Posts Tagged ‘unemployment’

Is price inflation good for real estate in Australia?

Sunday, July 24th, 2011

One of the assumptions made by many people is that rising price inflation is good for property prices in nominal terms. In other words, many people see property as a hedge against price inflation. The experience of the past (especially 1970s) has a strong influence on this belief.

But today, in Australia, from our observations, we believe that the relationship between price inflation and property prices is breaking down. In fact, we would argue that price inflation probably has a negative effect on property prices.

To understand why, recall that we wrote in Does inflation (deflation) benefits the borrower (lender)?,

Debt servicing burden = (Debt payment rate ? Growth in wage) + Price inflation rate

Today, the problem is that in Australia, with the two-speed economy, wages are rising in one section of the economy but is relatively stagnant on the other. In relative terms, mining wages in Western Australia are sprinting ahead of wages at say, office workers in Sydney.

But unfortunately, since the GFC, cost of living has been rising faster than general rise in wages. For example, as Retail therapy impossible in this housing market reported,

Now look at your pay packet, take away the things you can’t avoid spending money on, remove what you’re paying in rent or paying off a loan, and look at what is left. You may find that’s smaller than ever, despite the fact we’re in a mining boom. But the trickle-down effect of that boom seems a long way away from Sydney. We’re part of the second tier of the economy here, the one that isn’t doing so well. Still, rent and housing prices continue to go up. And the bills come first before that new coat, that new stereo . . . even repairing those cracks on the walls or the dents on your car.

As you can see from our simple equation, with the cost of living rising faster than increase in wages, debt servicing burden will increase. Furthermore, the Reserve Bank did not help by raising interest rates. The increase in debt servicing burden puts a squeeze in discretionary spending- that explains why shoppers seems to be going on strike, putting the retail sector under pressure.

This increase in debt servicing burden is putting on the dampener on house prices. It dampens people’s appetite for borrowing more money and increases their propensity to save. Less borrowing means less capacity to bid up house prices. It also pushes more mortgage holders to be delinquent with their home loans, which increases the likelihood of forced sales. This is the first round of effect on house prices.

Rising cost of living pushes the retail sector deeper into trouble as shoppers shut up their wallets. Since consumer spending account for 60% of the Australian economy, a weak retail sector is hardly good news for employment in the country. As we wrote in RBA committing logical errors regarding Australian household finance,

Given Australia?s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises.

Rising unemployment will put further pressure on house prices. As we wrote in Does house price crash follow unemployment or is it the other way?,

[Rising unemployment] will feed into the second round of impact of lower house prices, which in turn lead to further rising unemployment. This will feed into the? third round of impact.

Now, cost of living is rising despite a rising Australian dollar. What if the dollar falls substantially? What will happen to the cost of living?

Does house price crash follow unemployment or is it the other way?

Wednesday, June 8th, 2011

One of the most common idea floating around in Australia is that as long as unemployment rate does not spike, mortgage defaults will not rise and consequently house prices will not crash from mass foreclosure selling.

That idea, taken in isolation, is self-evidently true. But is it logically correct to leap from this idea and jump to the idea that as long as the tide of unemployment holds low, there wouldn’t be a housing crash in Australia?

To answer this question, let’s take a read at this interesting article from MacroBusiness,

Australian banks pretty much only know how to lend against property. From time to time they rabbit on about lending against cash flow, but the truth is they do not have the skills. They vanished in the 1990s when merchant banks started disappearing. ?Investment banks are just financial tricksters fiddling with assets. As we see with Macquarie?s fate, they do not know how to invest in real businesses that achieve steady growth from serving customers.

There has been a sharp rise in business credit for SMEs since the mid 1990s, which pretty much tracks the property asset bubble.?In 1996 it was about $13 billion, two thirds of which was secured against property. By 2008 it was $63 billion, 75% of which was secured against property. In 2010, it fell to $56 billion. Again, about 75% is secured against property. About two thirds is secured against residential property.

This level is high by developed world standards. According to the World Bank,the average for developed economies is to have 56% of SME loans secured against property.

Banks are still lending, but mostly only where the loan is fully secured by tangible assets and personal guarantees (and, in some cases, key man insurance). Where there is an existing loan, banks are requiring additional security. Members stated that lenders were no longer prepared t provide finance on ?soft? security ? such as cash flow or good will (unsecured finance) ? as had been available pre-GFC.

In Australia, residential properties underpin much of the collateral for SME loans. The implication of a decline in house prices is the reduction in the value of the loan collateral. That will result in a tightening of credit. A precipitous decline in house prices will result in a credit crunch for SME. A credit crunch for SME will result in cash-flow problems, which in turn will result in mass layoffs (i.e. higher unemployment). A decline in house prices will also sap away consumer confidence via thewealth effects, which in turn will drain consumer spending out of the economy, which in turn will result in high unemployment in the retail sector.

So, the first round of impact from falling house prices will be rising unemployment. That will feed into the second round of impact of lower house prices, which in turn lead to further rising unemployment. This will feed into the? third round of impact.

Also, falling house prices can happen at the margins. You don’t need a mass selling panic to trigger a fall in house price. As we wrote inSpectre of deflation,

One thing many people fail to understand is that values of financial assets can vanish as easily as they are created in the first place. It is a fallacy to believe that just because money has to move somewhere from one asset class to another, the overall valuation in the financial system cannot contract. The very fact that all the money in the world cannot buy up all capitalisation is proof of that fact. This leads us to the next question: how do financial assets derive their value?

As we mentioned in The Bubble Economy, we have to understand the principle of imputed valuation. Suppose you have a house which you bought for $100,000. What happens if one day, your neighbour decide to sell his house (which is similar to yours) for $120,000? When that happens, your house would have to be re-valued upwards to $120,000 even though you had done absolutely nothing. The same goes for stocks. All it needs for a stock to increase in value is for a pair of buyer and seller to transact at a higher price. As long as the other shareholders do absolutely nothing, that higher price will be imputed into the values of the rest of the stocks. Thus, when asset values rise, all it takes is a handful of them to trade at higher prices in order for the rest to be re-valued upwards. If assets can ?increase? in value that way, it can ?decrease? in value that way too.

To put it simply, credit drives house prices, which in turn drives credit. Falling house prices will drain credit, which in turn pushes down house prices.

Growing structural unemployment in Australia

Thursday, June 10th, 2010

Today, the Australian stock market and the Aussie dollar performed relatively well. Alan Kohler, the financial news commentator in ABC News gave the reason why- China and Germany?s industrial production, Australia?s job ?boom? and so on. Incidentally, this is an example of narrative fallacy and lazy induction as described in our book, How To Foolproof Yourself Against Salesmen & Media Bias. Anyway, we will leave you to follow up on the issue of media bias.

But first, we will look at this news article,

Australian employment jumped a strong 26,900 in May to extend a remarkable run of jobs gains that suggests wage pressure could build earlier than thought and require yet further action on interest rates.

That article was published just before 5 pm. Coincidentally, in the streets of Sydney, another news article reported,

Thousands of protesters marched through the streets of Sydney’s CBD today, waving colourful banners and chanting demands for equal pay for women.

This is the sort of things that the RBA fears and give them a reason to raise interest rates. However, though the falling aggregate unemployment rate looks good, it masks a hidden problem. The problem is of the same nature as we described in Overproduction or mis-configuration of production?,

This is the key insight from the Austrian School of economic thought. Over-production or over-investment is not the problem. Rather, the trouble lies in the mis-configuration of production and mal-investments

In the same way, it is not the aggregate level of unemployment that tells the whole story. Rather, if unemployment is to be a threat to the Australian economy, it will be its configuration that is the cause. Recently, we saw this article, Recovery doesn’t extend to long-term jobless,

LONG-TERM unemployment continues to rise sharply and has increased for 18 straight months, despite the better performance of the economy and the overall improvement in th1e labour market.

A Herald analysis shows that Centrelink payments to people without a job for more than a year have risen by 27 per cent, or nearly 72,000, to 334,244 people in the year to April.


While the economic stimulus package has been credited with saving Australia from a deep recession, there remain pockets of deep disadvantage.

This mis-configuration between surplus supply of unemployable labour and shortage of employed labour is what economists call ?structural unemployment.? Also, according to the ABS, the youth unemployment rate in Australia is 3 times the national average. This is another large pool of structural unemployment.

As that article continued,

A senior analyst at the University of Sydney’s Workplace Research Centre, Mike Rafferty, said it appeared that as the economy had improved it was people moving jobs or within jobs that had benefited.

”The people who are benefiting first are perhaps those that already have jobs and are able to move into better jobs or perhaps from part-time to full-time work,” he said. ”It’s not the same picture for the people not in the labour market.”

Since the official unemployment is based on a sample of surveys whereas Centrelink payments is based on the actual number of people seeking welfare, we can argue that the latter presents a more accurate picture of the unemployment situation in Australia.

A rising structural unemployment will increase the drag in the economy as government welfare payment will have to be increased. If this growing trend is not arrested, then this growing pocket of disadvantage will increase, resulting in social problems down the track. Unfortunately, these structural unemployed do not make it to the aggregate figures.

Unemployment in Weimar Germany

Thursday, October 15th, 2009

Since the powerfully rally several months ago, there are many economic indicators that seems to point to an economic recovery (there are also indicators that point to worsening economic conditions). In Australia, we have the ‘honour’ of being the first Western developed country to be on the road to recovery, with unemployment rate actually falling. The Reserve Bank of Australia (RBA), in the belief that emergency threat of deflation is over, decided to raise interest rates (and indicated that more rate rise will follow).

For the bears (particularly for those who are in the deflation camp), this is a very trying time. Some of them even seem to be throwing in the towel (e.g. Gerald Minack).

But is it really blue skies ahead?

Our view is that, when governments print copious amount of money, mirage of prosperity can appear. In fact, money printing, in addition to doing wonders for stock prices (see Should you be bullish on stocks?), can also do wonders for the unemployment rate. Let’s take a look at this book, The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany, written by Costantino Bresciani ? Turroni, an economist who lived through the German Hyperinflation of the 1920s,

In the summer of 1922 unemployment practically disappeared. It appears that?in spite of the gaps caused by the war in the ranks of the working population?the total number of individuals occupied in industry, agriculture, commerce, public services, etc., was greater in 1922 than before the war.

Next, we will show you the graph of the unemployment rate:

German unemployment rate 1913-1922

German unemployment rate 1913-1922

As we can see, in the midst of hyperinflation in Weimar Germany, as the standards of living of workers collapsed (as the German mark depreciate against the US dollar), the German economy had made great ‘strides’ in the area of unemployment!

So, don’t be surprised if the US economy’s unemployment numbers actually improved in the months to come. This need not necessarily be a sign of prosperity. Instead, it can be a sign of inflation.

RBA committing logical errors regarding Australian household finance

Tuesday, March 31st, 2009

Ric Battellino, the deputy governor of the Reserve Bank of Australia (RBA) gave a speech today. Regarding Australia’s household finance, he said,

We continue to believe that the market here will hold up better than overseas. There are a number of reasons why this is likely to be so, but perhaps the most important is that we did not have the same deterioration in lending standards that occurred elsewhere. By and large, the great bulk of Australians who took out housing loans have been able to afford the repayments. Notwithstanding some rise over the past year, the 90?day arrears rate on housing loans is only 0.5 per cent, which is broadly in line with its long?run average and well below that in countries such as the US and UK.

As he said that, we imagine he was thinking somewhere along the line like this:

  1. US sub-prime loans resulted in bad debts
  2. Bad debts busted the US economy
  3. A busted US economy led to higher unemployment
  4. Higher unemployment led to more bad debts
  5. And so on…
  6. Because Australia has very little sub-prime debt
  7. Therefore Australia’s economy is not likely to be as busted as the US

If this is what he’s thinking, we think Ric Battellino has made a very grave error in logic. He’s mixing up cause and effect.

No doubt, in the US, it’s sub-prime (which by the way is yesterday’s story) that triggered the bust in the US economy in 2007. But for Australia, it’s the deterioration of  the global economy that will trigger the bust of the Australian economy. The effects of a bust will be rising unemployment, followed by bad debts, then debt deflation and then finally falling asset prices. In other words, the triggers are different, but the effects will be the same because Australia has the same debt disease as the US and UK.

Given Australia’s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises. As unemployment rises (which all mainstream economists in the government and private sector are forecasting), it will eventually reach a critical mass of prime debts turning sub-prime. Once this critical mass is reached, the deterioration in the Australian economy will accelerate (see what’s happening in the US and UK today). This is the point we made in March 2007 at Can Australia?s deflating property bubble deflate even further?,

In Australia?s case, with her towering levels of debt, any external shock can easily tip her over to a recession, which can lead to further asset (e.g. real estates and stocks) deflation.

By now, it should be clear that whatever the external shock is not the issue?the point is that Australia is highly vulnerable.

To make matters worse, the First Home Owners’ Grant (FHOG), while giving housing sector a temporary boost, are increasing the proportion of potential sub-prime loans in the financial system.

The fact that those at the helm of the RBA are committing such logical errors does not engender our confidence.

Effects of retreating foreign banks in Australia

Sunday, November 23rd, 2008

Recently, we found this news report in the mainstream media:

 A significant retreat of foreign banks from the Australian corporate lending market is under way, which will leave the “Big Four” domestic institutions scrambling to pick up the slack in a mass refinancing of company debt due to happen over the next 12 months.

According to research compiled by banking analysts at Merrill Lynch, the total debt raised by Australian companies since 2006 stands at $285 billion. Merrill estimates that as much as $54 billion of that amount is held by what it describes as “retreating” offshore banks.

“This dislocation represents a potential benefit for major banks to refinance and upsize to good customers at vastly improved margins. However, it also raises the likelihood of potential bad debts collapsing sooner and a need for capital.”

As we mentioned before in Can falling interest rates and rising mortgage rate come together?,

In other words, there are not enough domestic deposits to fund all the needed credit (e.g. home loans) in this country.

Australia is dependent on foreigners for credit because of its lack of domestic savings. The retreat of foreign banks from Australia will result in more credit rationing for Australia’s businesses. Over the next 12 months, as businesses need to refinance their company debt, they may find that either (1) the price of money will go up further or (2) credit being denied. With the economy slowing, Australian banks are increasingly more careful with their lending. Furthermore, the recent lending fiascos (e.g. ABC, Centro, etc) will mean that they are in damage control mode, which implies that they will have to be even more stingy with their lending.

What is the longer-term effect of this?

Inevitably, this means that the weaker businesses will fail because their supply of credit is choked. Those who still have credit flowing through their balance sheet will find their debt repayment cost increases. That, along with falling revenue due to the slowing economy means that they will have to cut costs more aggressively. Since employees are one of the greatest costs for businesses, staff retrenchments will be undertaken. Laid-off workers will tighten their belts and cut their spending, which means other businesses will have their revenue cut. Businesses will become more pessimistic about the future, which means they will no longer invest for the future. This will result in businesses higher in the chain of production to suffer, which means they will have to cut the number of staffs. Many of these unemployed workers have large amount of debts, which means they will have to sell their assets (e.g. house) to de-leverage. This will in turn depress asset prices. Depressed asset prices will increase the chances of asset owners to fall into negative equity, which means that should they become unemployed, their debts will become bad debts for the banks. Bad debt for the banks will mean further rationing of credit. Further rationing of credit will start the next round of vicious cycle.

In engineering terms, this is called a positive feedback loop. It would not be easy for the government to intervene strategically to short-circuit this feedback loop.

Government’s contradictory messages

Wednesday, October 22nd, 2008

Back in Can China save Australia?, we mentioned about SBS’s Insight program, Greed. As we read the transcript of that program, we cannot help but realise that while the government officials are busy trying to deal with this crisis, they are sending out contradictory messages as a side effect.

For example, take a read at this:

JENNY BROCKIE:  But what sort of possibilities are we talking about here? I mean unemployment going up to 10%, 20% in the event of this taking hold in Australia? What could happen?

LINDSAY TANNER:  Definitely not. None of us can see into the future and the international crisis is obviously so unprecedented that it’s very hard to make predictions, but the fundamentals in Australia are very strong. We’re better off than virtually anybody else in the world to deal with these problems and we remain optimistic that we will be able to ride through this buffeting in reasonable shape.

On one hand, Lindsay Tanner ruled out the possibility of Australia’s unemployment going north of 10%. Yet, on the other hand, he said that no one knows the future and make predictions. If you notice, by saying “Definitely not,” he is already making a prediction!

Incidentally, in Jobless rate may double as China slows, JPMorgan Australia’s chief economist Stephen Walters said that

“We now expect the jobless rate to more than double to 9% in late 2010, from the current 4.3%,” Mr Walters said. “Softer growth in one of Australia’s leading export destinations means Australia’s export volumes will be lower, as will be the terms of trade.

“That said, on our forecasts, there will be 1 million unemployed Australians by the second half of 2010.”

The current way of measuring the employment rate includes those who are under-employed (see Nearly 600,000 Australians under-employed). When the economy slows down, it is those kinds of jobs that will be shed first, especially jobs in businesses that depend on discretionary spending (e.g. retailing). Therefore, a figure of 1 million unemployed people is not so unthinkable after all.

The next contradictory message from the government is on spending:

JENNY BROCKIE:   OK, there are quite a few things in what you’ve said that I’d like to pick you up on because we live in very contradictory times at the moment. You’re saying we should be thinking about thrift. You’ve just released a $10.4 billion package and you’re telling people to go out and spend. I mean, should Siobhan keep spending, keep getting into debt? What’s the message the Government is sending at the moment?

We believe that the government’s $10 billion stimulus package is a misguided Keynesian policy that will not solve the problem.

Firstly, as we said before in Will Australia?s own pump-priming work?, it is far too little to combat the deflationary force.

Secondly, even if it is big enough to induce the masses to spend, it is the wrong medicine. If such policies are carried out to the extreme, the outcome will be hyperinflation (see Bernankeism and hyper-inflation). As we explained in Supplying never-ending drugs till stagflation,

Students of the Austrian School of economic thought will understand that indiscriminate ?printing? of money will worsen the plague of mal-investments and structural damage in the economy. Like drugs, the more you ?print? money, the less effective it will be in stimulating economic growth (see What causes economic booms and busts?). Eventually, it will come to a point that the economy will not respond positively anymore no matter how much money is being ?printed.?

Without the liquidation of mal-investments and restoration of the structural imbalances that is brought about by deflation, applying bigger and bigger stimulus packages will only function in similar ways to drugs- more and more for less and less effect. The reason why Keynesian reflationary pump-priming worked during the Great Depression was that it was applied after the cleansing effects of the deflation had done its work. But today, in reaction to the financial crisis, governments all over the world are doing so before the purge of fire. As a result, the much-needed economic correction that the economy had to have will not happen.

Unknown unknowns trips up many turkey forecasters

Sunday, October 12th, 2008

As we explained in our previous article, Real economy suffers while financial markets stuff around with prices, the massive deflationary forces from the free market is being (and will continually be) counteracted by government attempts at inflation (see our guide, What is inflation and deflation?). The result will be great volatility in prices, which will undermine business calculations and long-term planning by the free-market.

At the same time, many economic forecasters will have their forecasts and ‘predictions’ completely stuffed up, which will mean that their credibility will be severely undermined. Many of these forecasters simply fail to see that the ground has been shifting as they make their projections. The recent deterioration of the global financial system will cause many of them to back-flip on their views. Those who cling on stubbornly on their previous (and erroneous) positions will have their credibility rubbished by history. Simply put, these forecasters completely failed to see turning points at the economic cycle. We really marvel at the fact that some of these forecasters are paid highly to produce expensive reports that turned out to be wrong. How could they possibly not see such an obvious looming financial disaster? It really takes a special effort to put on the blinkers in order NOT to see it coming. We are so marvelled that we have to write up a guide (Why are the majority so wrong at the same time and in the same ways?) to explain why.

As you will have heard the news by now, Prime Minister Kevin Rudd announced that the Australian government will guarantee all (a change from the $20,000 guarantee last Friday) bank deposits for 3 years. Also, there is other bad news in that announcement as this news report says,

Prime Minister Kevin Rudd has warned that economic growth and job security could be in jeopardy as the global financial crisis entered a “new and dangerous” phase.

As he equated the current financial turmoil to a national security crisis, Mr Rudd today signalled the jobless rate for next year was likely to be higher than originally forecast in the May budget.

`So, unemployment is likely to be higher. That’s just levelling with people … It’s likely to be higher than has been projected. We don’t have numbers on that.

Associate Professor Steve Keen believed that the unemployment rate could reach around ten percent range or more. The economic implication for this is very ugly. As we explained back in March last year (2007) at Can Australia?s deflating property bubble deflate even further?,

In Australia?s case, with her towering levels of debt, any external shock can easily tip her over to a recession, which can lead to further asset (e.g. real estates and stocks) deflation.

By now, it should be clear that whatever the external shock is not the issue?the point is that Australia is highly vulnerable.

The global financial crisis is an example of an external shock that we warned back then.

As we further explained in June 2007 at What can tip Australia into a downward property price spiral?,

With the Australian debt levels so high, a recession (with an accompanied increase in unemployment) will result in more distress property sales and further downward pressure on property prices. In such a scenario, what is happening right now in Western and South-Western Sydney can be extended to the rest of Australia.

The Australian economy is very highly leveraged towards the residential property sector. Rising unemployment will exert a downward pressure on property prices (due to the high leverage of the household sector), which along with that will expose the weakness in the Australian banking system (it has been said that mortgages made up of 50% of Australian banks’ loans- you may want to check up on that figure). A major weakening of the banking system will result in a major tightening in credit standards, which can even result in the deflation of credit growth (credit growth is already slowing down significantly in Australia). This will then feedback into the economy as a sharp drop in consumer spending, which along with the ongoing de-leveraging process (see De-leveraging in the real economy- mortgages), will put a major pressure on the retail sector (in addition to the financial sector already under a serious stress). This in turn will feedback into rising unemployment, resulting in another round of vicious cycle.

Now, let’s take a look at some of the economic forecasters and have some humour along the way.

In this news report, Bad day for house sales as jitters spread,

Angie Zigomanis of BIS Shrapnel said people were increasingly worried about their future: “If you don’t think your job is secure then no matter how low mortgage rates go, you are not necessarily going to enter the market.”

Remember BIS Shrapnel? Back then, they were writing forecast reports with erroneous and nonsensical logic (see Can lower interest rates re-inflate the property price bubble? and Another faulty analysis: BIS Shrapnel on house prices). It looks that they are beginning to back-flip on their views.

Let’s take a look at the views of a perennial bull, Craig James senior equities economists of CommSec,

Mr James said the recent report from the International Monetary Fund stressed that the Australian housing market would not experience the same dramatic falls as the US and Britain because of the nation’s strong population growth, fuelled by immigration.

Oh really? Strong immigration will help to keep upward pressure on housing demand in Australian? Well, let us take a read at another news report, Aust rethinks immigration boost as global financial crisis buffets economy,

Australia said on Friday it will re-think a large boost to immigration as the global financial crisis buffets the economy and places a brake against years of strong growth.

Mr James fails to understand that:

  1. Immigration tends to be very cyclical along with the economic cycle.
  2. In the face of rising unemployment and slowing economic growth, new migrants will put additional on the Australian economy. That is the reason for the government re-think on immigration.

It is obvious that extrapolation of current immigration figures into the indefinite future is flawed.


The ruction in the global financial system will put a spanner in the works of many forecasters. In the months and years to come, we will see the rise and fall of many forecasters as reputations are made and destroyed and credibility gained and lost. The first shall be the last and the last shall be the first.