So according to Chris Joye, I’m “poor old Steve Keen”.

The only reason I’m sorry for myself is for letting this exchange (Macquarie Group interest rate strategist Rory Robertson sprang the bet on me in front of an audience at Parliament House) distract me from my main focus on the macroeconomy.

This bet has taken on a life of its own and undergone more redefinitions than Phyllis Diller had facelifts (for those of you too young to know, Diller is a comedienne who once remarked that if she had one more facelift, she’d be sporting a goatee).

So let’s set the record straight.

Firstly, it wasn’t a prediction but a historical analogy. In an interview with Kerry O’Brien I was asked what my expectations were for house prices in the economic downturn that I correctly predicted.

I stated that house prices had fallen by about 40% over the 10-15 years after Japan’s Bubble Economy collapsed, and I saw no reason that Australia would avoid the same fate.

From its peak to its current level the Japanese index has fallen 42%, and the 40% fall took 14 years.

Secondly my analogy was on a peak to trough fall in nominal house prices. I didn’t make it in real terms, nor was I trying to call the peak itself. When the bet was made in November of 2008, that peak was 131. I was not claiming that 131 would be the peak, but that when this financial crisis had played itself out, house prices would have fallen by something like what they have done in Japan.

Later, for the sake of closure I agreed that if the index ended above 131 by the end of 2009, I would walk, even if I still expected it to fall 40% from that any new peak.

Discussions between Chris, Rory and I led to the following clarification from Rory:

  • 40% drop from 131 peak is 78.6 on abs index … that’s when I [Rory] would walk.
  • If that 131 level is regained in any period of time after a fall of less than 20% … doesn’t touch as low as 104.8 … then you [Steve] have committed to walk.
  • Recall that down 20% to down 40% is no-man’s land…

That’s where the bet stands — and it could well have me walking in the next year. The peak could well be higher than 131 after the governments’ First Home Vendors Boosts pumped up the sub-$500K range by as much as $40K, and the return of speculators at that lower to median range. But I expect the bubble to burst as it has elsewhere on the planet, so that Rory will have to follow that trail some years hence.

Finally, Chris claims that those expecting a price collapse ignore “the fact that house prices are determined by demand and supply”. No we don’t. We focus on something Chris seems to ignore: that in asset markets, prices are determined by demand and supply and leverage.

To use the silly static logic of neoclassical economic thinking, the “demand curve” can shift out because of the volume of demand—supporting the “prices will rise” camp. But it can also shift down because banks’ willingness to lend drops. With a LVR of 95%, leverage transforms a $50,000 deposit into $1,000,000 buying power; but if LVRs drop to 80% (say), that “demand curve” will fall vertically from the million dollar level to $250K.

So physical demand and supply imbalances can favour rising prices, while monetary leverage-based demand trends can favour collapsing prices. In that tag team contest, I back leverage every time.

Peter Fray

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