We had a preview of that underlying confidence when Ticky Fullerton interviewed National Australia Bank CEO Ross McEwan this week. Naturally, the optimism is moderated by the China trade war plus a growing apprehension about what might happen in the US economy and its impact on Australia. I will detail that below.
In Australia, the greatest bank fear is that we will face a shortage of skills, which will require a considerable increase in migration once the quarantine issues are sorted out. The banks in their discussions with the federal government are receiving unofficial assurances that they will facilitate a migration of skills. In turn, this will maintain the underlying pressure on the residential property market.
For most of 2020, the banks were apprehensive about March 2021 because around that time the various stimulations and levers that insulated the Australian business and consumers from the worst of the COVID-19 repercussions would run out.
There were grave fears of massive bad debts particularly if house prices, as forecast, had fallen. But house prices have increased and in some areas the rise has been spectacular.
That means that the high-risk residential property loans that were undertaken before COVID-19 or during the crisis can now be repaid in full by the sale of the house should that be required. That slashes the amount of bank problem loans.
There still remains substantial problem loans via zombie companies and others who have not recovered, which will require increased write offs. But most of the banks have had no major write offs for over a year and they have built up substantial unused provisions which should be sufficient.
During those tough times, large numbers of small and medium sized businesses quietly reorganised their operations and in many areas, they have cut their operating costs by 10 – 20 per cent. They are in much better shape and are now starting to explore increasing their bank overdraft to fund necessary equipment and possible expansion. Part of that increased bank loan demand comes from the fact that enterprises of all sizes are examining their supply chain and making themselves less dependent on imports.
Some of the larger companies now understand that they will be required this year to pay their small enterprise suppliers in 20 days and are organising the necessary banking facilities. The small suppliers are jubilant that their cash flow is about to be transformed. The Reserve Bank is assuring everybody that they think they can hold interest rates until 2024 unless there is a big rise in wages. At this point businesses are very reluctant to increase wages substantially although the overall shortages of labour may force up payments unless the migration arrives in time.
On the housing front Australia appears to be at last starting the decentralisation drive that has been dreamed about for generations. The vast majority of our population on the east coast is concentrated in Sydney, Melbourne, and Brisbane. Now in Victoria, Geelong and Ballarat are booming, and Bendigo looks like following. In NSW and Queensland there is a swing to the south and north coast which extends inland to places like Toowoomba.
Publicly it’s being linked to working away from the CBD, but the decentralisation switch looks like being much bigger, which will spread opportunities.
The government’s aid programs have enticed first-home buyers back into the market and we are going to see a substantial rise in home ownership. Again, this is a fundamental change in society which will increase its overall stability. Most people who rent will pay more (outside of Melbourne’s Dockland apartments) because supply is drying up. Those state governments that have been trying to protect renters have increased the risks for landlords which, in a supply shortage, will drive landlords to require higher returns.
But then comes the risk of the US, which is much more serious than a few blips in the 10-year bond market. The US has been growing its money supply by about 20 per cent a year in recent times. Any country that does that normally sees inflation break out. But it has not happened in the US partly because the COVID-19 pandemic slowed the velocity of money as people became scared and held onto their savings. The Biden administration plans to substantially increase what is already a huge money supply growth rate.
While the pandemic continues at serious levels, the low velocity of US money will continue to curb the money supply impact. But the rapid spread of vaccinations will remove those velocity curbs on the impact of rampant money supply.
Given that there are already some skill shortages in the US, the possibility of a sharp rise in inflation next year is very real. And that will trigger a big rise in bond interest rates which in turn will hit certain parts of the US stock market. The impact will spread to Australia. Australian banks are big long-term borrowers in the US, but do so on a rotating basis so while the impact will be severe there will be delays.
There are few precedents for what is about to take place in the US but a similar situation took place more than a hundred years ago in Germany. During the First World War, Germany’s money supply kept rising by around the current US rate but the war time velocity curb, like COVID, curbed the impact.
The exuberance after the war removed the money velocity curbs and with other forces triggered hyper-inflation because there was not sufficient supply of goods and services. We are not looking at that sort of event in the US, but if interest rates rise 2 or 3 per cent, highly leveraged borrowers will be hit hard. At this stage, those fears are in the distance and it’s time to enjoy what will be a very strong 2021.
After months of apprehension, most of Australia’s banks are becoming more confident and that confidence will be reflected in Australian prosperity in the coming year.