…relax nothing to worry about, I just wanted to get your attention and drive home an important point this morning.
The BAD NEWS subject line is reported to be the most opened email subject line there is (It’s not my opinion, it’s actually tested and proven with hard data).
Interesting. As human beings, we are a lot more attentive and responsive when there is a bad news story. Newspapers and television networks here and abroad have built billion-dollar empires on this known fact.
Like it or not, human beings love bad news… and its probably costing you a fortune in lost opportunity if you’re being sucked into it and can’t think for yourself…
So what does all this have to do with the money market and property?
Someone asked me to comment on some report that predicted BAD NEWS … A coming economic meltdown in Australia. Full of persuasive facts and figures, it seemed to make a compelling case.
I thought I’d share my response here. I’ve always found it’s useful to pick apart the arguments you don’t agree with – if only to reassure yourself of you own convictions.
So there’s two points to note first up. One, these kind of reports have been doing the rounds for as long as I’ve been in the game. These guys end up like those loonies waiting for the alien mothership to come and take them to home to paradise.
“It didn’t happen this year… But next year for sure.”
Two, if you look at who’s actually behind the publication. It’s almost always the gold guys. Sometimes the silver guys.
Precious metals enjoy a safe-haven status. Money tends to flow into real stores of value in economic down-turns. As they point out, the value of gold hasn’t changed since the middle ages, and they’ve got a lot to gain by sending us back there.
But leaving some suspicious agendas aside, what’s the argument that they’re running this time?
The most common one you hear is the “financial bubble” thesis. This is the idea that there’s been a massive over-expansion of the financial sector, not just in the run up to the GFC, but over the past 25 years. As it unwinds, credit will contract, lending will fall and the whole economy will shrivel up like a burning packet of chips.
There’s a few seemingly compelling stats and charts doing the rounds…
- Between the mid-80s and 2007, the ratio of credit to GDP increased from around 50 percent to around 160 percent.
- At the same time total assets of the banking system rose from about 50 to about 200 percent of GDP. Check out this graph here from the RBA
- On the same track, funds in the wealth management industry increased from 30 to over 130 percent of GDP.
The argument runs that this has taken credit, and the financial sector as a whole, to unsustainable levels. The deleveraging we’ve seen since the GFC is just the beginning, and the path back to “normal” levels will be littered with the wreckage of the stock and housing markets.
“The mother-ship is coming!”
Where do you start? Well, to begin with, there’s a faulty logic at work here. If you throw a ball in air it must come down, but gravity is a peculiar dynamic.
I mean, in the mid-80s people were listening music on walkmans. Then there was a massive explosion in portable storage devices in the run up to the GFC, but no one’s predicting that the i-pod era will unwind and we’ll all go back to listening to tapes.
Most things evolve and grow. So the real question is, has the growth and evolution of credit been driven by fundamental changes to the financial system, or has it been driven by irrational hype and hysteria?
Well, let me give you 5 reasons why the expansion path of credit seems pretty reasonable to me.
- We got wealthier – National Income keeps increasing. Australians get richer every year. However the cost of basics is relatively unchanged, and so disposable income increases even more quickly than income itself. This expands our ability to service debt. We could simply afford to take more debt on, and so we did.
- We got older – At the same time as we were getting richer, we were, on average, getting older. The expansion in the wealth management industry, particularly super is not surprising then. And a large part of this expansion was driven by using leverage to quickly build portfolios.
- We got loose – Deregulation in the late 70s and early 80s radically changed the financial sector from one of that was price controlled and credit constrained to one where it is predominantly determined by the market. And the market, it turns out, wanted to see a lot more credit in the system.
- Computers got smarter – the financial services industry is an information-intensive industry. In fact, pretty much the only thing it produces is information. Computers and the digital age, kicking into gear in the mid-80s, created a massive expansion in our ability to store, analyse and safely transmit information (do you know anyone who still uses a chequebook?) As technology improved, the financial sector’s ability to sustainably supply credit increased.
- Inflation was tamed – Back in the late 80s mortgage interest rates got up to 17 percent, as the RBA turned all its guns on inflation. However, with inflation squarely under the thumb, as it has been for the past 20 years, interest rates have come down, and allowed us to service a lot more debt.
Together, I think these 5 reasons make a pretty compelling case for the expansion in credit we’ve seen over the past 25 years.
At the very least, if credit was to unwind in the way that the doomsayers are saying it will, you’d need to see some massive downside drivers, something on the same scale as 20 years of deregulation. But there just isn’t anything like that. Only a decreased appetite for debt and tighter government controls, which, at best, only explain the small contraction we’ve seen so far.
But if you’re happy with the path of growth, then the only other question then is, are you happy with the actual level?
And if you’re worried about a financial meltdown, then you want to look at countries that have actually had a meltdown: like Ireland and Iceland.
This graph here shows banking sector assets though the GFC. Ireland peaked at over 9 times GDP, Iceland at 4 times. The Australian story looks very bland in comparison. There’s no bubble building (or popping!) here.
No. Claims that Australia is facing a financial meltdown are rubbish.
Stick to your guns. It’s still a buyers market and there are opportunities everywhere.
The only safe bet is: if you don’t act now you’ll regret it.