There has been a lot said, many megabytes devoted to and much news ink used in commentary
about a bubble in Australian housing.
People ask me if I think that Australian housing is in a bubble. I usually answer in the affirmative and
furthermore tell them that Australia’s and many of the world’s housing has existed in a bubble for
the past 45 or so years.
I will get back to this in a moment, but first I’d like to say that just because Australian housing is in a
bubble, does not mean that it cannot continue for a while longer, although I personally believe we
are closer to the end point than the start point. As John Maynard Keynes supposedly noted, the
market can remain irrational longer than we can remain solvent.
Now, a very quick history lesson on events that happened 45 or so years ago and why this has
created numerous property bubbles in Australia and the world. In 1968 then US President Lyndon
Johnson eliminated US dollar gold cover. That is, the US no longer had to have a percentage of gold
in their reserves to cover each US dollar that was in existence. This was taken a step further in 1971
by the then US president Richard Nixon who suspended the US dollar’s convertibility into gold, which
meant that a US dollar could no longer be exchanged for gold.
Prior to this, under the Bretton Woods agreement in 1944, the US dollar was backed by gold and by
proxy, so were the world’s currencies as they were valued against the US dollar on the exchange
When the gold link was severed, the world changed from a gold backed to a credit backed and
driven economy. This meant the economy would only grow if credit was increasing, so people were
greatly encouraged to accumulate more debt by governments and central bankers. Many people
were happy to oblige.
Anybody who bought property in the past 45 or so years has been the beneficiary of this huge
loosening of credit brought about by the actions of both Presidents Johnson and Nixon.
When looking at Australian house prices from about 1880 until late 1960’s/early 1970’s, prices were
relatively flat, when adjusted for inflation. Once credit was loosened however, from the late 1960’s
onward house prices went parabolic over and above the inflation rate. The gains seen over the past
45 or so years are a product of this huge credit expansion.
Pretty much anybody who purchased property in that time, benefitted from increasing values. With
few exceptions, property prices generally went up far in excess of the inflation rate.
The people who benefitted from this windfall weren’t geniuses, they were just in the right place at
the right time. But many thought they were, because they made money each time they sold
property and because they didn’t understand the underlying parameters that allowed this to occur.
So the myth of property prices doubling every seven to 10 years was born. The fact that this had only
happened over the past 45 or so years wasn’t recognised. “45 years” somehow became “always”.
There were even pretty graphs with a starting year point and an ending year point to support this
property doubling “fact”, but once again, the data was extrapolated and prices averaged out over
the time frame, rather than show actual annual prices for the period in question. And more often
than not, these were not adjusted for inflation. As previously mentioned, inflation adjusted property
prices stayed fairly flat until the late 1960’s. They certainly didn’t double, for example, from 1910 to
1920 or 1930 to 1940, but the graphs made it appear as though it did.
However, in the current environment of low inflation and low interest rates, property prices are now
starting to pull back and I believe they are reverting back to the more normal mean of only
increasing in line with inflation.
Changing demographics as baby boomers retire and change from spenders into savers, will impact
on property prices as well, particularly when they start to sell their assets to fund their retirement.
Not just prices for property, but shares and businesses as well.
Overbuilding of flats around Australia’s capital cities will also have a dampening effect on housing
prices, particularly in attached dwellings. Real sustained property price corrections could happen as
soon as the 2017-2018 financial year, if not sooner.
The way global economies are at the moment, there are no guarantees that prices will remain
stable, let alone increase any time soon. And with the oversupply of flats coming into the market,
most likely just as the global markets enter a serious downturn, falling real estate prices are a very
real possibility, particularly from investors exiting the market. When they are not seeing any real
capital gain (after inflation), have very low or no yields and longer vacancy periods, but still have to
put their hand in their pocket every month for expenses, there could be a rush for the exits.
Real estate, after all, is a non-productive consumption item.
Prices may rise but people seem oblivious to the fact they can also fall. What goes up can also come
down. So capital gain only really exists if it is realised. Unless capital gain is locked in (ie. sold at the
highest valuation price), it’s not real capital gain.
You cannot rely on the greater fool theory forever. This is the theory that a greater fool will come
along and pay you more for your “asset” than you paid for it initially.
The banks have been complicit in this, allowing borrowing against any increase in equity so the debt
load is constantly increasing. This strategy is also pushed by property spruikers as a means of
increasing your property portfolio.
Yes, a property investor might have a two million dollar property portfolio. But if it’s secured against
a debt of $2.5 million thanks to falling property prices, that’s hardly a sound financial position to be
in. If and when that happens, the friendly bank won’t be quite so friendly any more.
The problem is that, as previously mentioned, housing is a non-productive consumption item whose
purpose is to provide shelter, but is being sold as an investment item reliant on capital gain rather
So, as well as property not doubling every seven to 10 years over a long period of time, Australian
property prices can also actually fall. And this is even more likely at this particular juncture.
We are entering a deflationary period, a period of asset price falls. The reason the massive money
printing or quantitative easing programs we have seen over the past few years by many countries
have not succeeded in increasing asset prices consistently, kick starting the economy or causing
massive inflation or even hyperinflation, is that this money printing has just stopped the deflationary
forces from having their full effect. It’s why the global economy is sluggish at best. With the amount
of money printing carried out by various governments, global economies should be booming. They
Just as record low, and in some cases negative, interest rates have similarly been unsuccessful in
getting the global economy moving.
There is a train of thought, particularly amongst politicians and central bankers that inflation is good
and deflation is bad. But I disagree. Before the turn of the last century, (and incidentally before the
proliferation of central banks), deflation was as much a part of an economy as inflation. Before the
1900’s, periods of inflation were generally always matched with periods of deflation.
It was only when central banks decided that deflation was a bad thing that we have had persistent
inflation. Inflation has only been a feature of modern economies from about the early 1900’s
onwards (incidentally, the US Federal Reserve Bank came into being in 1913).
Why is deflation the enemy? Deflationary periods are useful to dampen and remove malinvestments
from the markets and bring the economy back into equilibrium. This is now being
prevented from happening.
Japan is well into its third decade of deflation. Asset prices (property, stocks and businesses) are
about half the value they were during the 1980’s and have never recovered those highs. The
various governments of the day have tried desperately to stimulate inflation and asset price growth
through massive quantitative easing (far greater than the US) and zero and negative interest rate
policies. It hasn’t worked. Inflation is still negligible and asset prices are still languishing. And yet
Japan is still ticking along nicely and they’re in no immediate economic trouble. Why? Because
inflation isn’t needed!
And why are our politicians and central banks so desperate to see inflation? Because it increases
asset prices, which brings about the so called “wealth effect”. When asset prices are rising, people
feel wealthier and more secure and this supposedly encourages people to spend more. And why is
this a good thing? Because under a fiat (debt backed, not gold backed) monetary system (pretty
much all developed nations and most developing nations) in order for the economy to grow, we
need to borrow more and get further and further into debt. In other words consume today with
The record amount of debt we currently have in Australia does not bode well either. Australia is
currently one of the most indebted nations in the world. We have record amounts of private and
corporate debt, and public debt is increasing faster than any other developed nation.
Rising public debt endangers our AAA credit rating, which in turn will increase borrowing costs for
the major banks causing interest rate rises above the RBA “official” rate. Many of the private debt
holders won’t be able to afford any interest rate rises. A massive amount of this private debt is
secured against this non-productive consumption item, property, which will either be defaulted
upon or sold at a loss.
What does this mean for the housing bubble? Who knows! It could continue for another 10 years,
start to deflate next month or pop in a year.
The markets can only be gamed for so long before they revert back to the mean. We are probably
now entering an extended deflationary period and sluggish global economic growth, after more than
100 years of constant inflation. Get used to it. This is most likely the new normal.