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Commodities tumbling

Now down more than a quarter since the peak of  June 2010.

Not good news for Australia and increases the likelihood of a further rate cut in the coming few months.

In brighter news, our manufacturing index picked up sharply today.

Graph: RBA Index of Commodity Prices


Productivity crisis... the Blogging sector.

All been a bit light on blogs this week, I'm aware.

In my defence, I'm on a tropical south-east Asian island with a large coral reef, so there are better things to be doing than droning on about share prices and the like.

Fear not, though, as I'm flying out tomorrow and will return afresh with a barrage of new content in due course.

Aussie dollar has staged something of a fightback while I've been out snorkelling, helped no doubt by the better-than expected jobs data - back above 96 cents, though we'll see for how long.

Better day ahead for stocks (overdue!) and...surprise, surprise, property values are 'moving up' again.

I'm not sure they were ever going down really...just the index correcting itself after overcooking the gains in Q1. Sydney and Perth markets looking very strong indeed at the moment.


Homebuyer confidence at its highest level for 6 years

Genworth released its Homebuyer confidence index for July, showing the gauge at its highest level for 6 years.

The index increased by more than 7% from 93.4 to 100.1

The main driver of the increase was the state of New South Wales, although in fact confidence increased across every state.

Given how the index is measured, the combination of increasing prices and lower interest rates mean that it is unsurprising to see the gauge moving up strongly.

Source: Residex

Meanwhile, Residex reports that Sydney's property market is at its strongest in 20 years, with house prices increasing by 7.37% over the past 12 months.

Residex CEO John Edwards noted the auction clearance rates moving above 80% as another indicator of the strength of Sydney's property markets.


Banks rally


Source: ASX


Mortgages for 4.69%?

HSBC has dropped its fixed rate home loans as follows:

2 year fixed - 4.69%
3 year fixed - 4.79%
5 year fixed -  5.09%

The major Aussie banks are also offering very low fixed rates now as the competition for market share hots up.

Shares finally seeing a brighter trade up ~1.60% so far, with they bank stocks rebounding...


Stocks keep on

A little knock for the bank stocks today due to talk of a proposed deposit insurance levy.

Still, it's been quite  a past month for the Aussie stock market, with valuations gaining around 5%.

Source: ASX


Sydney 81.4% auction clearance rate

Solid enough result for Melbourne today, recording a 69% auction clearance rate according to APM (REIV recorded 70% from their sample).

That's just about par for the course for the softer winter months.

On the other hand, the Sydney market is absolutely flying recording another very high clearance rate of 81.4% per APM.

The median sale price on the day was more than $800,000. 

With properties selling so quickly in Sydney, prices will very likely continue to rise to new heights in the coming months.


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Property Update: Lessons from the UK crisis

I write for Property Update today on the topic of the UK housing crisis.

You can read the article here.


The accelerating Australian population boom

It's a bit of a mystery to me why people are so keen to try to dismiss population growth as a key factor which underpins our major capital city property markets.

I mean, just take a look at today's numbers from the ABS:

Source: ABS

In the year to December 2012, the population of Australia increased by 394,200 people or 1.8%, which is way ahead of the long-term average of 1.4%.

Of course, population growth does not occur smoothly across the states. 

In some states such as South Australia (+15,600), ACT (+8,600), Northern Territory (+4,200) and Tasmania (+400), the absolute growth numbers continue to be quite small. I don't expect that to change too much.

On the other hand, take a look at what is happening in the states which house the major capital cities.

The population of WA is absolutely booming by 3.5% in the year to December 2012 or 83,000 people, so it's little wonder that the Perth property market is flying.

And in Queensland (+92,500), Victoria (+99,500) and New South Wales (+90,400) the population growth continues apace.

People continue to head largely to the capital cities, and so it's little coincidence that over the past 12 months prices in Sydney (+4.61%) and Perth are smoking along (+7.8%). Growth in Melbourne has been a little more subdued (+2.12%) but then, why wouldn't it be? Melbourne has, after all, experienced a quite phenomenal boom in prices since 2007.

It's small wonder that we struggle to keep up with accommodation and infrastructure needs with population growth figures such as these reported today.


Return of the Urn 2013? Poms 1 Green caps 0

Unbelievable stuff in the first Ashes Test in Nottingham, with England squeezing home by only 14 runs.

Australia are now $4.50 to win the series if anyone is feeling brave...

Can't wait for the 2nd Test at Lords!


Gold capitulation continues

A big bounce for Aussie stocks today up around more than 1.6% following positive US economic data.

But gold shed another 3.3% to just $1,228/oz. 

In the second half of 2011, prices had stormed up to $1,900/oz but this year alone the precious metal has lost a quarter of its value.

Source: kitco


The nature of growth

Greetings from bright but rather brisk England where I've been hanging out for the past week. Busy as ever, I've been taking in a bit of culture, being the history buff that I am. 

In the last week, I've visited the ruins of the 6th century fort of Bolingbroke Castle, which was once one of the most important sites in Britain, being the birthplace of Henry IV. Today, it's essentially a mound of earth and a pile of stones in the countryside, but tremendously interesting nonetheless!

This morning I also visited the magnificent Kings College in Cambridge which was founded by Henry VI in 1441, and the restoration of which - a bit like the unending painting of the Sydney Harbour Bridge - seems to be an ongoing, 365-day-a-year job.

And, just in case all that wasn't tiring enough, I've also been spending some time with my three nieces.

Not having children of my own, I forget just how darned noisy and energetic kids can be, and I'm also amazed at how they seemingly eat round the clock: breakfast at 7am, sausage sandwiches by 9am, morning snacks by 10.30..."Well, they're growing kids, y'know..." - and it's true enough, they definitely are growing!

Physical growth and price appreciation

So, what have I missed in the world of Aussie real estate this week? Prices are on the move in some cities, it seems, with data provider indices showing some "growth".

A couple of commentators have again highlighted the risks inherent in mining towns, noting the possibility of land being released. I wholeheartedly agree with this assessment, although I note that this risk extends to many regional towns in general: land being available for release introduces a risk of very weak real long-term price appreciation.

Over here in the chilly south-east of England, it's very noticeable how so many former greenfield sites have been developed on the fringes of provincial towns and the smaller satellite cities in recent years. New property developments are sprouting up all over the place in fringe suburbs, with the UK Government and Bank of England pushing things along with its 'Help to Buy' scheme and ZIRP respectively.

While UK median prices have shown a very moderate uptick (this can happen when new builds come online), in many areas outside London the prices of existing properties remain way below where they were in 2007.

Remember that the physical growth of a town or city does not necessarily equate to price growth in existing properties, and this is especially the case where new land is being released.

In London, the dynamic is markedly different. Not only is there a massive, growing population and almost no prime land available for release, investors from Britain and overseas who were spooked by share market crashes during and after the financial crisis are simply throwing money at the property market, pushing prices up to unheard of levels, way ahead of their previous peaks.

"Room to grow"?

Some commentators say that investors should buy in the cheapest quartile of the market where properties have "more room to grow". 

But properties do not "grow", unless of course you are investing in building them to make them bigger. No. Instead, properties, just, well...kind of sit there.

Plants grow. Trees grow (though, as the saying goes, trees don't grow to the sky). My nieces grow. 

But properties do not grow.

And besides, why on earth should each successive generation pay more for property than its immediate predecessor? Particularly now that the deregulation of lending standards and products is well in the past and interest rates have fallen to as close to the 'zero bound' as they hopefully ever will be in Australia. 

If you want investments to grow - like my nieces - they need to be fed. You need to re-invest in them.

If you want a term deposit to grow, re-invest the interest.

How do companies grow? Because companies tend to only pay out a small portion of their net earnings as dividends and they retain sufficient capital to re-invest in the business. 

This is why value investors and Buffett-types seek businesses with strong and growing owner earnings (reported earnings with depreciation and amortisation added back, less capital expenditure for plant and equipment) - they want companies which can be self-perpetuating and are able to re-invest in their own futures.

If you want to grow your own share portfolio, re-invest your dividends via a dividend re-investment plan (DRP).

But, I'm afraid to say, properties do not "grow", especially if you take the approach recommended by some pundits of not maintaining properties to a reasonable standard.

In fact, if you don't re-invest in a property regularly through paying for repairs and maintenance (as the chaps do at Kings College in Cambridge nigh on continually) then eventually the property will fall down and you will be left with a pile of rubble and some earth (such as exists at Bolingbroke Castle in rural Lincolnshire).

Price growth

It's common to talk of "market value" or "intrinsic value" in the world of real estate. 

But what is market value? It's really only what another individual or entity will pay for the title at a given point in time.

Imputed rents don't make for a great measure of 'fair value' in residential property for they take little account of the emotional factors impacting homebuyers. In property, price is perhaps a far more appropriate word to use than value.

All things being equal, the price of a property should only move in line with inflation: as the currency becomes gradually worth less over time, the price of property should slowly tick up accordingly, but no faster than inflation.

A property in strong demand might potentially move rather in tandem with the growth in household incomes over time, with the effective speed limit for price growth being the ability of the populace to service mortgage repayments.

So how does an investor source price growth which outperforms inflation over the long term? Ultimately, unless you are a skilled renovator (and, let's face it, most property investors definitely aren't) there's only one way that it is possible to do this, by finding a property which:

(1) is in an area with a strongly increasing population, with real wages appreciation and booming demand;

(2) is in an area where there is little or no land available for development or release and thus supply does not keep pace; and

(3) where investors are pushing up prices through seeking returns on their capital.

This discounts most regional markets and fringe suburbs where land is available for release, demand is very low and price-to-income ratios remain subdued.

The markets which are fitting the criteria for price growth at present are Perth, Sydney and Darwin and prices are increasing accordingly.

Investors tend to prefer capital cities and the combination of land-locked suburbs and growing populations tend to be a happy one for investors and an unhappy one for homebuyers, pushing the price of the prime-location land ever higher. 


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Prices set to soar as dollar falls to 33 month low

Inflation in the pipeline as the dollar falls, reports SMH here:

The days of cheap overseas travel and attractive online prices are over, leading economists say. With the Australian dollar falling to a 33-month low on Thursday, travel and online retail prices are expected to soar immediately.

Petrol, whitegoods and electronic equipment prices are expected to rise by up to 10 per cent.
Mr Harvey said if the dollar dropped below 80 cents compared with the US dollar, consumers should expect a 25 per cent increase 
"Anything in a foreign price will go up straight away," AMP Capital's chief economist Shane Oliver said. "It's the same with online suppliers. That price, when translated, will be higher than it was six week ago."

Also, expect travel costs to increase.


How are futures markets seeing the interest rate decision?

Fairly conclusive then, with the chances of rate cut to 2.50% being 100% priced in.

Does that mean that there is 0% of chance of interest rates staying on hold? 

Not quite. 

August 2013 cash rate futures contracts are trading at 97.455, so what it essentially means is that a 50bps  (0.50%) cut to 2.25% is considered to be as likely as rates staying on hold at 2.75%.

On balance, therefore, a 25bps (0.25%) cut to a record low of 2.50% cut is the red hot favourite outcome today.


UK housing market +3.7% and ready for lift-off

Flicking through The Times this morning, and there are no fewer than six separate articles discussing Britain's housing market recovery.

The Halifax House Price index shows that prices nationwide are up over the past year (+3.7%).

While prices in some parts of south-eastern cities such as London and Cambridge never really stumbled, many other parts of Britain have endured a 5 year slump.

The UK's FTSE share market also jumped by 3% yesterday after the Bank of England's new Governor Mark Carney "went to extraordinary lengths to convince markets that monetary policy will remain loose."

The Bank has left UK interest rates at a rock bottom 0.5%, but markets had begun to price in rate rises in 2015.


Property Update: are low interest rates working?

I write for Property Update here on whether monetary policy is being effective.

Since I wrote this we've had weaker retail trade figures and a 4 year low in business confidence reported by the NAB survey - there's another interest rate cut in the pipeline.

In brighter news, US stocks are up for a fourth day in a row on earnings optimism, the Dow passing 15,300.


Rio hits record iron ore production

Rio Tinto (RIO) released its second quarter operations review showing sizeable y/y increases in production and shipments of iron ore, as well as material increases in copper, aluminium, thermal coal and titanium dioxide production.

If you've been up to the Pilbara in recent times, you'll already know what a spectacular sight the operations up there represent. From the ASX release:

"-Record first half iron ore production, shipments and rail volumes despite a conveyor belt 
breakage resulting in one of five ship loaders being side-lined for almost three weeks and 
unseasonal wet weather which led to flooding in the Pilbara. 

-Expansion of Pilbara capacity to 290 million tonnes per year remains on budget and on time to 
deliver first tonnes by the end of the third quarter of this year. Delivery of first tonnes will be 
followed by a steady commissioning and ramp-up period. Completion of the Rail Capacity 
Expansion infrastructure project was the most recent milestone reached in the quarter."

Some have pointed out that this is not all beneficial to Australia as our major resources companies are 100% not Australian-owned.

This is true: Rio has a very complex group structure being a dual-listed group with a maze of subsidiaries, and ownership is spread widely around the world - as indeed are its ~70,000 global employees.

A glance at Rio's segmental reporting disclosures in its most recent annual report shows that a large chunk of the group's gross revenue is from iron ore production, with a sizeable percentage being shipped to China.

The Australian-based employees will benefit from the group's massive wealth (the group has a global market capitalisation of well over $100 billion) and of course Australia will benefit from mineral royalties, which is good news for the state of WA.

Such major projects also create employment and revenues for mining services companies, so the increasing levels of production can have a knock-on effect.

And this, naturally, is what Australia wants to happen through the second phase of its mining boom.

Meanwhile, Rio will hope that the iron ore price stays as high as it is today at above US $125/tonne.


Dow futures rise as economy adds 195,000 workers

US payrolls up for a second straight month +195,000 workers beating market expectations of +165,000.

The US unemployment rate is 7.6%, so there is still plenty to do, but this is a stark improvement on the 9%+ levels of two years ago.

"Not a booming report, but a satisfactory report" as the US recovery continues...


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Gold miners slammed

There has been a reasonable bounce in the gold price in recent weeks, but much of the pain has already been felt by the gold miners.

Share prices had been pumped up across the sector as forward earnings estimates were modelled based upon a continuing high gold spot price, but as institutional investors pulled funds out of the sector the gold price collapsed.

And while ever-bullish brokers had rated a swathe of Australian miners as 'buy' recommendations based upon a copper price of around US$5.00/lb, nervous global sentiment has failed to see this happy position materialise with the copper spot languishing at a decidedly pessimistic ~US$3.10/lb.

US gold miner Newmont has been forced to take a large write-down totalling US $1.5 billion as well as laying off staff.

Gold and copper miner Newcrest Mining (ASX: NCM) has already been hit with impairment write-offs totalling a whopping A$6 billion and has a correspondingly ugly share price chart, the company having lost almost three-quarters of its market capitalisation in the past 2 years.

Similar pain was felt by Goldcorp, who booked a $2 billion write-down after recording losses highlighting potential impairments.

This highlights the potential volatility of companies which are exposed heavily to one metric such as a commodity price or an exchange rate.

While larger mining companies hedge forward their revenue streams, lower commodity prices will ultimately be reflected in the bottom line and lower earnings.

As mining companies deplete their resources over time, they tend to retain capital for thepruposes of re-investment, rather than distributing strong dividends back to shareholders.

This makes it especially important to be wary of buying resources stocks when they are trading at high price-earnings multiples based upon unpredictable commodity price forecasts.

Source; ASX


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SQM's Louis Christopher on the Aussie housing market

Interesting video on Switzer TV here featuring Louis Christopher of SQM, who tends to talk a lot of sense.

He notes that the Sydney market is very strong with stock levels plummeting (by more than 23% y/y), and this is being reflecting in housing data, with the Sydney market easily breaking new highs and rising. 

Price growth in Sydney has shown no real signs of slowing to date.

Perth has been on a great run thanks to the mining boom, but the housing market could begin to slow as the mining construction boom passes its peak, notes Christopher.

Christopher also believes that the Adelaide is likely to remain soft due to plenty of supply. 

Plenty have been tipping Adelaide as a hot market for many years now but price growth has been weak and dwelling values remain around 4-5% below their previous peaks. 

Quality investments in Melbourne would have represented an infinitely better selection since 2008 with prices booming dramatically. And, for that matter so would Sydney.

Unsurprisingly, the Melbourne market has calmed down since its meteoric rise, though inner- and middle-ring  suburbs seem to have remained robust enough.

Dwelling Prices graph


Property Observer: most read articles

My piece on the Aussie housing bubble is the most read article on Property Observer.

Take a read here.


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Sydney dwelling prices +2.7% in June

The month draws to a close and RP Data's index shows that Sydney dwelling prices are up more than 2.7% in the month of June alone, increasing substantially from $649,000 to more than $667,000.

While I'm not a fan on monthly figures due to their inherent volatility, this should at least put an end to the flawed discussions of prices falling (or more properties being sold into a falling market) - they aren't.

While futures markets have priced in a one-in-five chance of an interest rate cut on Tuesday, particularly in light of the below figures, interest rates must surely be kept on hold in July. 

The futures yield curve still expects interest rates to hit 2.50% by October 2013, but any signals of rapid dwelling price appreciation certainly won't encourage further cuts.

The next round of inflation data for the June quarter will be released on 24 July which will play a key role in determining future interest rate movements.

Over the past 12 months all of the main capital cities except for Adelaide have demonstrated capital growth, with Sydney (+5.6%) and Perth (+6.0%) leading the way.

The 5 city capital aggregate has consequently increased (+3.9%) over the period.

Source: RP Data


Aussie dollar to fall to 75 cents?

From SMH:

"More bears have joined the downgrading party against the dollar, with a major investment bank expecting the currency to fall to US75¢ in 12 months as enthusiasm for what was once dubbed the ''Goldilocks economy'' grows cold.

While the dollar has fallen more than 13 per cent against its US counterpart since mid-April, Credit Suisse analysts said on Thursday they expected it to slip further to US87¢, a level it has not seen since July 2010.

The analysts forecast the dollar to drop to US75¢ in 12 months. 

''Our feeling remains that either the dollar will continue to fall naturally or the RBA will need to give it another push with a further interest rate cut,'' Credit Suisse said."

Markets are pricing in a 47% chance of an interest rate cut on August 6 - those odds look too low to me at this distance.


In forecasting news of a different kind, the long range weather forecast for England for the remainder of the month is for hot weather, which bodes well with Britain's Andy Murray in to the final four at Wimbledon and the Ashes cricket starting next week.

It's a sticky 24 degrees here today - and a lot warmer than that sounds!


Bloomie survey sees unemployment 5.6%; housing finance jump

The latest Bloomberg survey expects unemployment of 5.6% next week, up a tick from 5.5% in May with only a tiny increase in jobs forecast.

Over the past year, jobs growth has been all about New South Wales, which has been reflected in a surging housing market in that state.

Employed persons
Graph: Employed Persons

Unemployment rate
Graph: Unemployment Rate

Source: ABS

The survey also expects housing finance to jump by much positivity around the housing markets at the moment.

Meanwhile, what's happening in auctions?

Mebourne recorded a 71% clearance rate today (last week revised to 70%) from 317 reported auctions, a level which should be regarded as 'solid enough'.

In Sydney, auction rates continue to perform very strongly with a scorching 78% clearance rate last weekend.

The hot sector of the market remains the inner west with some 67 auctions today.

Hopes of a correction in Sydney have been dashed.

Dwelling prices in the city are now up by more than 8% since their lowest point of just over one year ago.

As there tends to be a time lag in the data, strong auction clearance rates such as are still being recorded suggest that Sydney's price gains still have some way to run yet. 

After that, investor attention should probably turn to Brisbane.

More experienced heads such as Michael Matusik suggest that housing recoveries tend to "head north" in Australia. 

And Brisbane is overdue for a better run, particularly for those who buy the in-demand property types and in the right locations.


Great stuff at Wimbledon yesterday, teeing up a thriller of a final between Britain's Andy Murray and Novak Djokovic on Sunday. Lions vs. Wallabies kicking off in less than one hour's time...


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Gold-mining company Newcrest sank as low as $9.96 in the trade, having been pole-axed from above $40 in 2011.

A complete mess - business reviews, project withdrawals...bottom-picking when the share price halved turned out to be a very poor strategy.

Wonder what Jordan Wirsz is thinking today after he advised buying gold at US$1,729/oz as well as tipping a 60% crash in Australian property prices (they went up)?

Very ordinary.

Source: ASX


Spillard (again) ends in Kevenge

So, Labor has another leadership spill (again) and Australia will get another Prime Minister (again).

Well, kind of, we'll be reverting back to Kevin Rudd (again), for now at least.

It's all a bit deja vu.

This is only a politics blog to the extent that politics impacts the economy, and I think that, regardless of whether the Coalition or Labor get voted back in in the coming few months, it will be a challenging period ahead.

I doubt there will be many immediate game-changing shifts in economic policy. 

Both parties have pledged to steer clear of reform on the negative gearing tax rules, for example. Will we see any major shifts on the Carbon Tax or the MRRT? 

Whether or not Rudd returning the favour on Julia Gillard by stabbing her in the back will be enough to save Labor in the forthcoming election is highly doubtful.

The bookies certainly don't seem to think so with Labor priced at odds of $5.00 as compared to Abbott's Coalition quoted at $1.15.

It's all very well changing leaders on the basis that politics is "about personality", but is Australia really going to re-elect a party which can/t seem to get its own house in order?

It was only a matter of three months ago that after Rudd's most recent failure to challenge for the leadership that he said he "was a man of his word" and he would "never" partake in a leadership spill.

Sure, we have short memories but not that short.

Rudd's election campaign will doubtless be run along the lines of portraying Labor as the "proven" or known quantity which has steered Australia away from recession through a challenging period. Abbott will be portrayed as the "risky unknown quantity" (not without some reason, it must be said).

In Rudd's own words, talking of Labor's tiresome leadership squabbles and internal wranglings: "All this now has to stop".

Well, yep, I guess it will - in two or three months when the whole debacle will finally be ended by an election and a leadership contest which we're actually allowed to vote in.


Too easy a win for Queensland in Origin II at Suncorp stadium - sends the Aussie dollar back up to 92.9 cents...



US unemployment falls from 7.6% to 7.4%

The US economy added 162,000 workers in July as unemployment continue its downward trend of the last couple of years from 7.6% to 7.4%.

It had been hoped that the payrolls data would show more jobs added, but the drop in the unemployment rate was nevertheless welcome.

Some people are trying to down play the progress made by the US, terming it a 'bubblecovery'.

No. It's a steady recovery.

Source: Bureau of Labor Statistics


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Could one of Australia's main lenders fail? (and what would happen if they did?)

The Big Four

Australia's four major banks were named this week as being the most profitable in the whole world...for the third year in a row! Big bank profits appear likely to come it at well in excess of a combined $25 billion, and probably some way higher than that.

Why? It's partly because the Australian banks have wider interest margins than most, and lower equivalent costs. 

It's also because of a lack of competition worthy of the name. After a number of smaller lenders went to the wall during the global financial crisis, the 'big four' banks (Commonwealth, Westpac, ANZ, National Australia Bank) control a massive 83% of the mortgage market in Australia. 

Last year, as cuts in the cash rate were relentlessly delivered by the Reserve Bank of Australia (RBA), the major lenders consistently failed to pass on the full cuts to borrowers citing 'higher funding costs". It's laughable really, given the profits which will now again be reported, but the truth is that the banks get away with it because of the "feeble competition". It's an oligopoly.

Sure, there's talk of introducing more competition, and perhaps Macquarie will step in to become a fifth major player, but it all feels rather half-hearted given the monstrous profits which have once again been generated.

Some are more equal than others

Under Corporations Law, you might be forgiving for thinking that all companies are created equal. In theory, maybe businesses are in many ways equal, but in reality some are far more equal than others. If a retail company becomes insolvent and goes under it would be sad news for the owners and the employees, but the sun would likely come up tomorrow and the world would continue as before. 

There are some industries which the government might elect to support, such as car manufacturing. And then there are some businesses without who out entire financial system would implode: namely, the banks.

Without the banks to transfer money between borrowers and lenders, for want of a better word, we'd be well and truly stuffed. How would we even survive on a day-to-day basis with no cash cards, credit cards,  internet banking, ATMs? Undeveloped countries manage to run cash economies reasonably enough, but for the Australia of today, we'd be faced with almost unthinkable turmoil.

What do the banks DO?

At the simplest level, banks make their colossal profits through charging a higher rate of interest on their loans than they pay out on the money we bank as deposits.

If you've ever tried to buy a property with a deposit of less than 20% of the purchase price (an 'LVR' of more than 80%) you'll be aware that the bank can charge you a higher rate of interest as well as hit you up for Lenders Mortgage Insurance (LMI) as compensation for the higher perceived risk.

Investment banks also generate profits from issuing financial advice or from engaging in transactional activities such as capital raisings or takeovers.

Of course, under the modern system of banking, banks are not required to hold enough money to pay all of its depositors. It's known as fractional reserve banking. If we simultaneously all demanded our cash, the banks would not have the funds available to pay us, so much rests on our collective confidence in the institutions. Sometimes governments therefore choose to guarantee deposits up to a certain level in order to shore up confidence.

In fact, where I am today - in England - we saw a modern version of an old-fashioned 'run on the bank' in 2007 after rumours spread of the Northern Rock bank being in financial strife. The result was that the Bank of England had to step in as the 'lender of last resort' to provide emergency funding. The UK Treasury ultimately intervened and nationalised the bank.

Last resort

And that is the key point. 

There is simply no way Australia could allow one of its major lenders to fail because the fallout would be catastrophic beyond belief. For this reason the banks receive what is known as an implicit guarantee from the government.

The paradox of an implicit guarantee is that it can cause the largest banks to become larger still. They are seen as more creditworthy which can attract more business, and the very act of becoming larger reassures banks that they will become 'too big to fail'. An implicit guarantee could therefore the theory be seen to encourage reckless management.

However, banks will quite rightly be subject to increased regulation in the form of BASEL III and stress testing. 

What would happen if a major bank failed?

Overall, it is unlikely but certainly possible that with massive exposure to residential property one of our major banks could fall into difficulties. Take a look at the typical capital structure of a bank's balance sheet - you will notice that the net asset positions are surprisingly low given the vast loan balances on the books. 

However, a bank collapse would have the most diabolical and far-reaching consequences for the Australian economy. 

What would happen? Well, consumer confidence would instantly evaporate, the money supply would be annihilated as the insolvent or failed bank ceased lending funds to instead shore up their reserves...and we would likely end up in a deflationary economy with disastrous outcomes for the entire country.

So, it is for all these reasons that hell would probably freeze over before one of our major lenders would be allowed to fail. In business and economics, some are indeed created more equal than others.


A bit of talk of 'Ruddmentum' in the press - on a two party preferred basis Labor might have gained as much as five points in the polls! I'm not sure how thorough the polls were, though. Business leaders, who hate uncertainty, will push for an early election to be called.