A Century of Policy Mistakes | Niels Jensen

In A Century of Policy Mistakes Neils Jensen describes the demise of Argentina over the last 100 years.

A century ago Argentina ranked as one of the wealthiest countries in world, behind the United States, the United Kingdom and Australia but ahead of countries such as France, Germany and Italy. Its per capita income was 92% of the G16 average; it is 43% today. Life in Argentina was good. It enjoyed the benefits of one of the highest growth rates in the world and attracted immigrants left, right and centre. Boom times galore.

Argentina’s wealth was based on agriculture, but also on its strong ties with the UK, the pre-World War I global powerhouse. Equally importantly, it understood the importance of free trade and took advantage of the relatively open markets which prevailed in the years leading to the Great War. Most importantly, though, it benefitted from, but also relied upon, enormous inflows of capital from the rest of the world. All of this is well documented in a recent piece in The Economist which you can find here.

Neils identifies three main causes:

  1. An over-reliance on commodities;
  2. Failure to invest in education; and
  3. An increasingly closed, inward-looking economy.
  4. It occurred to me that, apart from education, Australia has made the same mistakes.

    Read more at A Century of Policy Mistakes | Niels Jensen – Absolute Return Partners | PRAGMATIC CAPITALISM.

Deflating Australia’s land bubble

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Great post by Leith van Onselen
Reproduced with kind permission from Macrobusiness.com.au
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Prosper Australia has provided a submission to the Senate Inquiry into Housing Affordability, which is well worth a look. The submission first provides nine metrics illustrating Australia’s residential property bubble, which include the following:

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It took forty years from 1950 to 1990 for housing prices to double, but only fifteen years between 1996 and 2010 to double again. The surge in housing prices is driven by the tremendous growth in household debt, as owner-occupiers and investors take out ever larger mortgages to speculate on housing. The household debt to GDP ratio reached a record high of 98 per cent in 2010, the same year real housing prices peaked. In 2013, the mortgage and personal debt ratios were 86 and 9 per cent, respectively, for a combined household debt ratio of 95 per cent.

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As mortgage debt escalated, investors’ net rental losses increased rapidly from 2001 onwards. In that year, net rental income losses were just over $1 billion, rising to $9.7 billion in 2008 as the cash rate peaked at 7.2 per cent. By 2010, when mortgage debt reached its historical peak relative to GDP, investor losses eased to $5.1 billion as the cash rate fell to a then historic low of 3 per cent in 2009 following the global financial crisis (GFC). The latest data shows income losses rose to $8.2 billion in 2011, the second largest absolute loss on record…

The housing market meets economist Hyman Minsky’s definition of a Ponzi scheme, as gross rental incomes minus expenses are clearly insufficient to meet principal and interest repayments. As 67 per cent of property investors are negatively-geared as of 2011, investment decisions are predicated upon expected rises in land values, not rents. This strategy will inevitably fail, as the escalation in real housing prices can only be sustained by a continual acceleration or exponential rise in mortgage debt.

The price to income (P/I) ratio, otherwise known as the median multiple, is another measure of residential property valuation…

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From the mid-1990s onwards, housing prices outpaced household incomes, and the P/I ratio increased from 4 to 7 nationwide. It is impossible for household incomes to match the rise in housing prices during the boom phase of a property bubble, as wages grow more slowly, usually just above the rate of inflation…

Land is the largest tangible market in Australia… Our housing bubble is actually a residential land bubble, as the total land values to GDP ratio doubled between 1996 and 2010, when it reached a record high of 298 per cent ($4.1 trillion). In real terms, residential land values rose from $895 billion in 1996 to a peak of $3.2 trillion in 2010, a relative increase of 262 per cent. This ratio is closely matched by a similar rise in the value of the residential housing stock. The rise in residential land values, rather than structures, is responsible for almost all of the increase in the value of the housing stock…

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Prosper then places the blame for Australia’s expensive housing on convergence of factors, with Australia’s inefficient tax system front-and-centre:

A convergence of factors are responsible: a large cohort of irrational investors gambling on housing prices, a FIRE sector willing and able to facilitate a credit boom, and low property and land taxes attracting speculators to this asset class…

A positive feedback loop has emerged between housing prices and mortgage debt, with rising prices prompting the take-up of more debt in an upwards spiral…

An inefficient taxation system, comprised of low property and land taxes, allows landowners to expropriate ‘geo-rent’ (economic rent derived from land) by capturing the uplift in land values generated by taxpayer-funded infrastructure and rising economic productivity… Government willingness to tax wages and business ahead of land has elevated its privileged status, resulting in larger capital sums being paid by owner-occupiers and investors.

It also advocates land tax reform, which it claims would significantly improve incomes, affordability, and productivity:

Counter-intuitively, reducing wage and business taxation and increasing land tax would not necessarily lower fundamental land prices, given the offsetting boost to disposable wages, profits and hence rents, but it would certainly lower bubble-inflated land prices. Land tax reform – urged on government by every independent tax review in living memory – would firmly correct the price to rent and income ratios. If Australia wishes to escape or ameliorate the profound financial destruction of a bursting land bubble, the solution lies in this equation…

Prosper also slams housing-related tax expenditures, which undermine the integrity of the tax system:

The generous scope of tax expenditures relating to the housing market has served to further increase prices. Tax expenditures are defined as a deviation from the commonly accepted tax structure, whether it is a tax exemption, concession, deduction, preferential rate, allowance, rebate, offset, credit or deferral. Australia has the highest rate of tax expenditures among our OECD peers, at more than 8 per cent of GDP. Tax expenditures are vulnerable to lobbying, and often compromise the fairness and efficiency of the tax system. Lavish tax expenditures for both owner-occupied and investment property has significantly worsened housing affordability because they allow landowners to capture greater amounts of geo-rent and prioritise unearned wealth and income over what is earned. Existing home owners capture the most benefit, ahead of first home buyers, investors and tenants.

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These tax expenditures provide a strong incentive to speculate on housing prices, and are reinforced by already low property taxes. Investors perceive rental income as secondary to expected rises in capital prices, while first home buyers over-leverage themselves to enter a bubble-inflated market…

Tax expenditures, combined with the ongoing deregulation of the banking and financial system, has transformed the housing market into a casino. Residential property is commonly viewed as a speculative asset to flip, rather than shelter to raise a family in…

Finally, Prosper provides two recommendations to the Senate Inquiry:

Recommendation 1: Reform Land Value Tax. The ideal tool to moderate land bubbles and properly fund infrastructure already exists in the hands of state and territory governments: state land tax (SLT). Unfortunately, this tax has been so riddled with exemptions and concessional treatments it must be considered dormant…

We suggest the current government introduce a nationwide one per cent federal land tax (FLT) – fully rebatable on SLT paid – to oblige the states and territories to use their taxing powers properly. State governments could adjust their tax rules and keep every dollar the FLT raises, to the benefit of all Australians. The Commonwealth Parliament would be entitled to argue this intervention is for sound economic reasons and dissipate the political fallout. Placing state and territory finances on sound bases would vastly improve the federal system mandated by Australia’s Constitution. Transitional arrangements would need to be considered. Rebating all stamp duty paid against a hypothetical past SLT obligation would address concerns of fairness and equity…

Recommendation 2: Macroprudential Regulation. A range of macro-prudential tools are needed to moderate housing price inflation and subdue credit growth in a pro-cyclical financial system, such as those affecting the loan to value, (LVR), debt servicing (DSR) and debt servicing to income (DSTI) ratios.26 Quantitative restrictions should be placed on the share of new mortgages with moderately high LVRs…

To reduce systemic risk, a large rise in capital and liquidity ratios (buffers) is required to ensure banks can withstand a future economic downturn, bank run or large fall in the value of collateral. Research suggests the probability of a banking crisis can be reduced to a 1 in 100 year event by raising core equity (Tier 1) capital ratios to 11 per cent in isolation or raising core equity to 10 per cent with an addition rise in liquid assets of 12.5 per cent (the rise in liquid assets over total assets). For the Big Four banks, this would represent a rise of around 3 per cent in core equity…

The full submission is available here.

ASX 200 stalls as Aussie Dollar retreats

The Aussie Dollar retreated from resistance at $0.91. Breakout below primary support at $0.885 against the greenback would warn of a primary decline, with a long-term target of $0.81*. Follow-through below $0.865 would confirm. Recent Twiggs Momentum peaks below zero also indicate a primary down-trend. Respect of primary support and recovery above $0.91 is unlikely, but would suggest that a bottom is forming.

Aussie Dollar

* Target calculation: 0.89 – ( 0.97 – 0.89 ) = 0.81

The ASX 200 is consolidating below resistance at 5450, waiting for a lead from US markets. Bearish divergence on 13-week Twiggs Money Flow suggests long-term selling pressure, but completion of a large trough above zero (TMF recovery above 30%) would change this. Breakout above 5450 would signal an advance to 5800*. Reversal below 5400, however, would warn of another correction.

ASX 200

* Target calculation: 5400 + ( 5400 – 5000 ) = 5800

ASX 200 VIX below 15 indicates low risk typical of a bull market.

ASX 200 hits resistance

After a healthy start to the day, the ASX ran into poor Flash Manufacturing PMI out of China. The Aussie Dollar fell through 90 cents, suggesting another test of 87 (US cents).

Aussie Dollar

The ASX 200 faces strong resistance at 5400 to 5450. Rising 21-day Money Flow indicates medium-term buying pressure and breakout above 5450 would confirm a primary advance. But reversal below 5400 would warn of another correction; follow-through below 5350 would confirm.

ASX 200

* Target calculation: 5350 + ( 5350 – 5050 ) = 5650

ASX 200 resurgent

The ASX 200 is testing resistance at 5380. Rising 21-day Twiggs Money Flow indicates medium-term buying pressure. Follow-through above 5400 would suggest another advance. Respect of 5380 is unlikely, but would warn of another correction.

ASX 200

* Target calculation: 5350 + ( 5350 – 5050 ) = 5650

ASX 200 VIX below 15 indicates low market risk.

ASX 200 hammer

The ASX 200 recovered above 5200 Monday after a last week’s hammer candlestick flagged support. Follow-through above the descending trendline would suggest another advance. Breakout above 5400 would confirm. A 13-week Twiggs Money Flow trough above zero would strengthen the signal. Failure to break the descending trendline would warn of another decline, however, and breach of 5000 would signal a primary down-trend.

ASX 200

The ASX 200 VIX retreated to below 15, reflecting low market risk.

ASX 200

ASX 200 at risk

The ASX 200 is at far greater risk of reverting to a primary down-trend. Retreat of 13-week Twiggs Money Flow below zero, after a bearish divergence, warns of strong selling pressure. Failure of support at 5050 would strengthen the signal, while breach of 5000 would confirm. Respect of the rising trendline is unlikely, but would continue the up-trend.

ASX 200

Breach of support at 5000 would suggest a fall to the long-term trendline, around 4600. Reversal of 13-week Twiggs Momentum below zero again suggests a primary down-trend.

ASX 200

The ASX 200 VIX is rising, but below 20 still reflects low market risk.

ASX 200

Also, none of our macro-economic/volatility indicators indicate elevated risk, but you can’t argue with the tape.

ASX 200 breaks support

With secondary weakness in both China and the US, the ASX 200 broke support at 5200, signaling another correction. Reversal of 21-day Twiggs Money Flow below zero suggests short-term selling pressure. Recovery above 5250 is unlikely, but would indicate a bear trap. Failure of primary support at 5050 would warn of a primary down-trend.

ASX 200

The monthly chart illustrates the importance of primary support at 5000. Breach would confirm the down-trend, suggesting a fall to the long-term trendline, around 4600.

ASX 200

* Target calculation: 5300 + ( 5300 – 5200 ) = 5400

The ASX 200 VIX rose sharply, but (below 20) continues to reflect low market risk.

ASX 200

Aussie dive hurts ASX

The Australian Dollar is declining after breaking primary support at $0.885, offering a long-term target of 80 cents*. Exporters and import replacement industries on the ASX will benefit from the weaker Aussie Dollar in the long-term, but the short-term impact is negative, with overseas investors retreating from the market.

Australian Dollar/USD

* Target calculation: 0.885 – ( 0.97 – 0.885 ) = 0.80

The ASX 200 is heading for a test of support at 5200. Breach is likely and would signal a test of primary support at 5000. Declining 13-week Twiggs Money Flow indicates selling pressure. Recovery above 5400 is unlikely in the short-term, but would signal a primary advance, with a long-term target of 5800*.

ASX 200

* Target calculation: 5400 + ( 5400 – 5000 ) = 5800

ASX 200 hanging man

The ASX 200 is testing short-term resistance at 5300. Rising 21-day Twiggs Money Flow suggests buying pressure, but the latest hanging man candlestick is bearish. Follow-through above 5320 would indicate an advance to 5400*, while reversal below 5200 would test primary support at 5050.

ASX 200

* Target calculation: 5300 + ( 5300 – 5200 ) = 5400

The ASX 200 VIX below 20 continues to reflect low market risk.

ASX 200 VIX