Juggling asset bubbles in China and Australia
Both countries are accepting targeted financial bubbles as a necessary risk. In China, the target is the stock market
China and Australia have a lot in common. Both countries have escaped widely predicted financial crises. Both economies are sagging under the weight of deflated investment booms. And as they try to stoke demand, both are accepting targeted financial bubbles as a necessary risk.
In China, the target is the stock market. Some are warning that China’s bull market is just an elaborate form of procrastination orchestrated by policymakers to bury past financial excesses.
Yet as each day passes, the yelps of protest are dying down. No wonder; the stock market has been unshortable for nearly a year. Even some of the most vocal China bears are now rebranding themselves as high-profile bulls.
Doubters find a parallel in the US, accused of stoking a housing bubble to cover up the effects of a burst internet bubble – only to face a greater crisis down the road.
On the bright side, financial assets as a percentage of both gross domestic product and household wealth are relatively small. This makes a stock market bubble a lesser evil. Chinese policymakers went to pains to curb excesses in the proper market, but seem to be allowing the equity bull market to rage.
Australia, on the surface, appears to be playing a much more dangerous game. Record low policy rates have helped push the property market to historically high valuations in some market segments.
The overall stakes are very high. At an aggregate level, household debt to GDP is above 125 per cent, among the highest in the world. Australia banks are vulnerable: lending to homebuyers is their biggest business segment.
The Reserve Bank of Australia has acknowledged that the property market is overheated in some niches, such as high-end Sydney. But after performing financial stress tests on households, the RBA argued in a recent report that the fallout from any correction would be contained.
“The results [of stress tests] suggest that, despite rising levels of household indebtedness in aggregate, the distribution of household debt has remained concentrated among households that are well placed to service it,” the report said. “In turn, this suggests that aggregate measures of household indebtedness may be misleading indicators of the household sector's financial fragility.”
In other words – it is the rich who are in bubble territory, and they can afford it.
Like China with its stock bubble, Australia’s high-end real estate market has acted as a valve to release some of the pressure from increasingly accommodative monetary policy. This anyway seems to be what policymakers are hoping – is this a reasonable gamble?
Australian policymakers deserve some good will for their past record. It wasn’t just luck or Chinese demand that spared the country from a financial crisis like other OECD peers. Banks were prudently regulated than elsewhere.
Other signs of good governance include: public debt to GDP is low, healthcare spending is efficient, individuals have been forced through superannuation to save for their futures, and last year the government sensibly raised the retirement age to 70, one of the OECD’s oldest.
Every single year for the past five years, pundits have predicted a recession in Australia. This year is no different, nor is the prediction without cause. But to leap from here to expectations that a recession will prick the housing bubble and cause a financial crisis is dubious. The RBA’s argument is a convincing one: most Australians have too much skin in the game to default on their mortgage loans.
The situation in China offers an interesting contrast. Technically, a reversal in the equity bull market would be contained since the country’s stock-market-to-GDP ratio is low, and financial assets make up only a slither of household wealth.
But the problem is that the stock market has come to represent the financial reforms so crucial to a new, rebalanced China, one that is less dependent on overheated investment spending.
If this gambit fails, the issues of past excesses in the financial sector will resurface. And not just for psychological reasons – banks are raking in fees on financial services, which helped offset the cost of moderately rising non-performing loans.
Beijing’s strategy may very well pay off, and Australia may not be lucky forever. But these are different kinds of bubbles, and China’s is much dicier.