Spectrum
WELCOME TO THE DOG YEARS
Paul Sheehan
09/04/1999
Sydney Morning Herald
Page 1
Copyright of John Fairfax Group Pty Ltd
Are we living in a debt bubble PAUL SHEEHAN investigates.
WE ARE rich. The net worth of each Australian - every man, woman and
child -is now about $130,000. This means the average household is sitting on
net assets of about $350,000. That's a lot of assets by any standards.
Australia is in the midst of an economic expansion that makes the '80s boom
pale by comparison. Australians are sitting on a paper mountain, a money
mountain. The stakes are high, because the money mountain of the '90s has
been built partly on personal debt, market confidence, bullish real estate
prices and historically high stock valuations. We are living not just high, but
fast. The Internet revolution is moving so quickly that people talk of dog
years -a Net year is the same as a dog year, seven times faster.
Welcome to the Dog Years.
There are plenty of reasons to worry about the solidity of this paper
mountain. Here are 10 of them:
1. Personal debt is growing.
Household debt more than doubled between June 1990 and June 1998 (from
$123 billion to $290 billion), an increase of 136 per cent, much faster than
the increase in the value of assets (up 87 per cent) and much faster than the
growth in the economy, according to the Reserve Bank. (This debt can be
discounted about 40 per cent by the impact of inflation.)
Fifteen years ago, Australians were saving 12.5 per cent of their income.
Today, the personal savings rate is 0.6 per cent, the lowest rate ever, and
leaves households vulnerable to a meaningful rise in interest rates.
Last year, personal loans and credit-card debt grew by 14 per cent. The
personal bankruptcy rate has trebled in the past decade. Household debt has
doubled in a decade, to 90 per cent of after-tax income.
2. The stockmarket overhang.
As recently as the early 1980s, the Australian stockmarket was quite small
compared with with the whole economy, with a total market value equivalent
to one-fifth of gross domestic product. Not any more. As of June 30, the
value of the stockmarket was equivalent to 88.6 per cent of GDP.
Since 1990, the stockmarket has increased in size by more than 400 per cent
(from $140 billion to about $570 billion), far outstripping the growth of the
economy. 3. Asset prices have soared. Ten years ago, shares were selling at
an average of about 10 or 12 times a company's earnings. Today, they are
selling at twice that ratio - almost 25 times earnings, well above the historic
range -according to the most recent figures from the Australian Stock
Exchange. The baby-boomer generation, with its income and investment
bulge, has created a "weight of money" effect - more money chasing
relatively fewer equities and quality properties.
The world's most powerful economist, Dr Alan Greenspan, chairman of the
US Federal Reserve, has gently but repeatedly expressed his concern about
high stockmarket valuations. 4. Small investors are pouring into the market.
"A large amount of the workforce time is now taken up with day- trading on
the Internet," says the McKinsey & Co analyst Andre Dua. The Internet has
made share trading easier and cheaper, stimulating tremendous growth in
online trading by small speculators.
The Commonwealth Bank's online share trading arm, Commonwealth
Securities (Comsec), now has 370,000 clients (there were none four years
ago) and a dominant 70 per cent of the online share-trading market. It is still
adding customers at a rate of 800 a day.
People are also borrowing more to buy shares. The head of Comsec, Paul
Rickard, says the growth of margin loans - money borrowed against share
purchases - has been "huge". The Reserve Bank is more specific. It says the
amount of margin loans outstanding has doubled in the past two years to $4.2
billion. This follows the US trend, where shares bought on margin reached a
value of $US173 billion ($271 billion) in June, almost four times the margin
debt that existed at the time of the 1987 Wall Street crash.
The number of active day-trader accounts in the US has risen from 100,000
in 1994 to more than 5 million, and is projected to be 15 million by 2001.
Fifteen million day traders confronted by a bear market may spell
l.e.m.m.i.n.g.s. 5. Wealth inequalities are growing. According to research at
New York University, 85 per cent of the new wealth created by the
stock-market boom has been captured by 10 per cent of American
households. Bill Gates, the co-founder of Microsoft, has a personal fortune
that exceeds the economic output of all but the 20 largest countries.
Income and wealth disparities are also widening throughout Australian
society: between the skilled and the unskilled, between city and country, and
between areas of Sydney. 6. Corporate payments are bloated. Major
corporations have become less egalitarian. According to figures quoted
recently in The Economist, the average American chief executive now takes
home 419 times the wage of the average factory worker. This disparity has
ballooned tenfold in the past 20 years. It has been fuelled by large stock
option packages. In Australia, the discrepancies are not as great but are
growing rapidly, another American trend Australia is following.
Among the 200 major US corporations, outstanding share options awarded to
executives amounted to 13.2 per cent of corporate equity at the end of 1998,
or about $US1.1 trillion, and the generosity of these options packages is not
reflected in corporate accounts. 7. Warren Buffett is worried. Buffett, the
most successful market investor in the world, said the Net bubble had to
burst and has been scathing about the aforementioned explosion in corporate
option packages, treating them as hidden costs that dilute the true earnings of
companies.
Buffett also doesn't like the size of the US trade deficit, which he regards as
inflationary. Inflation hawks such as Buffett argue that too much credit is
being given to productivity gains from the digital revolution and not enough
credit to the prolonged decline in oil and commodity prices. If they rise, so
will inflation. 8. Australia is in deficit to the rest of the world. Speaking of
deficits, Australia's current account deficit has risen to more than 6 per cent
of GNP, the threshold that concerns policy-makers. This makes the economy
inherently more vulnerable to external decisions (on interest rates, for
example) beyond the control of our policy-makers. 9. The global financial
architecture is flimsy. Intense commercial pressure to beat the market has led
to an explosion in speculative funds flowing through the global financial
market, dwarfing investment and trade flows. The former chairman of the
US Federal Reserve, Paul Volcker, is among those who have warned that the
speculative capital flows have become destructively volatile. His views echo
warnings by the financial speculator George Soros.
Last year, the de facto bankruptcy of the big New York hedge fund
Long-Term Capital revealed dangerous levels of debt exposure among
dozens of major trading houses speculating in financial derivatives and the
futures markets. 10. The cannibals are coming. While the Internet may be
comparable with the infant motor industry of 1920, it is also going to
cannibalise many businesses. We are about to enter an era of creative
carnage, and some big brands are going to disappear.
On April 26, the price of the most spectacular of the Internet boom stocks,
Amazon .com Inc, reached $US221, giving the company, which has never
made a profit, a market value of more than $US30 billion, more than the
entire market value of the global publishing industry. Amazon dropped
more than 60 per cent after that peak. The other great Internet market
maker, America Online, crashed more than 50 per cent from its April peak,
and the online auction house eBay crashed 65 per cent. Overall, Net stocks
plunged more than 40 per cent between April and July before staging a rally.
Australia's economic and market psychology has become so tied to the
fortunes of Wall Street that if US interest rates are spiked up in response to
inflationary pressures, Australia may not shrug off the impact as
comfortably as it weathered the Asian economic storm.
The fever in Internet stocks has seen a big bang, a big bust and then a rally in
the space of a single year. Or seven dog years. ALL this is a seismic cultural
shift in so short a time. The size and speed of the changes have taken
Australia into uncharted territory. Some of that territory is dangerous,
particularly the rising gap between rich and poor, which erodes the supposed
egalitarianism that underpins Australian cultural mythology.
The information age has created more wealth faster than ever - $8 trillion
since 1995. Thanks to the noted author Professor Lester Thurow, we now
know that more American billionaires have been created in the past 15 years
than in all America's previous history combined, and that's even after
inflation is factored in. Thurow compares the 1990s with the 1890s, when
the transforming new economic force was electricity. He provides a simple,
compelling example: the lighting that can be done today with a 33 cent light
bulb would have cost $1,445 in 1883.
This elegantly explains why millions of people have poured into Internet
stocks, a digital gold rush, with market miners hoping to discover the next
General Motors, or General Electric, or Microsoft, while the digital
economy is still in its infancy.
So, despite the high speed of the economy, with all the attendant risks, there
are also plenty of reasons why Australia can continue to enjoy prosperity and
growth. Here are 10 of them: 1. Personal wealth has surged. The per capita
wealth of Australians was $123,021 as of June 30, 1998, according to the
latest Treasury estimates. This total (which will have nudged past $130,000
by now) compares with $67,577 per head a decade before.
Nine years of economic expansion has seen robust rises in housing prices,
share holdings and superannuation funds. Even after allowing for inflation,
Treasury estimates show that per capita wealth has increased in real terms by
more than 40 per cent in the past decade.
Importantly, the high growth in net personal assets has seen debt levels
actually decrease as a percentage of household wealth.
"The fall in interest rates, which is what inspired the large increase in debt,
has meant that household interest payments have fallen to about 6 per cent of
disposable income from a peak of around 9 per cent in 1989-90, so the debt
servicing burden has fallen," says the former deputy secretary of the
Treasury, Des Moore, who now operates the Institute for Private Enterprise.
Australians have thus behaved rationally by using a period of low interest
rates to build up assets. The increase in personal debt over the past decade
can be discounted by 40 per cent for inflation, and the 0.6 per cent household
savings rate is offset by significant growth in personal savings in the form of
real estate, shares and superannuation funds. 2. The mega nest egg. Between
now and 2010, the baby-boomer generation in Australia will inherit roughly
$200 billion from their parents, mainly in the form of residential property.
The whole economy has been changed by a historic confluence of events: a
demographic bulge; an information revolution; globalisation; privatisation
and securitisation.
In 1993, the Harvard- educated economic forecaster Harry S. Dent wrote a
book entitled The Great Boom Ahead, predicting that the 1990s would see
the greatest market boom of this century. At a time of economic uncertainty,
Dent predicted the Dow Jones Industrial Index would reach 8,000 by 1998.
The core of his argument was that the unprecedented size and wealth of the
baby-boom generation would bring levels of investment and consumption not
seen before, and produce a mass-scale switch from bank accounts to share
portfolios.
Today his core argument seems obvious, yet at the time, with the Dow at
3,500, his prediction seemed far-fetched. Harry Dent, not conventional
wisdom, turned out to be right. 3. The Internet revolution. This boom isn't
tulips or blue sky mining companies. There is blue sky in the stock
valuations, but also multibillion-dollar investments, multibillion-dollar
infrastructure being built, productivity gains flowing through the economy,
and changes rippling through society and commerce that we don't even
understand yet.
Some of the most rigorous and sceptical policy-makers, including Alan
Greenspan and a number of his Federal Reserve governors, have expressed a
belief that productivity advances may be delivering higher growth without
higher inflation.
Des Moore says: "We have to take more seriously the optimistic thesis,
emanating mainly in the US, that the developed world may now be in a new
economic paradigm that offers faster economic growth with less fluctuations
and recessions. Of course, we have all been told before about so-called
`golden ages' that never eventuated . . . but there does appear to be some
basis to it this time." 4. The infrastructure boom. The advanced economies
are experiencing one of the historic infrastructure booms that occur every
few generations, such as the beginning of this century with the introduction
of electricity and the internal combustion engine, or the 1860s, with the
expansion of the railroads and the telegraph. These booms produce surging
rates of productivity and a decline in wholesale prices.
Economic activity is surging inside and around the Net sector, with an extra
30,000 jobs being generated for technology professionals over the coming
year and companies engaged in multibillion-dollar investments in fibre
optics, microprocessors, lasers and other technology for the digital
transformation of commerce, education, health care, communications and
management. 5. The stockmarket can be much bigger. Although the
Australian market has soared in value relative to the rest of the economy, it
remains relatively modest in size compared with other economies. According
to figures supplied by the Australian Stock Exchange, US market
capitalisation at June 30 was 143 per cent of GDP; in the United Kingdom it
was even higher, 162 per cent; Sweden 125 per cent, Canada 98 per cent,
Singapore 95 per cent and in stock-hungry Hong Kong, 213 per cent.
Australia, at 88.6 per cent, seems modest by comparison. 6. The market
mountain has a much broader base. In the past 10 years the number of
Australians who directly own shares has risen fivefold, from 1.1 million to
5.5 million, or more than 40 per cent of the adult population.
The market's growth in this decade is the equivalent of $30,000 for every
adult Australian, and the parade of major new stock floats (Telstra,
Commonwealth Bank, Woolworths, Qantas, AMP, C&W Optus, TAB etc)
has greatly broadened the market's base. The 1 million small investors who
bought an average of 1,300 Telstra shares since the float of 1997 have seen
their Telstra holding grow from $4,300 to about $11,000. 7. Mary Meeker is
not worried. "There's no doubt in my mind that the aggregate market value
for the Internet sector will be a lot higher in three years than it is today. It is
just a question of which companies succeed and which companies fail. I think
there will only be a couple of handfuls of companies that really succeed."
Mary Meeker is rich and influential because, as the Internet analyst for the
investment bank Morgan Stanley, she partly directed the Internet boom. "The
Internet is the only thing I've seen, in 27 years, that seems to be affecting
every industry group," she told The New Yorker recently. "It's time to build
a brand. It is really land-grab time." 8. The Internet bubble deflated, but the
market did not. While the Internet leaders went into free-fall in the middle
of this year, the overall stockmarket remained solid. The historic bull market
of the past 16 years has been driven by a force much bigger than the
Internet: the aggressive re- structuring and globalisation of American
corporations.
The boom has followed higher profits and a flow of investment through
mutual funds and pension funds by baby boomers, which since 1995 has
helped the US market build some $8 trillion in financial wealth, creating a
halo of consumer confidence and spending in the US that has propped up the
global economy. 9. Australia has become globally competitive. Australia's
economic growth in the 1990s has outpaced nearly all developed economies,
including the US. According to the Reserve Bank, Australian productivity
growth in the 1990s has doubled the growth rate of the 1980s and beaten
most other developed economies.
Imports and exports are now more significant to the economy (the equivalent
of 41 per cent of gross domestic product) than they were in 1990 (33 per
cent). It is the result of the often painful structural reforms by the Hawke,
Keating and Howard governments.
Australia's ability to service its foreign debt has also improved significantly
during the 1990s, when measured as a percentage of exports. 10. Perspective
is everything. When inflation has been factored into the historic growth of
the stockmarket, the time-line for the stockmarket over the past century does
not look scary at all. It looks heartening.
Which brings us back to Harry Dent, the rabblerouser who rightly predicted
the Dow would explode upwards. He has written a sequel, The Roaring
2000s, with a chapter entitled "The Greatest Boom In History: 1998 to
2009", which argues that if the economy continues to perform well the Dow
Jones Industrial Index could reach 35,000 in the next 10 years, driven by the
peak spending years of the baby-boomer generation. Once again, his
prediction seems wild, far-fetched, and has been thrashed by sensible
analysts.
Which brings us back to Harry Dent, the rabblerouser who rightly predicted
the Dow would explode upwards. He has written a sequel, The Roaring
2000s, with a chapter entitled "The Greatest Boom In History: 1998 to
2009", which argues that if the economy continues to perform well the Dow
Jones Industrial Index could reach 35,000 in the next 10 years, driven by the
peak spending years of the baby-boomer generation. Once again, his
prediction seems wild, far-fetched, and has been thrashed by sensible
analysts.
But what if Harry Dent is even half right? There are economists, some of
them sensible, who argue that the US economy is only midway through an
era of prosperity that began when the bull market started in 1982, and the
technological revolution has only just begun.
Even the latest issue of The Atlantic Monthly carries this same argument in
its cover story, under the headline "Dow 36,000", by James Glassman and
Kevin Hasset of the American Enterprise Institute. They argue that
traditional stock valuations are out of date and stocks are in the process of
tripling in value within a decade as new valuation methods replace the old.
History also says there could be a paper landslide, brought on by higher
inflation, higher interest rates and some unpleasant seismic surprise we
haven't even thought about. (Even Harry "hypergrowth" Dent predicted a
depression after 2010 when he was predicting a market boom in 1993.)
Big changes at high speed - not the most relaxing combination. No wonder a
sense of job security has become a casualty of our times. But these are the
Dog Years and the dog is supposed to be man's best friend.
ALL ORDINARIES INDEX
1891: First telephone call.
1920: First regular commercial radio broadcasts.
1926: Television invented by John Logie Baird.
1976: Microsoft established.
1981: IBM PC introduced.
1992: World Wide Web developed.
1994: Internet online trading begins.
1995: Bill Gates becomes world's richest man.
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