The Reserve Bank cuts interest rates and promises rates will be lower for longer. The Australian stockmarket hits a record high, keen bidders return to weekend housing auctions.
That’s the way interest rate cuts disappear – they are turned into higher prices. That’s nice for people who own assets, not so nice for those who don’t.
Part of the way lower interest rates are supposed to stimulate the economy is by encouraging people to borrow more to buy assets. More money chasing things means the price of things goes up.
With Australia’s notoriously high level of household debt, encouraging more borrowing, rather obviously, is a double-edged sword.
But the way cheaper money works, borrowing more and higher prices make sense – with one big caveat: the borrowing can continue to be serviced, i.e. the borrower doesn’t become unemployed or divorced and the economy doesn’t hit the wall or, more dangerously, suddenly improve, resulting in interest rates rising again. In other words, don’t look down.
Putting aside that caveat for a moment, what follows is a simplified example of how the RBA cutting rates – in the absence of federal government stimulus – can turn a goose into a swan, or maybe a dog into swan, to mix my species further.
I’ve long been wary of the rental yields promoted by real estate spruikers and suspected the average small-time property investor greatly underestimates the costs of the game.
By the time maintenance, agents’ fees, body corporate fees and levies, vacancy periods, council and water rates, renovations and insurance all grab their share, a genuine net yield of 1 or 1.5 per cent is often reality for the landlord class – and I’m assuming here that the property is not mortgaged.
(Yes, I know, some properties do much better, but some also do worse.)
With the help of negative gearing and our fat capital gains tax discount, that hasn’t mattered much to investors who’ve relied on the price of the property forever rising to deliver the real profit.
As investors who bought at the top of booms have discovered, housing prices don’t always go up, which rather complicates matters. Add transaction costs (mainly stamp duty) to, say, a 10 per cent price fall and the capital gains side isn’t looking so flash. Rental yield starts to matter a lot more, as the game becomes one of hold-on-and-hope-for-the-long-term.
Putting price falls aside, just a roughly stable housing market means rental yield is what counts. In countries that lack our skewed tax system and reliance on mum-and-dad landlords, it’s actually normal for housing investment to be mainly about rental returns.
So on top of credit being harder to get and the crack-down on interest-only loans, it’s no surprise that investors found other things to do on Saturdays than attend auctions.
The main inhibitor was the lack of reward for trying to catch a falling knife – all that stamp duty to buy something that might be worth less this time next year, forget it.
Contrary to earlier fears, FOMO (fear of missing out) hasn’t been replaced by FONGO (fear of not getting out) in Australia. But there’s no need for investors to rush in when there’s so much doubt about prices. The track record of Sydney housing in particular has tended to be booms followed by lengthy periods of not much happening to prices at all.
Ever-cheaper money starts to change that equation.
For those with money to invest, a genuine net yield of 1.5 per cent with the chance of capital gains somewhere down the track begins to look attractive if banks are only offering about that much for term deposits and guarantee that inflation will reduce the worth of the capital.
And if it’s possible to borrow for 3 per cent with the interest being tax-deductible, the holding cost for someone in the top tax bracket is marginal.
Thus lipstick can be applied to a pig, or a dog investment turned into a swan, relatively speaking.
But then Harris’ Law comes into play: Everything is capitalised.
Coined by Tony Harris, a former NSW Auditor General, it means that every government policy change (and interest rates for that matter) gets built into prices. For example, a generous grant for first-time buyers is soon built into the price of first homes, leaving the buyers with little benefit.
The interest rate cut turns out to be a sugar hit – sweet for a while, but then empty, lacking sustainable substance. Yes, the dog turns into a swan, investors come back to the market and, all other things being equal, prices rise enough to leave the financial sums pretty much where they were before the rate cut.
The people who profit most are those who already held the assets before the policy change. Everyone else plays catchup.
The same factors are at work on the stockmarket, only quicker. The chase for dividend yield is on, pushing prices higher and, in the process, yields down. A dollar for every article on picking dividend-paying stocks (including some I’ve written myself), and I’d be substantially wealthier.
Meanwhile, those stuck with term deposits – wary of investing in appreciating assets or needing ready access to funds or lacking enough capital for them to think it worthwhile – are the biggest losers.
That also is the way softer monetary policy is supposed to work. The central bank wants to encourage more investment, more risk-taking, to stimulate the economy. In part, the encouragement comes from punishing people sitting on cash, forcing them to invest it in riskier assets.
But here’s the big problem: we’re rather short of productive additional investment opportunities – companies aren’t doing all that much productive investment for shareholders to invest extra cash in.
Thus it looks like more money being chased into speculation, into pushing up the price of existing assets, rather than creating new ones the way the text books theorise.
And all this is happening while the cornerstone of the global economy, the US treasuries market, is being corrupted by the Trump administration. Even amid healthy economic growth, the deficit for this American fiscal year widened to $US747 billion ($1.09 trillion) in the first nine months, 23 per cent higher than the same period a year earlier.
Mr Trump’s crazy tax cuts were more than a sugar hit, more of an adrenaline injection. Predictably, the neoliberal voodoo economics promise of tax cuts paying for themselves has failed to happen.
Now Mr Trump has successfully dropped the weights on the Federal Reserve to cut US interest rates in another attempt to keep the credit party going.
As Bloomberg has reported, the Trump who once said he would eliminate the US national debt is now approving a Federal budget that will usher in annual deficits of more than $US1 trillion ($1.46 trillion).
No, it’s not sustainable. And the pressures created impact the rest of the world while each interest rate cut is capitalised.