Property markets are plunging, but we really should have seen it coming
If history is nothing more than a series of cycles, why are we so often blindsided by what should be the utterly predictable?
As the plunge in Australian property gathers pace, we at least can take some solace that we are not alone. Nor is market volatility confined to real estate.
Property markets from London to Beijing and Perth to Paris have the wobbles right now while, in recent months, American builders have taken a hiding from nervous investors worried the US real estate market may have peaked.
Then there’s Wall Street — it’s just endured another brutal week, dropping 4 per cent as the heavy selling that began in September and gathered pace in October shows no sign of abating.
Most tech stocks, which were soaring until then, are now in correction and even bear territory as the broader market on Friday surrendered all this year’s gains, rattling nervous investors across the globe with our market now down around 12 per cent from its recent peak.
Some US economists just can’t get their heads around it.
Global growth looks good. Inflation is on the mat. Unemployment is the lowest in a generation. Wages growth, while weak, is recovering. Interest rates remain at or close to historic lows.
What’s not to like, they argue, as they rattle off a laundry list of impressive stats to back their arguments.
In almost every market, unique, one-off events are being blamed for the jolts sending shockwaves through the system. There’s the US trade war with China, the Italian banking system rocking Europe, the chaos surrounding the UK’s clumsy exit from Britain, the shocking revelations from our very own royal commission into bank misconduct that have tightened lending standards.
All have played a part. But larger forces are at work, and as the volatility extends into the tail end of 2018, it’s becoming increasingly obvious that global finance is at an inflection point.
Pretty simple really. Soaring asset prices have been stopped in their tracks by either rising interest rates or cash rationing, now pricking holes in those bubbles.
No matter where you look, there’s another mountain of debt.
Spurred on by the lowest interest rates in human history, it’s the primary factor that has fuelled dramatic price hikes in almost every asset class, from housing to stocks and bonds. Everything, that is, except for wages.
China’s Government is swimming it. Australian households are up to their ears in it. US corporations are borrowed to the hilt.
At some stage, it has to be repaid or refinanced. Either that, or another banking crisis will erupt. And the catalyst will be rising interest rates.
In the past few years, America’s central bank has pushed rates higher on eight occasions. A ninth was expected this week with another four next year.
Just a month ago, America’s monetary mandarin Jerome Powell was gung-ho about it all, arguing the US Fed would continue to pump up the price of cash, to keep pace with the recovering US economy.
Now, suddenly, he’s not so sure. Rates could be close to the peak.
The about-face has been reflected here too. Until last week, we were told the next move in Australian rates would be higher, a view questioned by your columnist for more than a year.
But as the property market unravels, the prospect of any hike in the foreseeable future has evaporated.
Instead, last week, the Reserve Bank opened the possibility of not just rate cuts but, if things really deteriorate, the kind of radical monetary stimulus that has landed the rest of the world in its current predicament.
Central banks — friend or foe?
As the Global Financial Crisis gathered pace a decade ago, central banks struck a kind of Faustian pact with those it was supposed to keep in check; financial markets.
As the price for saving the global economy from ruin, central banks became players in the system, perhaps even captives. Not only were the perpetrators of the crisis spared any consequences for their actions, they were allowed to continue making oodles of cash from the bail-out.
The US Fed injected almost $US4 trillion into the system by buying up US Government bonds and mortgage debt.
Europe did the same. Japan’s central bank went several steps further. It now owns close to half of all Japanese Government bonds; so many it has killed the market. It since has had to switch to buying shares on the Tokyo stock exchange just to keep pumping cash into the system.
Take a look at the Bank of Japan stimulus
A graph shows the Bank of Japan balance sheet in comparison with Japan’s GDP.
So how far can markets fall?
A long way is the short answer, at least in theory. The big question is whether central banks will allow it, given the amount of cash they’ve invested.
Pumping money in certainly helped save the global economy. Turning off the tap was problematic. Unwinding the stimulus, however, is proving a major headache.
The US is in the reversal process right now. It’s withdrawing around $US50 billion a month from the American economy and, while the graph below illustrates it’s so far soaked up only a tiny proportion of the cash injected over the past decade, it would appear the shrinking supply of cash is beginning to be felt.
History shows the Federal Reserve’s balance sheet is shrinking.
(Thomson Reuters Datastream/Federal Reserve)
Hence, the sudden trepidation from Mr Powell. Getting into the market was comparatively easy. Extracting itself unscathed is proving far more difficult.
That’s why the Fed is leery of upsetting financial markets. It has a massive stake in their performance which essentially has the tail wagging the dog.
Where the Fed once called the shots on markets, it now has become beholden to them and is likely to jettison any strategy that may jeopardise financial market stability.
That’s not the only phenomenon causing heartburn.
Mr Powell recently copped a shellacking from US President Donald Trump over his determination to raise interest rates, with the President calling the policy “crazy”. It was perceived as an unprecedented attack on the central bank’s independence.
If Mr Trump ever twigs that the Fed’s policy of pulling cash out of the system is destabilising Wall Street, hurting real estate and crimping America’s growth, just imagine the fallout. Heads could roll.