Dissent is Patriotic

“Don’t bet against the United States of America.” - Warren Buffett

Sometime in the late nineties, my heroes changed from Michael Jordan and Charles Barkley to Warren Buffett and Charlie Munger. Warren Buffett has a public, proven track record as the single greatest investor of all time. He has doubled the return of the S&P 500 over a course of nearly fifty years. His results are so astonishingly good that if I were to find out that Buffett was from the future and had built a time machine in order to capitalize on his knowledge of future events, I would not be the least bit surprised.

The quirkiest part of Buffett’s success is his lack of sophistication. Good ol’ Warren and Charlie get together and analyze businesses. They look at balance sheets. They look for sustainability. They try to buy good companies that have fallen out of favor for great prices. They believe in buy and hold. During the go-go nineties, Warren and Charlie refused to buy in to the dot com hype. They were laughed at and called dinosaurs. Warren Buffett wrote several published pieces discussing how equities would offer sub par returns for the coming decade, warned against the increasingly obvious stock bubble, and made many defensive calls. Warren and Charlie went against the common wisdom and instead applied common sense and were 100% right in their assessment.

Immediately after the dot-com crash, Buffett warned of the impending housing bubble. He referred to derivatives as “financial weapons of mass destruction”. Experts including the Chairman of the Federal Reserve, Alan Greenspan, publicly disagreed with Warren’s assessment. The Wall Street Journal, most economists, investment banks, and Americans themselves declared, “This time it’s different!” It wasn’t.

I recently told some friends on a cruise of the Yarra River and Port Phillip Bay that we had made the decision to return to the United States. As we were enjoying the sunshine and free alcohol, many people looked at me as if I had lost my mind, “But the US economy is in the shitter” was the common refrain. And if one were to read Australian newspapers, one might get that impression. However, any who knows me knows how I feel about Australian newspapers...

Let me explain the miraculous growth engine that has powered Australia’s economy for the last twenty years and how this is all going to end. I am American, I am from the future.

Following the last recession in 1991, due to limited zoning (ironically applied to nearly unlimited land), house prices gradually started to increase. For those that owned homes, they now had the ability to “tap into the equity of their home” by refinancing. This started happening a lot and a bunch of newly rich Australians purchased consumer goods (for way too much money, but that is a different rant). As house prices increased, it attracted more people with the lure of easy money. Interest rates decreased attracting even more people. WIthout any worthwhile stocks to invest in (seriously, name one ASX 200 company you would like to have ownership in) real estate became the only way to build wealth. More buyers than sellers led to higher prices. Higher prices led to home equity loans. Home equity loans led to consumption further increasing economic output. The overall wealth effect and the near religious belief in property as a means to wealth led to more buyers. Rinse. Lather. Repeat.

For fifteen years, this went on with property prices increasing some years almost 20%. Then the Great Recession or the Global Financial Crisis (GFC) or whatever you want to call it hit. The unspeakable happened. House prices went down. Declining house prices had the potential to throw off the entire economy that depended on house pricing going up, consumers taking out home equity loans and spending the money, and the government collecting piles of money in the form of stamp duty (5% of the home’s sale price goes right to the state). So the RBA lowered interest rates to all time lows and started giving away money to first time homeowners.The allure of free money proved to be so powerful that getting a free grant of $15k to buy an astonishingly crappy two, cramped two bedroom apartment for $500k seemed to make sense. It doesn’t. Australia has some of the most expensive real estate in the world at the same time it is one of the least densely populated nations. It doesn’t add up.

I have seen plenty of people comment in The Age and other sources that it doesn’t matter if house prices stay flat (never go down - house prices couldn’t conceivably go down). Owners simply will not sell until home prices go back up so it doesn’t matter. Except it does. Over a million households (out of a population of only seven million households) are “negative gearing”. Negative gearing means losing a lot of money every single month in the hopes of making it back in capital gains.If the hope of capital gains disappears, so will the willpower to keep throwing money away every month on a deflating asset. Refis will disappear. Spending will grind to a halt. The wealth effect starts to work in reverse. Lack of spending leads to increasing unemployment. Increasing unemployment leads to foreclosures which leads to lower house prices. So the cycle feeds upon itself, but in reverse this time.

The RBA has now painted themselves into a corner. Interest rates are currently near all time lows. Sadly, this is actually starting to reinvigorate the housing market. Over the next year or two, the RBA has the ability to bring interest rates to zero, as it is in the US. However, at the first whiff of inflation, any increase in interest rates will set off a wave of foreclosures as the average Australian buying at these prices absolutely cannot afford it. I cannot forecast accurately when this will happen, I can only assure that it will happen. It has happened before and to ignore the lessons of the US, Ireland, Spain, and the UK is simply willful ignorance.

This viewpoint is not popular. Commenters in Australian newspapers who espouse views similar to mine are accused of “talking down the economy”. Seriously. As if our tiny, unpopular opinion can cause the entire economy to fall (it is the gravity and magnitude of the bubble itself that will cause its inevitable collapse). It is eerily similar to what happened in the US prior to the second Gulf War. You could hear the phrase “dissent is patriotic” amongst the liberals. At the time, I thought they were wrong. Now in hindsight, I can see clearly the US had no authority, cause, justification, or plan in invading Iraq. It was a huge mistake and the dissenters served a purpose. We should have listened.

I cannot emphasize enough how privileged I feel to have had the opportunity to live and work in Australia. I am not writing this to be negative or because I have an axe to grind. My dissent is a form of patriotism, a warning to my friends I have grown close to in my travels here. The road ahead is going to be difficult. Reading macrobusiness or Steven Keen, saving money, and speaking out against property “investment” is not tyranny. It’s patriotism. Like Buffet, avoid common wisdom and pay attention to common sense.