Frank Gelber says property investors should strap themselves in and enjoy the ride.
So much for the downturn in the Australian economy, let alone the recession that many expected. It turns out that, even as the doomsayers were in the ascendancy, the economy was picking up through the second half of 2009. The recovery is now well entrenched, setting the scene for a strong upswing driven by rolling investment cycles. Forget the prophets of doom who insist we’ll slip back into crisis mode because our debt is too high, because countries won’t be able to meet their financial obligations, because the banking system will have the second round of crises, or any one of a number of doom scenarios. We’ve already had our correction.
In particular, much of what we’ve seen in the GFC is an unwinding of the consequences of the financial engineering debt binge, which fuelled the preceding asset price and investment booms. While for some countries the road out is difficult, it is a road out. Much of the “animal spirits” risk has gone out of the system. What remains is a heightened perception of risk leading to more conservative behaviour, and taking most of the reality of risk out of the system. Australia has had a charmed run through the GFC with only a moderate downturn and little over-investment to absorb before investment resumes, with rolling investment underwriting the upswing. That process has now begun. In fact, we’re setting up to build momentum into a phase of strong growth this decade. The risk is that, if investment cycles are synchronised through the upswing, an investment-driven boom will set the scene for a subsequent bust.
Last year we saw what can only be called a soft landing, with GDP growth of 1.3 per cent, a slight deterioration in employment and the unemployment rate rising from 4.2 per cent to a peak below 6 per cent. Given the severity of overseas-developed world recessions, that was extraordinary. Much of the initial downturn came from a collapse of confidence. We were never going to have a big recession in Australia. Certainly, we were exposed to the financial engineering logic and the overpricing of assets. The GFC curtailed investment before we had a chance to go over the top. Hence Australian banks weren’t exposed to substantial bad debt – there was a credit squeeze rather than a fully-fledged financial crisis. Nevertheless, the drying up of both debt and equity finance curtailed investment in property development, new mining projects and general investment by businesses. In the downturn, the collapse in private investment wasn’t as bad as we first thought.
Even now, we’re still working on projects we started before the downturn hit and already starting to set up the next round. As time progressed, it became apparent that the downturn in private investment would come through later, would be shallower and would recover sooner. Now, as both equity and debt finance constraints start to ease, we can already see the shape of the recovery in private investment. Meanwhile, the weakness in the private sector was offset by aggressive monetary policy, with reductions in interest rates boosting household disposable income. At the same time, aggressive fiscal policy cushioned the impact on the private sector. The household handouts boosted retail sales. The end of the handouts coincided with the recovery in confidence in the second half of last year, keeping private consumption expenditure reasonably solid.
The tax concessions on new investment brought forward and boosted equipment spending. The payments for housing insulation boosted alterations and additions work. Substantial increases in government investment in infrastructure, in education and now health, offset much of the decline in private sector investment. Fiscal policy worked to cushion the economy from the impact of the private sector downturn, but at the cost of blowing out expenditure, and hence budget deficits. The other side of the coin is that pressure to reduce deficits will reverse that stimulus. Government investment projects still have a way to run, but will come under pressure as recognition of the recovery puts pressure on government budget deficits. To me, that’s a problem. Fifteen years of underinvestment by governments trying to reduce their budget deficits, through the 1990s and into the next decade, was a primary cause of the infrastructure bottlenecks subsequently experienced.
Addressing budget deficits through manning practices has proven difficult for governments, particularly when facing election. The easy way has always been to reduce infrastructure spending. But we need the infrastructure to make Australia a better, more effective place to live and work. Now, with GDP growth through last year of 2.7 per cent, recognition that the recovery has begun will change policy settings. Interest rates have started to head back towards a neutral setting and will rise further. Indeed, given the likelihood that strong growth will run into labour and capacity constraints, and hence demand-inflationary pressure, three or four years from now, we think that interest rates will significantly overshoot neutral before this cycle is over. Next cab off the rank will be cuts in government expenditure.
Remarkably, the government got the timing right on counter-cyclical investment this time.Having filled the gap left by the fall in private investment, cutbacks in government spending, and particularly investment, will make room for the next resurgence in private investment. After last year’s further setback, the residential recovery has already begun. And we need it. The substantial deficiency of residential stock will continue to drive up housing prices, despite affordability problems, impacting particularly on the rental market and on first home buyers. Plans for the next round of mining investment have been brought forward – particularly gas, iron ore and coal projects. There will be a short pause in investment work done between the last round of projects and next but, given what we already know, mining investment will be sustained at extremely high net investment levels for much of this decade, boosting the economies that service that investment.
Commercial building will take longer to come through but, given current constraints on development and the likelihood of solid demand, we can already see the logic for the next round of investment. Rolling investment cycles will drive the strength of the economy this decade. The major risk is that synchronisation of those cycles both in upswing and downturn will cause oversupply and lead to a boom through most of the decade, setting us up for an investment bust and subsequent recession – just like the 1980s and 1990s recessions. Of course, the timing of the different cycles will depend on external as well as internal factors – if they’re not synchronised we won’t have the magnitude of boom and bust. We don’t yet know how the timing of those cycles will pan out. We’ll have to play it by ear. But the peak of the boom and subsequent bust wouldn’t be until the end of the decade. And we’d have quite a ride before we got there. I’m looking forward to it.