In recent interviews and ‘leaks’ it has become apparent that that the Treasurer and the Government could be thinking that Australia may need to endure a period of declining real wages (and therefore our standard of living) to allow the economy to re-balance and transition. If this is the Government’s view, then the transitioning of the Australian economy will become painful for many.
Certainly the transition from a resources-based economy would be aided by a weakening Australian dollar (which would protect the broader Australian industrial sector and stimulate non-resource exports). However, Government Ministers are becoming publicly concerned (reported in the AFR on Tuesday, April 22) with the lack of responsiveness by the RBA in addressing recent strength in the Australian dollar. To all appearances, the RBA continues to sit on its hands, bereft of policy initiatives.
In last week’s Investing Report, we suggested that the RBA should consider monetary policy settings that meet those policies set across the US, Europe and Japan. A form of quantitative easing is required. However, it appears that the RBA’s chief focus remains with inflation rather than with sustained economic growth. This narrow view of their Charter may result in the Government becoming increasingly frustrated as it frames the budget.
There is evidence of a lack of co-ordination of policy structures between the Government and the RBA. The independence of the central bank is a wonderful ideal, but not one adopted in the US, Japan and Europe. It is another example of the fantasy that envelopes economic policy settings in this country. The fact that our Treasurer was oblivious to the decline in real wages in the US prior to his visit suggests that fantasy is a deep seated problem.
If we fail to develop an economic strategy where monetary policy is co-ordinated with the Government’s fiscal policy, then the economy is in danger of being whiplashed by offshore policy settings.
Therefore, we should consider the issues that may confront our household sector in the coming year. Budget decisions and changes will soon be made. Given that context, it is important to review the current lay of the land for Australian households. An environment of high household debt, rising inflation and lower real incomes would certainly test the profitability of many domestic companies.
The position of Australia’s households
In contrast to recent US history, Australian wage earners and households have experienced a sustained period of real income growth and wealth generation over the last 20 years.
Key factors have been a steady growth in real wages and the unrelenting growth in the value of residential property. This growth in wealth was most profound in the period leading up the GFC as household and investment asset values lifted dramatically with household leverage. The equity crash of 2008 had a marked effect on wealth and the recovery in the Australian share market has been subdued when compared to offshore markets. In contrast, residential property has once again taken off in the last two years.
The next chart shows the steady lift in household indebtedness over the last 20 years. In this regard the Australian economy is following the precedent set by the US. In the US, debt fueled the consumption binge prior to the GFC. In Australia, it is increasing mortgage debt, investor leverage plus non-resident investing that is fueling the lift in property values and the resultant increase in household wealth.
Figure 1. Household liabilities (as a % of household assets) Source: ABS, Goldman Sachs Global Investment Research
Historic low interest rates have meant that household interest payments on debt have declined as a percentage of household disposable income. This measure of serviceability fails to acknowledge that the repayment of capital on household loans is a growing obligation. In a perverse way, Australian banks are well rewarded through growing profitability when households service interest but expand their debt loads and therefore repay loans slowly.
Figure 2. Debt servicing ratio (as a % of household disposable income) Source: ABS, Goldman Sachs Global Investment Research
Housing affordability in Australia is rapidly declining as first home buyers struggle to enter a market bolstered by investors. Low interest rates are not a panacea for young households if residential property becomes ever more expensive.
Figure 3. Value of approval for established housing (in billions) Source: ABS, Goldman Sachs Global Investment Research
A scan across Australia’s private sector debt shows that the bulk (about 60%) is backed by mortgage security. Another 8% is household debt that is funding personal consumption, and a declining portion is corporate debt that mainly funds capital investment.
Figure 4. Australian private sector credit growth Source: Goldman Sachs Global Investment Research, RBA
Once again, this trend of higher household leverage and lower corporate leverage is indicative of an economy that is likely to suffer slower growth and higher unemployment. As mentioned earlier, the high Australian dollar is not encouraging broad investment across the economy as the mining investment cycle matures.
Figure 5. Corporate gearing ratio Source: ABS, Goldman Sachs Global Investment Research
Recent economic growth reports for Australia (December quarter 2013) showed that the economy continued to ride the benefits of the Chinese resources cycle. However, similar to the US prior to the GFC, Australian economic growth has become highly dependent upon household consumption.