern Hemisphere in 2008. A lot of people tried to sell their houses at the same time and, because of that, the financial system was not able to absorb that pain; hence, they were not able to lend to new homebuyers the same amount of debt that they had been able to lend to those individuals who were trying to sell their houses. So you end up with what could be essentially a ‘house of cards’ moment.

CHAIR: Wouldn’t the sequence of events, when you talk about the price going down and people needing to sell, be the interest rate going up, people not being able to fund that and therefore having to sell, and creating more properties on the market and fewer buyers? Supply and demand force the prices down, so one begets the other.

Mr David: Yes. But unemployment is also a significant factor. Raising interest rates can affect people, and so can have them losing their jobs, particularly if they are negatively or neutrally geared.

CHAIR: Let’s get back to the question of what could be put in place to prevent such volatility, and by whom.

Mr David: To be quite frank, if you started crunching the numbers and war gaming that type of situation, you would see Australia would have a big problem on its hands. Our banking system and our lenders’ mortgage insurance companies would be too undercapitalised to be able to absorb a significant shift in, let’s say, mortgage defaults, with higher interest rates and fewer people being able to pay their mortgages.

CHAIR: You cannot see a remedy for the problem that we have now?

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ECONOMICS COMMITTEE

Mr David: You could, but it would be a very expensive remedy, particularly if it were on the back of deteriorating economic conditions. You would be talking well into the hundreds of billions of dollars if you are trying to save something.

CHAIR: Looking back at what could have or should have been done, what suggestions would you have?

Mr David: Throughout the research I have done and Philip has done, each using different methodologies, we both came to the conclusion that 2008 was essentially a prime moment. Had we not gone to the same extent to save the housing market back in 2008 as we did, we would have seen a deleveraging event on the back of a mining boom, which would have helped alleviate some of the economic pain. That does not mean that Australia would not have experienced a recession; it would have experienced a recession. But, in saying that, you would have seen homeownership or house prices become significantly more affordable, and our banking system would not have continued on its essential lending binge. On the back of that, in terms of the fundamentals and the core, when you look at what we would be paying for house prices today, I would highly doubt that you would be paying close to $900,000 for a median house in Sydney today had we deleveraged back in 2008.

CHAIR: Of the alternative, you would feel that if nothing is done there is every chance that there is going to be a crash—the most significant crash we have had?

Mr David: Yes, because the RBA has basically, in the last few years, burnt too much of its own ammunition in terms of keeping house prices as high as they are today. It is quite concerning to see the interest because, in the last three downturns we have had in the property market, albeit very small downturns, we have used more than two per cent interest rate cuts—in the last three times—and we have only got two per cent, and we are a commodity-producing country.

I am not too sure if you know what is happening over in Brazil at the moment, but what you are seeing is a reverse effect where they are seeing their economy fall quite hard, and their central bank is forced to raise interest rates. So all this expensive cost of bringing down the Australian dollar has come at a cost of allowing house prices to essentially rise out of control in Sydney and Melbourne and leaving our central bank, which has the most powerful economic tool, the interest rate, with little reserve. Two per cent does not do—you could find the adverse effect of them trying to bring down the interest rate. It would be very hard to do that if we were to see our scenario take place.

CHAIR: Their problem is that they need to have the interest go down in one area and up in another. Would you agree with that?

Mr David: No. I think—

CHAIR: At times? When you are trying to control inflation, you might need to bring down the interest rate when you want to control it within a certain range. But then that is having the unintended consequence of heating up the property market, so it would be better if you had the interest rate going up higher in the property market but lower for the general economy?

Mr David: Yes, but, if you see what has happened in the Northern Hemisphere, particularly in countries that have economic zones that have pretty close to a zero-interest-rate environment, you lose, on the back end, income earned by deposit holders. We have seemingly forgotten this sector. We have definitely forgotten whether anyone cares about bank depositors or not in this country anymore, I guess we could argue. But two per cent is a very difficult sum of money for a retiree to survive on if they are trying to do the responsible thing in keeping cash in their bank account. So, while it could benefit by bringing down the interest rate to mortgage holders, it severely impacts deposit holders. In Europe, that has been a prime contributor to the increase of inequality in those countries, because the majority of middle to lower income people who kept their savings in their bank the whole time are burning through their cash, when they were not really aware of all the financial products that were out there to take advantage of through the quantitative easing projects.

Mr CRAIG KELLY: I have just a few questions. On one of the graphs in your submission, you show that the value of the dwelling, as a percentage of GDP, has been fairly constant throughout time, and it has been the land value increase that has actually affected housing affordability. Doesn’t that get back to more a supply issue rather than—

Mr Soos: I can answer this.

Mr CRAIG KELLY: I know you have been talking about Reserve Bank interest rates and things, but isn’t the issue of the increase we have seen in the cost of land, rather in the cost of the dwelling, simply a factor of supply?

Mr Soos: It is a pretty complex issue. We have had previous inquiries that have delved into this issue: the Productivity Commission in 2004, the Senate inquiry in 2008 and the one that just reported a couple of months

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ago. It is usually argued in the mainstream in Australia that the reason why land prices are so high is that we have a shortage of dwellings. Once Lindsay and I went through the stats from the ABS to actually examine the issue: do we have a shortage? How does one calculate a balance in the housing market? We went through the data, and we found, quite surprisingly, that the majority of the housing price inflation that we have experienced so far, from 1996 to 2015, occurred between 1996 and the year before the global financial crisis, which was 2006. What is surprising is that during this 10-year period we had persistent surpluses of housing, not shortages. One could ask: how on earth can a shortage be underpinning higher prices when we have been producing surpluses for most quarters over that 10-year period? This is shown on figure 25 on page 22.

Mr CRAIG KELLY: Can I just ask how you actually compiled that data?

Mr Soos: Sure. In the economics literature, it is accepted that the best method of attempting to determine the balance in the housing market, whether surplus or deficit, in any one particular time period is to compare the change in population—and hence households—to the change in the flow of dwelling completions. So you can see in one particular quarter how many people entered a particular region or city and how many properties were built during that same period. So what we have done—

Mr CRAIG KELLY: Does that data include foreign students?

Mr Soos: It includes what the ABS defines as ERP—the estimated resident population—which would include foreign students, yes. Lindsay and I have purposely used a very conservative methodology, which is outlined a couple of pages back.

What we have done is that we have only included private dwellings. We have excluded a small number of public dwellings. The public housing stock is only about five per cent of the total housing stock in Australia. We only used dwelling completions, not approvals or commencements. Completions are further adjusted for secondary dwellings, so you consider vacant all holiday homes. This data is found within the National Housing Supply Council reports.

We also adjusted for estimated replacements and demolitions, because not every new completion will result in new supply. Rather, you can have an old house that is knocked down and then rebuilt as a completion. A small number of residential dwellings are created through commercial construction activity—for instance, an apartment above a shop. We excluded that small number. We also included births in the flow of new population, even though that does not translate into demand for new housing, because obviously babies and children do not pay the rent or the mortgage; their parents do.

So what we have is a very restrictive methodology. What we have done is divide the flow of population for every quarter by the household occupancy rate to get the number of households that occur in every quarter, and then divide that by our net completions rate.

Mr CRAIG KELLY: I will just take a little step back on that. I understand there has been a decline in the average number of people in each household, but I am not sure over what period of time. Is that factored into those numbers as well?

Mr Soos: Yes. That decline has been occurring since we have had records, going back to the late 19th century, when we used to have an average of about 5.1 persons per household. That has fallen steadily every decade, to 2.6today. We have factored that in as well.

The net result of all these calculations is shown in figure 25. We see that from 1996 through to 2006, even in the face of this restrictive methodology, we have produced persistent surpluses, even as real housing prices have boomed significantly. Post-2006, two significant events occurred. One was the build-up to the GFC. Under those conditions we would not expect property developers to increase supply due to the uncertainty that was generated by the GFC. Neither would we expect owner-occupiers or investors to step up purchases. So construction did moderate slightly.

Then, from about the end of 2006 onwards, we had a steep rise in population growth, primarily due to net overseas migration. A great proportion of the migrants were international students. Hence, from 2006 onwards we have had housing deficits. As population growth moderated in around 2010 we had some surpluses. As population growth increased once more, we had more deficits, but for the last couple of quarters we have been producing surpluses in the housing market.

This tends to falsify the claim that a shortage is underpinning the growth in housing prices, because how on earth could housing prices boom between 1996 and 2006 in the face of significant surpluses? Sydney alone had the largest increase in housing prices from 1996 to early 2004, yet that was on the back of significant surpluses. It simply does not make any sense according to the shortage argument.

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What does make sense is looking at the trend in rents, not prices. The reason prices are as high as they are, as Lindsay has noted, is debt finance speculation, which is irrational. However, rental prices cannot be leveraged. They are more likely to be efficient and determined by the interactions of supply and demand. Between 1996 and 2006, rents in real terms were flat. After 2006, when we had the period of deficits during the global financial crisis, there was a strong increase in rents and also an increase in the rent-to-income ratio. Households were paying more and more in rent as a proportion of their total budgets.

Since about 2013 the rent-to-income ratio has moderated. We are now seeing that rents are essentially plunging in some of the capital cities like Darwin, Canberra and Perth, while they are holding steady in Melbourne and Sydney. The major reason is the end of the mining boom in those states and also the APS cuts in Canberra.

According to our supply index, that has resulted in continuing surpluses. We have only provided this at the national level. The submission would be far longer if we had to provide a breakdown for every state and territory. But the main thing to take away from this is that we should be looking at the trend in rents to determine if there is a shortage. For most of the period of the housing price boom, from 1996 to 2015, rents have been pretty much flat in inflation-adjusted terms, apart from during the GFC and in some mining towns.

In the United States, the tiny handful of economists who did identify their housing bubble and predicted the global financial crisis made the same kinds of arguments—that is, if there really was a shortage, as the mainstream were saying, we should see a very, very strong increase in rents. In fact, rents would be matching the trend in prices, but that did not occur. Once their bubbles burst, we know that there was a large amount of oversupply in the United States, Ireland, Spain and so on.

Mr CRAIG KELLY: Can I test your theory out, just on the rents: what about the issue that we have seen a decrease in interest rates, and therefore investors have been prepared to accept a lower return as interest rates have come down and rents actually have not increased?

Mr Soos: This would not explain why property investors are negatively geared, because, if the decrease in interest rates was a factor among increasing housing prices, one has to question: ‘Why are investors negatively geared?’ because their rents have not been able to cover the increasing amounts of debt that they have taken on. If a handful investors around the country pursue this strategy—that is, running rental income losses while chasing capital gains—and they fail or go bankrupt, that is fine. But when the entire investor market is negatively geared and chasing a capital gain, while they run significant net rental income losses, then that is a very big problem because that is essentially a Ponzi scheme. Even though rents did increase significantly during the GFC and in some mining towns, that was not anywhere near enough to offset the exponential boom in mortgage debt, even as nominal interest rates have come down over the last two decades.

CHAIR: When you say that interest rates have come down, you might be looking at the cost of renting this particular property: it goes up by 50 per cent or 100 per cent in value but your rent might only increase by a tiny proportion of that. Does that offset the perception that rents have come down?

Mr Soos: Not particularly, because the same thing was borne out in the United States. The argument that was made ad nauseam was that, even though rents were flat, higher prices could be justified because the nominal interest rate had fallen significantly. The same argument was made in Ireland and Spain and so on. The thing about lower interest rates is that investors do not just bid up the price of housing because they believe rents are capitalised at a lower interest rate and therefore prices should be higher on that basis. The only way that housing prices can deviate significantly from rents is through debt-financed speculation, and that is not a rational reaction to lower interest rates. It is irrational exuberance, because over the long-term—

CHAIR: When you say ‘rational’, would that also mean sustainable?

Mr Soos: Yes, because, even as the nominal interest rate has come down, it has not been low enough to offset the exponential boom in mortgage credit. That is why, since about 2001, the entire investor property market has been negatively geared, on aggregate.

Mr CRAIG KELLY: Just going back to that graph at figure 25: since 2006, there has been a significant undersupply in new housing—is that correct? Am I interpreting that correctly?

Mr Soos: Yes. So negative values indicate a shortage, whereas positive values indicate a surplus.

Mr CRAIG KELLY: So that I understand clearly what you are saying—you are saying that undersupply has not put that much upward pressure on housing prices?

Mr Soos: Housing prices should only increase in proportion to the extent that rents can increase. That is something we have learnt from studies of long-term housing prices: that, despite the booms and busts, housing

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prices generally track the trend in rents. As we see in figure 26, below, I have added a cumulative figure of all these surpluses and deficits, and, as we can see, even under the most restrictive circumstances, Australia had an oversupply of about 350,000 dwellings in 2006. However, the deficits that have emerged since have lowered that cumulative oversupply.

Mr CRAIG KELLY: So you are saying that is an oversupply?

Mr Soos: Nationally, but the figures differ from state to state.

Mr CRAIG KELLY: So with that 300,000, are they empty residences?

Mr Soos: Some of them would be, yes—that investors have purchased during the debt finance speculative boom.

Mr CRAIG KELLY: So in 2006, around the nation, we had around 300,000 properties more than we needed on the market?

Mr Soos: Correct.

Mr CRAIG KELLY: At the moment it is around 180,000 additional properties?

Mr Soos: Yes, even under the most restrictive circumstances possible.

Mr CRAIG KELLY: That is contrary to some of the other evidence that we have heard.

Mr Soos: It is pretty much contrary to everything that has been written over the last decade on this issue.

Mr CRAIG KELLY: I am not saying it is wrong; I am just interested in how that differs from what others are saying.

Mr Soos: A lot of submissions to this inquiry claimed that there is a shortage underpinning high prices, but no-one actually provided any evidence of it. But we have provided a short 10 pages of evidence, including our methodology and how we have gone about it. I think the reason why the government, the banks and the real estate industry do not do that is that if they did do the sums, as we have done, it would pretty much showed the same kind of data that we have shown and, therefore, they would not be able to claim that there is a shortage underpinning housing prices.

Mr COLEMAN: You have written in your submission that there is no need for this inquiry to take place at all, especially considering that it has been known since 1879, with the publication of Henry George’s Progress and Poverty, what the most effective approach is in terms of addressing these issues. Could you expand on that?

Mr Soos: We have had a whole raft of major inquiries into this. In 2004 there was a Productivity Commission report that covered all the main issues—supply, demand and debt—but the government did very little about it. In 2008 we had a Senate inquiry and the government did not do much of anything. We also had the Ken Henry tax review, which did touch upon housing and tax concessions. Governments on both sides—this is not partisan—have done next to nothing on this issue. We have just had the current report released a couple of months ago, and I very much doubt that much will be done with that.

We also had the Murray inquiry, which again touched upon tax concessions. It looks like no government from either side will do much with these issues. Whether it is to do with the demand side or the supply side, there are many critical issues that need addressing—and we have listed some in our submission. I do not really see the point in holding more inquiries if the government has not even done much on implementing the recommendations of previous inquiries going back to 2004.

Mr COLEMAN: You also say that ‘the system assists Australia’s army of private monopolists, usurers, speculators, rent seekers, free riders, financial robber barons, control frauds, inheritors and indolent rich’.  You suggested before that you have done the real research in relation to some of these issues but the banks, government and so on have not—for whatever dark reasons that may be. You see the whole system as being obviously out of whack with reality. Why do you think that is? Why do you have the clarity that the banks, regulators and financial institutions lack?

Mr Soos: It is a problem that has existed since the founding of Australia. Since the end of the social democratic period in, say, the mid-seventies, the deregulation of the banking and financial sector has essentially allowed the banks to lend out an exponentially rising amount of credit. That has resulted in the financialisation of Australia’s economy whereby, instead of running a productive business or employing your labour, it is easier to profit from speculating on assets—in the stock market, the housing market, commercial and industrial real estate, derivatives and so on. This tends to be rather parasitic and inefficient. We should look more closely at the example of Germany, which has managed to really keep a lid on speculation in its domestic economy. Its unconsolidated household debt to GDP ratio is about 50 per cent, whereas ours is now at over 118 per cent and still rising. The long-term trends in Australia’s economy in the neo-liberal era from the late 1970s onwards

Page 38 House of Representatives Friday, 7 August 2015

ECONOMICS COMMITTEE

suggest that we have moved from a production and consumption economy to a more financialised speculate-and-profit economy.

You asked the question: why do we have the clarity where many others do not? As Mr David pointed out, we are independent from the government, from what we call the FIRE sector, finance, insurance and real estate, and from trade unions. We have the ability to examine the research and not let any conflict of interest determine what we say and what we write.

It is also worth looking at the United States. Something we have touched upon is that, in 2008, there were 15,000 professional economists employed in that country. How many identified the US housing bubble and predicted the global financial crisis? Fifteen. That is 0.1 per cent, which is, quite frankly, pathetic. In Ireland, which had a massive housing bubble and crash, three economists in that country identified the bubble. In Spain, we cannot really find records of anyone doing that. What happens is that, when it comes to the asset bubbles, the mainstream are totally ignorant, and I think one of the reasons is simply conflicts of interest. While spectators are making huge windfall gains, at least on paper, policymakers and government regulators stand by the side. They do not want to interfere with this supposed wealth creation process.

Also, during the formation of asset bubbles, the economy grows strongly and there tends to be low unemployment, low delinquencies and so on, and this gives the illusion of stability. So regulators become complacent and they prefer just to sit by the wayside, without realising that the real problem here is the exponentially growing stock of private credit that is used to bid up asset prices. Even in the post-war era, we have had a number of deleterious asset bubbles. The first major one was in 1973, a large commercial-industrial real estate bubble that peaked in 1973 and then collapsed. That was followed by a smaller housing bubble that peaked in 1974 and collapsed. We had a smaller cycle in Sydney that peaked in 1981 and then fell. We had the stock market bubble of 1987. Then, leading up to the peak in 1989, we had a truly massive commercial real estate property bubble, which then collapsed during the early 1990s recession, and I believe that was the major cause of the recession, where commercial prices in real terms fell by about 65 per cent in Sydney and Melbourne and 75 per cent in Perth. That was our last major real estate bubble.

Mr COLEMAN: Sorry to interrupt, but can I pick up on your earlier point. So you would advocate a return to what I think you described as a socially democratic or socially liberal era—I do not want to put words in your mouth; correct me if I am wrong. You described the pre-mid-70s era and you seemed to suggest that a fairly fundamental social change and perhaps somewhat radical change is necessary. Is that fair?

Mr Soos: The policies under the social democratic period never really dealt with the issue of debt finance speculation and the formation of asset bubbles. As we saw, there was a large real estate bubble in 1973 or 1974. So, the macroprudential policies and the regulation of the banking and financial system did manage to keep at least a cap on the speculation. But as the governments have progressively—I would argue regressively—deregulated the banking and financial system, especially under Hawke and Keating, that has allowed banks to lend out an exponential amount of credit. In the long run, that benefits bankers, landowners—for a while—but really it tends to gut the productive capacity of our economy, and that harms both capital and labour while benefiting a section of ultra-rich bankers. From a public policy point of view, that is rather adverse.

CHAIR: Thank you very much for coming here today. Thank you for your contribution, which is most worthwhile, and for all the work you have put into research and study over a great period of time. If you have been asked to provide any additional material, although I do not think you have, please forward that to the committee secretariat. You will be sent a copy of the transcript of your evidence, to which you can make corrections of grammar and fact. Again, on behalf of the committee, thank you very much for your attendance and your contribution.

Mr Soos: Thank you.

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REFORM HAPPENS

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TOON

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SOME MORE THOUGHTS ON P – R = W + I

Henry George’s formula P – R = W + I tells us that the incomes of workers and business should not be taxed, because they are earned incomes, whereas the economic rents from natural resources such as land, forestry, fishing, spectrum, &c., are more proper revenue bases – because these are unearned by companies and individuals, being created by society at large. [See here and here for earlier notes on the importance of George’s largely undiscovered formula.]

As we currently fail to capture these natural resource rents to the public purse instead of taxes, the economic health of society is sorely compromised, not only to the extent that taxation erodes wages and profits, but also by its deadweight effects that adversely cascade into costs and prices. It is these effects that price Australia out of markets – not wages or profits.

Let’s now look at the formula’s primacy in understanding debt:

When governments fail to capture sufficient land rent (in its broader sense, viz, all natural resource rents and government-granted privileges), it is privately capitalised into higher and higher land and other prices, into booms, then bubbles, and the eventual financial collapse when the bubble bursts. Business profits and workers’ wages are meanwhile diminished by increasing taxation as land prices and commitments to concomitant impossible mortgage debt levels rise.

The formula demonstrates an inverse relationship between privatised rent and wages and profits. i.e. Wages and company profits will fall as capitalised rent (land prices) increase, and rise when land prices diminish. In this sense, increasing land prices may be seen as the deep pathology integral to any understanding of impossible debt levels.  Yet banks continue to lend money against escalating land prices and expect to be bailed out when land price bubbles burst!  Being clearly remiss in their risk analyses, banks believe they deserve a pat on the back for putting the financial system at risk!

Incredibly, the modern economist is only prepared to deal with the ailment of excessive debt without tracing it back to its origins, as cleverly demonstrated by George’s P – R = W + I.  Why is this?  Are rentiers so terribly important that their scam in capturing as much publicly-generated economic rent as possible at the expense of wider society must not be exposed and challenged?  The questions must be asked:  What collateral is required by banks?  Is it not real estate values? Is not a large proportion of real estate value simply these pathological land prices which history shows collapse every eighteen years or so?

As big rentier banks continue to ‘game’ the system by encouraging small rent-seekers to play their relatively tiny role so they, too, will baulk at the kind of tax reform essential for any healthy society, world economies continue to fester and worsen for want of understanding this most important equation.

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GOOD LUCK, LARRY!


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