One of the most quoted observations in finance is John Maynard Keynes quip that ‘markets can stay irrational for longer than you can stay solvent’. It nicely describes the absurdity of Australia’s soaring household debt, mostly attributable to inflated property prices. As Keynes implied, markets do eventually correct, return to some sort of rationality. That is what seems to be happening in the Australian economy. The folly of allowing two and a half decades of out-of-control mortgage lending is beginning to reach its inevitable conclusion.
It has long been obvious that there was a problem, but as is often the case with financial excesses there was little collective will to do anything about it. It split Australian society in half: those lucky enough to buy before the bubble and those either priced out of the market or forced to take on excessive debt. In Sydney, for example, it has been estimated that it would take over 46 years to save for a house deposit on an average home. On that basis a 20-year-old can expect to have saved enough for a deposit by retirement age.
The pressures from the excesses are mounting. The Reserve Bank has been raising interest rates, hoping to quell inflation, and the impact on the household sector, whose debt is running at 117 per cent of GDP, has been brutal. The economy grew by just 0.2 per cent in the June quarter, and 1 per cent over the last year.
It is the weakest rate of growth since the 1991 recession. Household consumption turned negative (minus 0.1 per cent) as higher interest payments squeezed domestic budgets. Household income per head is also falling. It was only government spending that kept the economy in positive territory, contributing 0.3 percentage points, mainly ‘social benefits to households,’ according to the Australian Bureau of Statistics. Effectively that is government debt was being used to ease the impact of excessive household debt.
What typically happens with bubbles is that people only slowly recognise reality, then they suddenly cannot avoid it. We have not quite reached that second point yet. It is still being treated as an incremental problem that can be ‘managed’ with more government spending – which I suppose is a possibility in the short term given that Australia’s government debt is below the OECD average.
It is not, however, an incremental problem. It is a structural problem that has distorted Australia’s financial system. A hint of the price that will be paid came from the RBA governor Michele Bullock, who said lower income borrowers ‘may ultimately make the difficult decision to sell their homes.’
"It is a structural problem that has distorted Australia’s financial system. A hint of the price that will be paid came from the RBA governor Michele Bullock, who said lower income borrowers ‘may ultimately make the difficult decision to sell their homes.’"
To make matters worse, the tactic of raising interest rates to stop inflation is unlikely to work. The intention is to suppress demand, which has been achieved. The problem is, much of the inflation is due to the rising cost of supply, not demand pressures. Global supply chains fragmented in the wake of the Covid crisis and the Ukrainian war split the world into two: the West and BRICS+. The efficiencies of globalisation, which for most of this century kept prices low, are fading away as the world economy divides.
There is nothing Australian authorities can do about such international developments. They could take some of the heat out of the housing market by reducing immigration, as Matt Barry observes. But they will not. Another thing the authorities might consider is a rethink of their policy on energy, whose rising costs are contributing to inflationary pressure – something implicitly acknowledged in the Federal government’s provision of an energy rebate for all households.
There is good reason to change course. For one thing, despite the introduction of renewables, the proportion of energy accounted for by fossil fuels in the global economy has barely changed over the last 20 years, falling from 86 per cent to 84 per cent of the total. More energy has come from renewable sources, but overall consumption also grew. As the hedge fund manager Kyle Bass has commented, energy transitions take four or five decades. He pointed out that those who think it is possible to immediately switch fossil fuels off ‘have no idea how the grid works and no idea how business works.’
Another development is that the BRICS+ alliance, which has over 80 applicant countries and represents a bigger proportion of global GDP than the G7, is largely comprised of countries that either sell fossil fuels (Russia, Saudi Arabia, Brazil) or nations that badly need to import them (India, China). They are not going to aggressively move to zero carbon, it would be national suicide.
The third problem is that the financial markets’ use of the metric Environment, Social Governance (ESG), which has been critical to the funding of decarbonisation, is in trouble. The big US financial players are distancing themselves from the 'climate change' agenda. BlackRock, JPMorgan Chase, and State Street have exited from Climate Action 100+, a coalition of the world’s largest institutional investors that pledges to ‘ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change.’ The passive fund Vanguard, the world’s second largest financial institution, had left earlier.
These four fund managers oversee assets of about $US25 trillion, which is approximately a quarter of the funds under management in the world. They exited for two reasons. There was an implicit bargain whereby compliant companies would not only get to save the environment they would also see their share prices perform better than non-compliant companies. That has not happened. Better returns have actually come from investing against ESG-compliant companies.
An even more pressing problem was that 16 conservative state attorneys general in the U.S. have demanded answers from BlackRock’s directors regarding the Climate Action and ESG initiatives. Other fund managers and banks have seen the writing on the wall. Nothing concentrates the mind of fund managers more than the prospect of clients withdrawing their funds – in this case state government pension money.
Thus Larry Fink, chief executive of BlackRock, who in 2022 was openly blackmailing corporate CEOs to comply, is now saying that he finds the ESG term ‘unhelpful’.
The tide is turning on decarbonisation and, again, nothing Australia does will have any influence.
Rethinking Australia’s energy policy in order to reduce inflationary pressure would thus seem to be the realist option. It may soften the impact of the housing-debt crisis that will eventually require initiatives like debt cancellation, debt-for-equity swaps, or techniques to rename or restructure the debt. Or maybe there will be hyperinflation to reduce the real value of the debt, in the manner of Zimbabwe or Argentina. Whatever it turns out to be, it will not be good.
David James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.