No more flogging the debt horse

A golden age for Australian retailers is over. Gone. Finished. Retailers offer plenty of short-termscapegoats for their current woes: the carbon tax, the flood levy, the higher Australian dollar, higher interest rates. But, in reality, the current downturn in retail spending is much more deeply rooted and structural than that.

Australian households have now completed an historic and one-off adjustment to the halving of mortgage rates during the 1990s. For households, this halving in borrowing costs, along with looser lending standards, allowed them to simply borrowtwice as much.

And borrowwe did. Formuchof the early 2000s, everyweekend was greeted as an opportunity to rush downto the local homemaker centre to load up cars and then houses with the latest leather lounge suite, plasma TVor other gizmo. Why? Because we could.

Retail sales grewby about 8 per cent a year,well above what could be sustained by wages growth of about 4 or 5 per cent. The rest was debt.

But, eventually, all this spending, along with the increase in business investment associated with mining boommark one, created an incendiary mix. Inflation began to rise.

The Reserve Bank lifted interest rates 12 times between 2002 and 2008. Mortgage rates hit an eyewatering 9.5 per cent and households began to realise they had reached the limits of what debt they could service. Mortgage pain made households realise, belatedly, they had maxed out their credit limit, again, and left them wishing for some way to reduce their debt exposure.

Then, wham, a gift from the financial gods: a global financial crisis that, without significantly harming the economy, saw interest rates slashed in half and direct cash handouts from the government.

The household savings drive that is so confounding retailers today, really began with that first stimulus cheque in late 2008. And households haven’t stopped saving. National accounts show households, instead of spending more than they earn as they did before the crisis, now save about 10 cents in every dollar they earn, and have been doing so since late 2008.

The global financial crisis provided households with both the means to save – lower interest rates and cash handouts – and the motivation. Households could only stand by and watch as their share and superannuation portfolios crashed. It helped them realise they couldn’t just rely on debt-funded asset price gains to build wealth. If they wanted to buildwealth, they’d have to do it the hard way, by saving.

Households today are split into roughly two groups: low-income battlers and high-income deleveragers. And neither group is feeling much like indulging in retail therapy.

Low-income households simply can’t spend because all their income gains are going on higher costs for necessities such as electricity, gas and healthcare. They’re still spending – but not at the shops.

At the top end, higher-income earners are using any extra cash to pay off debt.During the early 2000s debt binge, the Reserve Bank ran studies to find out which households were most exposed. It found that, reassuringly, most of the increase in debt had gone into the hands of those who could most afford it. Unlike in the US, where low-income households were given loans they could never afford, in Australia the increase in debt was largely in the hands of middle- and high-income earners.

The weakness in high-end retail sales, such as at David Jones, suggests it is now these higherincome households who are leading the savings charge. Why? Once again, because they can. These are the people who regularly check their superannuation and share portfolios and wonder if they’ll ever recover their cost base, let alone make a gain. The period of lower interest rates during the financial crisis gave them a glimpse of blue sky, and they’re going for it.

Sure, other factors are at play in the current retail downturn, which, while fundamentally structural, is also in some ways cyclical. The higher Australian dollar, a product of the mining investment cycle, means it is cheaper for Aussies to shop overseas. Plenty of high-income earners are still shopping in department stores – but they’re doing it at Macy’s and Neiman Marcus, not Myer and David Jones.

Retailers are also feeling the impact of slower population growth. Under theHoward government, population growth hit about 3 per cent a year. But the Rudd andGillard governments, responding to political pressure, have since tightened up on student visas, while the financial crisis reduced the number of temporary skilled migrants. Population growth has halved, contributing to retailing woes.

Growth in retail sales is now running at about 2 per cent a year, which is unusually low. So yes, some recovery in retail sales is overdue, perhaps to somewhere more like 5 per cent annual growth, in line with wages and population growth.

But the debt-fuelled days of 8 per cent growth are over.

The bottom line for retailers is that they must get used to permanently lower sales growth. This is bad news for shareholders and bad news for retail employees. But for the economy as a whole, this deleveraging by households is a good thing. It’s something households across the rest of the developed world are desperately trying to achieve but that only we have the ability to do effectively, thanks to the income boost from the mining boom.

The Reserve Bank is happy to see some weakness in retail spending to make room for increased spending by businesses in the mining sector.

And if households can reduce their debts and build a buffer for future international financial turbulence, that is no bad thing.

This entry was posted in Banks, Housing, Inflation, Interest Rates. Bookmark the permalink.

One Response to No more flogging the debt horse

  1. Nick says:

    You do realise that “saving” actually means reducing debt – so if there is a debt deflation, whereby asset prices go down, whilst wages stay stagnate or drop and living costs go up, it wont matter if you reduce your $350,000 mortgage to $315,000
    In the short term dis-leveraging (the proper term) will cause the economy to go into recession. In the long run, reducing private debt to GDP from the current 160% to ca. 40% makes a more robust economy. But this will take over a decade.

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