Fisher’s Money Illusion

The price of fish

I can remember when a can of Coke after a junior rugby game cost 10 pence and a packet of chips (or crisps as we say in England) cost even less.

By the time I was at high school in Huddersfield (Yorkshire) the price of a can of Coke was 30 pence, which felt a little unfair, although perhaps not as unfair as living in Huddersfield (ohh, joke).

These days if we go to a service station we can get hammered for several dollars for a small bottle of Coke. In my head, though, 30 pence still feels like a fair price.

And for a product like Coke, it probably is! The product costs only a few cents per can to produce. What we are paying for is the astronomical advertising and promotions budgets.

The Money Illusion

In 1928, Irving Fisher wrote an important book called The Money Illusion, which explained how we as humans tend to think in currency in nominal terms rather than real terms.

It’s an illusion, particularly because now in the modern era we have fiat currencies – the currency itself has no intrinsic value, so we should instead think in terms of its purchasing power and how that shifts over time.

The idea was popularised further by the great John Maynard Keynes.

What are the outcomes?

Sometimes contracts are not indexed for inflation and sometimes, though not always, prices can be ‘sticky’ – they don’t move up smoothly in line with inflation.

Studies have shown that we want to move heaven and earth as and when we are given a 2% pay cut, yet if we are given a pay rise of 2% when inflation is cruising along at 4% that somehow feels more ‘fair’ to us.

The Money Illusion in Australia

Is there an illusion happening in Australia today? Well, to some extent, but I think it’s a little more complex than that.

Adam Creighton recently highlighted in Charter magazine (geeky mag for Chartered Accountants) that over three decades, incomes have oustripped price growth across all income groups in Australia.

Since 2003, he notes, the poorest fifth of houses holds are $42 better off and the richest fifth $576. The Money Illusion dictates that we instinctively focus on nominal price increases rather than real price movements after accounting for inflation.

That said, the cost of living in Australia is definitely high and there is some debate as to whether the CPI data released by the ABS represents this fairly.

I’ve recently been looking at getting a short-term let in Sydney’s CBD – and while I probably to some extent am being suckered by the Money Illusion, those prices are not completely illusory! Australian cities are expensive places to be a renter these days.

Investment markets

It’s popular to talk of “the share market being at a 5 year high” and you sometimes also hear property market commentators say that “shares have returned nothing in 5 years”.

 

 

 

 

 

 

 

 

Source: ASX

This is deceptive on two counts.

Firstly, partly due to inflation and partly due to rebalancing, you would expect the share market indices to move higher over time.

For this reason it makes more sense when assessing if the market is expensive or cheap (rather than to focus on the headline index figure) to look at other measures such as average PE ratios and prevailing dividend yields.

Secondly, commentators from a non-financial background seem unaware that shares are an income asset. You buy shares for the dividend stream with attached franking credits not purely for the potential capital gain – so to say that “shares have returned nothing” shows a clear misunderstanding of the asset class.

Australian property

In property, it is commonly said that “prices are at unprecedented highs” or similar. Prices are indeed high but it’s not quite as simple as that here either.

 

 

 

 

 

 

 

 

 

 

 

 

If you look at dwelling prices on a city-by-city basis you can see that all is not equal.

There is no question that Melbourne has been a massive outperformer, although there is more than one market within the city as I’ll consider below.

Prices in Canberra shot upwards in the period to 2010 and look set for a weaker period as the number of ACT employees in the public sector seems set to fall.

Dwelling prices in Adelaide have been mostly dead in the water for more than four years, and similarly Brisbane has had a weak run since its last strong appreciation some half a decade ago.

Regional prices are going nowhere fast.

In Sydney, while prices are around all-time highs, if you wind the chart back to 2003 you will see that prices have only increased by 25% since that time whereas household incomes have increased by around 15% more than this during the same time period. So while there is much talk of “unprecedented” prices, in fact, in real terms median prices have fallen over the last decade.

So where does the bubble talk come from?

So taking all of the above into account, how can Australia be in a bubble as some claim? Especially given that interest rates have been dumped from 17% to just 2.75% which surely must result in higher household leverage? The problem stems from the fact that so many of us want to live in just a few locations, and particularly in only two cities. And, more than almost any other equivalent country, we want to live in urban locations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Our lack of population density is absurd when compared to other countries – millions of us are crammed into a few urban areas, and people wonder why prices are driven up…

 

 

 

 

 

 

 

 

 

 

 

 

 

RBA studies show that the price of green field land in cities such as Melbourne, Brisbane and Perth is cheap (see chart below), although construction costs and government levies wrench the median price of detached housing higher. In Melbourne, the cost of green field land spiked during the first homebuyers boost and then receded again.

 

 

 

 

 

 

 

 

 

 

 

 

 

The city markets are multi-speed, however. In Melbourne some CBD markets have performed very poorly, and as noted, in the fringe suburbs where land value appreciation is weak, prices remain relatively cheap.

However, the price of Melbourne’s established dwellings in the popular suburbs have powered ahead, and until we change our thinking, little else seems likely to change in this regard. We need better transport, planning, approval processes, construction and infrastructure. Simply building more dwellings does not work in a country with a booming population if nobody wants to buy or live in the new builds. 

Sydney

In Sydney, it’s a similar, although slightly different story. Investors have cottoned on to the trend and are flying back into the market, and are focussing heavily on established, medium-density dwellings in the inner and middle ring, as well as terraced houses in certain inner western suburbs.

The cheapest and the fringe suburb sectors of the market and particularly the premium priced dwellings are underperforming, however, and as a result the median dwelling price data for May will show moderate losses.

Investors will doubtless love this because it will likely cause the RBA to keep its hand away from the interest rate trigger for longer. But ask those who actually work in the industry what is happening in the established middle market and you will see a different pattern emerging, which is growth and prices pushing through to all-time highs.

Crashniks and housing bears will no doubt mock this observation – but before you scoff, I’d ask you to point me in the direction of any median- or mid-priced property which has fallen significantly in price in the eastern suburbs, the north shore or in the inner west? It hasn’t happened in any meaningful way and nor does it appear likely to.

Prices in the broad middle market are on the move and with the cash rate being cut yet again in May serviceability is close to its best level in years. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

APM predicts 10% price gains in Sydney’s middle-market for these reasons. 

It’s not a bubble yet, but we could well end up with one as appropriate supply lags a booming demand and Australia’s grand plan continues to focus on packing ever more of us into a few popular suburbs. It hasn’t worked to date and I doubt it will in the future.