Once More For The Dummies Blowing Bubbles

I'm Just Sitting Here Watching The Bubbles Go Up (I Just Had To Let It Go)

Yeah, I know I know. I've been saying there's a property bubble in Australia and it dates back a good decade and a half, but the RBA, Treasury and all governments have been talking it down for the entire time. All of a sudden this quarter, Treasury, then the RBA have come out and stated they've seen the elephant in the room. What's even more astounding is that in the face of expert advice, the Prime Minister said he just wants property prices to go up because it's in his personal financial interest; Worst-Treasurer-Ever Joe Hockey said, get a better job if you want to buy into property; and the real estate sector pundits are coming up with all manners of statistics why it might not be a property bubble that is unfolding. Some are even arguing that it can't be a bubble because it's only a shortage of supply - which makes as much sense as "get a better job". Post-hoc arguments like that don't really count as analysis.

The cycle of blame in the media has gone into overdrive as foreign investors who have bought up the top end of town are blamed, as well as negative gearing and the relative lack of supply, record low interest rates, and the notion that property never goes down. One imagines there are any number of journalists who will never get into the Sydney housing market with their straight up journalist's salary. But they're all barking up the wrong tree. Is there a bubble? Yes. Did it start yesterday? That would depend on what you mean by 'start' and 'yesterday'. I can assure you the phenomenon didn't manifest itself out of the blue, out of seeming nothing.

The point is, when too much money chases too few assets, that's the definition for inflation. In the past when inflation reared its ugly head, central banks would raise interest rates to calm down prices. This was how the inflation component of Stagflation of the late 1970s and early 1980s was tamed in America by Paul Volcker, and is the very mechanism by which we understand "the recession we had to have" in the early 1990s in Australia when interest rates soared to 17.5%. Those were some heady days!

Since then, our central banks and governments have indulged in a few naughty practices and it comes down to this: They've been screwing with the way inflation is measured in such a way as to under-report it. They've been doing it for some time, and to such an extent that inflation looked markedly lower than the Australian Bureau of Statistics' own cost-of-living measures. For a good decade now, we've lived in the condition where inflation has been reported markedly lower than the cost of living.

Simply put, the RBA is setting interest rates too low because it's measuring inflation incorrectly. Why does it do so? Because it gets rewarded easier that way, by lowering the hurdle just a bit each time. And because it's setting it too low, there's a property bubble going on; and because it's measuring it incorrectly, it took until this quarter for both Treasury and the RBA to come out and say there's a bubble.

Seriously folks, if inflation is reported lower, it gives licence to central banks to ease monetary policy rather than tighten it. By underreporting inflation for so long, there has been a cumulative easing of monetary policy to such an extent that we're now at 2% interest rate as a property bubble rages on. There's simply too much money chasing too few assets, but the RBA won't pull back from easing because it's believing its own inflation figures. Meanwhile, the general populace who have inelastic economic needs - food, clothing shelter, power & telco - have faced a rising cost of living for so long that they hardly have the disposable income to keep consuming. Private debt has reached incredible highs in Australia, as it has in other anglophone countries, and it's stopping people spending the way the RBA thinks it should. Adding more credit and easy money to the mix isn't going to work.

So what should they be doing? The answer is pretty simple.
The RBA needs to dust off the old way of calculating inflation used back in the 1980s, and figure out just how much they've under-reported inflation over the years; then they need to jack up interest rates just like they did in the early 1990s, to convincingly take away the punchbowl. But without doing so, they're letting all the easy money take up zombie positions in the economy and there will never be a return to strong growth. And at the end of the day, strong growth is their mandate.