Is Australia really like Japan?

Photo: Shubert Ciencia, Creative Commons

Japan – The Basket Case

Another week, another article comparing Australia to property markets in Japan. If I only had a buck for every time people said “but in Japan” – we’d definitely never experience price deflation Down Under because I would be a zillionaire, out spending like a certified madman.

There’s no question that Australian property prices can and do fall, and indeed so they did in 2011 and early 2012. They remain below previous peaks in all capital cities, except in Sydney which zooms on to fresh heights. I don’t rate the never-ending comparisons with Japan, though. 

It’s actually the brutal effect that Japan’s deflation had on its economy and living standards that leads nervous central banks such as the Fed in the US and the Bank of England in the old dart to drop interest rates to the effective bottom of the zero-bound range and engage in ‘quantitative easing’ (QE). They must avoid currency deflation at all costs.

It’s impossible to read our central bank boards’ minds, of course, but one assumes they would err on the side of caution with regards to inflation and not make the mistakes Japan made (namely, failing to create a sustained increase in the broad money supply, and tightening monetary policy again too soon when deflation was strangled, leading to its famous ‘lost decade’).

Incidentally, Japan finally seems to have learned its lessons and is engaging in so-called ‘abenomics’ which promotes a range of policies including radical QE, the setting of negative interest rates and targeted inflation, which has seen GDP growth return promisingly. Japanese Yen don’t have a use-by date printed on them, but may as well: check out how the stock market has responded (+56.5% on last year, despite the recent wobble).

Forget fundamentals, this is the new normal: booming asset valuations when the QE tap is turned on, and a panicked stampede for the exits at the merest hint of it being switched off again.

Source: Bloomberg

Ageing Demographics

A large part of Japan’s problem has been demographic. More than a fifth of the population is over 65 – meaning it is occupied by some 30 million ‘older people’. Worse still, the population has been falling, which is never going to be a positive dynamic for economic growth.

Whether we like it or not, Australia will face the ageing population problem and issues related to its dependency ratio, but she will not allow her population to fall. Instead, our population is soaring, by 392,500 heads in the last 12 months recorded.

My Pommie pal Catherine Cashmore, who is always worth listening to (not just because she’s English; rather because she is ‘in the property market’ every day and not only stuck behind a desk) argues in this article that while population growth might not cause property prices to grow in an upswing, it can sometimes hold prices up in a downturn.

Cashmore also explains why established dwellings in Australia’s inner suburbs are frequently favoured by homebuyers and investors in outer and fringe locations, and, importantly, that while supply and demand has an impact on prices, the supply of and demand for credit has a greater bearing.

Why Deflation Will be Avoided at All Costs

It’s all too common for people to criticise our inflationary economy, but maybe it’s worth re-capping why deflation should and will be countered at all costs.

In theory, you might think that price deflation could be a good thing. We could go down to the servo and find that instead of being charged an extortionate $100 to fill up the Holden Thunder ute and acquire a four ‘n’ twenty pie with a pack of Lamington fingers (for this is how most Australians live, of course), it might only cost us $80 and we’d be effectively richer as a result. Cool.

Rewind the clock, though, to the Great Depression, where price deflation was accompanied by falling prices (including real estate prices), banks collapsing, countless companies going bust, astronomical levels of unemployment and the most brutal period in the 20th century across the globe. Just like the more recent global financial crisis, the Great Depression was preceded by debt-funded greed and speculation, and the Dow Jones index increased by a preposterous fivefold in just six years.

When prices fall, those who hold debt are punished, and this is particularly so in the housing market. You could buy a house with a $500,000 mortgage today only to discover that the underlying asset is only worth $400,000 next year, leading to what is known euphemistically as being in ‘negative equity’ (i.e. up the creek, minus paddle).

It’s fairly common today for people to say that anyone with mortgage debt has got it coming to them, and they’d deserve all they get. That may be so, but the real problem with a deflationary economy is the potentially relentless downward spiral.

The Deflationary Spiral

If you think you can buy the Lamingtons and the four ‘n’ twenty next week for fewer dollars than this week, you’d likely become disinclined to spend, and this leads to consumers hoarding cash. Retail trade dries up and Caltex probably have to drop their prices further to entice you back to the servo.

This becomes a total nightmare for Caltex because they still have to pay the pump attendant a $40,000 salary, but their turnover and margins are getting clobbered. They probably have to lay off one of the pump attendants.

Of course, with no job, the ex-pump attendant won’t be borrowing money to buy a house, so the amount of money in the economy falls. It’s the exact opposite of inflation where too much money is chasing too few goods pushing up prices.

The real risk in this circumstance is accelerating deflation (which is what Professor Steven Keen erroneously predicted would happen to house prices in the latter half of 2012; instead they increased strongly, largely due to investors returning to the market in anticipation of further price gains).

The best case outcome for the Australian housing market (in my humble opinion, at least – renters always disagree) is that prices continue to increase, but only moderately and at a lower level than the growth in wages, thereby effectively becoming cheaper over time. Unfortunately, price movement is rarely so uniform.

High inflation also brings its own uncertainties and can lead to boom-bust cycles, which is why we have a target range of inflation of 2-3%.

What if Australia Stumbles Towards Recession?

Three things would happen. Firstly, interest rates would be dropped. Unfortunately interest rates in Australia can only drop so far until they hit a number starting with a ‘0’, so if that doesn’t work, the ‘printing presses’ will be switched on (QE), which actually means that the RBA will start buying assets (e.g. bonds), effectively increasing the money supply.

And thirdly, specifically with regards to the property markets, if prices began to slide dramatically, there would likely be other interference, such as, for example, relaxing the rules on foreign buyers, or other meddling. Non-property owners don’t like it being said, but that’s what, in my opinion, would probably happen.

It’s easy for pundits to be critical the RBA’s policy of targeted inflation, but, much like when we complain about getting older, it sure as heck beats the alternative.