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After the interest rate rises « Previous | |Next »
December 11, 2003

I see that there are tensions between Peter Costello, the federal Treasurer, and the Ian McFarlane, the Reserve Bank governor. It is all about "spiking the bubble" of runaway growth in housing credit. Costello and the Howard government are facing an election at a time when the Reserve Bank is raising interest rates. There may be more interest rates rises next year to help the "correction in the property market" along.

You can feel the cool winds blowing across the market.

Election time means we are seeing attempts to brow beat the Reserve Bank by Government Ministers. That tightening monetary policy to keep inflation in check means a slowing Australian economy, a slump in the property market, and more people being left behind. Hence the political interference from the Prime Minister down.

The tide is running out on the Howard Government. They want to spend bags of cash in a big election splurge. You can bet there won't be that much spent on infrastructure renewal. It's all about tax cuts to boost consumer spending. They are hoping for a big high tide from the American economic recovery to carry them home.

And the Americans? Economic recovery looms but the US dollar continues to fall because of their ballooning current account deficit. That deficit just keeps growing larger and larger.

It is more than normal election tensions. It is about a housing bubble fueled by the boom in lending for investment property, that is driven along by negative gearing. Negative gearing provides the shelter from the high taxes on tax-payer incomes. It's a tricky one. Negative gearing will be placed to one side.

As homeowners are hit with extra mortgage payments----"adverse shocks"----propety speculators wil come unstuck with falling prices, especially those who use deposit bonds (no need to pay a deposit) with the intention of quickly selling their investment before settlement.

| Posted by Gary Sauer-Thompson at 12:14 PM | | Comments (6)


It should be of great interest to view a particular type of 'constitutional'market(ie in a Public Choice Theory sense) at work here. On the one hand incentives to invest, via negative gearing achieves massive investment in large quantities of ostentatious housing with relatively low rental returns. On the other hand, with no such driving force to escape high marginal income tax rates behind it, the need to achieve relatively high returns with the natural forest environment produces a similar result, namely less natural environment.

Curiously enough, I was recently introduced to the extreme case that investment can willingly occur with nil or indeed negative financial gain. While talking to 18yr old Lee, a YR12 student from China, he explained such an extreme example. His grandfather had explained how this worked when the Communists came to power in China. They would visit a town or subuurb and select the odd wealthy individual, who was tried and summarily executed as an enemy of the worker and the Revolution. The street were quickly awash with cash, gold, jewellery, expensive furniture and art, as the population decide it no longer required a return on it anymore. The Communists happily gathered this up for the good of the community.

Given the eventual, relatively poor long term return on this investment by the Communist Govt, the serious question for the Left/Green movement is how to ensure a wiser investment of capital in privatised hands, without such a draconian incentive scheme. Nevertheless, such extremes of investment returns do show how socially and environmentally desirable, private investment regimes could be constituted with more carrot than stick. You just have to get the price right.

If the humble Observa's comments here are a tad more obscure than usual, it is perhaps because they belong in the Ecological Vandalism post.

Not really. There is something absurd about all that capital going into high rise high priced investment apartments (capital from the developer and investor using credit) and then it all being wipped out when prices fall because of the concerns of the regulator whohas an eye on what the US is doing.

It is all about wasteful expenditure and sacrifice.It haslittle to do with utility.

More to do with the Aztecs than the Protestant ethics me thinks.

There is plenty of Protestant ethics at work here with negative gearing in real estate and investment in harvesting pristine forests. The market is working perfectly as you would expect it to. The rub is, that it is one particular 'constitutional' market that is working very well to achieve the outcomes observed. Albeit this market is one achieved after an extremely long process of the science of muddling through or incrementalism in design.

The important thing to realise is that there can be many other constituted markets which could be designed. The most important design feature would be one that gave a powerful incentive to investment in pristine wilderness as a countervailing force to its demise by the other forces we see now. It needs a coherent redesign of our market system to achieve this, but it can be done. I have been tossing around a particular design for some time now after gaining some very useful insights with the various blogs. The only trouble is the explanation of the design evolves with some new insight almost weekly, although the basic skeleton has remained intact for some time. I'll have to find the time and the discipline to write it all down for appraisal by the experts.

Ze grand plan, hey? We await with interest.

More like the grand plan for competition Scott.