Is Australia a net food importer?

Measuring food is difficult. Do we use kilograms, or calories?

I’ve covered the value of food security before.  But the obvious truth that Australia is a massive exporter of food, in terms of both kilograms and calories, does not stand in the way of the grocery lobby group, the Australian Food and Grocery Council (and yes, I am very late to this story).

Here are some examples

This alarming result shows food and grocery manufacturing – which employs 288,000 people – is now a net-importer of food and grocery products which impacts industry’s growth and competitiveness (here)

But Ross Gittins' b%&*$it detector was straight on to it

According to figures compiled by the Department of Foreign Affairs and Trade, last year we had total exports of food of $25.4 billion and total food imports of $11 billion, leaving us with a surplus of $14.4 billion. Even if we ignore unprocessed and look only at processed food, we still had a trade surplus of $5.8 billion. (here)

He continues to pick apart the claims.

So how did the food and grocery council get exports of $21.5 billion and imports of $23.3 billion for 2009-10, giving that deficit of $1.8 billion? By using its own definition of ''food and groceries''. We're not talking about farmers here, but the people who take their produce and process it for supermarkets.

So the council's figures exclude all our unprocessed food exports, including wheat (worth $4.8 billion in 2009), other grains and live animals. On the other hand, they include ''grocery manufacturing products'' such as medicines and pharmaceuticals, plastic bags and film, paper products and detergents.

That's food? It turns out that our exports of ''groceries'' totalled $4.9 billion in 2009-10, whereas our imports totalled $12.9 billion, leaving us a ''grocery'' trade deficit of $8 billion. This is hardly surprising. Since when was Australia big in the manufacture of medicines? If you leave out groceries, the report's figures show we had exports of processed food and beverages worth $15.9 billion, compared with imports of $9.9 billion, plus exports of fresh produce worth $700 million against imports of less than $500 million.

That leaves us with a trade surplus of $6.2 billion for fresh and processed food and beverages. We've been conned.

This all leads me back to the arguments I made about the value of food security. If food security is important, why isn’t computer security, or medicine security, or car-making security, or plane-making security, or any other "fundamental economic ingredient" security given the same attention? Indeed, we could not produce the amount of food we currently do without imported picking, packing and transport equipment, so unless we secure those, we won’t even have food security.

The graph below is a final reminder about our food net export position relative to other nations, and our relatively low direct agricultural subsidies.

Real per capita wealth trend

As part of my recent habit of examining trends from the perspective of the individual, or household, I have compiled a measure of real net wealth per capita.

The reason for this is to add another perspective to the more general question of how the Australian economy has fared post-GFC.

As you can see, the average Australian's real net wealth is exactly where it was at the end of 2006.  Have we really spent four and a half years just treading water?

The interesting relationship is between the trend in real wealth and the trend in retail turnover.  The 2007 peak of per capita wealth also happened to be the end of the growth trend in retail spending.  It is also important to note that in the last decade, home values have comprised around 60% of total household assets, which leads on to conclude that the fate of retail rests heavily on the fate of home prices.

The Sydney housing boom ripple effect

Sydney is different. Since 2003 rents have risen faster than prices. I imagine the rest of the country would find that hard to believe, given their experience. But this is just one piece of evidence to show that the property cycles in Australian cities are nonsynchronous.

The past twenty-five years of data show that the Sydney residential property market is the least volatile, and is always first to boom. In fact, you can chase the price growth ripples from Sydney and Melbourne across the country – to Adelaide, Brisbane, Perth then Darwin. This might be one reason that such divergent opinions exist in the media, academic and professional circles.



If we looked only at the above graph, we would note that the two biggest markets, and arguably most attractive cities, have had the least growth since 2000. That seems particularly counterintuitive.

But if we look long-term the explanation is clear – Sydney and Melbourne had their major boom years before the other cities in the late 1990s.

Each of the charts that follow this post compare the timing of booms in capital cities against Sydney’s booms. The blue background shading matches the Sydney boom periods, with the red shading the boom periods of comparison cities. This exercise reveals a number of things.

• Sydney and Melbourne booms in the 80s and 90s started and finished within a year of each other. In fact, their cycles are the most in synch of all markets. 
• Brisbane lagged Sydney’s late 1990s boom by 4 years – making it an early 2000’s boom. This appears connected to the fact that Brisbane’s 1980’s boom lasted about 4 years longer than Sydney’s. 
• Adelaide followed Sydney’s lead more closely than Brisbane in the 1990s, and lagged Syndey more closely in the late 1980s. 
• Perth’s 2000s cycle was similar to Brisbane, although in the 1980s it had sharper and shorter price rises. 
• Darwin is a world of its own - booming when other capitals had prices tracking below trend. 
• Brisbane, Melbourne and Perth prices have been ‘catching up’ to Sydney over this 25 year period. This could be because the quality of homes is catching up to those in Sydney, and also due to a convergence of income levels between the cities. 
• For some reason, Adelaide is falling behind other major cities (lowest long term growth trend) 
• Sydney never falls as far below its trend as any other city. My eyeballing suggests that price volatility is lowest in Sydney. 

This might have lessons for property investors outside of Sydney. If you are in Brisbane, Perth or Adelaide and follow the Sydney trend a couple of years behind, you will do well. If prices are flat in the major capitals, take your money to Darwin.

What about from 2011 on? Sydney appears below its long term trend, and it rarely drops far below this trend. The other capitals are above their trend and do fall quite far below trend during economic downturns. My personal view is that Sydney stability will continue.

The other question to ponder is the trends in this period could validly be applied from now on. Deleveraging is the most important new consideration, and we have seen the dramatic affects this can have on asset values if we simply look to the US and some European property markets.

My expectation is that prices will fall until such time as yields are high enough to be attractive to investors who aren’t expecting capital gains in the near future. To me, this might mean yields might get higher, relative to interest rates, than we have seen for 30 years. And for that to happen, prices will fall. Of course, if the RBA drops rates significantly, this will dampen falls, but I doubt lead to the market grinding out modest growth (ie. matching inflation) for a couple more years yet.

Retail in detail

My recent post on broad retail trends might have provided a reasonable picture of the sector as a whole, but retailing is a diverse beast. One aggregate number is insufficient to describe the performance of the sector.

My approach is to examine retail from a household perspective. Rather than look at total turnover in current prices, I will examine real spend per capita in each of the main retailing subsectors. I do this because economic theory has a lot to say about changes to household spending patterns during economic cycles.

Economic theory would suggest that in boom times, retailers of luxury goods would see turnover increase more rapidly than incomes. As Wikipedia explains - In economics, a luxury good is a good for which demand increases more than proportionally as income rises. The reverse should also be true for these goods.

Importantly, retail trends need to be seen in the context of a housing driven wealth effect. The wealth effect is an increase in spending that accompanies and increase in perceived wealth, rather than spending which is driven by growth in incomes. 

The wealth effect is also behind many of the saving decisions of households. Since 2005 the trend of declining household savings rates was dramatically reversed. We now have a household saving ratio not seen since 1987 (see the RBA’s chart below). This is an important backdrop to the retail story.

These factors are important to consider if you foresee near term home price declines. In this scenario, spending in wealth driven retail sectors would be expected to fall more than flat or falling household incomes, and increased savings alone would suggest.

Now to the detail.

The graphs below show the performance key subsectors in retailing. Note the log scales, which mean a straight line indicates a constant rate of growth – the steeper the line, the higher the rate of growth. Note also that this is a real per capita measure, which is indicative of trends in household spending decisions. Quarterly chain volume data is used, with May 2011 current price data adjusted to substitute for June 2011 data. The ABS explains some of the trends in more specific subcategories here (definitely worth reading the context of this post).

A few points jump out at me from the graphs. First, household goods (maroon in first graph) have outperformed by a long way, for a long time. This category includes furniture and appliances, hardware and gardening, floor coverings and electrical. This sector also appears to have seen the sharpest shock around the end of 2007 – from having the strongest rate of growth to nearly the weakest. The rising part of the curve might partly be attributed to a greater appetite for expensive furniture and appliances, which is indicative of a luxury good effect. Also important is the impact of the construction boom of the early 2000s which has since collapsed in many areas.

Second, clothing and accessories (green line) was on a declining trend for 14 years until 1997. For a decade since then, the growth rate in this sector was only bettered by household goods. Spending recovered strongly since the GFC. I’m not exactly sure why this might be the case. Perhaps some readers have experience in this sector.

Food retailing has been the steadiest (as you would expect) with only a slight easing from the growth trend since 2009 (maroon in second graph).

Other retailing (which includes pharmaceuticals, recreational goods, cosmetics and books) appears very sensitive to the housing wealth effect, seeing big spending boost during the 2002-03, the 2007, and the 2009 house price booms. Surprisingly spending has remained strong since the GFC – the only retail sector where this has occurred.

We might attribute some of the recent robustness to the high Aussie dollar. The ABS explains that pharmaceuticals and cosmetics and toiletries are the strongest components of this sector.

Cafe and restaurant spending (orange line) also appears sensitive to the wealth effect, and is noticeably one of the more volatile sectors.

Department store spending has been declining steadily since the end of 2007 (purple line). Anyone who had closely examined this data would not have been so surprised about David Jones’ recent profit downgrade. Spending at department stores is now back where it was in 2003 on a per capita basis. 

Finally, the second graph has the period of 2002-03 circled. This is simply to highlight that all retail sectors grew at abnormally high rates during the house price boom of this period. Indeed, we can see the wealth effect correlation between house prices and retail growth in many sectors in 2007 and 2009, although to a lesser extent.

My near term outlook is for a subdued retail sector. As I have said before, I believe that in these challenging times for retailers, innovation will be the key to staying ahead. New business models that use internet shopping to good effect, with a small physical store presence might be one path for many. Those companies who adapt quickest will benefit.

The retail picture

Yesterday, my second favourite blog examined trends in retail spending following David Jones' 'shock' profit warning.  A long discussion about how best to represent the current retail climate ensued.

So to follow up, I have produced a graph of real pre capita trends in retail spending on a log scale to give, what I believe, is the best picture of retail spending patterns over time.  The per capita element is not necessary from an industry perspective, as total turnover drives the health of the industry no matter who spends it. But from a household spending perspective it is revealing.

The peak of this real per capita index is Dec 2007 (dotted line), and is down about 0.35% since that peak.  You could say that each persons retail spending has been flat for three and a half years after more than two decades of consistent growth.  In the decade prior to this peak per capita real growth in retail was 3.5%pa.

From an industry perspective, real turnover has grown at 1.7%pa since that peak, whereas in the decade prior, real total turnover grew at 4.9%pa.  This is clearly quite a shock to the sector, and I hope it stimulates some overdue competition and innovation in retailing in this country (as I have previously discussed).

Bundle of rights explains planning and prices

I have never heard the phrase 'bundle of rights' used in any property market discussions, yet the principle forms the legal basis of property itself.

Put simply, when one buys property they are actually purchasing a bundle of property rights associated with that land title. These rights are granted to the title holder by the State. This bundle of rights approach allows us to distinguish between, and appropriately value, different types of tenure, such as freehold and leasehold, and for differing levels of planning regulation, native title rights, and rights to minerals (which even freehold land owners does not have rights to).

When you value property, you value just those rights that are granted to the title holder by the State. A block of land where the title grants a pastoral lease with 10 years remaining will be valued differently if it was a freehold parcel. Changing the legal rights of the owner may vastly change the market value of the property because the property is different – it is a different set of rights, even though the physical land has not changed.

And so we move on to town planning. Local governments have the power to decide what rights, in terms of land use and scale of development (amongst other things) to grant to which parcels of land through their planning regulations.

When people argue that town planning restricts land market activity and leads to higher values, they are generally confusing basic economic theories of production with fundamental theories of valuation of property rights.

When to Buy and Sell houses

I came across the Commonwealth Bank - RP Data Home Buyers Index recently. It is designed to estimate the balance of supply and demand in a suburb to indicate whether it is currently a ‘buyers market’ or a ‘sellers’ market. Their website explains:

The Commonwealth Bank - RP Data Home Buyers Index estimates effective supply levels based on the number of properties being advertised for sale within the region.

...On the demand side of the equation, Australia's largest home loan lender, the Commonwealth Bank, provides a summary of the number of home loans that have been funded across Australia. Once we factor the Commonwealth Banks share of market into the equation, the number of home loans funded provides one of the timeliest estimates of housing demand in the market place.

This indicator may signal which direction prices are moving at any point in time, and is therefore a useful tool for market analysts. However, I was wondering if there is a rule of thumb that residential property investors could use to time their entry and exit from the market to maximise returns?

To answer that question I propose Murray’s Retrospective Indicator for Buying and Selling.

Warwick McKibbin tells it straight

RBA director Warwick McKibbin has a reputation for speaking his mind on key economic matters. It appears he is at it again, and it is worth considering his informed views on some global and local matters.

Here are my favourite points from the linked article.

Referring to the most recent global economic crisis as a mere ''blip'', he said the coming crisis could undo the mining boom and bring on inflation of the kind not seen since the 1970s.

The response globally to the financial crisis was mostly to kick the can down the road.  At some point this must stop, and the longer it goes on, the worse the resolution must be.

Joking that he could not talk about Australian interest rates, which were in any event ''always appropriate'', the Reserve Bank board member warned that the inflation would spread worldwide.

I would say that Australia has been severely buffered from global inflation by our exchange rate.  Who knows how long this can last.  My suspicion is that if interest rates go up to fight inflation, our local economy will flounder and we will end up having to drop interest rates severely and get our share of inflation anyway.  

Australia needed a sovereign wealth fund to store mining income while it lasted, ideally stored in a separate account for each taxpayer so the government could not raid it.

Of course I agree about using the tax revenues raised from the mining investment boom to save for our future.  The idea about giving each taxpayer an account seems particularly interesting.  I haven't put much thought into it but at first glance like the idea.

The $50 billion national broadband network epitomised the sort of waste Australia could not afford. ''I would say to any politician who thinks that spending is worthwhile, take your salary as shares in NBNCo. If you think it's a good investment, you'll be ahead,'' he said.

While I think the idea is great, the positive externalities generated by the NBN should factor into the equation, yet these can't be captured by revenue from broadband access.  But in general I like the idea. 

What pay rise?

I work with a bunch of economists. Now is the time of year we have performance reviews and negotiate pay rises and promotions. But no one has yet discussed the fact that high effective marginal tax rates (EMTR) greatly reduce the real take-home benefits of a pay rise.

(EMTR is an estimate of the change in take home income after tax, and after accounting for reduced welfare payments)

An EMTR higher than 50% is very common in Australia for low and middle income earners, and any push for greater middle class welfare will simply increase this perverse tax incentive.

For example, you get a pay rise approximating CPI of 4%.  Your average tax rate is 25% (meaning you get 75% of your gross pay in the hand) and your EMTR is 50% (meaning that you only get 50c out of every extra dollar of your gross salary). In this case you actually have a pay reduction in real terms. 

You take home pay only increased 2.7% (but the government net tax portion of your income has increased by 8%).

In the above example for your take home pay to keep pace with CPI you need an 6% pay rise.  If you are a lower income earner whose cost of living increases typically exceed CPI, you will need an even higher pay rise just to break even.

High effective marginal tax rates might be a contributing factor in the rise of middle class welfare.  High EMTRs mean that employers payroll costs must grow at a rate much faster than CPI just for employees to break even.  If these type of pay rises are not supported by the real growth of the economy governments may increase welfare to maintain standards of living.  This further increases EMTRs in a reinforcing cycle.

An additional point is that the significant impacts of effective marginal tax rates on changes in take home pay is generally ignored when comparing changes in gross household incomes to the cost of living, or the cost of housing.

In sum, one major economic problem with high EMTRs is that your employer faces a 4% increase in the cost of employing you for a 2.7% increase in your net pay.

Concern over the AUD

The Aussie dollar has maintained its above USD parity levels for some time now.  Given Australia's reliance on imported consumer goods, this has raised many concerns.

Now it appears that the actions of foreign central banks might be another factor to consider. The Russian central bank recently bought $4.7billion of AUD.  It seems that our relatively good economic performance is  attracting a fair bit of attention.

There are suggestions that the RBA might want to intervene to take the pressure off the AUD, and indeed their current dealing reflect concern over the high value of the dollar.  Maybe this a partly a factor in their fx dealings, but it doesn't appear to be (see chart below for RBA fx dealings).

The question comes down to whether we choose to buffer our domestic firms from foreign economic upheaval, or are we ‘all in’ in this global economy game?

I think a reasonable middle ground is to support a mining resource tax and a sovereign wealth fund to balance our economy.  I recently suggested that Quarry Australia was not a desirable place to be, and some type of counterbalancing policy would be inherently stabilising.

Whether this would have much of an impact on the AUD I don’t know. But another part of me thinks – stuff it. Go all in. AUD to $1.25+. The non-mining sectors of the economy will get the shake up they really need to improve efficiency and competitiveness in the long term.   You see I wasn't thinking long term.  Maybe short term pain would give productivity the jolt it so desperately needs.

But of course, there are real people's lives to consider as well, and shake-ups like that are painful. 

The other argument to consider is that Australian businesses benefit when foreign markets are booming, so why not let them face the risks when foreign markets are failing?

Given the high probability that any government intervention will be an ineffective mess anyway, maybe we should just let the market function for a while.

There are plenty of questions, but unfortunately no easy answers.   Expect much more debate on this situation in the coming months.

Real estate commission madness

The Queensland government is set to remove the maximum commission that residential real estate agents can charge from the Property Agents and Motor Dealers Regulation 2001. Currently the regulation prescribes in Schedule 1A that

The maximum commission payable on the purchase or sale of residential property is—

(a) if the purchase or sale price is not more than $18000—5% of the price; or

(b) if the purchase or sale price is more than $18000—

(i) $900; and

(ii) 2.5% of 

The common practice since the introduction of the regulation has been for all agents to charge this maximum.

The Deputy Premir Paul Lucas is spinning that dergulation will somehow benefit home sellers. Yeah. Right.

Admittedly, NSW, Vic and the ACT don’t have regulated commissions for real estate agents, and the common practice in these states is to charge 2.5% for homes in urban areas, and between 2.5% and 4% for homes in outer and remote areas. It appears from this comparison that Queensland’s regulation mostly benefits those in outer areas and rural and remote areas - those with the lowest value homes.

The question you must ask, is whether the regulation is disrupting functioning markets such that there is an efficieny gain from removing it? I have yet to hear of a real estate agent refusing a listing because the commission is too low. There are always other agents willing to try their luck.

In fact, recent competition suggests that more agents are negotiating below this maximum. I wrote earlier how lower commissions could be a massive competitive advantage for new agencies.  

Indeed, when the regulation came in home prices across Queensland were less than half of their current levels. So for every sale, an agent now makes double from charging the same commission. If this regulation was a problem we should have felt it years ago, not now.

Poor REIQ Chairman Pamela Bennet reckons “the regulation of commission rates for residential property transactions has not kept pace with the changing market resulting in consumers not receiving the benefits originally intended” What now?

For the maximum to have kept pace with the changing market it should have been reduced over time so that the inflation adjusted average commission was constant – theoretically providing the same benefits as originally intended.

The only logic I can see is that the government thinka this change will stimulate sales and hand them back some stamp duty revenue? Sorry. That's not going to happen.

Population and housing all muddled up (and now corrected)

RBA governor Glenn Stevens needed to say something about house prices in his recent speech. What he said was a little muddled, but if it is meaningful, does not bode well for home prices.  The analysis however got quite a bit of support from one property commentator.

First to the governor’s housing commentary –

It surely is no coincidence that the two state capitals that have had the clearest evidence of declining house prices over the past couple of years – Brisbane and Perth – are the two that previously had the highest rate of population growth and that have since had the biggest decline in population growth. Moreover, it is hard to avoid the conclusion that changes in relative housing costs between states, while certainly not the only factor at work, have played an important role. Relative costs are affected by interstate population flows, but those costs then in turn have a feed-back effect on population flows. This is particularly so for Queensland.

Historically, Queensland has had faster population growth than the southern states, as it has seen a slightly higher natural increase, a rate of net international migration on par with other states and a very substantial net positive flow of interstate migrants. Net interstate migration to Queensland peaked around 2003 – not long after Sydney dwelling prices had reached a new high relative to other cities. Interstate migration at that time was contributing a full percentage point a year to Queensland's population growth. By 2008 this flow had slowed a bit, but international migration had picked up and Queensland's population growth increased, peaking at nearly 3 per cent. Western Australia's population growth was even higher, peaking at almost 3½ per cent.

Meanwhile, at least up to 2007, people were confident and finance was readily available. Brisbane housing prices, which had been a bit over half of the average level of Sydney and Melbourne prices in 2002, had risen to be almost the same by 2008, which was unusually high.

The rate of interstate migration to Queensland then slowed further, to be at its lowest in at least a decade. The effects of that on state population growth were compounded by a decline in international migration, something seen in all states. At the same time, finance became more difficult to obtain and lenders and borrowers alike became more risk averse. This happened everywhere, but its effects in Queensland seem to have been more pronounced. Since then, Brisbane housing prices have been declining relative to those in the southern capitals and the construction sector here has found it tough going.

I decided to check the facts. Below is a graph derived from the ABS Sept 2010 demographic statistics on State populations. The figures show that WA did in fact have a population growth spurt during 2008, but that WA and QLD still retain their claim to the highest population growth rates in the country. In fact, Vic also recorded declines in growth rates of a similar magnitude to QLD in 2009-2010, but home prices have been far better maintained there. 

The only conclusion, to draw, if we believe the RBAs population explanation of home prices, is that with national population growth rates now down the gurgler, home prices nationwide can expect significant falls.

Quarry Australia

Glenn Stevens' address to the Economic Society of Australia in Brisbane yesterday reiterated the RBAs forecast of our future - Quarry Australia. Is that where we want to be?

The speech was full of useful analysis and commentary on domestic and global economic trends, but I have many concerns.

First, I'm not sure why the benefits of the mining boom are not spreading to the States with the largest mining investments. The Queensland government is broke yet still feels the need to stimulate the construction sector to the tune of $10,000 per new home. Further, if the property market is a good indicator of overall economic performance, the resource states seem to be taking a hammering. And by the way, the federal government stimulus is still ongoing, with $2billion still to be spent even in June 2011. So the unstimulated state of the economy is yet to be seen in the data. I didn’t hear a peep about that.

Stevens did raise the issue of falling home prices in Brisbane and Perth, suggesting that the reasons were all down to population growth and risk aversion by households. If we believe his population explanation for home price (which is rubbish anyway), then we have to believe the whole country’s property market is due for a crash, with immigration rates falling rapidly since mid 2008 (see chart below).

Some of his comments on housing follow, but the bolded sentence still confuses me. I could paraphrase - "the bank has no idea why Brisbane and Perth prices are down, but most likely it is because they were too high. We have no idea if prices elsewhere are also too high"

It surely is no coincidence that the two state capitals that have had the clearest evidence of declining house prices over the past couple of years – Brisbane and Perth – are the two that previously had the highest rate of population growth and that have since had the biggest decline in population growth. Moreover, it is hard to avoid the conclusion that changes in relative housing costs between states, while certainly not the only factor at work, have played an important role. Relative costs are affected by interstate population flows, but those costs then in turn have a feed-back effect on population flows. This is particularly so for Queensland.
...
The rate of interstate migration to Queensland then slowed further, to be at its lowest in at least a decade. The effects of that on state population growth were compounded by a decline in international migration, something seen in all states. At the same time, finance became more difficult to obtain and lenders and borrowers alike became more risk averse. This happened everywhere, but its effects in Queensland seem to have been more pronounced. Since then, Brisbane housing prices have been declining relative to those in the southern capitals and the construction sector here has found it tough going.

My other major concern is the following comment which is the justification for placing all of Australia’s bets on mining and energy.

For a long time, the world price of foodstuffs and raw materials tended to decline relative to the prices of manufactures, services and assets. But for some years now the prices of things that are grown, dug up or otherwise extracted have been rising relative to those other prices. This is mainly due to trends in global demand. At any point in time for a particular product we can appeal to supply-side issues – a drought, a flood or a mine or well closure, or some geo political event that is seen as pushing up prices. But stepping back, the main supply problem is really that there has simply been more demand than suppliers were prepared or able to meet at the old prices.

We do not have to look far for the cause: hundreds of millions of people in the emerging world have seen growth in their incomes and associated changes in their living standards, and they want to live much more like we have been living for decades. This means they are moving towards a more energy- and steel-intensive way of life and a more protein-rich diet. That fact is fundamentally changing the shape of the world economy. Even if China's growth rate moderates this year, as it seems to be doing, these structural forces almost certainly will continue.

The graph of Autralia's terms of trade (below) show the pattern of declining raw material prices since WWII, which changed some time in the early 2000s (assuming that our terms of trade is somewhat representative of the relative prices of raw materials and manufactured tradeable goods).

As a general rule, raw materials should become relatively cheaper over time as capital makes us more productive and raw materials easier to extract. This is always true even if there are natural barriers to resource extraction. Changes from this trend caused by a surge in demand are almost by definition temporary.

The generic argument is that China and India are making huge capital investments, thus they need a lot of energy and minerals. These countries are also getting wealthier and consuming more (and meat in particular). But the boom is driven by capital investment – building roads, rail, bridges, dams, buildings etc – which cannot be sustained for long at such a high pace. 

Remember, this a change in relative prices, not quanitites. Prices can fall extremely easily with the smallest of changes to the volumes of minerals and fossil fuels being traded.

The RBA, however, seems to think this price structure will be sustained for some time even though it never has in the past - the natural limit for the terms of trade appears to be around 80.

My main concern is that frighteningly, the RBA, and probably much of the government, sees Australia’s future as a single bet on mining, and is willing to sacrifice much of the remaining economy for this to happen. Unfortunately this is a lose-lose proposition for most of the country.

All other sectors of the economy lose while the mining investment booms. When it crashes, we all lose because there is nothing else left in the economy to absorb capacity in a relatively short period. Remember, the minerals will be in the ground if we don’t mine them now, but the decades of production chains elsewhere in the economy are easily destroyed and slow to rebuild.

I acknowledge that the RBA has a single tool in its toolbox, but surely the message we should be hearing is that a strong and stable economy is a diverse economy. Quarry Australia is a very volatile and risky place to want to be.

Australian retail playing catch up

Almost every day now I am drawn into conversations about how much cheaper common consumer products are to buy online. The following is a list of products my immediate circle of friends has bought online from overseas (mostly from US and UK web stores) in the past month – books, shoes, DVDs, dresses, tailor made shirts and suits, camera accessories, toys and computer parts.

The price differences are astounding. Books delivered to your door from the UK for $8 when local bookstores are asking $24 for the same book. Shoes that retail locally for $200 are just $100 delivered from the US. It seems that if you can’t find online prices for less than 50% of the local retail price you just aren’t trying.

The Australia Institute (TAI) conducted a survey of online shopping and has some great examples of the price differences between local and online foreign retailers. A Sony Bravia television is half the price to buy online from the US ($995 instead of $1999), DVDs are usually half the price online, and even high end bicycles are half price if you get them delivered from the UK ($1599 instead of $2999).

Even more bizarrely my local bottle shop has a six-pack of imported German beer for $10 – that’s $4 less than the XXXX that is delivered a mere two kilometres from the brewery (and yes that is the brewed in Germany beer, not the locally brewed German style).

And one thing that really bugged me was that at the Hofer supermarket in Vienna a couple of years ago - Australian wine was 2.5euros a bottle, but the same wine here is more than $10.

What is going on!

We have a situation where not only are Australian products more expensive locally, but so are imported products!

My theories are -

1. Adjustments to higher exchange rates are very slow. If the dollar appears to stabilise around $1.05USD we can expect local prices to slowly converge to international prices.

2. Australian retailers are simply years behind their European and US counterparts in terms of adopting more efficient business models (think Aldi, Ikea),and especially for online retailing. Again, we can expect this to change slowly.

3. Australians still feel wealthy and don’t feel compelled to hunt for the best deals. This is changing as the TAI survey showed.

4. Many have suggested high rents for well located retail space as part of the explanation. This might be a contributing factor but I imagine that the trend for retail rents is down.

5. People get upset when prices fall. Remember the milk wars, the beer wars?

6. Local producers have no incentive to sell locally below the price they receive from export markets (as I discussed here).

I’m open to any other suggestions, but there really doesn’t seem to be one factor to explain this retailing discrepancy. I also believe that the price differentials between local and foreign online retailers are likely to shrink from now on.

Dwelling finance springs back

The ABS released their April dwelling finance data today, and there was quite a bounce for owner occupiers across all States, but investor finance continues to fall.

Taking a look at the big picture it is hard to know whether this one month's data is particularly meaningful.

GDP down 1.2% for the March qtr

In the next 24 hours there will be a frenzy of economic commentary about the national accounts data and the importance of the last quarter's figure for the RBA board meeting next Tuesday.  My money is on no move by the RBA and more poor economic data this year.

For interest, below is the GDP per capita and Real net national disposable income per capita over the past deacde.  Notice the last few years (since end 2007) have been very flat for GDP per capita, and volatile but not really moving for net national disposable income per capita.

Brisbane and Perth housing slide continues

RP Data-Rismark released their dwelling price data for April today (here).  Brisbane and Perth are leading the price slide with Sydney and Canberra showing small gains.  This follows a stream of poor economic data recently.

I March 2010 I suggested that the next interest rate move by the RBA would be down.  I was wrong.  They increased another 75 basis points in total in their April, May and November decisions. 

My reason for suggesting they must move down is that the economy was much weaker than they anticipated, and the outlook far less bouyant.  Given this recent data one must think that their optimism is slowly fading.

2011 will be a very interesting year indeed. 

Getting my head examined - a Chris Joye rebuttal

Don't get me wrong. I agree with Chris Joye on some things - lowering the inflation target (perhaps not right at the moment), pushing for a more streamlined NBN, and supporting Malcolm Turnbull's political ambitions.

But when it comes to the housing market the guy with all the numbers is happy to overlook the strikingly obvious and adores a verbal stouch with his foes - the group he calls 'housing nutters'. In fact he just recently recommended the following 

At the same time, anyone who claims that a 1% year-on-year retracement in dwelling values is a major asset-class event (cf. the share market frequently falling more than 5% on a given day) needs their head examined, with the greatest of respect. And I sincerely meant that latter caveat: you genuinely should seek medical advice if you are convinced that house prices are plummeting. 

Let's take his advice and examine what is in my head (noting that I don't believe a 1% year-on-year fall in national home prices in isolation is a concern). 

Joye often likes to draw attention to the low volatility of the housing market compared to the share market (eg here and here). But he neglects a few important differences. 

1. The housing market has at best monthly data only. Moreover each month's price data point is essentially an average. The share market would be far less volatile if you measured it that way and averaged away each month's price extremes. Not that volatility represent risk in any case. 

2. The share market is an equity market. If you want to compare like with like you need to compare the change in home equity to the change in share prices. If there is $1.7trillion in housing debt outstanding against $3.5trillion worth of housing, you can double any housing price change to calculate the change in equity of homeowners on average. Of course prices are set at the margins so perhaps for the price setting buyers and sellers the leverage, and importance of small price movements, is even greater. 

3. The negatively geared investor sets the market price (apart from the recent burst of FHBs). This means they are losing money every year. Any small decline in value decreases their equity substantially in addition to losses already incurred. 

4. The marginal homebuyer is heavily leveraged - 80% plus. This is not the case in the share market. Remember, leverage works to improve both gains and losses. 

5. The wealth effect is much stronger in the housing market than other markets, particularly due to leveraging and the sheer size of the asset compared to household incomes. 

6. Cost of home ownership is much greater than simply the interest cost. For most homes around 25% of the gross rent is spent on annual costs (refer to 3.) 

7. Housing market crashes, while they feel almost spontaneous, actually take some years to eventuate.

Irish housing - 5 years to fall 28%, or 0.41%/month

US housing - 6 years to fall 31%, or 0.38%/month

UK - 2 years to fall 21%, or 0.8%/month (and still 18% down from their peak 4 years later) 

8. Lastly, I feel sorry for anyone who shared Joye's property optimism and bought into the Brisbane or Perth property markets in the past two years.  While the share market hasn't been crash hot, 6% returns on cash has been pretty flash.

Anyway, if these notes are a sign of a mad man, well so be it ;-)

Wealth effect driven by the housing market

Leith van Onselen over at Macrobusiness has written a couple of very important and timely articles on the wealth effect. Put simply, the wealth effect is an increase in spending that accompanies and increase in perceived wealth.

In relation to housing, this paper suggests the wealth effect increases our propensity to consume by 9c per dollar of increased housing value (which is further supported here). So if the housing stock of Australia is valued at $3trillion (some say between 3.5 and 4 trillion), and market values increase 10% in a year, then we will spend on average 9% of the $300billion of new 'wealth', or $27 billion - with $6 billion of spending occurring prior to the end of the next quarter.

Importantly, this money is spent before it is earned by selling the asset. The easy access to home equity lending has been a contributing factor to the size of this effect, enabling households to spend their capital gains before they have been realised which increases their financial risk.

There are few readily available studies about the size of this effect in reverse, but if the same values hold in both directions we can look at some interesting scenarios.

If prices fall 2.5% nationally over a quarter then we lose $75billion of perceived wealth, with an immediate reduction in spending in the following quarter/half year of about $1.5billion and ongoing reductions in spending totalling $7billion

With about $1.7trillion of bank loans outstanding, that is about the same effect on spending as an increase in interest rates of 0.25% and keeping them there for two years (which will mean $4billion extra is spent on interest repayments per year). This of course assumes that house prices are not dramatically affected.  Indeed, if we consider that interest rate moves are likely to also bring down home prices, we can expect a much greater effect from the monetary lever.

That’s why house price falls of just a few percent can cascade into a crash so easily.

I would suggest the reason the wealth effect in relation to housing is much higher than found elsewhere is that many people who benefit/lose from house price changes are highly geared, which increases/decreases their equity more quickly for a given price change.

On this note I would add that you can’t directly compare share market volatility to house price volatility, since the share market is an equity market. To make a direct comparison you need to compare the volatility of the equity component of the housing market with share market, or the volatility of the share market value plus the value of debts held by those listed businesses to the housing market.

Peter Schiff predictions

Peter Schiff was ridiculed for years when he predicted that the US housing bubble and credit binge would result in a massive asset price bust and recession.  You could describe his economic philosophy as Austrian, and as the recent Keynes and Hayek rap video explains, the bust is a direct consequence of the boom, not some seperate economic event that can be avoided through government intervention.

In this early 2009 video Schiff predicts the collapse of the US dollar and makes some very astute observations that may resonate with Australians.  Enjoy.