>[Anyone know why Australia's doing so well?]
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The reserve Bank Governor reckons he knows and he's determined to put a stop to it.
http://www.theage.com.au/articles/2002/06/03/1022982671208.html
Why your interest rates are on the up
By Tim Colebatch June 4 2002
When a central banker speaks his mind freely, start worrying. Ian Macfarlane spoke his mind freely on Friday, and his key message could not have been clearer: interest rates will increase significantly in the coming year, and borrowers should beware.
The Reserve Bank chief's testimony to the parliamentary Economics Committee raised two issues of immense importance for Australians' future. One of them he tackled directly, while the other was left unsaid - there are issues that even in his frankest moments, a Reserve Bank governor cannot raise.
The issue he discussed freely was the role that low interest rates have played in fuelling the boom in housing prices over the past five years: a boom that has almost doubled the average price of a home in Melbourne, and lifted prices by between a third and a half in the other mainland capitals.
That growth, Macfarlane told Australia, cannot last. It has been driven by a oneoff fall in mortgage rates, from an average 15per cent in the late 1980s to an average 7 per cent in the past five years. That more than doubled households' capacity to service a loan. And households have responded by borrowing twice as much, sending house prices soaring.
But there were no more oneoff falls in interest rates ahead, he said. In the short to medium term, they will be rising, back to neutral, which translates to mortgage rates somewhere in the range between 7.5 and 8.5 per cent. And there, barring unforeseen bad news - such as sustained weakness in the world economy - they will remain.
The issue he did not raise was what impact a long period of stable house prices would have on the potential growth rate of the Australian economy. Australians have enjoyed two decades of relatively good economic growth, partly because they have spent those two decades on a borrowing binge from the rest of the world. Net foreign debt, $8 billion in 1980, has soared to $332 billion in 2002.
Will we continue to borrow heavily from the rest of the world, and if so, what will we spend it on? And if we end the borrowing binge and start saving more and spending less, what impact will that have on our economic growth in the decade ahead?
First things first. Ian Macfarlane's message was so blunt that one newspaper headline labelled him "Macfarlane the merciless". In fact the reverse is true: in making his message so clear, the Reserve Bank governor was trying to head off the boom in housing prices and debt before it ends in a damaging bust.
Twenty years ago, the Reserve points out, an average house in the state capitals cost about four years' wages. In the mid-1990s, it cost fiveandahalf years' wages. But now it costs almost eight years' wages. The growth in house prices has run far ahead of growth in our incomes.
We could afford to pay these higher prices only because of the oneoff fall in interest rates, Macfarlane pointed out. But even in the very long term, there will be no comparable fall in interest rates ahead. Future growth in house prices will rather resemble future growth in income.
In the short term, the Reserve pushed interest rates to 30-yearlows last year because it feared Australia might fall victim to a global recession. That danger has now passed. To leave interest rates at these very low levels would risk reigniting inflation, limit the Reserve's power to cut rates as needed in future, and risk fuelling a boom in asset prices (that is, housing prices) that could end this long economic expansion. To put it simply: what comes down must go up.
But the big issue behind this is how such a future will alter our potential growth rates, and our relations with the rest of the world. Even a decade ago household debts were about 50 per cent of takehome income. Now they are 110 per cent of our income, and while we have been borrowing that from the banks, they have been borrowing it overseas.
In June, 1996, the banks and other financial institutions owed a net $80 billion overseas. By December, 2001, that had more than trebled to a net $251 billion. In fiveandahalf years, the finance sector borrowed a net $171 billion from the rest of the world. And in that time, the amount of money they lent out for housing almost doubled.
Australia is a rich country, and Treasury tells us that net household wealth has been rising, on average, by 10 per cent a year in the past decade, climbing by almost $50 billion a year. Yet we continue to borrow heavily: a net $37 billion in 19992000, $21 billion in the last financial year, and $22 billion in the first nine months of this one. In the six years since the Howard Government took office, net foreign debt has soared from $193 billion to $332 billion. That has provided the fuel for our high growth rates - but it is unsustainable.
Australia and the United States face similar problems in weaning themselves off a dependence on foreign borrowing. The best path is to wean ourselves off it before the rest of the world cuts us off much more roughly.
Ian Macfarlane's warning is a positive step towards that.
Tim Colebatch is economics editor of The Age. E-mail: tcolebatch at theage.com.au