Month: June 2015

Greek Debt Crisis Enters Final Stage

June 27, 2015 / Brett Romero / 0 Comments

The never-ending saga of the Greek debt crisis appears to be finally entering its final phase this week. After 5 months of negotiations, Greece’s creditors, led by the IMF, have made a final offer to the Greek government, and it is an offer of more of the same – i.e. austerity. For its part, the Greek government needs to make a decision before Tuesday next week when it is expected to run out of cash.

Background

For those that have seen the headlines, but have not had the time to dig into what is actually happening in Greece, first a little background.

As early as 2010, it became clear that the Greek government was in trouble financially. It was running large deficits and was quickly accumulating a debt that bond markets increasingly believed were unlikely to be repaid. As a result, the yields on Greek Government bonds (the rate of interest that the Greek government has to pay to borrow money) began to spike, further increasing the risk that Greece would be unable to repay its debt.

To avert a crisis, the IMF, the European Commission and the European Central Bank (“the Troika”) provided loans to the Greek government to help pay off their existing debt. By doing this, these organizations essentially took the majority of Greek government debt off the books of a range of mostly German and French banks, and put it on their own books.

However, in exchange for the provision of these loans, the Troika insisted that the Greek government implement a series of measures to improve the budgetary situation. These measures mainly consisted of cuts to the public service and pensions, but also tax increases, and other measures. Generally these measures are referred to as “austerity measures”. Despite the warnings of many prominent economists that cutting government spending in a recession would cause further damage to the Greek economy, the measures were pushed through – as they were in a range of other countries.

Sadly, the warnings provided proved accurate. By January 2015, the Greek economy was suffering from 25%+ unemployment and GDP had fallen 25%, far more than had been forecasted by the Troika at the outset of austerity. As the economy shrunk, so did government revenues and so further cuts were required to try meet the surplus target.

In January this year, the Greek people tired of years of crushing austerity, elected what has been called a ‘far-left’ government[1]. Syriza, a party that for most of the recent past had been attracting less than 10% of the vote, was all of a sudden front and center, and with a clear mandate to renegotiate and bring an end to austerity – but also to keep Greece in the Eurozone.

What is Happening Now?

After 5 months of increasingly bitter negotiations between the Syriza government and the Troika, and with the deadline approaching (Tuesday next week), there were two final offers made.

For their part, the Greek government proposed a range of austerity measures that more or less met the Troika’s demands in terms of net budgetary impact. The difference was that they proposed smaller cuts to pensions with the gap being made up with a range of tax increases. Hilariously, the proposed measures were rebuffed over concerns it would hurt the growth of the Greek economy.

The Troika then made their final offer to Greece. Even after all the evidence of how destructive and counterproductive austerity, the offer was basically the same as the original demand. Many took this as a sign that the Troika are aiming to force Syriza out of government, or Greece out of the Eurozone.

What happened next appears to have caught most observers by surprise. On Friday night, the Greek Prime Minister Alex Tsipras announced he would take the final offer to a referendum to be held on July 5^th. Although this is sure to further aggravate the Troika (if that is even possible), this would actually appear to be a very clever move on the part of Syriza.

The biggest issue for Syriza since their election has been how they would manage to maintain their two key promises – to stay in the Eurozone and bring an end to austerity. After 5 months of failed negotiations, they have almost certainly proved beyond doubt that the Troika are not going to give any ground on austerity. By calling a referendum, they force the Greek people to choose what they want more – Eurozone membership or the freedom to run their own economy. Either the Greek people willingly accept further austerity in exchange for staying the Eurozone, or they accept exiting and take their chances on their own.

For their part, Syriza have made it clear they believe going on their own is the better option. As part of his announcement to the Greek people, Tsipras took the chance to lambast the institutions making up the Troika (translated from Greek):

“These proposals -– which directly violate the European social acquis and the fundamental rights to work, equality and dignity — prove that certain partners and members of the institutions are not interested in reaching a viable and beneficial agreement for all parties, but rather the humiliation of the Greek people.”

“Greek citizens, I call on you to decide –- with sovereignty and dignity as Greek history demands — whether we should accept the extortionate ultimatum that calls for strict and humiliating austerity without end, and without the prospect of ever standing on our own two feet, socially and financially.”

What Happens if the Greeks Choose to Exit?

No one knows for sure – but it won’t be pretty. Essentially, a chain of events will mean Greece will need to revert back to their own currency (essentially a new Drachma), which in itself leads to further impacts. The first and most serious of which is that the Greek government would need to impose capital controls – basically stopping people from moving their money out of Greece.

In anticipation of this measure, Greeks have been pulling Euros out of Greek banks at a record pace the last few weeks and either moving it offshore, or effectively stuffing their mattresses. After the announcement of the referendum, the pace further quickened with pictures flooding into Twitter of lines at ATMs on Saturday morning and reports that many ATMs had already run out of cash.

Looking further forward, after the change to a new currency, there is an expectation that it would depreciate very quickly against the Euro. As a result, vital imports like oil and medical supplies would suddenly become hugely more expensive causing problems in the health sector as well as for business in general. On the flip side, this depreciation should provide a boost to Greek exports (primarily tourism and agriculture). However, it is questionable how much benefit this can provide given the large internal devaluation that has already occurred.

The only possibly good news is that the Greek government is already running a primary budget surplus (surplus before the costs of borrowing are included). By defaulting on its existing debt, it would not need to issue new debt to meet payment obligations in the short run (although a depreciating currency could impact that). Longer term, by most measures, the Greek budget is actually in a strong structural surplus (i.e. if the economy wasn’t hugely depressed, the budget would be in a much better position than it currently is). If the Greeks could manage even a small amount of growth after leaving the Euro, they could find they are quickly running large surpluses.

For the Eurozone, a Greek exit is no longer the risk to financial stability that it once was, but it could be a risk to political stability. If Greece does exit the Eurozone, there will be several countries monitoring the situation very closely. Spain, Portugal and Ireland (not to mention Italy) have all undergone differing levels of austerity over the past 4-5 years, and all have seen very high levels of unemployment and significant falls in GDP as a result. If (and it is a big if) Greece exits the Eurozone AND manages to keep the country from falling apart completely, these other countries may be tempted to do something similar.

From there, the Eurozone project could completely unravel. And make no mistake; this would also be disastrous for the northern European economies, including Germany. Without the relatively unproductive southern European countries in the shared currency zone, the Euro would be expected to appreciate strongly, doing serious damage to Germany’s export driven economy and even more so to less efficient countries like France and Italy.

This scenario has led to some speculation that the Europeans will try to make any Greek exit as difficult as possible – to deter other countries from exiting. But this strategy has its own political ramifications. Essentially the European Union would start to look like a union held together by the threat of economic ruin rather than goodwill and mutual benefit. At that point, the question becomes what kind of union does Europe really have?

What Happens Next

Even though the Greeks have declared their intention to hold a referendum to decide on whether they will accept the bailout conditions, they don’t actually have enough cash to survive until the referendum date. As such, they are asking the creditors to provide an extension for a few days to get to the referendum.

Early indications are that they will be refused even this small extension (the creditors are really pissed off…). To do this would appear to be a dumb move politically and with very little gained financially, but it took a lot of dumb moves to get to this point, so nothing can be ruled out. If they do hold the line and deny Greece the extension, essentially everything gets moved forward. On Tuesday, assuming the European Central Bank stops providing liquidity (cash) to Greece’s banks, the Greek government would be forced to step in with a new currency and we will officially have the first example of a country leaving the Eurozone.

The Greeks have put the gun to their collective heads and shown they are ready to pull the trigger. The only question left is will Europe stop them, or hand them a bigger gun?

Why Australians Love Foster’s and Other Beer Related Stories

June 25, 2015 / Brett Romero / 0 Comments

Sports. Hot summer days. Manly men. Attractive women. Whether beer is your go-to drink or not, it’s hard to not be impressed with how beer manufacturers have ensured their product is strongly associated with a range of desirable situations and topics for the average male consumer. But, despite being a common theme across countries, there are two in particular that have really taken this message to heart, to the point of being comical: Australia and the US.

Australia and the US are two countries where beer has become almost synonymous with the notion of being a “man”. Our sporting heroes appear in ads selling beer, our favorite sports teams are sponsored by beer, and when it’s not sports, it’s scantily clad women, beaches, blokes being blokes, or all three together.

But perhaps the most interesting aspect of the beer culture in these two countries is that, despite the similarities, there is an amazing mutual lack of understanding between the two. Australians for the most part have nothing but disdain for American beer – which from their perspective consists only of Bud, Miller and Coors (someone particularly familiar with international beer might venture “oh, but I don’t mind that Sierra Nevada”). Meanwhile most Americans’ knowledge of Australian beer starts and ends with a Foster’s at the Outback Steakhouse.

Both are woefully uninformed views. Hopefully, the following 1800-odd words can help clear up a few of the myths and misunderstandings – and add some mutual appreciation.

Australian Perceptions of American Beer

Mention American beer to an average Australian and you are likely to hear the words “tasteless”, “weak”, “watery” and “yellow fizzy water”, among other things not suitable for a professional blog. And let’s be honest, looking at a list of the top 10 beers in the US (see Table 1), it is hard to argue with those sentiments – the list is full of light (light carb for Australian readers) and relatively flavorless American style lagers[1].

Table 1 – Top 10 US Beers by Volume

	Label	ABV	Type	Producer
1	Bud Light	4.2%	Light Lager	Anheuser–Busch InBev
2	Coors Light	4.2%	Light Lager	Molson Coors
3	Budweiser	5.0%	American Adjunct Lager	Anheuser–Busch InBev
4	Miller Light	4.2%	Light Lager	SABMiller
5	Corona Extra	4.6%	American Adjunct Lager	Anheuser–Busch InBev
6	Natural Light	4.2%	Light Lager	Anheuser–Busch InBev
7	Busch Light	4.1%	Light Lager	Anheuser–Busch InBev
8	Michelob Ultra Light	4.2%	Light Lager	Anheuser–Busch InBev
9	Busch	4.3%	American Adjunct Lager	Anheuser–Busch InBev
10	Heineken	5.0%	Euro Pale Lager	Heineken International

Unfortunately, it is these top 10 mass produced beers that come to mind when Australians (and most people outside the US) think about American beer. That is a shame because what many Australians are completely missing out on is the absolutely massive and amazing craft beer scene that is thriving in the US.

Craft Beer in the US

Despite appearing to be a recent phenomenon, the American craft beer scene has been making its mark since the mid-90s. After declining for much of the 20^th century, the craft beer scene exploded from 446 breweries in 1993 to 1,514 by 1998. After a lull through the early and mid 2000’s, the numbers again took off in 2008 and 2009. By 2014, there were 3,464 breweries in the US.

By comparison, in Australia (depending on who you ask) there are between 100 and 200 breweries. There are at least 4 states in the US that have more breweries than the whole of Australia[2]. Craft beer also has a significantly larger proportion of the US beer market than in Australia (11% vs. 2-3%). In fact, when you look at just how big craft brewing has already become in the US (and it is still growing at a rapid pace), it makes headlines in Australian papers like “Has the craft beer machine reached saturation point?” seem a little ridiculous.

Asides from the pure numbers though, arguably the most admirable aspect of the craft brewing scene in the US is the way small breweries and brewpubs become a point of reference for the local area. In Australia, craft beer is still largely seen as the domain of inner city hipsters and beer snobs. In the US, bars and pubs will often take pride in ensuring they have the offerings from the local brewery on tap. For beer lovers, this means travelling the US provides a veritable smorgasbord of different craft beers that change with every town and season.

American Perceptions of Australian Beer

Mention Australian beer to an American, and you are likely to hear exactly one word: “Foster’s”. More knowledgeable Americans might venture that they have heard Foster’s isn’t actually that popular in Australia, which is both true and untrue. Let me explain.

Foster’s Lager, the beer most Americans (and basically everyone not from Australia) associate with Australia is a beer produced by the Foster’s Group. What many don’t know is that the Foster’s Group actually produces a large range of beers under different labels in Australia, most of which make no mention of the name “Foster’s”. Looking at the top 10 Australian beers (see Table 2), you will notice that 5 of the top 10 beers in Australia are produced by Foster’s, and in particular their largest brewery – Carlton & United Breweries[3].

Table 2 – Top 10 Australian Beers by Volume

	Label	ABV	Type	Producer
1	XXXX Gold	3.5%	American Adjunct Lager	Lion Nathan
2	VB	4.9%	American Adjunct Lager	Foster’s
3	Carlton Draught	4.6%	American Adjunct Lager	Foster’s
4	Tooheys New	4.6%	American Adjunct Lager	Lion Nathan
5	Tooheys Extra Dry	4.6%	American Adjunct Lager	Lion Nathan
6	Carlton Mid	3.5%	Light Lager	Foster’s
7	Carlton Dry	4.5%	American Adjunct Lager	Foster’s
8	Corona Extra	4.6%	American Adjunct Lager	Anheuser–Busch InBev
9	Pure Blonde	4.6%	Light Lager	Foster’s
10	Hahn Premium Light	2.6%	Light Lager	Lion Nathan

However, despite the popularity of Foster’s beer, it is actually very rare to find Foster’s Lager in Australia anymore. In fact, the only place many Australians are likely to find it is in the imported beer section of the local supermarket or bottle-o.

But this wasn’t always the case – up until the mid 80s Foster’s Lager was actually a very popular beer in Australia and was sold as a premium label amongst Foster’s other offerings. It wasn’t sold with the ubiquitous “Australian for Beer” branding, but it did have some pretty classic advertising – take a minute to relive 1980s Australia through this classic Foster’s TV spot from 1984:

So how did Foster’s Lager go from a mainstream beer to the imported section? In the mid 80s, due to changes in the Australian beer market and how Foster’s was marketing their various beers, Foster’s Lager started to lose popularity domestically as the company focused on promoting other labels such as Carlton Draught and Victoria Bitter (VB). As the then Foster’s CEO Trevor O’Hoy explains in an interview in 2006 (emphasis mine):

“Foster’s Lager had grown up as a mainstream Australian beer, punching at equal weight with VB in our portfolio. When we took it overseas, however, we took the brand slightly up-market and played heavily on ‘brand Australia’ – with international advertising featuring Paul Hogan, iconic Australian imagery and the ‘Australia’s famous beer’ tagline. That turned Foster’s into a top 10 international beer brand.

The flipside to this success was that Foster’s became the beer Australians drank overseas, not at home. Our Australian sales teams focused on the mainstream brands such as Carlton and VB, as well as innovating in cold filtered, craft brewing, dry, low carb and the light and mid categories. Foster’s Lager really didn’t have a champion or new positioning in Australia and its volumes slipped from the late 80s onwards.”

One final footnote to the Foster’s story, in December 2011, Foster’s became a subsidiary in the world’s second largest brewer by revenues, SABMiller[4]. Sadly, this means that the vast bulk of the beer being drunk by Australians is now owned by non-Australian multinationals.

Why isn’t Craft Beer Big in Australia?

As mentioned earlier, the craft beer scene in Australia is relatively small and under developed when compared to the US, even accounting for population differences. Yet Australia is a wealthy country with a healthy love for beer, so why hasn’t craft beer taken off in Australia like it has in the US?

A big part of the problem is the huge market share of the two biggest beer producers in Australia, Lion Nathan and Foster’s, and how aggressively they protect that market share.

A key weapon used by the big two to maintain market share is the tap or pourage contract, something that would be illegal in the US. When negotiating to supply beer to a bar, hotel or pub, a contract will be agreed to that sees the brewer provide rebates and other benefits[5] to the venue owner in exchange for securing exclusive access to most, if not all, of the taps. As an end consumer, this often means that Foster’s or Lion Nathan will own every beer (and cider) on tap at your regular watering hole.

A second key to maintaining market share is the willingness of Lion Nathan and Foster’s to buy out smaller brewers that are proving popular. Even many Australians will be surprised to learn that beers they thought were coming from small independent breweries (White Rabbit, Little Creatures, Bees Knees, Fat Yak, Knappstein, Matilda Bay) are in fact owned by Lion Nathan and Foster’s.

Competing against these two giants, craft breweries fighting to get access to taps, with typically more expensive small batch products, are often left with the choice of continuing to scrape out a living selling by the bottle, or selling out altogether. Even when a craft brewery does manage to get access to a tap, venue owners are often made generous offers to boot them in favor of another label from the big brewery that has locked up the other taps.

An example of how difficult it can be for craft brewers to get and maintain access to taps was provided in an excellent article by Adele Ferguson in the Sydney Morning Herald last year. The following is an excerpt from that article detailing the experience of a pub owner in Melbourne:

“Sitting down to his computer, a Melbourne publican discovered an email waiting for him. Sent by an executive from Carlton & United Breweries (CUB), it contained an offer that left him gobsmacked.

One of CUB’s specialty brews had been ”selling very well” in other pubs, the email explained. It then suggested the publican sell that brew on tap – at the expense of a specific competing craft beer that the publican was already offering. ”I’ll donate the first keg,” the CUB executive offered.”

Positive Changes Brewing?

Despite the duopoly in the Australian beer market, craft brewers are having some impact on the Australian beer market. The presence of viable craft breweries with a wider range of beers available has forced the big breweries to significantly diversify their offerings. As a result, even though all the beers on tap may be from the same company, there is typically a much wider range of offerings today then there was even 10 years ago.

And things could be about to get significantly better for craft brewers. The Australian Competition and Consumer Commission (ACCC) is rumored to be investigating whether tap contracts and other anti-competitive practices are legal under the Competition and Consumer Act. Even if they are found to be legal under the current law, the fact that these practices have been exposed is likely to create pressure for new regulations to be developed to help craft brewers survive and thrive.

For those that have seen the diversity and creativity on display in the US craft beer market, any change that gives craft brewers in Australia a better chance would be very welcome.

Classic Beer Adverts

Finally, for those looking for some light entertainment, I spent some time digging around YouTube for some classic Australian beer commercials. Unfortunately the older ads are few and far between, but I did find a top 10 from the last 10 or so years. Enjoy:

[1] Before Australian readers get too smug, they may want to sneak a look at their own top 10 (see Table 2) – it makes for equally dismal reading

[2] California – 431, Washington – 256, Colorado – 235, Oregon – 216

[3] See, the title wasn’t lying to you, Australian’s do love Foster’s

[4] Yes, that Miller

[5] Business development allowances, tickets to sporting events, promotional gear etc

US Labor Market Update – The Grind Continues

June 16, 2015 / Brett Romero / 0 Comments

On June 5, the Federal Reserve released its latest Employment Situation Summary. The results were slightly better than expected – 280,000 jobs added in the month of May compared to an expected 226,000. There were also small upward revisions to the previously released numbers for March and April.

In terms of the long-term trends in the participation rate identified previously (see here), this update didn’t really change much. The participation rate has more or less stopped falling over the past 12 months, currently sitting at just under 63% (see Chart 1). The percentage of the civilian non-institutional population[1] that is employed continues to climb slowly back towards to 60%, but is still well below the peak of over 63% reached in 2007.

Chart 1 – Participation Rate vs. Employed as Percentage of Civilian Population

The benchmark unemployment rate for May was 5.5%, a slight increase from 5.4% in April and was matched by a slight increase in the number of people unemployed, up to 8.7 million. Even though this goes against the general downwards trend in unemployment since 2010, Chart 2 shows how this slight uptick doesn’t really impact on the broader trend.

Chart 2 – Unemployment Rate

Unemployed Breakdown

Looking at the breakdown of the unemployed (see Chart 3), the average period of unemployment continuing to normalize, with the number of people unemployed for 5-14 weeks now below the number unemployed for less than 5 weeks. The group of people unemployed for 15 weeks or more, although still large by historical standards, also continues to fall in both percentage and absolute terms. To provide some indication of just how far the size of this group has fallen, in mid-2010 there were over 9 million people who had been unemployed for 15 weeks or more. That number is now less than 4 million, a decrease of over 55%.

Chart 3 – Unemployed Persons by Length of Unemployment

The improving situation for the unemployed is also evident in the average weeks people spend unemployed (see Chart 4).

Chart 4 – Average Period of Unemployment

Industry Breakdown

In Pa rt 4 of this series, we looked at what was happening to the number of people employed in various industries in the US economy. Chart 5 provides an update for some of the more interesting stories from that piece.

Chart 5 – Employment by Various Industries

By and large we see long standing trends continuing. Manufacturing continues to undergo a renaissance, bucking a long downwards trend. Nearly 1 million jobs have been added since the low point in early 2010. Education and health services, and professional and business services continue to grow strongly, while the government sector is basically still going nowhere.

Previously, we also looked in some detail at the Information sector, in particular the technology related subsectors. Chart 6 shows the breakdown of the information sector and its various subsectors.

Chart 6 – Employment in the Information Sector

What Chart 6 reveals is that the ‘Other information services’ subsector is clearly adding jobs at a fast pace, with data processing, hosting and related services also increasing employment. Chart 7 shows the employment growth rate in these two subsectors combined since 2006.

Chart 7 – Tech Subsectors Employment Growth

Since 2011, these sectors have been adding jobs at an annualized rate of between 6% and 8%. In total this has led to a 35% increase in jobs in these sectors since the start of 2011 – which is fantastic growth. But these subsectors are starting from a very low base –a 35% increase only translates into an additional 139,000 jobs. By way of comparison, over that same period, professional and business services added over 2.6 million jobs, education and health services added 1.9 million and even manufacturing added 700,000 jobs.

One thing to keep in mind though is that the tech boom is causing jobs to be created in other fields that service the technology sector. Lawyers, accountants, talent recruiters and HR personnel, among others, all provide support to the technology sector. Most of these roles are likely to sit in the professional and business services, which we just saw has added a lot of jobs. A big part of that story could be the tech boom.

[1] Persons 16 years of age and older residing in the 50 states and the District of Columbia, who are not inmates of institutions (e.g., penal and mental facilities, homes for the aged), and who are not on active duty in the Armed Forces.

Australian Housing Bubble – Further Reading

June 15, 2015 / Brett Romero / 0 Comments

Over the past 2-3 months, the mainstream media coverage of housing prices in Australia has exploded. Every commentator appears to have had a piece on this topic and was waiting for the right time to publish it. That right time is apparently now. For those interested in additional reading on this topic, here are some of the better pieces I’ve come across:

The banks and real estate: a Ponzi scheme that could ruin us? – Ian Verrender | ABC News

The housing crash we had to have: A Gen Y perspective on the bubble – Matt Ellis | Rational Radical

Another interest rate cut will fuel a housing bubble in danger of bursting – Greg Jericho | The Guardian

It’s not Hockey’s job comment that should worry us most – Michael Janda | ABC News

Blowing bubbles: the tricky task of tackling Sydney’s property market – Amy Auster | The Conversation

4 charts of the ‘largest housing bubble on record’ – Wolf Richter | Wolf Street

The Sydney housing bubble to pop – but how? – Michael Pascoe | The SMH

The mother of all housing bubbles – Chris Joye | The Australian Financial Review

Women and Corruption Issues in Kosovo

June 11, 2015 / Brett Romero / 0 Comments

For those that don’t know, over the past couple of months I have been spending time working with a tech startup/NGO here in Pristina called Open Data Kosovo. The main aim of the organization is to encourage and facilitate the release of data and other information by the government of Kosovo (and related bodies) in order to increase transparency and reduce corruption. So far they have been fantastically successful, getting both national and international media attention, which is all the more impressive when you consider they are only now coming to the end of their first year of existence.

One of the main things I have been working on since joining is putting together some analysis of the various datasets they have been publishing online to see what conclusions can be provided to the public that might help create a more informed discussion of the issues. The first piece has now been published on the Open Data Kosovo website and we are excited to see what kind of feedback we get. If you want to take a look, please click the link below:

More women in leadership would probably reduce corruption, but is there a more effective way?

Australian Housing Bubble Redux

June 9, 2015 / Brett Romero / 3 Comments

In the recent piece about the Australian economy we touched on the issue of the bubble in Australian house prices. Over the weekend, Saul Eslake, Chief Economist at Bank of America Merrill Lynch and one of Australia’s most respected economists, added his thoughts to the debate. A lot of his concern is around the longer term affects on people who are locked out of the housing market:

“I would say [rising house prices] are causing social harm because they are widening the gap between those who have houses and those who don’t, and freezing younger generations out of home ownership,”

In a country like Australia where, much like the US, owning your house is seen as a noble goal that everyone should be able to achieve, this could signal a cultural change. Home ownership in Australia is at its lowest level since 1950 as investors increasingly snap up properties, not for the rent/income they will generate, but for the assumed capital gains. In recently released data from the Australian Taxation Office (ATO) for the 2012-13 financial year, 1,967,260 (or just over 15% of all taxpayers) claimed rental income. Of those, 64% declared a net loss (i.e. they claimed deductions for negative gearing). Think about that for a second – almost 2 out of every 3 people with an investment property in Australia are actively losing money on that investment. What do these investors do if their expectation of further capital gains changes?

“2 out of every 3 people with an investment property in Australia are actively losing money on that investment.”

With all these statistics, why is there still an argument about whether a housing bubble exists? A big part of the problem is that there is no qualitative measure of a bubble. In hindsight they tend to be blindingly obvious, but one of the reasons bubbles occur at all is that most people don’t notice them as they are inflating. Adding to the problem is the reluctancy of politicians and commentators to call out bubbles or even use the word ‘bubble’ because of the negative connotations – bubbles tend to burst. The following was the response of Australian Assistant Treasurer Josh Frydenberg when asked about the possibility of a housing bubble on the ABC Insiders program on Sunday morning:

“I don’t think there is a housing bubble… In the early 2000s housing prices increased by 20 per cent for three years in a row and then were steady for a decade. And there wasn’t a bubble that led to a major correction.”

However, as the situation becomes more extreme, more and more respected commentators are starting to sound the alarm on this issue, even if they avoid calling it a bubble. Saul Eslake again:

“What I do say, without any hesitation at all, is that Australian prices of housing in most Australian cities, and particularly in Sydney, are, as [Reserve Bank governor] Glenn Stevens called them in September last year, ‘elevated’,”

So, leaving aside talk of bubbles, what are the facts?

Australians have record levels of housing debt as a percentage of income
Almost 2 out of 3 property investors are losing money on their properties
The median house price in Sydney is now over AU$900,000
Rates of home ownership are at their lowest levels in over 60 years

Whether or not you want to call it a bubble, that seems unsustainable to me.

Why the RBA doesn’t want to cut rates

June 6, 2015 / Brett Romero / 0 Comments

The first Tuesday of the month is interest rate day in Australia, the day the Reserve Bank of Australia – the Australian equivalent of the Federal Reserve – announces any changes to the official cash rate. The decision for June was to leave interest rates on hold at 2.0%.

In a situation that will feel relatively alien to readers in the US, Australian interest rates have never really been close to 0, but have been falling since late 2011 (see Chart 1).

Chart 1 – Australian Cash Rate vs. US Federal Funds Rate

What has been leading to falling rates in Australia over a period where the US has been slowly recovering and the Fed Reserve is slowly edging back to normalizing interest rate policy? As is usually the case, a mix of factors are involved.

Iron Ore and Coal Prices Return to Earth

A story that most people outside Australia have at least heard about is the large mining boom Australia has been enjoying over the past decade or so, and that it was largely driven by demand from China. What they may not know is that this mining boom has been largely driven by just two commodities (well technically three) – iron ore and coal (two types of coal – thermal and metallurgical). Chart 2 shows the prices of iron ore and thermal coal[1] in AUD/tonne since the 1995.

Chart 2 – Iron Ore and Thermal Coal Prices 1995 to Present

From this chart, we can clearly see the huge increase in prices that boosted the Australian economy. This was particularly pronounced for iron ore which went from between AU$16-AU$17 a tonne for most of the 90s to over AU$180 a tonne in 2010 and 2011.

Aside from generating huge profits for anyone who happened to own a coal or iron ore mine, what this price rise also led to was a large amount of employment in areas that weren’t just digging up the commodities themselves. This included:

Exploration of possible new mining sites – at AU$180 a tonne everyone wanted an iron ore mine
Building infrastructure that facilitated the large-scale digging up and exportation of these commodities – ports needed to be built and/or expanded, mining pits dug, roads paved and so on
Providing services to mining companies – lawyers, accounts, caterers and so on

After peaking in 2010/11 though, things started to go into reverse. By late 2013, much of the investment in infrastructure had run its course and the people who were employed to build that infrastructure were no longer needed. Prices were falling, bringing into question the viability of a lot of higher cost mines (and the mining companies running these mines) set up during the boom period. In short, a lot of people formerly employed on mine sites or in mining services roles were finding themselves looking for a new job and the rest of the economy was (and still is) struggling to pick up the slack. This in part is because of the …

High Exchange Rate

For those that haven’t decided to brave the 20+ hours of flight time to visit Australia in the recent past, Australia has become an extraordinarily expensive place. Sydney and Melbourne have been consistent fixtures in the world’s most expensive cities to live lists over the past 10 years.

Most of this was driven by a very strong Australian dollar, which was in turn driven mostly by the mining boom. In addition to buyers of commodities needing Australian dollars to buy the products they wanted, Australia became the target of a large volume of carry trade with currency traders looking for a relatively stable economy to park money at a relatively high interest rate. As a result of this, at the height of the mining boom, the AUD was buying almost $1.10USD.

Since that peak, the Australian dollar has depreciated around 30% (see Chart 3), easing a lot of the price pressure. However, as of 2015, Sydney and Melbourne still rank 5^th and 6^th on the world’s most expensive city list, as provided by the Economist Intelligence Unit’s (EIU) bi-annual Worldwide Cost of Living report.

Chart 3 – AUD/USD Exchange Rate 1995 to Present

The RBA has publically been stating that they believe the value of the Australian dollar is too high in an attempt to talk down the value of the Australian dollar (often called ‘jawboning’) and provide a boost to the non-mining sectors of the Australian economy. They have also progressively lowered the cash rate from 4.75% in 2011 to 2.0% today, in an attempt to stem the carry trade. As we have seen, to some degree they have been successful, but the exchange rate is still higher than they (and many other commentators) believe is optimal.

Unfortunately, some bumbling on the part of the RBA (or the execution of a plan that no one else understands) has blunted some of their efforts. At the previous monetary policy meeting at the start of May, the RBA lowered the official cash rate from 2.25% to 2.0%, but removed any talk of further cuts from the publically released meeting minutes (removing the “easing bias”). Doing this then had the opposite of the desired result and caused a spike in the Australian dollar.

Chart 4 – Consumer price index; year-ended change 2000 to 2015

So why are they removing the easing bias? Why don’t they just slash rates further – after all inflation is running below the target band (see Chart 4)? The problem is they are worried about the…

Bubble in House Prices

The RBAs hesitancy to cut interest rates further is mostly due to a concern about further encouraging investment in housing and contributing to rising house prices, which look to be well into bubble territory.

For those that aren’t too familiar with Australia, particularly the modern, post ‘put-another-shrimp-on-the-Barbie’, Australia, being a property tycoon has become something of a national obsession. Home renovation shows are everywhere and are getting huge ratings. Morning news regularly holds interviews with the latest property ‘success story’.

This obsession has led to Australia becoming a world-beater when it comes to levels of household debt. The Australian Bureau of Statistics (ABS) produced a great series of charts in May 2014 showing some alarming statistics. See below for some of the highlights:

Chart 5 – Household Debt vs. Annual Income[2] in Australia 1987 to 2013

Charts 6 and 7 – Household Debt vs. Annual Income – Various Countries 2001 to 2013

After 20 years of Australians continually buying properties off each other for ever-increasing prices, funded mostly by increasing level of mortgage debt, something changed. Perhaps it was the median house price in Sydney soaring past AU$900,000 (approximately US$700,000 at today’s exchange rate). What ever triggered it, in recent months, the talk in Australia has become all about a bubble in house prices, particularly in Sydney and parts of Melbourne. The Secretary of the Department of the Treasury, John Fraser, recently became the latest high profile public figure to weigh in:

“When you look at the housing price bubble evidence, it’s unequivocally the case in Sydney, unequivocal,”

More over, he drew a direct link between high house prices and low interest rates:

“It does worry me that the historically-low level of interest rates are encouraging people to perhaps over-invest in housing,”

And there is plenty of evidence to support the notion that the rise in housing prices is increasingly due to investors as opposed to owner-occupiers (see Chart 8).

Chart 8 – Investor Housing Credit as a Percentage of Total Housing Credit 1990 to 2014

Meanwhile, belying the sparkling reputation the Australian Government has earned internationally in recent times[3], the Government has all but ruled out taking any meaningful action to reverse key policies that are currently encouraging investment in property – negative gearing and the capital gains tax concession being two of the main culprits. When asked in a recent session of question time by the leader of the Opposition Bill Shorten to respond to the comments from John Fraser, Prime Minister Tony Abbott responded as follows:

“As someone who, along with the bank, owns a house in Sydney I do hope our housing prices are increasing,”

Summing Up

All this leaves the RBA in quite a pickle. Relatively high interest rates (by the standards of developed nations internationally) continue to keep the exchange rate at higher than desired levels, which makes Australia an expensive place to do business. This in turn harms Australia’s two big non-commodity exports – higher education and tourism – just when they need to pick up the slack from a cooling mining sector. But lowering interest rates risks further fueling a bubble in house prices which the Government seems quite happy to ignore.

I don’t imagine there are too many people who would like to be in the shoes of RBA Governor Glenn Stevens right now.

Keep an eye on this space for further updates as this all unwinds.

[1] This is an example of that classic Australian trait – sarcasm

[2] Gross disposable household income received during the previous year.

[3] If anyone can find a good historical price series for metallurgical coal, I’d love to hear from you