Economy, living standards and the debt trap

Issue 

Financial journalists are earning their bread and butter speculating on the depth of the recession that awaits the world economy.

Already the US and European economies are in recession, defined as occurring when economic output contracts for two or more consecutive quarters.

Australia has avoided recession — so far. However, economists have seen the writing on the wall. The Japanese and Chinese economies (destination for the larger part of Australian exports) are both slowing. Rio Tinto is expecting demand for its resource exports to drop off significantly in 2009.

"The mining giant is forecasting that the Chinese export sector will come under increasing pressure over the course of 2009, as demand from industrialized countries weakens in the wake of the Western credit crisis", Forbes.com opined on October 15.

World currency markets are punishing the Australian dollar, which has lost 39% of its value against the US dollar in a matter of months. The "Aussie" dollar's value is linked closely to expected fortunes of commodity prices and is sinking as expectations grow dimmer.

Meanwhile, Australian households — buoyed by 16 years of economic boom, fuelled by resources exports (iron ore, coal and bauxite in particular) to the voracious Chinese economy — have spent up big.

* * * * * *

Like what you are reading? Then get Green Left Weekly delivered to your door every week, and help ensure Australia's best independent news sources can continue being produced.

Subscribe now, special introductory offer of seven issues for $10.

* * * * * *

Household debt grew to $1 trillion in 2006 on the back of big rises in house prices (the median house price was nine times the average annual wage in 2005) and the easy availability of credit cards. Australian households owed $44 billion on credit cards in August, according to News.com.au on August 17, showing that more households are using credit cards for everyday spending, with wages failing to keep pace with prices.

There is also a growing insecurity among workers, measured by the latest Australia at Work survey conducted by the University of Sydney Workplace Research Centre. The report showed that 17% of workers were finding it hard to make ends meet, according to the October 29 Sydney Morning Herald, with 39.5% saying they were just coping. The figures mark an increase of 2% on those reported a year ago.

Falling household wealth

At the same time that debt levels are at their highest, house prices are falling. Those with mortgages are finding that while their debt levels are rising, the value of their "assets" — primarily "the family home", but, with the collapse of the stock market, also their superannuation — is falling.

The pending crisis is so clear, even the Reserve Bank of Australia (RBA) has noticed it.

"Many households have also recently experienced falls in their wealth, after a long period over which wealth rose steadily", the RBA's Financial Stability Review for September argued. "The value of housing assets — which represent nearly 60 per cent of the value of the household sector's total assets — declined slightly in the first half of 2008, with established house prices flat or falling across most capital cities."

Australian households are "highly geared" in the parlance of the economists; they have borrowed big to buy houses at very high prices on the expectation that the value of the house will continue to rise, so that their debt will always remain smaller than the value of their "asset".

Falling house prices mean that households are threatened with negative equity — the size of their debt (primarily their mortgage, but also their credit card and other personal debt) is higher than the value of their home. While this presents a real problem for home buyers under increasing mortgage stress, it is also a problem for the banks and the economy as a whole.

The International Monetary Fund's World Economic Outlook released in April argued that Australian house prices were overvalued by at least 25%. However, speaking to ABC radio's PM on April 4, University of Western Sydney economist, associate professor Steven Keen, argued that the scale of overvaluation was more like 60%. "It's been the biggest speculative bubble in world history", he said.

A large portion of the demand for houses comes not from home-buyers, but from investors, cashing in on the generous tax concessions given by the federal government for investing in property. With increasing prices, first home buyers' share of the housing market fell from 21.8% of the market to just 17.5% between 1996 and 2007, while investors' (read speculators) share increased from less than 15% to 45%, according to federal treasury statistics.

Housing speculation

The housing "bubble" (where the price of a commodity is artificially raised by speculation) is fuelled in Australia by negative gearing, whereby "investors" in rental housing can offset their "losses" (interest and maintenance on the house as compared to rental income) against other income, reducing their tax and giving them more money to bid up the price of houses.

When selling an investment property, on the other hand, speculators are given a 50% "concession" on capital gains tax under changes to legislation introduced by the Howard government in 1999, meaning that half the profit that they receive on the sale of the house is tax-free! Much of this free money is then ploughed back into the system, increasing house prices even more.

After almost a year in office, Labor has failed to limit either of these gifts to speculators. While planning to offer tax concessions to developers who build subsidised rental housing, it has failed to do anything about the largest cause of the unsustainable rise in housing prices. Apparently it has no plans to do so in the future, either.

However, there is evidence that the Australian housing bubble may be about to deflate. Ironically, this would be at the expense of those home buyers who bought their houses during the height of the boom.

Credit crunch

House prices in the US have fallen by 20.6% since their peak in June 2006, according to marketwatch.com, and were the first victim of the US subprime crisis, which has triggered the global financial meltdown since September. And economists believe that the bottom has not yet been reached.

In Australia, house prices fell by 2% in the June quarter, according to a report in the July 31 SMH. The report also indicated that the volume of house sales had fallen by around 30%, showing a slow-down in demand.

As the housing market "corrects" (the bubble deflates) over the next few years, housing prices could see falls as dramatic as those in the US, leaving many home buyers holding on to a mortgage costing more than the value of their house.

Add to that the prospect of a recession and therefore growing unemployment. Even the relatively optimistic Ross Gittens predicts "a recession that lasts a year or two, with the unemployment rate rising to double figures", in his October 29 SMH column.

Prime Minister Kevin Rudd has made much of the fact that Australia's banking system is among the most stable in the world. Would it remain so, on the back of a huge slump in house prices and the resulting spike in mortgage defaults brought on by a recession?

If you like our work, become a supporter

Green Left is a vital social-change project and aims to make all content available online, without paywalls. With no corporate sponsors or advertising, we rely on support and donations from readers like you.

For just $5 per month get the Green Left digital edition in your inbox each week. For $10 per month get the above and the print edition delivered to your door. You can also add a donation to your support by choosing the solidarity option of $20 per month.

Freecall now on 1800 634 206 or follow the support link below to make a secure supporter payment or donation online.