The Next Bubble Coming From Down Under

www.debtdeflation.
com/blogs

A Motley Crew interview on

Australian House Prices
The Motley Fool’s international investing team will be visiting Australia for a week starting on February
15th, meeting with more than a dozen domestic companies to get a feel for what the Australian stock
market has to offer. If you’d like to get their impressions, sign up for their free dispatches here. Their
overview piece on the trip itself is entitled “One Last Giant Property Bubble”.
I'm one of the people they'll be interviewing, and as a prelude they posed 3 questions to me:
 Is Australia’s housing bubble bigger than the one in the US?
 What would trigger a correction?
 Who would get hurt the worst?
In my typical fashion I supplied a thesis when a crib sheet was required, so my answers had to be edited
somewhat for their site:
The Next Bubble Coming From Down Under
Here’s the original full‐length version.
Is Australia’s housing bubble bigger than the one in the US?
The Australian housing bubble is categorically larger than the USA's, though in standard bubblology talk,
the main reason that it is—that it was far more a pure speculation on prices than the American bubble—
is touted as one of the reasons that "Australia is different" and a crash won't happen here.
Before I elaborate on that point, here's the data. The raw data for the US is the Case‐Shiller Index, while
the recent raw data for Australia comes from the Australian Bureau of Statistics established house price
index. This has two series—one using 2003‐04 as a base year, and the other 1986‐87. I combine the two
to produce a composite index from then till now.
For pre‐1986 data, I use the numbers derived by an Australian academic Nigel Stapledon in his PhD
thesis, which used newspaper records to derive series for Sydney and Melbourne going back to 1860.
Figure 1 compares just the recent (post 1986 data), where Case‐Shiller's base year is 2000 and the ABS's
is 2003‐04:
Steve Keen’s Debtwatch A Motley Crew on House Prices Page 1

www.debtdeflation.com/blogs

Figure 1
Nominal House Price Indices

250
Australia
USA
200
Nominal House Price Index
150
100
50
0
1985 1990 1995 2000 2005 2010 2015
Case-Shiller; ABS 6416
Figure 2 puts them to the same base year of 1986. It's now obvious that nominal house prices in
Australia have risen far more than in the US since 1986: a factor of six increase, versus a peak of about a
3.5 increase in the USA (which has now fallen to less than a 2.5 times increase after the US bubble burst
in 2006).


Figure 2
Nominal House Price Indices

600
B E
Australia
USA
500
June 1986 = 100
400
300
200
100
0
1985 1990 1995 2000 2005 2010 2015
Year
I also mark on it the beginning and end of the Australian government's contribution to this Ponzi
Scheme, the most recent incarnation of its "First Home Owners Scheme", which gives first home buyers
a cash grant towards their first purchase that is then levered up by a bank loan when they go shopping.
For this reason I call it the "First Home Vendors Scheme", since the real recipients of the government
largesse are the vendors who sell to these new entrants—and they get not merely the government
money, but the levered amount that the banking sector throws on top of it.
When the "Global Financial Crisis" loomed (as the "Great Recession" is called DownUnder), the then
Rudd Labor Government doubled this grant to $14,000 for an existing property and tripled it to $21,000
for a new one, in what they called the First Home Owners Boost, and which I nicknamed the First Home
Vendors Boost (FHVB). The Scheme, which began in October 2008, was supposed to last 8 months but
was extended to 14 months because it was "so successful".
Back to the data. Consumer price inflation has run at different speeds in the two economies, so real
prices are the best for comparisons; Figure 3 deflates the Case‐Shiller 20 city index by the US CPI, and
the Australian data by its CPI.


Figure 3
Real House Price Indices

300
B E
Australia
USA
250
June 1986 = 100
200
150
100
50
1985 1990 1995 2000 2005 2010 2015
Year
The intriguing aspect of this comparison is that the two bubbles tracked each other from 1997 till 2004
(with the Australian at a higher level since a mini‐bubble back in 87‐89 that I'll return to later), and then
diverged. The Australian trend broke first, but then restarted just before the US bubble finally burst. The
Australian bubble then broke again in 2008, only to be restart shortly after by the FHVB. It has recently
topped out, with one quarter of falling prices (with the nominal index dropping 0.3%), and the latest
rising by 0.7% (bear in mind however that the 0.3% fall for the September quarter was first shown as a
0.1% increase, and both figures are still subject to revision).
A final long‐term comparison to see just how Australian and US house prices really compare uses
Stapledon's data back to 1890, when the Case‐Shiller Index began:


Figure 4
Long Term Real House Price Indices

400
B
Australia
USA
Aus mean pre-1983 (90)
300 Aus mean 49-83 (117)
USA mean pre-1997 (98)
200
100
0
1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Whether this period marks the beginning of the end of the Australian house price bubble will only be
clear in hindsight, but the volatility of the index is now extreme, and the impact of the FHVB on it is
obvious in Figure 5.


Figure 5
Quarterly House Price Changes

25
B E
20
15
Percent annualized
10
5
 10
Nominal Prices
 15
After Inflation
 20
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

This is not a new phenomenon: though I apportion most blame for the Australian house price bubble to
the finance sector, there’s little doubt that the fuse itself was lit by the government’s interventions via
the First Home Owners Scheme, which began in 1983.
‘This Government was elected . . . with a commitment to boost the nation's
economy . . . Our housing policies are an essential element of our national recovery
strategy . . . Our program is designed to achieve the dual objectives of ensuring that
housing plays a key role in our economic recovery and ensuring that Australian families
can gain access to adequate housing at a price they can afford.
The main elements of our program are . . . a new more effective scheme to assist
low income home buyers ‐ the first home owners’ scheme . . . to get the housing industry
moving without delay we removed the savings requirement from the existing home
deposit assistance scheme . . .’ (First Home Owners’ Bill 1983)
This scheme has always been used as a means to stimulate the economy, and it’s worked—but in much
the same way that an anabolic steroid will help an athlete win a medal: it pumps up the performance at
the event, only to leave the athlete with long term health problems in the future. From 1951 until the
FHOS was introduced in 1983, the average quarterly increase in house prices was 0.07%—which is
statistically indistinguishable from zero, given that the standard deviation was 1.73%.


Figure 6
Change in Real House Prices and the FHOS

30 12
Prices 11
25 Unemployment
10
FHOS
20 9
Percent of Workforce
8
15
Percent p.a.
10 6
5
5
4
0 3
2
5
1
 10 0
1970 1974.6671979.333 1984 1988.6671993.333 1998 2002.6672007.333 2012
Year

After the Scheme was introduced, the average quarterly increase increased by more than a factor of ten
to 0.94%, and the volatility rose as well. Since there have also been periods where the Scheme was
removed and when it was doubled, it’s possible to drill down further on its impact—and it’s bleedingly
obvious that it both increased house prices and their volatility.
Table 1
Stats Before After All During Between FHOS When FHOS

FHOS FHOS Data FHOS periods doubled
Mean 0.07% 0.94% 0.47% 2.17% 0.25% 3.10%
Min ‐5.53% ‐3.73% ‐5.53% ‐2.26% ‐2.26% ‐0.92%
Max 3.91% 7.86% 7.86% 7.86% 2.95% 4.93%
Std. Dev. 1.73% 2.17% 1.99% 2.71% 1.26% 1.83%
Count 131 110 241 25 51 7
Government interventions in this asset market make it very hard to work out a decent base year from
which to compare Australian house prices to those in America. Prior to 1949, the Australian government
enforced a rental ceiling, which kept house prices artificially low. Since 1983, it has run the First Home
Vendors Scheme, which (along with other interventions like negative gearing) kept prices artificially
high. I take 1970 as the best date for a comparison of the Australian and US house price indices, since
it's halfway between when the price spurt caused by the abolition of the rental control scheme had
petered out, and the new regime of keeping house prices high took over. So Figure 7 is my preferred


series comparing Australian and US house prices (with the B marking the introduction of the First Home
Vendors Scheme):
Figure 7
Long Term Real House Price Indices

300
B
Australia
275
USA
250
225
Index 1970 = 100
200
175
150
125
100
75
50
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

As tends to happen at the end of a bubble, when prices have been driven far higher than incomes,
spruikers have claimed that Australian house prices are not really high when compared to incomes. The
Demographia survey's comparison of median house prices to median incomes has been disparaged by
spruikers who happily compare median house prices to average incomes, where those average incomes
include imputed rental returns from owner‐occupied dwellings, superannuation entitlements that can't
be used to pay mortgage bills, etc.
This tends to be an interminable debate about what should and what shouldn't be included, so I prefer
to compare the house prices to the broadest possible measure of income: GDP per capita (which
understates the problem because GDP includes imputed rental income from owner‐occupied dwellings,
which of course can’t be used to pay the mortgage!). Starting from the same date, this yields the
comparison of Australian house prices to income shown in Figure 8, on which basis Australian house
prices are at least 50% overvalued, with all of the rise above the long term average occurring since first
the Howard and then the Rudd government doubled the FHVB in response to fears of a recession.


Figure 8
House Price Index to GDP Per Head

200
Howard Rudd
Index (170)
Mean (119)
175
+ 3 St. Dev.
- 3 St. Dev.
150
June 1953=100
125
100
75
50
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Another take on affordability and whether housing is overvalued is to consider income per household,
since it could be argued that the increase in women's participation in the workforce since 1970 has
meant that two (or more) incomes are being earned per dwelling, making a higher price affordable.
Figure 9 compares the house price index to household disposable income per dwelling (using the RBA
table G12 for disposable income and ABS tables 4102 and 87520037 for the number of dwellings).


Figure 9
Ratio of House Price Index to Disposable Income per Dwelling

275
250
225
Index 1960=100
200
175
150
125
100
75
50
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Spruikers claim that there have been significant demographic shifts, that houses now are bigger and
better than those in 1970 and so on. However all of the increase in the house price to GDP per capita
index above its average has occurred since 2001 (when Howard doubled the FHVB because of fear of a
recession), and there has been no real change in Australian demographics since then, as Figure 10 and
Figure 11 indicate.


Figure 10
Ratio of Population to Dwellings

4
3.75
3.5
3.25
2.75
2.5
2.25
2
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Year
Figure 11: The period 2006‐10 is the only one where population growth exceeded growth in dwellings
Ratio of Population to Dwellings

2.65
2.64
2.63
2.62
2.61
2.6
2.59
2.58
2.57
2.56
2.55
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Year


This is a good point to consider the usual spruiker case that house prices have risen because demand—
driven by rising population—has exceeded supply. One of the most regularly cited justifications for this
is the National Housing Supply Council report, which estimates the gap between supply and “underlying
demand”.
‘ . . . the Council estimated a gap of around 85,000 dwellings between underlying
demand for and supply of housing at 30 June 2008. The Council developed a
methodology for measuring the gap based on selected measures of homelessness,
including the number of marginal residents of caravan parks and the undersupply of
private rental dwellings indicated by the rental vacancy rate. The measures used in the
2008 report were:
 2008 gap size = additional private rental dwellings required in 2008 to
increase the number of vacant private rental dwellings to 3 per cent of the
total private rental stock
 + dwellings required to accommodate people who are homeless and
sleeping rough or staying with friends and relatives
 + dwellings required to house marginal residents of caravan parks.’
(National Housing Supply Council 2010, pages 65‐66)
These are legitimate measures of a social need, but they’re not a measure of the market demand for
housing! Figure 12 shows the correlation of changes in the number of Australians per house with
changes in nominal house prices:


Figure 12
Population Density Change & Nominal House Price Change

40 8
House Price Change
35
Population Per Dwelling Change 7
Population per dwelling change

Nominal House Price Change
30 6
25 5
20 4
15 3
10 2
5 1
0 00
5 1
 10 2
1975 1980 1985 1990 1995 2000 2005 2010 2015

A falling ratio of people to houses—so that the housing stock was growing more rapidly than
population—should have meant falling prices according to the standard "supply and demand"
argument. But what about the one brief period where population was actually rising faster than the
housing stock—between 2006 and 2010—and house prices also rose sharply?


Figure 13

Population Density & Nominal House Price Change
1 20
0.75 15
Nominal House Price Change

Population Density Change
0.5 10
0.25 5
0 0
Population Density
 0.25 5
House Price
Quarterly Change
 0.5  10
2006 2006.5 2007 2007.5 2008 2008.5 2009 2009.5 2010 2010.5 2011 2011.5 2012
Whoops! The correlation is actually strongly negative: minus 0.56. Population dynamics gave spruikers a
good story, but it wasn't what drove house prices up.
What did instead was debt. Demand for houses is not population increase: it’s people with new
mortgage loans. When you look at the relationship between new lending and the change in house
prices, you finally start to see some serious long run correlations (as long as the data makes possible,
anyway).


Figure 14
New Lending and Change in Nominal House Prices

30
New Lending % GDP
Annual Change in Price
Quarterly Change
20
Percent p.a.
10
 10
1990 2000 2010
Year

The correlation coefficient here is 0.53—rather better than the minus 0.06 that applies between change
in population per dwelling and change in price over 1975‐2010—and it improves when the trend of
rising mortgage new debt to GDP is removed. So we’ve had a debt‐driven housing bubble, just as has the
USA, and it’s the dynamics of debt that will determine when and how it bursts—not demographics.
What would trigger a correction?
Ponzi Schemes ultimately fail under their own weight, because they involve paying early entrants more
than they put in, while producing no profits with high running expenses. A debt‐financed Ponzi Scheme
can however appear to work for a long time, because the price of the object of the Scheme—in this case
house prices—can rise so long as debt levels per house rise faster still.
That was clearly the case in Australia. Property spruikers focus on the price increases and ignore the
debt, but the latter has risen far more than the former: nominal house prices are up by a factor of 15
over 1976, but debt per house has risen by a factor of 55 (Figure 15).


Figure 15
Price, Debt and Disposable Income per Dwelling

60
55
Debt (55 times)
Price (14 times)
50
Income (7 times)
45
Ratio to July 1976 = 1
40
35
30
25
20
15
10
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
Year
The turning point in that process appears to be nearby: both debt per dwelling to price (Figure 16) and
debt per dwelling to disposable income (Figure 17) appear to be topping out.


Figure 16
Ratio of Debt per Dwelling to Price

500
450
400
Index July 1976 = 100
350
300
250
200
150
100
50
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
Year
Figure 17
Ratio of Debt per Dwelling to Disposable Income

1000
900
800
700
600
500
400
300
200
100
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
Year


Figure 18
Ratio of Disposable Income per Dwelling to Price

110
100
90
80
70
60
50
40
30
20
10
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
Year
This underscores the fact that, just as in America, rising mortgage debt was the real fuel for rising house
prices. Though Australia didn't have as widespread a Subprime phenomenon as the USA, and many
more mortgages are held on the books of the banks, the level of mortgage debt actually rose faster and
higher in Australia than in the USA (The vertical lines on Figure 19 identify when the First Home Vendors
Scheme first began—in 1983—and when the recent doubling of it ceased—in January 2010; there is
however still a $7,000 grant for a first home buyer).


Figure 19
Household Debt to GDP

100
B E
USA (Maximum 98%)
90
Australia (Maximum 99%)
80 Mortgage only (88%)
70
60
Percent
50
40
30
20
10
0
1975 1980 1985 1990 1995 2000 2005 2010 2015

What will bring this bubble undone is its very success: having successfully driven house prices skywards,
the cost of entry into the market is now prohibitive so that the flow of new entrants is drying up. Since
the Scheme depends on a constant flow of new entrants, this alone will bring it unstuck. A gauge of just
how difficult it is to get into the market is given by looking at the ratio of the average first home loan to
the average income—when most first home buyers are going to have an income below the average.
The average first home loan has risen fourfold in the last 2 decades, from $75,000 to almost $300,000
(Figure 20).


Figure 20
Average First Home Loan

300000
275000
250000
225000
200000
175000
$
150000
125000
100000
75000
50000
25000
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

This rise has far outstripped increases in all incomes, let alone wages, which have lagged increases inr
productivity in Australia as they have in the USA. In 1992, the average first home loan was 2.5 times the
average before tax yearly wage income. Now it is 5.5 times as much, and it briefly reached 6 times
annual income during the frenzy caused by the Rudd Goverment's doubling of the FHVG (Figure 21).


Figure 21
Average First Home Loan to Average Wage

6
5.5
4.5
Ratio
3.5
2.5
2
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Year
Spruikers also claim that this increased debt burden just reflects lower interest rates. Even the Governor
of the Reserve Bank of Australia made such a claim:
The rough statistic that I have quoted many times was that the average rate of
interest was about half; that meant you could service twice as big a debt. Guess what?
That is exactly what occurred, and that had a very profound effect on asset values.
(Glenn Stevens, remarks to the House of Representatives Standing Committee on
Economics Finance and Public Administration, 2007, p. 26)
Let's see how well this argument stacks up against reality by considering the servicing cost on a typical
25‐year floating interest rate mortgage in Australia as a percentage of the pre‐tax earnings of Australian
workers.


The result is pretty stark: in 1992, servicing the average first home loan took under 20 percent of the
pre‐tax income of the average wage earner. Now it takes 60 percent. Since the average tax rate on
Figure 22

Payments on Average First Home Loan over 25 Years
100
90
Percent of average wage income
80
70
60
50
40
30
20
10
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Year
workers is about 22%, and since payments on your own home can't be written off against tax in
Australia, this means that the average wage earner would have only 20% of his/her income left for all
other expenses after paying the mortgage.
Clearly it's no longer possible for a single wage earner to buy the median house in Australia—and even a
2 bedroom apartment is out of the question. But what about a couple—what have they got left for
expenses after paying taxes and the mortgage?
Back in 1992, this was a doddle: paying the mortgage took just 12 percent of the family budget. Now it
takes 37 percent. For those unfortunate couples who took out a home loan while the FHVB was in
operation, it takes as much as 42 percent of their combined after tax income.


Figure 23
Payments on Average First Home Loan over 25 Years

50
Percent of after tax income of 2 average wage earners
B E
45
40
35
30
25
20
15
10
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Year
So the bubble will collapse because it has been too successful—and the government's doubling of the
FHVG has added to this because it encouraged new entrants who may have waited till 2011 to buy in
during 2009 instead. There are less first home buyers entering at the bottom of the escalator (Figure
24), and they are taking out smaller loans, while the trend in other loans is also headed down (Figure
25).


Figure 24
Number of New Housing Loans per month

70000
B E
65000 First Home Buyers
60000 Others
55000
Smoothed Sum
50000
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
ABS 560909a
Figure 25
Value of New Housing Loans as percentage of GDP

25
B E
22.5
20
17.5
15
Percent
12.5
10
7.5
2.5
0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012



So the volume of unsold properties is mounting and the time to sell is increasing. This normally precedes
the beginning of a downturn in house prices—since most vendors initially refuse to accept offers below
their reservation prices.
One reason that is often advanced as to why Australia won't suffer a US‐style housing price crash is that
there hasn't been a huge building boom here. The factoid is definitely true; but the obverse
interpretation is that Australia's housing finance has been even more speculative in nature than the
USA's. The fraction of total borrowing that has financed investment‐oriented construction versus
speculation‐oriented purchases of existing properties by investors has fallen from almost 60 percent in
the mid‐80s to under 10 percent now. In fact, "investors" in the Australian market now invest less than
owner‐occupiers do—though the recent spurt in the fraction of owner‐occupier loans supporting
construction from the all‐time low of under 8 percent to just over 11.5% was probably an artifact of the
tripling of the First Home Owners Boost for those building their own home.
Figure 26
Construction Loans versus Total Loans

60
B E
Investors
55
Owner Occupiers
Percent (smoothed investment data)
50
45
40
35
30
25
20
15
10
0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

In the aggregate now, less than 10 cents in every borrowed dollar builds a new home. This does mean
that there isn't an overhang of newly completed properties on the Australian market. But conversely,
the huge proportion of "investors" who have bought in solely to achieve capital gains means that the
investor side of the market is very fragile": any sustained pause in price increases means these investors
face mounting losses.


Figure 27
Aggregate Lending to Housing

70
B E
65 Investors
60
Owner Occupiers
55
50
Percent of GDP
45
40
35
30
25
20
15
10
5
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

The increase in the number of "investors" relative to owner‐occupiers played a major role in driving up
house prices. The rise in "Mum and Dad investors", as they were termed, saw investor borrowing rise
from about 15% of total mortgages in 1990 to over 30 percent since 2000.


Figure 28
Aggregate Lending to Housing

100
B E
90
Percent of total housing loans
80
70
60
50
40
30
20
Investors
10
Owner Occupiers
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Predictably, the rise in “investors” as a proportion of total borrowing saw rental income top out and
begin to fall.


Figure 29
Rental income as percent of GDP

8
6
Percent of GDP
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Most "investors" declare losses on their income tax (which is subsidised by the Australian scheme
known as negative gearing, where property speculators can write off losses on servicing rental
properties against all other income). However this ruse is only worthwhile if asset price inflation more
than compensates for the taxpayre‐subsidised losses made while owning a property. So the investor
proportion of the market is likely to add to supply if there is a sustained period of flat prices, since their
losses will mount in the meantime.


Figure 30
Rental income minus interest payments on investor loans

8
6
Percent of GDP
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

On top of this there are the usual "exogenous" factors: further increases in interest rates by the RBA,
and the prospect of a slowdown in China.
The RBA is convinced, by the boom in China and its neoclassical models of the economy, that capacity
constraints lie just ahead for Australia, and that therefore it has to increase interest rates to contain
inflation. This is a classic application of the "Taylor Equation" approach to monetary policy that pretty
accurately defined its behavior before and well into the GFC—taking September 2007 as the start of the
global crisis (the US Fed began slashing its rate that month).


Figure 31
Inflation and Unemployment

8
GFC
7.5 Inflation
7 Reserve rate
6.5 Unemployment
6
5.5
5
Percent
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
2006 2007 2008 2009 2010 2011 2012

The recent floods and cyclones in Victoria and Queensland are wildcards that will drive up food prices,
and the global bubble in commodity prices will also play through, but overall I expect that the RBA's
expectations of inflation caused by capacity constraints will not pan out—for reasons that I expand on
below under the Credit Impulse. I think they may well put rates up once more, but will then be forced to
start cutting them.
China is another wildcard for Australia. It is clearly the reason that our terms of trade, and especially the
prices for (and volumes of) our exports of minerals, are the highest they have ever been.


Figure 32
Australia's Terms of Trade

140
Terms of Trade
130
Commodity Price Index
120
110
100
90
80
70
60
50
40
30
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

I don't know enough about China today to make an informed comment here, but my feeling is that
China's growth can't be sustained, and that the Chinese authorities will do the best they can to secure
other sources of minerals. Certainly I wouldn't advise extrapolating the current incredible prices (or
volumes) for our minerals forward, which does make Australia's economic performance particularly
susceptible to a change in our fortunes with China.
My focus is on the endogenous force: credit expanding faster than both incomes and asset prices is
what drove asset prices up, and the failure of credit to continue growing faster than income is all that is
needed to set the reverse process of declining asset prices in train—while leaving the debt in place.
The Credit Impulse
The key factor behind not just the property bubble, but Australia's apparently outstanding performance
during the Global Financial Crisis—is what Biggs, Meyer and Pick christened "The Credit Impulse". In
contrast to neoclassical economics, I have a credit‐oriented analysis of capitalism in which aggregate
demand is derived not merely from incomes but from the change in debt. On this basis, the change in
aggregate demand will reflect both the change in incomes (GDP) and the change in the change in debt:
so the acceleration or deceleration of debt levels adds or subtracts from the change in aggregate
demand. This affects both economic performance and hence employment, and asset price change—
since from this perspective, aggregate demand is spent purchasing both new goods and services and
existing assets.


The collapse in the Credit Impulse was the factor that made the Great Recession great for the USA. The
much smaller collapse in the Australian Credit Impulse—and that it turned positive again on a yearly
basis n early 2010—is the primary reason why the downturn was so much milder in Australia.
Figure 33
Credit Impulse, Australia and USA

10
Debt Acceleration as Percent of GDP
5
 10
 15
 20
 25 Australia
USA
 30
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

The correlation of the Credit Impulse with change in employment over the long term is high:


Figure 34
Credit Impulse & Change in Unemployment, USA

10  40
Change in Unemployment Rate (inverted)

5  20
0 0
Credit Impulse
5 20
 10 40
 15 60
 20 80
 25 Credit Impulse 100

Unemployment change
 30 120
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Figure 35
Credit Impulse & Change in Unemployment, Australia

10  40

5  20
0 0
Credit Impulse
5 20
 10 40
 15 60
 20 80

Unemployment change
 30 120
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015



It's even more marked over the crisis itself, though clouded by the impact of massive government
interventions via fiscal policy and, in the USA, quantitative easing. The severity of the downturn in the
USA was directly attributable to how quickly accelerating debt gave way to decelerating debt, and the
decline in the rate of deceleration has been a major factor in attenuating the crisis more recently.
Though this sounds paradoxical and counter‐intuitive, it follows from the logic that aggregate demand is
the sum of GDP plus the change in debt: since the change in aggregate demand is the sum of the change
in GDP plus the change in the change in debt, a slowdown in how fast debt is falling can actually boost
aggregate demand. That is apparent in the US data from mid 2009—when the recession was officially
regarded as having ended.
Figure 36
Credit Impulse & Change in Unemployment, USA

10  40

5  20
0 00
Credit Impulse
5 20
 10 40
 15 60
 20 80

Unemployment change
 30 120
2007 2007.5 2008 2008.5 2009 2009.5 2010 2010.5 2011

The same qualitative phenomenon applies in Australia, though with much different magnitudes. Firstly
the deceleration in debt—the change in the Credit Impulse from positive to negative—was not nearly as
large, and it was reversed more rapidly.


Figure 37
Credit Impulse & Change in Unemployment, Australia

10  40

5  20
0 00
Credit Impulse
5 20
 10 40
 15 60
 20 80

Unemployment change
 30 120
2007 2007.5 2008 2008.5 2009 2009.5 2010 2010.5 2011

However the main mechanism for achieving that result—stopping the Credit Impulse turning extremely
negative, and pushing it back into positive territory—was the First Home Vendors Scheme. As a result of
that Scheme, households did not delever—instead they took on substantially more debt, with the
mortgage debt to GDP level rising by 6 percent. This more than counterbalanced dramatic deleveraging
by the private sector.


Figure 38
Debt to GDP by sector

100
B E
Household
90
Business
80 Government
70
Percent of GDP
60
50
40
30
20
10
0
1980 1984 1988 1992 1996 2000 2004 2008 2012

This can't continue, because the household sector is already more indebted than its US counterpart, and
the debt servicing costs in Australia are far higher courtesy of our much higher mortgage interest rates.


Figure 39
Mortgage debt and household disposable income

170 17
Mortgage interest percent of disposable income

160 16
150 15
Mortgage debt to disposable income
140 14
130 13
120 12
110 11
100 10
90 9
80 8
70 7
60 6
50 5
40 4
30 Debt ratio 3
20 Interest payments 2
10 Interest rate 1
0 0
1975 1980 1985 1990 1995 2000 2005 2010 2015

The quarterly data on the Credit Impulse implies that this is now turning negative again.
Figure 40
Credit Impulse Australia

12
B E
Debt Acceleration as Percent of GDP
3
6
9
Yearly
 12
Annualised Quarterly
 15
2006 2006.5 2007 2007.5 2008 2008.5 2009 2009.5 2010 2010.5 2011



This trend is likely to continue. The artificial boost to the rate of growth of mortgage debt caused by the
FHVB is gone, households are indebted beyond anything ever seen before, and high interest rates are
killing consumer spending. This in turn will cause a fall in aggregate demand that has to be worn by both
consumer and asset markets. The former effect will contribute to rising unemployment—countering the
positive boost to employment from the China trade—while the latter will reduce debt‐financed demand
for housing.
Who would get hurt the worst?
The most obvious losers from a price downturn will be the buyers enticed into the market by the FHVB,
many of whom began with 5% equity and who can therefore be easily thrown into negative equity
territory by even a small price fall.
This won't lead to "jingle mail" defaults in Australia because our housing loans are full recourse. But
since a trigger for the downturn will be a decline in aggregate demand as the Credit Impulse turns
negative, unemployment will rise—certainly in NSW and Victoria that don't directly benefit from exports
to China—and this will cause forced sales, though a lesser rise in bankruptcy sales than in the USA.
Figure 41
Finance share of income

6
5.5
5
Percent of GDP at factor cost
4.5
3.5
2.5
1.5
0.5
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

The second obvious group of losers will be the banks themselves, who have dramatically increased their
share of profits via the huge increase in mortgage debt. A decline in mortgage originations will reduce
their profitability, and their solvency since mortgages now constitute the more than a third of total bank
assets and over half of all banks loans.


Figure 42
Loans as Percent of Total Bank Assets

40
BE
Housing
35 Personal
Commercial
30
25
20
15
10
0
1975 1980 1985 1990 1995 2000 2005 2010 2015

Figure 43
Mortgages as percent of total loans

60
55
50
Percent
45
40
35
30
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012



Australian banks assert that they are well capitalised and that a downturn in house prices would have
little impact on their liquidity, let alone their solvency. That claim has proven false after the fact of a
property price crash everywhere else on the planet, and I expect Australia to be no different.
Figure 44
Assets of Australian Banks

70
65
60
55
50
Percent of Total
45
40
35
30
25
20
15 Austalian Loans
10 Base Money
5 Other Assets
0
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012


The Next Bubble Coming From Down Under

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www.debtdeflation.

A Motley Crew interview on

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 1

Nominal House Price Indices

Case-Shiller; ABS 6416

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 2

Nominal House Price Indices

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 3

Real House Price Indices

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 4

Long Term Real House Price Indices

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 5

Quarterly House Price Changes

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 6

Change in Real House Prices and the FHOS

Stats Before After All During Between FHOS When FHOS

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 7

Long Term Real House Price Indices

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 8

House Price Index to GDP Per Head

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 9

Ratio of House Price Index to Disposable Income per Dwelling

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 10

Ratio of Population to Dwellings

Ratio of Population to Dwellings

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 11

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 12

Population Density Change & Nominal House Price Change

Population per dwelling change

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 13

Nominal House Price Change

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 14

New Lending and Change in Nominal House Prices

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 15

Price, Debt and Disposable Income per Dwelling

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 16

Ratio of Debt per Dwelling to Price

Ratio of Debt per Dwelling to Disposable Income

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 17

Ratio of Disposable Income per Dwelling to Price

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 18

Household Debt to GDP

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 19

Average First Home Loan

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 20

Average First Home Loan to Average Wage

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 21

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 22

Payments on Average First Home Loan over 25 Years

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 23

Number of New Housing Loans per month

Value of New Housing Loans as percentage of GDP

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 24

Construction Loans versus Total Loans

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 25

Aggregate Lending to Housing

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 26

Aggregate Lending to Housing

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 27

Rental income as percent of GDP

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 28

Rental income minus interest payments on investor loans

Steve Keen’s Debtwatch A Motley Crew on House Prices Page 29

Inflation and Unemployment