A non-economist's crib to Australia's economic outlook - part one

Last week Ric Battellino, the Deputy Governor of Australia's Reserve Bank, delivered what was written up as an optimistic view of the Australian economic outlook.

Following some bad economic news, the Reserve Bank cut official interest rates yesterday (Melbourne Cup day) by 75 basis points. Commentators focused on the apparent difference between Mr Battellino's views and the decision. If things were so good, why was such a deep cut necessary?

Today the Australian Treasurer released the Treasury Mid Year Economic and Fiscal Outlook. Commentators focused on the headline numbers, the decline in the projected budget surplus.

I don't know about you, but I sometimes get confused in the flow of daily commentary and news, in part because I cannot always remember enough of past data and analysis to put it all into a context. For that reason, I thought that it might be helpful if I provided a sort of an economic crib to recent official statements.

Ric Battelinos' Speech

Those interested can find the original of Ric Battelino's speech here.

Headed An Update on Household Finances, the speech was concerned to reinforce confidence among Australian Australian households worried about recent developments.

Mr Battelino began by suggesting that the past five years had been an extraordinarily favourable period for Australian household income. This is an important starting point because it sets a context for the challenges Australia now faces.

During that period, real disposable income of the household sector grew on average by 6.1 per cent per year, resulting in a cumulative increase over the five years of more than 30 per cent.

This is quite a remarkable increase, meaning that the growth in household incomes in Australia greatly exceeded that in any other developed economy, round twice that in the US. For example, growth in real household disposable income was only about half that in Australia. Mr Battelino also noted that the growth in income in Australia was fairly evenly distributed through the household sector in that the percentage increase in real income was very similar across all the income quintiles.

This is a pretty good result, although it also means that income disparities increased because the rich have more bucks on which to get a bang than the poor.

Mr Battelino then looked at the impact of growth on household balance sheets.

This is an important issue because in Australia, as in the US, household debt has been rising. However, unlike the US, the Australian household position is quite strong.

If you look at the attached graph, financial assets at 30 June averaged around $275,000 per household while liabilities averaged $150,000 per household. Since then, the Reserve Bank estimates that average assets have fallen to around $245,000 per household, leaving quite a strong average positive position.

Note that these are financial assets. They include housing debt, but do not appear to include the value of the family home.

The graph shows just how important superannuation is to average household financial assets. Much superannuation is invested in shares, making the equity component much greater than the formal equity value in the graph.

This is important, because in the short term it means that over a million Australians approaching retirement are suffering from current falls in share values. However, in the medium term it also means that a large majority of Australian households are poised to gain from future increases in share values. Here Mr Battelino included a number of graphs to demonstrate the relative performance of shares.

The next graphic shows the total annual return on Australian shares over the last one hundred and something years. The return goes negative every five years or so, sometimes by significant margins, but the average return is very good.

He then compares the return on shares with the return on bonds, a safe cash equivalent, taking $100 in 1908 as a base. The hugely different returns on shares are easy to see in the graphic.

Quite simply, shares have beaten cash hands down over a very long period. This is likely to continue, providing a base for improvement in household financial positions as the share markets recover.

Mr Battelino then turns to look at the value of housing, the other key household asset.

Here he makes the very interesting point that the boom in Australian housing prices, one that peaked some time ago, did not elicit the same supply side response as in the US. This means that we simply do not have the same number of surplus properties, placing a floor under prices.

This, in combination with a better underlying household position than the US, helps explain why Australian banks have far fewer non-performing housing loans than in the US.

There are some hot-spots, Sydney's western suburbs for example. Further, non-performing loan figures are worse among non-bank lenders. Even here, though, the Australian position is better, with non-performing loans in Western Sydney by mortgage originators running at about 1.6 per cent as compared to over 2.5 per cent for US banks as a whole.

Comment

The main media coverage of Mr Battelino's speech focused on some of the supporting comments he made dealing with the broader economy. Here he flagged that inflation was still a problem, while pointing to some of the reasons why he thought that Australia would avoid recession.

These broader comments are best discussed in the context of the Mid Year Economic and Fiscal Outlook, the subject of the second post in the series. In the meantime, Mr Battelino's speech provides some interesting insights into the structure of aggregate household finances in Australia.