Looks like fear might be still driving investors and banks into defensive assets, which is putting the squeeze on new business lending. It’s tough to engineer growth this way, and means interest rates will have to fall further.
Is fear the biggest factor keeping interest rates low? Is fear the biggest factor driving the current property boom?
Think about it this way. Generally speaking, there’s three things we can do with our savings.
- We can stick in the bank and earn interest. That’s the safest route but currently it earns you sod all.
- You could buy existing assets, and bank on their returns; or
- You could invest in new assets – a new piece of factory equipment, a new building, or a new business concept.
Broadly speaking, this makes up a ladder of risk and return. Money in the bank is low risk, low return. New assets are higher risk, higher return.
Now when the GFC landed on our shores in 2008, there was a rush down the ladder towards money in the bank where it was safe and sound.
It wasn’t just here. The developed world over saw a rush to investment safe-havens.
But as we emerged from the long winter of the GFC, investors started getting bolder, and they stepped out to buy existing assets.
But oddly enough, that’s where it stopped. Investors in Australia and the world over never really stepped any further out along the risk spectrum. Demand for existing assets has been strong. Demand for new assets has been weak.
And that’s one of the things that makes this recovery so unusual. It doesn’t normally take this long for new investment to kick into gear.
And this has become a real headache for central banks. The RBA has brought interest rates down to historic lows. That’s created a bit of a feeding frenzy around existing assets, which has driven their price higher and higher. But investment in new assets has been weak.
In the US, the Fed brought interest rates down to zero, and then just started pumping money into the system hand over fist.
But it never made it’s way into the economy. Companies took the slush and used it to buy-back their own shares. This pushed share prices up, but there was little capital investment or new jobs to show for all that cash.
The recovery dragged on and on, and it still doesn’t look like we’re fully out of the woods.
This is a spanner in the works because new investment is one of the key ‘transmission channels’. It’s supposed to work like this: The RBA lowers rates. Firms borrow to buy new machinery and expand production. They hire new workers. Employment goes up. Output goes up. The people making the machines make more money… round and round it goes.
And ultimately, lower interest rates create more growth.
But that’s not happening right now. The RBA lowers rates. People buy existing assets. The price of those assets goes up, but there’s no new investment, no new production, and no new jobs.
And that’s what’s been happening with housing.
And I think this is why’ve seen some many knitted brows over at Martin Place in the last few weeks.
Because lower interest rates have done exactly what you’d expect them to do for property – they’ve pushed prices up. But that’s happened without the kind of massive pick up in general demand you’d expect to accompany record low interest rates.
And this is a multi-year phenomena.
Take a look at this chart here. This is one I drew up. It looks at bank lending in Australia and looks at the share of lending going to each sector.
What we can see is that there’s been a trend decline in the share of bank lending going to business, and a trend increase in the share going to housing.
In 1990, less than 25% of bank lending was going to housing. This year, it’s over 60%.
2001 was the milestone year. That’s where housing lending on the way up met business lending on the way down. They were an even 45% of the market each. But it’s been one-way traffic since then.
And it might not necessarily have been such a headache for the RBA if that extra lending for housing was going towards new housing – where it would be funding construction and jobs.
But it’s not. Currently 90% of housing finance goes on existing properties. And that’s only going up too. Back in 1985 it was 70%.
So all this is why monetary policy just doesn’t pack the same punch it used to…
And why the boffins over at the RBA have the brain-aches….
And why interest rates will need to fall further yet.
But to do that, the RBA will want to make sure, that from now on, the extra liquidity will get channelled into new assets, not old.
And this, I reckon, is one of the key reasons behind all this talk of macro-prudential tools. They want to encourage new construction, without sending investment lending over the edge.
They’ve got their work cut out for them. Because it’s not clear who’s to blame for these timid investment patterns.
Is it a wary Australian public still nursing wounds from the GFC? Possibly. Is it banks lured to the easy money of property and dropping the ball on business? Probably.
Or is it just what you get when property continues to be a stand-out performer, and the outlook is still looks far and away better than any other asset class, all things considered?
Now I’d say that’s definitely a factor.
It’s hard to know how it will play out in the long run…
But the RBA’s next move? Macro-prudential by the end of the year and rate cuts in 2015.
There. I called it.