The Reserve Bank is hoping that higher house prices will make consumers feel wealthier and start spending again. (ABC News: Graeme Powell)
Ever had that sinking feeling you’re in over your head, that you’ll never be able to get on top of that mountain of debt?
And what about interest rates? How on earth would we cope if they ever returned to anything like normal?
The good news, at least for those mortgaged to the hilt, is that rates are likely to stay extremely low for a very long time. We’re talking years, perhaps even a decade. Maybe even longer.
The reason is that hiking rates would cause way too much pain and possibly trigger a recession even worse than the crisis that shook Western capitalism to its core a decade ago.
That’s because central banks globally have boxed themselves into a corner. They literally have nowhere to go.
They’ve encouraged so many individuals, corporations and governments to borrow so much, by slashing interest rates to their lowest level in 5,000 years, that any future rate hikes potentially could cause enormous damage.
Here at home, it’s all about housing. Real estate now drives our domestic economy and, rather than attempting to cool a runaway market, the Reserve Bank once again is fuelling another boom.
In fact, in the absence of further help from the Federal Government, it has thrown caution to the wind and is banking on housing as its main weapon to keep our sputtering economy from stalling.
Two years ago, our monetary mandarins were fretting about a housing bubble blowing up the economy and successfully engineered a gradual deflation.
But as housing prices went south, households stopped spending and the residential construction boom ground to a halt, threatening to push unemployment higher.
Even worse, the price declines left thousands of households carrying more debt than the value of their property, particularly in Western Australia.
That posed a serious risk to the banking system, given our housing debt has trebled over the past 15 years to around $1.8 trillion.
Central banks have encouraged individuals, corporations and governments to borrow to an extent that any future rate hikes potentially could cause enormous damage. (Supplied: Australian Bureau of Statistics)
The end result? Borrowing restrictions were relaxed and the RBA since has cut rates three times, with another due as early as February.
It’s now hoping that higher house prices will make consumers feel wealthier and start spending again.
There’s just one hitch: housing prices again have surged in Sydney and Melbourne and, if the recent blistering pace is maintained, will be back at bubble levels early next year.
How Wall Street ate itself
We’re not alone in this. Cast your mind back to this time last year. Global stock markets, led by Wall Street, were in turmoil and a mild panic had begun to creep in.
The parallels with our housing market are uncanny.
The US Federal Reserve, having narrowly avoided economic catastrophe in 2008 by cutting rates to zero and implementing three massive rounds of money printing, figured it was time to unwind the stimulus.
Between late 2016 and the end of last year, it hiked rates eight times, pushing them to 2.5 per cent.
Most ordinary Americans were unfazed by the gradual hikes. Unemployment was low and the economy seemed to be on the mend.
Midway through last year, however, Wall Street caught a case of the yips. Investors hit the sell button as fears took hold that American companies wouldn’t cope. Debt was to blame.
For the past decade, corporate America has been on a borrowing binge.
US corporate debt now stands at an eye-watering $US10 trillion ($14.6 trillion).
The problem is, instead of tipping the cash into productivity-enhancing investments, corporate America ploughed most of that debt into buying their own shares.
That’s correct, their own shares. Last year alone, American companies spent $US1 trillion buying their own stock.
In fact, share buybacks, as they are called, have been the bedrock of Wall Street demand in recent years. Why on earth would any chief executive do this?
First, it’s an easy and tax-effective way to distribute cash back to shareholders. But the real reasons are that the extra demand for stock boosts the share price and because there are fewer shares on issue, it creates the illusion that earnings per share are rising.
It just so happens that most executive bonuses are based on rising share prices and earnings per share. Bingo!
This graph from investment bank Morgan Stanley highlights the folly of what has been occurring in the US. Once you add in dividends, American companies have been paying out more than 100 per cent of their earnings to shareholders.
That’s not sustainable, as investors discovered in 2001 during the dotcom bust and 2008 as the GFC took hold.
American companies have been paying out more than 100 per cent of their earnings to shareholders. (Supplied: Morgan Stanley.)
When interest rates are close to zero, when the cash you’re borrowing essentially is free, those running the show look like geniuses. But when interest rates start to rise, that debt needs to be serviced.
That’s why Wall Street began to tank late last year. Corporate America couldn’t afford the higher interest payments because it had been borrowing cash just to pass on to shareholders. All that debt and nothing to show for it.
Under pressure from a furious President Donald Trump, the US Federal Reserve reversed course and cut rates twice.
Low interest rates were supposed to boost business investment. Instead, they’ve artificially inflated Wall Street and now the Federal Reserve is too scared to push rates any higher for fear of sparking a market crash.
As Fed chief Jerome Powell noted in May: “Could the increase in business debt pose greater risks to the financial system than currently appreciated? My colleagues and I continually ask ourselves that question.”
Wall Street punched through new records a fortnight ago as the longest bull run in American history continues.
Once upon a time, financial markets reacted to government and central bank policy. Now it’s the reverse. Markets are driving policy.
Once upon a time, financial markets reflected or tried to anticipate what was happening in the real economy. Now, they’re leading it.
Just as debt can turbocharge returns in a bull market, it can magnify losses in a downturn. And with so much outstanding debt, with corporates and households so leveraged, a rise in interest rates could undermine markets, threatening consumption and growth.
That’s what has trapped central banks. They’ve gone to the extreme end of monetary policy. They’ve encouraged a huge uptake in debt and they’ve pushed asset prices into the stratosphere, widening the gulf between those who have assets and those who don’t.
It has distorted resource allocation and encouraged investors to take on far more risk than they’d ordinarily be comfortable with, just to get a return.
It has been hugely successful in staving off market collapses. But for how long? Maybe years.
No-one knows how to unwind this. No-one can afford to have it unwind. The pain would be too much to bear.