China still streets ahead

We can now cross off higher official interest rates from our list of things to worry about.

Let's doff our caps to the end of a six-year tightening cycle. Did it go too far? Yes it did, and I said so when they tightened in February and March. But that's not why we're in trouble now.

There's something else I'm really worried about: Australian house prices (but not for the reason you think). But there's one thing I'm not worried about at all which everybody else seems to be getting into a lather about: the Chinese economy now that the Olympics are over.

Property analysts who are saying that a shortage of supply will keep prices high are scaring the hell out of me not because I think they are wrong and that house prices will fall, but because they could be right.

House prices need to fall. In real terms they are cripplingly high, and if the economists are right, and we are in for another housing boom from here because of demand and supply, it will be disastrous.

In today's dollars - that is, adjusted for CPI inflation - the average Australian house price was steady at about $75,000 for the first half of last century, that is from 1900 to 1950.

In 1949 it jumped to $120,000 as the soldiers returned from the war and the great baby boom began, and then fell quickly back to $100,000 before gently rising to $200,000 in 1975 as incomes rose with the long boom in the 1960s.

The average real house price then remained at around $200,000 until 2000, albeit with some volatility, before rising dramatically in almost a straight line during the first seven years of the new century to $500,000 today.

As a result the average house price has jumped from three times average household income during the entire 20th century to five times now.

And as a direct result of that, total household liabilities in Australia as a percentage of household income are now 30 per cent more than in the US. Australians have had to borrow 180 per cent of income, on average, to finance their lives, while in the US they've borrowed a bit less than 140 per cent of income, on average (and that includes all the subprime mortgages that have caused so much trouble).

Mind you I'm not entirely convinced that house prices won't fall. Existing house prices fell in June for the first time in years, and the softness in the market has continued. The Melbourne auction clearance rate fell 3 percentage points to 60 per cent over one weekend in August, also the lowest for three years.

We could see a situation where the inflated prices of upmarket existing homes fall, while the shortage of basic housing holds the price of outer-suburban lower-priced housing up.
The problem is that incomes are going to fall as the economy slows, and the money has to come from somewhere. If the cost of shelter does not fall, or even stop growing, because not enough houses are being built, then spending on something else will fall even more.

In my view, we could be approaching a full employment recession. What I mean is that since the last recession, the workplace has been revolutionised, so that there are now a huge number of contractors, casual workers and small business people.

The old analysis of household incomes, which simply meant keeping an eye on the unemployment rate, is no longer valid because a large percentage of the workforce can now suffer an absolute decline in income without becoming unemployed.

Wages rarely fall, so in the days when everyone was employed, as long as you have a job you're income was OK; now half the workforce is employed as a contractor or a casual or owns a café, and they can lose customers or get fewer shifts.

What's more the executive workforce has been moved onto "at risk" salaries in the past 15 years as well, and has been living off bonuses for years. These are now drying up.
I worry that as the economy slows and incomes fall, if house prices don't fall because there is a shortage of them, then consumption spending will collapse as Australians have to devote more and more of their incomes to keeping a roof over their heads.

Forget about luxuries, restaurants and expensive holidays. It'll be bangers and mash and an on-site caravan at Christmas for a while, just to pay the mortgage or the rent.

But I'm not worried about China.

The commodity markets are, and metals prices have been crunched in the past few months as concerns grow about the Chinese economy now that the Olympics are over.

No doubt activity will subside after the Games, but the main thing going on in China, as we have pointed out many times, is the migration of people from the country to the cities.

The global head of commodities research for Citigroup, Alan Heap, told me in August that the equivalent of Australia's entire population is moving into cities every year. Those people require infrastructure. So China has to build an Australia for them every year.

I'm no China expert, but that is a mind-boggling earth-changing idea. They might be in small apartments rather than four bedroom mock-Georgian homes on quarter-acre blocks, but they will still need a lot of steel.

That's why I'm not worried about China.

About the author

Alan Kohler is Founder and Publisher of Eureka Report. Eureka Report is an online indepedent investing publication. Please visit www.eurekareport.com.au/asx for a 21 day free trial.

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