Deleveraging in the Australian economy bites

March 6th, 2011

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If you read the newspaper headlines and billboard advertisements recently, you may notice something interesting (if not, strange) happening. National Australia Bank (NAB) announced that it is ‘breaking up’ with the rest of the banks in a new campaign. That immediately provoked reactions from the other banks, including Suncorp with its “breaking up” theme in a recent billboard advertisement.

Soon, bank investors are fretting about a price war among the banks, which means the race is on to the bottom for profits. As this news article reported,

Investors are becoming nervous about the prospect of a price war breaking out between the banks, with one major brokerage labelling the attacks a ?negative sum game?.

What on earth is happening?

Only as recently as four months, politicians were aiming their gun sights on the banks for ‘lack’ of competition, when Commonwealth Bank (CBA) initiated a rise in their mortgage rates that was almost twice the rate rise of the Reserve Bank (RBA). There were talk about building a “fifth pillar” in the banking system. Today, the banks seem to be starting a price war among themselves, in a race to the bottom.

Well, the reason is dead simple. To put it simply, banks are in the business of lending money. That’s their core business. As we wrote before in The dark side of rising bank profits,

One way to make more money is to increase lending.

Banks, as publicly listed companies in the stock exchange, are always under pressure to increase their profits year after year (i.e. seek growth). Heavens forbid that their profits ever fall! All hell breaks lose if that ever happens!

But there’s one big problem for them today- the savings rate of Australians have shot up to 10%, which is the highest since the early 1990s! That means that Australians are saving more money and repaying their debts. In other words, the Australian economy is now undergoing a deleveraging process. Consequently, it is becoming harder for the banks to make more money by lending more money. A very crude (and thus, inaccurate) analogy would be to compare the banks to dogs fighting among each other for a shrinking pie. As that article reported,

The infighting is an indirect result of the sluggish credit market, with banks under pressure to find growth, the report said.

What does this mean for the Australian economy?

As we explained in detail in Significant slowdown for Australia ahead?, deleveraging sucks away the aggregate demand from the economy. The first to get hit will be the retail sector that is related to discreditionary spending. The structural shift of Australian consumers from shopping in retail stores to shopping in the Internet is a symptom of deleveraging.

Given that the retail sector accounts for approximately 60% of the economy, continuation of this structural shift in consumer behaviour imply that more pain is in store for the retail sector.

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  • I’m curious to see if the Australian government and central bank have similar perversions for propping up real estate as the U.S. equivalents? Subsidizing rates is one dangerous manifestation, legislative edicts another. Deleveraging in real estate via contraction in capital available to mortgage debt will be the ultimate test-will you aussies stand by and watch home prices take significant cuts, or will intervention be the name of the game?

  • Robert

    Given the gutless politicians that we have, I think they will try all means to prop up the bubble. But I’m not sure about the RBA. Glenn Stevens seems to be a hard money guy. If the RE bubble pops here, I think the AUD will take a dive and inflation will skyrocket. Glenn Stevens may not be so willing to accomodate the politician$ then.

  • The Fundamental Analyst

    The deleveraging scenario syncs well with other measures od retail activity such as the AIG groups Performance of Services index, which has been in contractionary mode in 12 of the last 14 months.

    Not to the extent it was in late 08, early 09 but still suggests a lack lustre environment for retailing.

  • Arthurrobey

    I don’t know what things are like where you are Rob. but here in Australia, Real Estate IS the economy and the religion and not to be discussed.
    Everybody is singing from the same hymnbook but I noticed that the choir is not as full throated as before.

  • Arthur Robey

    Here are some of the things that have been used to prop up the Real Estate bubble, Robert.
    Encouraging divorce and family breakup. This doubles the demand for houses.
    Encouraging immigration.
    Discouraging new political parties who might rock the boat. It is up to the gunells now.

    Would you mind teasing out the link between the the housing bubble and inflation?

  • Robert

    I think if the housing bubble crash, the AUD will crash along with it.

  • Robert

    If AUD crash, all our imports will skyrocket, including oil.

  • Joshua

    House prices are stabilising, with crash and boom off the table for the time being. We’ll experience moderate rises in most cities except Perth where we’ll see slight falls, nothing dramatic. I must say the bears made many bad calls (I include myself) and I only wish I would have predicted the unfair government stimulus to save the housing market. The stimulus was wholly unexpected. Nobody could have predicted it. Most bulls and bears now posting on AustralianPropertyForum.com thankfully believe in a stable outlook. The debate has calmed down, with neither side expecting large movements in either direction. The discussion has moved on to how long the stagnation will last before prices resume a definite direction (down or up). Something must be done to address the supply issue. There’s no doubt a shortage exists and is worsening. Rents and prices in my town (Perth) continue rising (undersupply). I don’t know what may happen population ramps up once more, a scary thought. Global citizens fleeing their depressed economies may wish to live in Australia. We should do everything possible to welcome disadvantaged migrants, but I worry about the upward pressure this places on house prices and rents. Joshua.
    http://australianpropertyforum.com