It has to. The extreme—unprecedented—moves that respective governments, policy makers and central bankers have taken in the past year are going to have an effect on the long-term health of the economy.

Let us take a brief look at what happened and what is still taking place in Australia.

In response to the crisis the RBA followed the lead of the central banks of the US and UK and increased base money considerably—from approximately $47 billion to over $72 billion, an increase of over $25 billion in just four months, something that has never been done before in Australia.

Although we don’t know exactly where the money went (the RBA does not comment on particular counterparties), based on the data it is safe to say that it went into the banking sector, either to encourage banks to keep lending to each other or simply as a direct subsidy by taking securities off the bank’s balance sheets and giving them cash in return.

The thing is, unlike the US and UK where the massive increase in base money is still sitting in reserves at their central banks (they receive a ‘safe’ level of interest and are keeping the reserves on hand for future asset write-downs), the Australian banks have already decided to use the new money. I’ll touch on where it has gone in a moment, but for now this means that at least some of the new money has already entered the wider economy and will have to have an inflationary effect at some point in the future. Historically it can take up to two years for an increase in the money base to end up in the CPI (a horrible, heavily manipulated figure)…but who knows this time. What it has done though, in the short term, is keep assets inflated, preventing prices in financial markets, housing, credit markets and so on from adjusting downwards.

So where has the money gone? A quick glance at the data for long-term securities reveals that a lot of the new money has probably entered that market with the amount invested, both public and private, increasing significantly since the money was injected. So the banks are monetising at least part of the government’s deficit with RBA-created money. This is important to note, because fiscal spending is not inflationary under one condition: when you as an individual buy a government bond. When you do this you are making a loan to the government; you are putting part of your cash holdings into the hands of the treasury. There is then no increase in the total quantity of currency or credits available and hence no inflation.

Now, when the banks buy government securities from their new reserves, as I suspect they have been, it is just as inflationary as effects of issuing more paper money. It is under this scenario that the government’s fiscal spending will create future inflation as the loans funding it are not sourced from real, productive savings: there are now more dollars chasing the same amount of goods.

Loans are still relatively stagnant, reinforcing the view that the banks are choosing to invest the new cash in relatively safe long-term securities instead of issuing new loans (although there’s hardly been a ‘crash’ in loans – loan growth is still close to 10% YoY and appears to be turning upwards).

So what does this all mean? For one thing, it appears the banks received a good ol’ fashioned bail out, although the RBA was much more covert in its efforts than the Fed. While this will probably prop up the financial sector in the short term, it can’t be good for the wider economy as prices, production and consumption have failed to coordinate…I have no doubt one of the reasons the market hit records recently is because a lot of the new money was being channelled into the stock market (it often is).

In the short-term the RBA is going to be under pressure to raise rates – I wonder if they can hold out until the election next year (Rudd and Swan will be putting a lot of pressure on them to hold off till then). I’m not sure if the RBA will fight the upwards pressure on interest rates by issuing more money (the only way they can keep it down) or if they will let rates rise…if they keep rates down until next year then inflation will be guaranteed in the medium-long term.

On the subject of inflation/deflation, the best indicator for future inflation has to be M3—coincidently, it is a figure that has been rising at near record levels over the past couple of years (34.8% from July 2007 – July 2009[1]).

Gold is also a good leading indicator for inflation; the AUD gold price (indexed) historically trends close to M3.

The above seems to indicate that inflation rather than deflation will be on the cards for Australia in the near future. Yes, there are plenty of bad debts that need to be written down but I don’t think we have to worry about deflation: the RBA will monetise most of the toxic assets and prevent the money supply and prices from falling too far. It is politically suicidal—for both Glen Stevens and the government—to allow deflation to occur on their watch.

This leads me to the fiscal issue. The reckless “stimulus” undertaken by the government has to have caused massive structural instabilities and further malinvestment in the economy. Rather than let the necessary restructuring occur, they have simply—at best—delayed it. At worst they have caused even more malinvestment and imbalances that will radiate throughout the economy for several years. It’s important to understand that the government can only create what it has first taken from someone else. All of the jobs the stimulus created are temporary in nature—they cannot be maintained unless the government keeps spending. They are not in areas demanded by the preferences of the consumers but by the fancies of Julia Gillard. Building roads to nowhere and new gymnasiums is wealth destruction plain and simple.

If the stimulus is wound down—a necessity to restore economic health—and the inflationary fears forecast above both take hold, stagflation is a distinct possibility. Especially considering that once rates start to rise again the glaring bubble that is the property market will come under stress and put further pressure on both the mortgage industry and jobs related to it (housing, construction and so on).

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved," -- Ludwig von Mises, Human Action

However, we do have more room to move than the US and UK (we actually export stuff and so have a larger pool of real savings to exhaust through government waste and bank subsidies), so it might be possible for the powers that be to keep this fiat regime going and avoid the necessary deflation (or hyperinflation and a collapse of the currency).

The beauty of monetary inflation is that it is never the same and does not necessarily affect the same industries. Loose-money policies at home and overseas could very easily create another asset bubble in our economy. Only time will tell.

[1] M3 growth has only matched this rate twice in Australia over the past 40 years. Those years were 1973 and 1989 and were followed with two recessions.

Building on what Drwasho wrote back in June, I have to say, I’m really not sure. There’s a good reason to believe both could happen but as always timing is the hardest part to predict.

The case for deflation is a strong one – commercial bank credit is in freefall as banks look to let their commercial loans run down and don’t seem to be replacing them with new investments. This has to have a strong deflationary effect on the economy and it’s unlikely any amount of prime-pumping on behalf of the Fed can counteract it. In fact, a lot of the new money is simply sitting in excess reserves, likely going into treasuries or simply collecting interest from the Fed (a new ‘tool’ in the Fed’s arsenal – paying interest on excess reserves) rather than funding new loans.

The deflationary theory is hardly new; it’s exactly what happened during the great depression. Rothbard, in America’s Great Depression, highlighted a few key reasons as to why deflation occurred despite the low interest rate, cheap money inflationary policy pursued by the government of the day. They are:

1)     Lower interest rates further discouraged the banks from making loans or investments. Just when risk was increasing, the incentive to bear risk—the prospective interest-return—was being lowered by governmental manipulation.

2)     The enormous increase in bank failures. With over 1,000 banks failing every year, bankers knew in their hearts that no bank (outside of the nonexistent ideal 100 percent bank) could ever withstand a determined run.

3)     Foreigners lost confidence in the dollar, partly as a result of the program, and drew out gold;

4)     American citizens lost confidence in the banks and changed their deposits into Federal Reserve notes;

5)     Bankers refused to endanger themselves any further, and either used the increased resources to repay debt to the Federal Reserve or allowed them to pile up in the vaults.

Today a lot of the conditions that prevented the politically ‘desired’ inflation from occurring back in the 1930s don’t exist. For one, we have a fiat money regime rather than a gold standard making it harder for foreigners to convert their US dollars to gold or other assets without losing value. Another big difference is that government’s around the world enacted a policy of deposit insurance, thereby preventing mass bank failures (creating ‘zombie banks’ instead) through bank runs. But aside from those two differences, the other points still hold true.

It’s important to remember that Bernanke is well schooled in the great depression. His problem is not that he doesn’t understand why inflation didn’t occur; it’s that he still believes inflation is the correct solution and is therefore looking to prevent the above from causing deflation this time around. He’s going to go all-out in an attempt to reinflate the bubble rather than let the necessary deflation and restructuring work its magic.

So can he do it?

This is what I’m not sure about. It’s going to be very difficult to get people to leverage up this time around. What we do know is that Bernanke will stop at nothing in his attempts to reinflate the bubble, an effort which may amount to nothing more than blowing air into a broken balloon. Excess reserves have increased astronomically, as they did in the great depression, but the question is whether they will make it into the money supply or not. At this stage every attempt has been fleeting with banks quite happy to buy up treasuries or simply take the small, but safe, return that the Fed pays them.

Will the new powers the Fed is after allow Bernanke to charge a negative interest rate on excess reserves, forcing banks to buy existing securities or create new loans, thereby increasing the true money supply? Will the growth in the public sector, public works, ‘stimulus’ and so on create enough spending to drive inflation faster than the private sector is deflating? These are all very curious questions and unfortunately, at this stage, no one knows. We’re stuck in limbo and all I can say is that the next several months are going to be very, very interesting.

Concerning Australia, this time around we have China. While in the great depression we were one of the hardest hit due to our export dependence and protectionist policies pursued by our major trading partners, this time we have a centrally-planned major trading partner in China instructing their factories to keep production up and, therefore, demanding our commodities. The export-focused, mercantilist policies of the Chinese government, while depriving their own citizens of deserved wealth, are in effect a subsidy for the Australian economy. By artificially keeping their currency low and subsidising their export industries they’re not only increasing demand for our raw materials but are supplying us with goods that are cheaper than they would be if China was a more free market orientated country. Yes, this is a bad thing for the Chinese people, but it’s good for Australians.

This leads me to believe that it won’t be as bad here as it will be in Europe and the US, despite our government rolling out the third largest stimulus package behind only the US and Korea (on a per-capita basis). The biggest threat to Australia is the growing size of the public sector, of increased regulation and the massive debt that we, and future generations, have been laden with for no good reason.

It seems, as with the US, Australian banks are finding it difficult to (likely voluntarily) create new loans to replace the ones that are running down. I’m more concerned, at this stage, about inflation in Australia than in the US. The RBA has been a bit reckless with their monetary policy – for example, they just increased the currency stock by $4 billion – an increase of almost 10% on the existing supply. This is money that won’t be sitting idle; it’s being spent and will have an impact on prices, perhaps not immediately due to the winding down of credit, but it will in the future. What happens when the banks start expanding credit and the RBA’s cash injection is already flowing?  This, together with the irresponsible spending by the government will have to force interest rates to rise if we’re to have any chance of avoiding price inflation.

When the government’s stimulus proves to be ineffectual at providing long-term jobs we’re probably going to be faced with rising inflation, rising interest rates and rising unemployment. But with an election looming, we probably won’t hear anything about that until Rudd is sworn in for a second, and probably final, term. The Keynesian solution adopted by this government requires endless doses of government spending, deficits and new money which will only lead to a growth in the welfare state, inflation and wealth destruction. The real solution is simple: get the government out of the way and let the necessary coordination between prices, costs and wages take effect.

It's late and for some reason I'm trawling the drivel that is the Australian media and stumbled upon a couple of articles which are correct but at the same time horrendously wrong in both their analysis and economics.

The first article - and let me add that as it involves a union it comes as no surprise - states that "...a China FTA could create 12,000 jobs for Australia but take away another 170,000 in the manufacturing industry." Now I'm not questioning their numbers - I'm sure the source (a report paid for by the Electrical Trades Union (ETU), hah) is reliable enough - I'm questioning the conclusions they derive from it. Dean Mighell, secretary of the ETU, goes on to say:

"People in the factories, people on the farms, small business people should have real and serious concerns about the implications of free trade agreements," he said.

"The ETU commissioned this report because we think that if we entered into a free trade agreement with China it is the death knell for our manufacturing industries and many of our food-producing industries."

Dean is correct but the solution he's after, for the government to prevent free, voluntary exchange between individuals is not something the government needs to involve itself in. By 'protecting' the manufacturing and food-producing industries by preventing the "dumping of goods into Australia" and other 'evils' that will lower the price of consumer goods in Australia, he is depriving every Australian of a potential increase in their standard of living. Yes, some small interest groups may lose their jobs, but the cheaper prices brought about by the increased competition will provide everyone in the economy with additional income to spend elsewhere (the savings they now make they can use to acquire more goods than they could before). This savings will then be spent in other areas, increasing demand, replacing the jobs that were 'lost'. Not only will we lose no jobs (in the aggregate), but we've all gained additional products, or wealth (of course, government intervention in the form of rigid wages, union barriers to entry and so on can restrict or delay the reallocation of labour resulting in unemployment).

The second article - the one I'm more peeved about - involves the OECD scratching the back of a fellow socialist and "new world order" advocate, Kevin Rudd.

"Australia's fiscal stimulus package seems to have had a strong effect in cushioning the decline in employment caused by the global economic downturn," it said.

"Less by the end of 2010 than if no fiscal stimulus measures had been taken," it said.

Now I'm not sure what these guys at the OECD get paid but if it's more than $0 then it's too much. They plainly state the obvious - that the stimulus prevented job losses - without going into any kind of in-depth, critical analysis at all. Of course the stimulus prevented job losses! It simply protected or insulated industries and jobs which are victims of catastrophic, unsustainable malinvestment and prevented the necessary realignment and restructuring of jobs, wages and prices. Is this sustainable in the long term? No, unless of course they plan to inflate yet another bubble and continue the boom-bust cycle, a policy that Hayek noted would eventually collapse on itself or, worse, lead to full blown socialism. To quote [emphasis added]:

"The great problem in all those instances is whether such a policy, once it has been pursued for years, can still be reversed without serious political and social disturbances. As a result of these policies, what not very long ago might merely have meant a slightly higher unemployment figure, might now, when the employment of large numbers has become dependent on the continuation of these policies, be indeed an experiment which politically is unbearable.

"Full employment policies, as at present practised, attempt the quick and easy way of giving men employment where they happen to be, while the real problem is to bring about a distribution of labour which makes continuous high employment without artificial stimulus possible. What this distribution is we can never know beforehand. The only way to find out is to let the unhampered market act under conditions which will bring about a stable equilibrium between demand and supply. But the very full employment policies make it almost inevitable that we must constantly interfere with the free play of the forces of the market and that the prices which rule during such an expansionary policy, and to which supply will adapt itself, will not represent a lasting condition.

"These difficulties, as we have seen, arise from the fact that unemployment is never evenly spread throughout the economic system, but that, at the time when there may still be substantial unemployment in some sectors, there may exist acute scarcities in others. The purely fiscal and monetary measures on which current full employment policies rely are, however, by themselves indiscriminate in their effects on the different parts of the economic system. The same monetary pressure which in some parts of the system might merely reduce unemployment will in others produce definite inflationary effects. If not checked by other measures, such monetary pressure might well set up an inflationary spiral of prices and wages long before unemployment has disappeared, and—with present nation wide wage bargaining—the rise of wages may threaten the results of the full employment policy even before it has been achieved.

"As is regularly the case in such circumstances, the governments will then find themselves forced to take measures to counteract the effects of their own policy. The effects of the inflation have to be contained or 'repressed' by direct controls of prices and of quantities produced and sold: the rise of prices has to be prevented by imposing maximum prices and the resulting scarcities must be met by a system of rationing, priorities and allocations.

"The manner in which inflation leads a government into a system of overall controls and central planning is by now too well known to need elaboration. It is usually a particularly pernicious kind of planning, because not thought out beforehand but applied piecemeal as the unwelcome results of inflation manifest themselves. A government which uses inflation as an instrument of policy but wants it to produce only the desired effects is soon driven to control ever increasing parts of the economy." - Friedrich August von Hayek: Studies in Philosophy, Politics and Economics, pp. 270–76

Apologies for the long quote but I felt it necessary. Back to the theme of this post, the horrible economic (or lack of) analysis provided by the Australian media (it's expected from the OECD), I think I'm going to have to create some kind of award for the worst piece of Australian economic/political journalism, perhaps on a monthly basis, just to highlight how completely oblivious they are on the entire subject. They, well the majority, just blindly regurgitate what the 'experts' tell them without a second thought. Did no one teach these people how to think?

Just one final word on the Hayek quote, mainly the final part about the government being "...driven to control ever increasing parts of the economy." This is something we're seeing in the US as well as here, governments get involved in the first place and then blam the market for problems caused by that very involvement, such as: creating a telecommunication monopoly, turning it into a quasi-private monopoly then blaming the market for it; maintaining a quasi-private health market which drives up the costs for everyone; inflating the money supply causing a financial crisis (and later inflation); and so on. What's the governments response to all of these government-created problems? More government, more regulation and more control. That simply equates to less individual freedom, higher prices and shortages/restrictions of some kind.

We need reform, but not the kind our politicians are currently undertaking. In fact, if you took everything Rudd and his legion of do-gooders have done since coming to office, doing the polar opposite wouldn't have been such a bad policy response.

Every high school or university student who studies economics and even the average layman who reads or listens to the media and the politicians is of the belief that inflation is a price phenomenon. They’re told that higher inflation and, consequently, higher interest rates are the result of higher prices – a nice little semantic trick, a renaming of terms which leads people to believe exactly what the government wants them to.

The “official” definition of inflation is akin to putting the carriage in front of the horse: a general increase in the price level occurs because of inflation, not the other way around. Prices don’t just rise for no reason; they rise because of unforeseen events (e.g. a natural disaster or drought causing a supply shortage or government regulation/price controls) or through the debasement of the currency – otherwise known as monetary inflation.

What I want to know is why so many smart people never ask the question: where do higher prices come from? To put it more succinctly, how is it that, with technology and productivity improving on a daily basis, prices go up rather than down?

The answer is in fact quite simple: prices rise year after year because the government (through their agency the Reserve Bank) increases the quantity of money in circulation. Let’s have a quick look at the data and see how much the money supply (M3) has increased since 1982 relative to Total Average Weekly Wages and the Price Level.

Quite staggering indeed. Over almost thirty years the government has increased the money supply by a whopping 1,363%. Wages, on the other hand, have only increased by 276% - but does that mean we’re 276% wealthier today than in 1982? Hardly. If you take a look at the increase in prices, they’ve risen by 193%. Yes, we are all wealthier today than we were in 1982, 78% wealthier in fact [1], and I should hope so too!

The issue I have is the endless improvements in technology and productivity are not being transferred entirely to the consumer, to the average Australian. The government, through the constant debasement of the dollar, takes a large percentage of the said gains for their excessive existence, wasteful ventures and to fund the welfare nanny state. This is effectively a hidden tax on everyone who is paid in Australian Dollars.

Not only that, but there are countless other problems caused by debasing the money supply aside from just theft, it: encourages malinvestment by suppressing interest rates and thus unemployment and wasted resources; keeps the poor poor (more on that in a bit); creates dependency on the state by eroding savings; encourages improvidence; and many, many more, including the eventual collapse of the monetary system itself (e.g. Germany, Zimbabwe). As Ludwig von Mises said,

“With regard to these endeavours we must emphasize three points. First: Inflationary or expansionist policy must result in overconsumption on the one hand and in mal-investment on the other. It thus squanders capital and impairs the future state of want-satisfaction. Second: The inflationary process does not remove the necessity of adjusting production and reallocating resources. It merely postpones it and thereby makes it more troublesome. Third: Inflation cannot be employed as a permanent policy because it must, when continued, finally result in a breakdown of the monetary system.”

So how do they do it? When the Reserve Bank increases reserves the new money has to flow somewhere. That ‘new money’ usually enters through the financial services industry through favourable credit conditions allowing them to lend to households, or invest on the stock market, real estate, and so on. If that doesn’t work, the government can always increase its deficit and oblige banks to monetise government debt (like they just did). The increased spending through “stimulus” and “infrastructure investment” enables the newly created money stock to enter the economy and therefore drive up prices [2].

As the first recipients of the new money, the banks and government are still buying at ‘normal’ prices – prices that haven’t yet adjusted to account for the recent increase in supply. This is how they secretly tax anyone earning or holding Australian Dollars – the increase in prices caused by the new money filters its way through the economy and the people who receive wage increases last – usually the poor – are the ones who are taxed the most. The financial sector, as early recipients – and usually the rich – benefits the most (after the government).

“To cover the fact that a central bank is merely a cartel which has been legalized, its proponents had to lay down a thick smoke screen of technical jargon focusing always on how it would supposedly benefit commerce, the public, and the nation... there was not the slightest glimmer that underneath it all, was a master plan which was designed from top to bottom to serve private interests at the expense of the public... the system is merely a cartel with a government facade,” G. Edward Griffin

Next time you hear a politician spouting off about how they’ll “fight inflation”, remember that they’re the ones who are causing it. All they would have to do if they honestly cared about lower prices and helping the 'battlers' would be to stop creating money, to cease deficit spending and to return to sound money. Unfortunately most, if not all politicians in Australia, don’t actually care about the 'battlers' so long as their own taxpayer-funded trough is kept full. So what’s the solution going forward? There are lots of ideas out there, from a return to a gold standard to free banking (i.e. banks being allowed to issue their own currencies) among others – but at the end of day the only thing that really matters is that ability to manipulate the money supply is taken away from the government as soon as possible.

“A private central bank issuing the public currency is a greater menace to the liberties of the people than a standing army...We must not let our rulers load us with perpetual debt,” Thomas Jefferson

We can always dream.

[1] Issues with the wage and CPI data aside (e.g. average wage may be higher but there may also be more unemployment. Likewise the CPI excludes a lot of 'everyday' items that may have risen significantly more than the figure suggests).

[2] There are other ways too – e.g. the Reserve Bank could always simply buy up assets for itself.

The latest ongoing debate amongst our political nomenklatura is about the $14 billion hard-earned tax dollars that are being spent on knocking down and rebuilding school buildings. When you consider that fourty-two percent (yes, 42%) of Australian families either don’t pay tax or receive more in government benefits than they pay in tax, this amounts to a significant ‘investment’ in education – but is it actually going to provide any long-term benefit for Australia or is it simply yet another example of the broken window fallacy [see Bastiat or Hazlitt], in other words a colossal waste of resources?

I’ll spare you the banter that’s being thrown around in parliament (a brief summary: Labor is defending the spending, saying it will “…modernise school facilities and support jobs in the local community,” and that it represents “…value for money;” the Liberals are calling it “wasteful and reckless spending.”) and instead focus purely on the numbers and whether or not it will ‘stimulate’ the economy – which was, after all, the whole point of it.

Fourteen billion dollars ($14,000,000,000) equates to almost $1,800 for every tax-paying Australian (assuming only 8million people pay tax). Now that’s a significant amount of money those taxpayers no longer have to spend or save – in other words, our omnipotent government has decided that they know how to spend the money better than you, the person who earned it. Whereas the taxpayer earns their income by satisfying the infinite and ever changing wants and needs of the consumer (whether as an entrepreneur or employee of an organisation that does), the government is under no such obligation. They’re not bound by profit or loss; indeed, on the contrary, all they care about are the various interest groups to whom they sold their souls to move up the political ranks.

The stimulus spending on education will not help our economy one iota. Yes, it will create, or rather maintain jobs in the building and construction industry. But at what cost? Going back, what about the $1,800 that taxpayers no longer have to spend or save? Lets assume this money was saved in a bank – that money would added to the national pool of savings which, due to supply and demand (and the subsequent reduction in the interest rate), would lower the cost of borrowing for businesses who would then been able to expand (invest) and spend on ‘productive’ consumption – that is, consumption that will enable future production and increase the total productivity and wealth of the nation. Not only that but it would create jobs in the process; jobs allocated by the market rather than through bureaucratic whims. The difference? One is sustainable while the other can only continue for as long as the stimulus does.

To answer my initial question, will the ‘stimulus’ of knocking down and rebuilding schools help the economy? Will it enable an increase in future production? Will promoting malinvestment and creating jobs in areas where they’re simply not needed achieve anything other than furthering political careers by gaining support from certain unions and interest groups? Unfortunately, no.

“Experience shows that nothing is operated with less economy and with more waste of labour and material of every kind than public services and undertakings. Private enterprise on the other hand naturally induces the owner to work with the greatest economy in his own interest,” Ludwig von Mises

Aside from boosting GDP statistics in the short term, the only thing that will be achieved by this stimulus (aside from shiny new school buildings for the kids of course) is a delay in the necessary reallocation of scarce resources from areas of malinvestment to areas where they’re most urgently needed. The reckless spending embarked on by this government is incredibly short-sighted and there is no doubt that in the process they have lowered the standard of living for all future Australians.

I'm back! Before I get settled back in I'd just like draw attention to an interesting journal article by Paul H. Rubin on Folk Economics, where he demonstrates that people aren't "programmed" to understand economics; instead, it's something that must be learned. This is in line with other studies I've read on gender differences in economics (which states that men have a better, on average, understanding of economics because they associate with people who have studied it within their social networks - in other words, they tend to be more exposed to it) and so on. All seem to conclude that it's exposure rather than "natural ability"; it's reading and study that dictate how proficient one is at economics (of course there are exceptions!). As I've mentioned earlier, getting people to take the "second step" in logic - to see beyond the immediate consequences of an action - can be quite the task!

Anyway, here's the abstract:

Folk economics is the intuitive economics of untrained persons. It is concerned with distribution, and does not allow for or understand incentives. Folk economic notions evolved in our ancestors in circumstances where there was little in the way of specialization, division of labor, capital investment, or economic growth. It can explain the beliefs of naive individuals regarding matters such as international trade, labor economics, law and economics, and industrial organization. It is important that voters understand economic principles. Economists would do a better job of persuading others and of teaching if we paid explicit attention to folk economics. Because untrained individuals do not fully understand gains from trade, training in economics is likely to improve welfare by increasing the number of trading opportunities. There is evidence that this is in fact true.

Go and have a read - it's only twenty odd pages. I'll get back to criticising the latest government "initiatives" in the next few days, not like it's difficult!

To the people of Australia,

I would like to clearly state, with no ambiguity, for the record, that Australia is in the mother of all housing bubbles.  That this housing bubble has indebted millions of Australians, financed an unprecedented level of credit-driven consumer spending that is the basis of our economy.  To add salt to the wound, we have borrowed extensively from every well-spring of credit we could find (i.e. credit cards, personal loans) without adding to our industrial capacity... we have gone spending crazy with other people's money.

How do I know there's a housing bubble?  I draw your attention to the following exhibits:

1)  100 year inflation-adjusted house prices (American and Australian).  As you can see, our housing bubble is worse than America's, which has famously burst... we're just running a little late.

2)  There is NO housing shortage

This one is the popular one I keep on hearing.. that we have a 70000-80000 shortage of homes across Australia.  So if this number were correct, the shortage would be more evident in some States compared to others.  However, the key word in my last sentence was 'if'... turns out, we don't have a housing shortage.  Did anyone every ask, 'Hey, where did that number come from?'... well, thanks to the fine people at http://www.dailyreckoning.com.au we now know.

It turns out that there was a report that fabricated this number (government fabricated, what a surprise).  Here's the bottom line, and I'll quote:

"The Council estimates that a minimum of around 85,000 dwellings is the gap (unmet need) in the supply of housing in 2008. This is based on the incidence of homelessness and the low level of vacancy rates in the private rental market."

I'll give you a moment to digest that statement... yes, the number that were using to fraudulently convince people that there will be a market for mortgages in the future is based on the number of homeless people there are in Australia.  I don't know about you, and no disrespect intended, but how many homeless people do you know are contemplating buying a house within the next year or so?  In case, like me, you were wondering how much of the homeless contribute to these numbers, here's the breakdown from the report:

"Dwellings required to address homelessness - sleeping rough = 9,000

Dwellings required to address homelessness - staying with friends and relatives = 35,000

Dwellings required to house marginal residents of caravan parks = 13,000

Dwellings required to increase rental vacancy rate to 3% = 26,000"

The funny part for me is the vacancy rate... it's just hilarious in light of this statement that the report makes:

"The Council estimates that a minimum of around 85,000 dwellings is the gap (unmet need) in the supply of housing in 2008. This is based on the incidence of homelessness and the low level of vacancy rates in the private rental market.  The Council acknowledges the crudeness of this estimate and also points out that there were some 830,000 vacant dwellings in Australia at the time of the 2006 Census."

So yeah guys, those numbers are bogus, they're fiction... if anything, we have an oversupply of homes.  This report came out in 2008 btw.

3)  Some experience from the boys on the real estate field.

I have a friend who works in real estate, and I'll quote his comments to me:

"I am in the industry and this is happening. The situation for most buyers right now is - 1) buyers are stretching themselves financially, 2) purchasing over priced properties, 3) think just because the interest rates are at record lows, they can afford their homes. Whats going to happen, once the Reserve bank increase rates or the banks themselves increase rates by .25% a lot of people will find it difficult to pay back. THEN they will want to sell to clear the home loans which they can't because house prices will have fallen by then or atleast the buyer activity will be lower and thus people selling will either have to hang in there & wait for a sale or go under. I'm seeing people now, who need to sell but they need $50,000 more than what the home is worth because they have to pay exit fees on fixed loans, agents commissions ($400k sales price is approx $11,000 commission) plus paying back the house loan. Banks aren't exactly giong to have a loan with no security... I believe buyers are being tricked into buying a home by the increased FHOG. They aren't researching the market at all. The truth is even if a buyer takes the $14,000 or $21,000 off the purchase price of their home, they'll still be paying too much. Buying a home is what most people are told to do, it's the Aussie thing to do! "Invest in bricks and mortar and you cant go wrong"<---- THAT'S OBVIOUSLY NOT TRUE. All the 1st home buyers I'm speaking to currently, all want to purchase before the end of September to "take advantage" of the FHOG.

I want to be clear here for the record, as I stated, that this housing bubble is going to unwind our economy and we are going to enter probably the worst recession in our history (maybe worse that the 1930s).  How did this happen, bottom line blame:

1.  The government

2.  Reserve bank (big one)

3.  Us, we should have known better.

How this will all happen and why it will be so severe will be elaborated in future posts.

God bless,

Dr Washo