Most Australians remain blissfully ignorant of the dire state of the global economy. With our never ending-house boom and cash inflows pouring in from higher commodity prices (and world equity markets soaring on QE), the problems engulfing the United States and various PIIGS (especially Ireland) insulate many people from the bitter global reality. That grim reality is the modern day “welfare state”, pioneered by the likes of France but now present in virtually all Western countries, is unsustainable and the pain will be widespread.

The only thing Australians ever seem to worry about (and in fairness, this may well be a media creation rather than a genuine widespread concern) is variable mortgage interest rates. Every Reserve Bank rate rise is greeted with utter horror, as if it is the inherent right of all Australian battlers is to receive hundreds of thousands of dollars in finance using permanently low interest rates to enable them to purchase a 350-square metre homes with ducted air-conditioning and three plasma TVs.

Of course, the cost of money’ s no longer dependant on what a bunch of people sitting in Canberra think it should be. Because the banks have sought short-term (and by short-term, that is less than 20 years) profits, they have lent far too much money to people buying residential homes. This has led to a shortage of credit. Not only are banks now unwilling to lend to ostensibly riskier businesses, but they need to borrow tens of billions of dollars from overseas institutions to fund Australia’s housing bubble. (Such is the Big Four banks’ willingness to lend, some of the banks actually increased the loan-to-valuation ratios on mortgage debt earlier this year).

This has meant that when overseas lenders want to charge more for money, that higher funding cost is paid by banks, who, as wholesalers of money, pass the cost onto retail buyers (mortgage holders). While there is some truth to the argument that banks act as a “cartel” due to high regulation, in reality, a wholesaler wouldn’t be expected to operate at a loss. Banks, however, should be heavily criticised for lending too much money to too many borrowers at a time when debt was plentiful and cheap (during the Great Moderation). However, instead of using the post-GFC period to stop lending, and crimp down on excessive household debt, Australian banks have continued to lend money and seek short-term profits. Bank executives, who are paid tens of millions of dollars a year based on short-term bank profitability, are encouraged to do this.

Australians should look very closely at the terrible situation occurring in Ireland. Rewind less than three years and the poor Irish folk thought they were an emerging economic power with their buoyant IT sector (a bit like Australians think they are invincible courtesy of our commodity exports to China). Because of this confidence, the Irish invested in residential property, heavily. They thought property would never fall in value, especially with such a strong economy. The only problem was the economy only appeared strong because foreign institutions (such as German banks and pension funds) were lending money to Irish banks, who in turn lent money to Irish home owners, who in turn bid up the price of Irish property.

When the foreign money stopped flowing suddenly, people realised Irish residential property was worth 35% less than people had been paying for it. This led to a dramatic Irish property collapse.

An emergency EU package (similar to what one used to save Greece from default earlier this year) will temporarily quell the immediate problems (the Irish are stubbornly refusing help at the moment, but will eventually have no choice but to accept the bail-out). The problem for Ireland is that bond vigilantes know that Ireland is a serious default risk and continue to sell Irish bonds such that their yield increases (to compensate for the higher perceived risk).

However, getting billions dollars in more loans won’t change the structural deficiencies in Ireland. In the same way that drinking methylated spirits does little to cure a hangover. Irish taxpayers, who unwittingly spent €40 billion bailing out the mistakes of Ireland’s big three banks (Anglo Irish, Allied Irish and Irish Nationwide) who lent too much money to property buyers now need bailing out themselves — private sector debt was taken on by the public sector, which only now realises it can’t afford to pay that debt, so is taking a loan from an even bigger public sector.

While not Ireland, the Australian economy does have some similarities to the temporarily roaring Celtic Tiger. Between 1992 and 2006, Irish house prices rose by 300%. In Australia, the median house price has increased from $139,000 in 1992 to about $500,000 now — an increase of almost 300% and far out-stripping economic growth, inflation and rental growth.

The Irish property collapse and subsequent bail-out required the Irish government to rediscover austerity as it attempts to reduce the massive budget deficit (currently 32% of GDP). This has further depressed the Irish economy, already struggling with unemployment of almost 14%.

The Irish thought that with low corporate taxes encouraging global investment (especially in IT) and a rampaging property sector, they had entered an economic nirvana. In reality, it was a debt-funded illusion fuelled by stupidity — and Ireland will be paying the price for decades. It appears that Australia may very well suffer a similar, albeit slightly less dire, fate.

Peter Fray

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