I can see 2011 going down as a year that will be remembered for civil unrest.

It started with a street vendor setting fire to himself in Tunisia and moved on to civil unrest in a number of countries in the Middle East. Then there were riots in London and, more recently, protests around the world against the richest 1%.

The protesters say they are opposed to “the fundamental inequality in society — social, economic, ecological — and want to change the ways that our society is structured and run so that way, the vast majority of people — the 99% — have their interests accounted for, their voices heard, their needs represented.”

As many of these protestors claim our society is run for and by “the 1%”, I found it interesting to read an article explaining exactly what it takes to join this exclusive club in a recent copy of the Australian Financial Review.

And by the time I finish explaining how to join the ranks of world’s richest 1%, you may find you’re already in it. But I’m getting ahead of myself…

What it takes to make it into the Rich1% Club.
Apparently it takes assets of $11.2 million to be amongst the richest 1% of Australia’s 8.4 million households.

The top 1% has a lazy $1.07 million kicking around in cash or it’s equivalent according to the Australian Financial Review. That compares with just less than $120,000 for the top 20% of households.

The average value of cars owned by the top 1% is $84,000; compared with $32,000 for the top 20%. And their financial security is covered by $1.4 million in superannuation, more than double the super held by the wealthiest 20 per cent.

Those who make it in the top 1% of rich people tend to have extensive share portfolios, worth $450,000 and have a business valued at an average price of  $3milion.

This is in line with the Merrill Lynch Cap Gemini report of High Net Worth Individuals that found 80% of this club made their wealth through business.

But that doesn’t mean that the wealthiest Australians don’t like property – they do and they are amongst the keenest property owners in the world.

If you are in one of those 84,000 households that make up the 1%, you are likely to live in a house worth on average $1.9 million and own other property holdings worth over $3milliion.

Now clearly there is a wide gap between the top 1% and the average Australian and figures from the Australian Bureau of Statistics show that Australia’s richest households are expanding their wealth three times faster than the poorest groups, and many are using property to leverage their wealth. I wrote about it here in a recent market commentary.

Another Perspective.
No one’s hardship should be belittled. Becoming unemployed or not being able to keep up your mortgage payments aren’t just financial problems. They’re social and emotional problems that strike at your sense of worth.

But things always need to be kept in perspective. Some really interesting numbers emerge when you expand your view and look at the richest 1% in the entire world.

It’s no secret that Australia is among the richest nations on Earth, so how much do you need to earn to be among the top 1% of the world?

According to an article by Motley Fool in Motley Fool the answer is US$34,000.

This article explains that in his book The Haves and the Have-Nots, World Bank economist Branko Milanovic shares that be in the top half of the globe, you need to earn just $1,225 a year.

To be included in the top 20% of income earners in the world all you need is a salary of US$5,000 per year. To be the top 10% you would need to earn US $12,000 a year. And to be included in the top 0.1% requires an annual income of US $70,000.

Dig even deeper and the figures become unconceivable.

According to the U.N., “Nearly half the world’s population, 2.8 billion people, earns less than $2 a day.” According to the World Bank, 95% of those living in the developing world earn less than $10 a day.

When you consider the context of the entire world, it means that the Australians we consider poor are among some of the world’s richest people.

A new report from Credit Suisse Global Wealth has revealed what many of us Aussies already know; that we are indeed living in the lucky country!

In term of average wealth per adult in 2011, Switzerland, Australia and Norway are the three richest nations in the world, with the average Australian worth close to $221,704, which is four times more than that amount boasted by each US adult. And the proportion of Australian adults who can claim a worth of more than $100,000 is eight times the global average. 

In short, most of those occupying Wall Street or Melbourne or Sydney would be considered extraordinarily wealthy by much of the world.

Many of those protesting the 1% are, in fact, the 1%.

Apart from having amongst the highest incomes in the world and the second best lifestyle, the ABS advises we also have one of the highest life expectancies on the planet.

Since 1990 six years has been added to the life expectancy of Australian males and four years has been added to the life expectancy for women. 

Anyone can join the 1% club.
But the protestors in Australia should remember that we live in the best country in the world. A country of opportunity where virtually anyone can make it into the BRW Rich 200 list. 

Clearly that’s just not possible in many other parts of the world.

Just look at this year’s Rich 200 List…
While 17 percent inherited some of their fortune, most were self made successes, some coming from working class backgrounds.

And there’s no use complaining about the school you went to, because attending a private school and having an elite education is clearly not a prerequisite to joining Australia’s wealthy. While some forged important networks at school, many went to public schools and others didn’t even finish high school. In fact less than half of those in the Rich 200 list have tertiary qualifications. 

And don’t say it’s too late…
You’re never too young and you’re never too old. The youngest member of this year’s BRW Rich 200 is aged 35 and has an estimated wealth of $1.01 billion, which is even more than the oldest member who at the age of 92 has accumulated $289 million.

Some final thoughts.
Just to make things clear – this isn’t to belittle the protestors’ message. I see merits in some of the Occupy protestors’ arguments.

And I’m definitely not against protesting – I grew up in the age of protests against the Vietnam War.

Needless to say I can understand why people would be upset when many of top 1% are perceived to have earned their income unjustifiably. Being paid by big corporations that in some cases have been run into the ground and then been bailed out by their governments doesn’t sound right.

Nor does a tax system where the wealthy seem to avoid tax and the poor seem to pay a disproportionate amount.

It’s hard to argue with that logic.

Remember…I’m not having a go at the protestors.

The Occupy Wall Street movement has attracted support around the world and many believe they have a genuine grievance. High flyers in the world of finance helped create the Global Financial Crisis and the poor of the world are now paying for it.

I’m just offering another perspective and reminding them that even though our system has lots of faults, it has created more prosperity, even for the lowest 1%, than most of the world can comprehend.

All eyes will be on Italy’s Draghi next week as he takes the helm of the ECB just days after European leaders hammered out a deal to solve the Eurozone debt crisis.

Mario Draghi to look after the Euro, and the European Central Bank

Mario Draghi now at the helm

All the world’s business leaders, economists and politicians eyes will be on Italy’s Mario Draghi next week as he assumes control of the European Central Bank just days after European leaders hammered out a deal to solve the Eurozone’s debt crisis.

The 64-year-old former Goldman Sachs banker officially takes over from Jean-Claude Trichet as head of the guardian of the Euro on Tuesday and then chairs the ECB’s regular monthly policy-setting meeting on Thursday.

The Italian could not be taking over at a more testing time for the single currency and its 17 member states as the world looks to see ifEuropecan really implement the landmark accord to tame a two-year-long debt crisis.

Analysts say the eurozone is not out of the woods and whileGreecemay have gained some breathing space through the deal, Draghi’s home country ofItalyis fully in the spotlight as it grapples with its massive debt.

Furthermore, with economic growth slowing noticeably across the globe, the spectre of recession has not been completely banished.

“Good luck, Mr Draghi — you will need it,” wrote the British daily The Telegraph in its edition on Friday.

Analysts agree that the legacy of Trichet, who for the past few years has been trying to steer the euro and the ECB through the toughest crisis in their short existence, is still unclear.

In May 2010, the Frenchman took perhaps one of the most controversial steps of his career when he decided the ECB should buy the bonds of eurozone countries that were having difficulty in getting financing the usual way via the markets.

Trichet, who was nicknamed the “Ayatollah of the strong franc” during his time as governor of the Bank of France, justified the move by insisting it was only a temporary measure.

But his critics argued it took the ECB beyond its core mandate, which is to keep a lid on inflation in the 17-nation eurozone.

Two of the ECB’s most experienced German policymakers — Bundesbank President Axel Weber and chief economist Juergen Stark — resigned in protest.

“The jury is necessarily still out on whether Jean-Claude Trichet will be the man who saved the Euro,” wrote Guntram Wolff, deputy director of the Brussels-based think-tank Bruegel, in a recent report.

Nevertheless, while the ECB was first seen as an institution that only set interest rates, under Trichet’s leadership it has taken on much more “far-reaching competencies and broad executive authority” and now played a “leading role in assuring financial stability in the euro area,” Wolff wrote.

For incoming Draghi, there are a number of key challenges, he added.

Amid calls for a cut in interest rates to combat the economic slowdown, the ECB has to also show that it is keeping a close watch on inflation.

The ECB would also have to reconsider the role it should play in the sovereign debt crisis, particularly after the latest developments.

At the same time, it should continue to work for a true euro-area fiscal authority, and last but not least, seek to regain the trust of EU citizens which has deteriorated sharply in recent months, Wolff argued.

Turning to possible interest rate moves, ECB watchers believe it will be too early for Draghi to announce a cut just two days after taking office, even if such a move might be warranted on the economic side.

Berenberg Bank economist Christian Schulz said a rate cut could have “a positive growth impact without shifting inflation risks to the upside” but Draghi would likely wait until December when the ECB’s next economic estimates are published.

Jennifer McKeown, senior European economist at Capital Economics, similarly felt the latest economic data “point strongly to the need for more policy support (but) there have been few hints that the ECB is intending to cut interest rates at its November meeting.”

Nevertheless, Draghi “is likely both to signal a rate cut in December and pledge to maintain the ECB’s unconventional support in the form of both unlimited lending to banks and further … bond purchases,” she said.

Commerzbank economist Michael Schubert believed the ECB “will probably have to considerably trim back its growth and inflation outlook before it is ready to slash rates.”

It’s hard to get a fix, as it were, on what the sudden drop in the gold price means because at the same time as the US dollar has rallied strongly, the Chicago futures exchange operator, CME Group, has whacked up margin requirements.

The minimum cash deposit for trading gold futures has been hiked by 21 per cent to $US11,475 per 100 ounce contract. The deposit for trading silver has been lifted by 15 per cent to $US24,975.

Speculators are dumping their contracts and fleeing the market, which is perhaps not a bad thing, and the gold price has returned to its five-year trend line on the charts.

Gold and silver futures prices were already falling as part of a widespread commodity bust and because the US dollar has gone up 6 per cent this month. There are now massive realignments taking place among currencies.

Gold – everybody’s favourite alternative currency – dropped 9.3 per cent in two days last week, its biggest two-day fall since 1983, and the Australian dollar has plunged nearly 10 per cent.

Commodity futures generally are dropping like so many stones, as speculators flee rising margin requirements and, more fundamentally, rethink speculative trading strategies entirely.

Global investors appear to have gone into capital preservation mode in a way that was not evident after the 2008 crisis.

That was because in 2008 central banks responded to the Lehman Brothers and AIG collapses by flooding the world with sustained liquidity, which led to a renewed burst of speculation in commodities.

Liquidity is now evaporating again because of the Greek default threat but central banks are in no position to ante up another flood of liquidity, and governments are in an even weaker position to provide fiscal support.

So not only are recessions now more likely in the advanced economies, there’s no money to be playing with commodity futures for quick trading gains. And the capital preservation strategy of last resort is the US dollar – cash or bonds.

As an aside: the jump in the US dollar is the last thing the United States needs right now. It desperately needs to increase exports to offset the weak consumer spending at home.

Do you believe what government officials and experts are saying about the debt crisis?

If so, you’re taking your financial life into your hands.

Just consider how many times they’ve been wrong,

issued deliberately misleading statements, or simply lied:

In 2007, they swore on a stack of Bibles that the debt crisis

was limited to sub-prime mortgages.

But the crisis promptly spread to all kinds of mortgages,

ripping through giant mortgage lenders like Countrywide,

Fannie Mae, and Freddie Mac.

In 2008, they admitted it had spread,

but swore that it was strictly contained to the housing and mortgage sector.

But in a few short months, it had enveloped commercial paper,

money markets, and nearly all of Wall Street.

Nearly every one ofAmerica’s largest banks either failed

or came within a hair of insolvency.

In late 2009, they rescued the bankrupt banks and mortgage lenders

using the $700 billion in emergency capital approved

under the Trouble Asset Relief Program (TARP).

Then, they ran deliberately lenient “stress tests”

on the biggest banks to “prove” to the public

that the emergency had passed.

But with the government now assuming liability for trillions of mortgages

and other bank obligations,

they transformed a Wall Street debt disaster

into an even largerWashingtondebt disaster:

The federal deficit ballooned to four times its pre-crisis size.

And in the euro zone,

where governments had also pumped massive sums into bankrupt banks,

the weakest countries likeGreecebegan to collapse.

In 2010, the European Union and the International Monetary Fund

put together a sovereign debt rescue package

that was even larger than TARP.

They pulledGreecefrom the precipice and

vowed never to let the contagion reel out of control.

But within a few short months,

the contagion toppledIrelandandPortugal

threatened a similar fate forSpain,Italy, andBelgium,

and even raised serious questions about the financial fate

of the two largest economies in the euro zone -FranceandGermany.

Clearly, each outbreak of the contagion, each government rescue,

and each new happy-talk pronouncement

has merely spawned a bigger disaster, impacting bigger institutions.

Has gutted the portfolios of more investors,

and ruining the lives of millions more Americans.

Now, here we are halfway into 2011 and they’re at it again.

This time with a complete package of misleading statements

and lies that make all previous ones seem candid by comparison.

Lie #1. They’re again saying that the debt crisis of 2008-09 is “history.”

The truth: The core cause of the crisis —

the gigantic pyramid of high-risk derivatives —

has never gone away.

Quite the contrary, the pile-up of derivatives on the books

of majorU.S.banks is now much larger — $244 trillion,

compared to less than $200 trillion before the debt crisis,

according to the U.S. Comptroller of the Currency (OCC).

Lie #2. They say thatAmerica’s largest banks have virtually no exposure

to a Greek debt default or a broader European sovereign debt crisis.

The truth: All major European andU.S. banks are linked through an even larger global network of derivatives,

now representing more than $600 trillion,

according to the Bank of International Settlements.

Therefore, even thoughU.S.banks may not hold large amounts

of European debts themselves,

they are directly exposed to European banks

that do hold large amounts of loans to

Greece,Ireland,Portugal, and others in jeopardy.

Lie #3. They insist thatAmerica’s largest banks are safe.

The truth: The largestU.S. banks continue to hold

nearly all of the derivatives in the country.

Goldman Sachs has $44.9 trillion in derivatives.

Bank of America has $52.5 trillion.

Citibank has $54.1 trillion.

And JPMorgan Chase towers over all others with $79.5 trillion

of these potentially dangerous investments.

In total, JPMorgan, Goldman, Citibank, and the BofA alone are exposed to $234.7 trillion in derivatives.

In contrast, among the thousands of other U.S.banks, the grand total of derivatives is a meagre $9.3 trillion.

In other words, these four banks are exposed to more than 25 times

the sum total of all derivatives held by every other bank in theUnited States.

Never before has so much financial power — and risk — been concentrated in the hands of so few!

Yes, these numbers, reflecting the “notional” value

of the financial instruments at play,

are far larger than the actual amounts invested.

But still, the risks are huge …

The derivatives held by Bank of America are

36 times larger than TOTAL assets;

At JPMorgan Chase, they’re 46.1 times larger than the assets;

At Citibank, 46.6 times larger; and

At Goldman Sachs Bank, a shocking 533 times larger!

Yes, in recent months,

some banks have reduced somewhat their exposure to defaults

by their counterparties.

But here again, the exposure remains massive:

According to the OCC, for each dollar of capital …

Bank of America has $1.82 in credit exposure to derivatives;

Citibank also has $1.82;

JPMorgan Chase has $2.75; and

Goldman Sachs is, again, at the greatest risk of all —

with $7.81 in credit exposure for each dollar of capital.

That means that if JPMorgan’s counterparties defaulted on 36% of their derivatives, every last dime of the company’s capital would be wiped out.

And at Goldman Sachs,

defaults on just 13% of its derivatives would wipe out its capital.

Lie #4. Misinformation about the government’s supersized debts is equally egregious.

They want you to believe that, although large,

the government’s debts are far below the danger zone —

thought to be around 100% ofGDP.

The truth: According to the Fed’s latest Flow of Funds report, the U.S. Treasury owes a total of $9.6 trillion, 64% ofGDP, which isn’t too bad.

But the U.S.government is also responsible for $7.6 trillion in debts

owed by government agencies, such as Fannie Mae and Freddie Mac.

The U.S.government’s total debt burden: $17.2 trillion

or 115% of GDP—

similar or WORSE than that of countries like

Greece, Ireland, Portugal, and Spain!

Lie #5. They argue thatAmerica is special because it controls the world’s dominant reserve currency.

The truth: Yes, that givesWashington the ability to print money with impunity … press other rich countries to accept its debts,

and borrow huge amounts abroad to finance its deficits.

But it’s more of a curse than a blessing!

It means that, more so than any other major nation,

theU.S.government is beholden to investors overseas —

often the same investors who have repeatedly attacked countries

like Greece and Ireland.

Ultimately, that could make the  U.S.even more vulnerable than Europe.

Now the question is, what do you think?

The debate is Australia is often confused by Slogans that Politicians pump out, to gloss over the truth,

and to make you to think everything is not OK,

except if things where handled their way they would fix it.

And the problem would go away. That is far too simple.

The truth of the matter is far more complex than that.

And while facts presented here are correct,

does it actually mean the USA economy is at risk?

Well to clarify the issues you really need to understand how “Hedge” markets operate, and what is the size of the overall world market? And which other institutions share the risk? Or how they mitigate it?

The role of the Hedge market is actually to mitigate risk, not create risk.

Certainly there are speculators playing in the market, and spikes in the market soon show if interest in a particular area is out of proportion with the rest of the market. To rely on regulators and Government authorities to manage or monitor excesses in this market is extremely difficult. You need to assess this whole complex area with a clear mind, and measure the potentiality of any risk that could cause this market area to implode.

Complex yes but not outside a reasoned explanation that would reduce the level of anxiety that the tenor of this article creates.

 Tell me what you think? 

The world’s biggest economy, the United States, may be spurning the opportunity to develop coherent climate change and energy policies, but the world’s biggest individual consumer of energy, the US Department of Defence, is certainly not.

The world of climate change policies is full of unlikely contradictions. In Australia, a Labor/Green coalition pushes for a market-based system to reduce emissions while the small government Tories argue for increased government intervention. In the US, the government finds itself incapable of providing the market signals that could unleash the forces of innovation, so the task of driving innovation and providing the budgets to bridge the path to commercialisation has fallen to its largest subsidiary, the United States Armed Forces.

Ambitious renewable energy policies are usually criticised for being both costly and risky, but the US Army, Navy and Air Force have a counter-intuitive view: they have developed the most ambitious policies anywhere in the world because they want to cut their costs and increase their security. The US Navy plans to replace 50 per cent of its petroleum consumption with alternative fuels by 2015, and wants half its overall energy consumption to be sourced from alternatives by 2020. The US Air Force wants to wants to source 50 per cent of its jet fuel from alternative fuels by 2016, while the US Army wants to sources 25 per cent of its energy needs from renewable sources by 2025.

US Navy secretary Ray Mabus recently said its pro-active position shouldn’t be a surpise, having helped pioneer the switch from from sail to coal for powering its ships in the mid-19th century, then the switch from coal to oil, and later from oil to nuclear power. It recently launched the first hybrid electric ship, dubbed the Prius of the sea.

In an environment where so many dismiss renewables as being either too hard or too expensive, it is refreshing to hear the Navy’s ambition. “Every time there were naysayers, who said you’re trading one form of proven, available energy for another that is expensive and not well known, and you shouldn’t do it,” Mabus told a conference in New York last month. “Every single time, those naysayers have been proved absolutely wrong, and they’ll be proved wrong this time.”

Lockheed Martin

These mandates have certainly grabbed the attention of the US armed forces’ principal contractors, such as Lockheed Martin, which has devoted much of the resources of its 140,000 engineers and scientists on to the energy sector. “We’ve been pretty good at getting people into space, make airplanes that fly upside down and backwards, and making fast ships. Now we’re applying those resources to energy,” says Christopher Myer, Lockheed Martin’s vice president in international business and energy markets, who is in Melbourne attending Clean Energy Week.

Some of the ideas it is pursuing are highly experimental. It recently won a $US400 million contract to develop high altitude blimps that are powered by flexible solar panels and fuel cells. It has also been mandated by the US Navy to develop a power plant using ocean thermal energy conversion (OTEC), where cold water is piped from the ocean’s depths and the energy generated from the temperature differential with the warm surface water is harnessed to drive a conventional rankine cycle turbine. Some say such technology has the potential to provide one third of the world’s energy needs.

Navy to reduce Costs

In any case, the Navy is keen to develop 24/7 energy sources. Hawaii currently relies on imported diesel for 96 per cent of its energy requirements, exporting more than $6 billion a year to fund those imports. WillOTECbe cheaper? “Not initially,” says Myers. “But over the long run, yes.”

The Navy’s huge bases at Guam and the Marshall Islands rely almost exclusively on burning oil. In Guam, it burns more than 10,600 barrels of oil a day, and wants 80MW of renewable energy installed within two years. On the Marshall Islands, it imports 30 per cent more oil, and pays nearly 40c/kWh for its energy needs – more than the cost of virtually any renewable source. Mabus said recently that every rise of $1 a barrel in the price of oil adds $30 million to its fuel bill. He says the single hybrid electric ship will save $250 million in fuel costs over the lifetime of the ship. The scale of its mandate is credited with a 50 per cent fall in the price of biofuels in 2010.

Lockheed Martin has also teamed up with several different wave and tidal companies to explore ocean energy sources, including for remote sensor buoys, and is investing heavily in alternative fuels, including algae and synthetics.

It is looking at the development of solar and fuel cell technologies for army bases, as well as generating energy from waste materials from those bases. It is a question of both energy security and personal security – most losses of life in the theatre of war occur along fuel supply lines. Lockheed also has contracts to develop woody biomass power plants, and others fueled by medical waste from army and veteran hospitals. And it is also investing heavily in concentrating solar thermal, applying its engineering expertise to look at how production processes can be improved to lower costs.

Interestingly, for Australian innovators and emerging renewable developers, Lockheed Martin is on the lookout for good ideas – particularly in the biodiesel sector, but also in other renewables – that could benefit from its contacts with the defence department, its massive balance sheet, and its expertise in project delivery. “Most innovative technologies struggle to get a product to market,” Myers says. “We can partner them and offer the product to the US government and others. We are a large company, we can close on projects, and we can give banks comfort.”

And if you doubt the Navy’s determination to wean itself off fossil fuels, consider this undertaking by Mabus: By next year, he wants to demonstrate a “Green Strike Group” composed of nuclear vessels and ships powered by biofuel. By 2016, he wants to sail the Strike Group as a “Great Green Fleet” composed uniquely of nuclear ships, surface combatants equipped with hybrid electric alternative power systems running on biofuel, and aircraft running on biofuel.

And Australian politicians fret over suggestions that they should mandate a marginal improvement in car fuel efficiency.

Joseph Stiglitz, the writer is a recipient of the 2001 Nobel Memorial Prize in economics and University Professor at Columbia University.

The names of the Beijing Group are: Professor Joseph Stiglitz, Professor Jean-Paul Fitoussi, Professor Haihong Gao, Professor Stephany Griffith-Jones, Professor Yiping Huang, Professor Peter Kenen, Professor Jing Li, Professor Jose Antonio Ocampo, Professor Yaga Venugopal Reddy, Dr Ulrich Volz, Professor Robert Wade, Mr Benhua Wei, Professor John Williamson, Professor Wing Thye Woo, Professor Geng Xiao, Professor Yu Yongding, Professor Liqing Zhang, Professor Zhu Andong

The international monetary system needs fundamental reform. It is not the cause of the recent imbalances and current instability in the global economy, but it certainly has been ineffective in addressing them. So a broad set of reforms is required, beginning with an immediate expansion of the current system of special drawing rights or money that can be issued by the International Monetary Fund. And here the Group of 20 leading nations must take the lead.

John Maynard Keynes once proposed a global currency, the Bancor, to be placed at the centre of the international monetary system. The idea never caught on. Instead, we now have a system dominated by holdings of US dollars. This has several disadvantages. The first is it creates a global recessionary bias during and after financial crises – because it places the burden of adjusting to payments imbalances on nations which run a deficit.

The second is the tension it creates, due to the use of a national currency, the dollar, as the global currency. This can lead to global volatility as a result of growing US current account deficits. These deficits are necessary, for creating sufficient global liquidity, but they also generate excessive indebtedness, both external and internal. So if the US were to shrink its deficit too quickly, a deficiency of supply of the global reserve currency could result.

Responses to global financial instability creates the third problem, where developing countries have accumulated large reserves as “self-insurance” against a future balance of payments crisis. These protect them during crises, but also add to global imbalances.

In the late 1960s a more limited global currency was created: the SDRs, issued by the IMF when enough member countries agree. The largest such issue – equivalent to $250 billion, and suggested by the G20 in April 2009 – was an enlightened response to the dramatic collapse in international private lending after the global financial crisis. It helped soften the negative impact of the crisis on growth.

Now, in the same way, the global role of SDRs should be increased, both through new issues and a bigger role for SDRs in IMF lending. New SDR issues could be introduced in times of declines in private capital flows or large falls of global commodity prices. These would increase the ability of current account deficit countries, such as Pakistan or Egypt, if they were hit by an external shock.

In practical terms the G20 should encourage the IMF to issue a significant amount of new SDRs during the next three years, up to a value of $390 billion a year. Such a move would have a number of benefits. It would reduce the problem of recessionary bias, by allowing central banks to exchange SDRs for hard currency, such as dollars or euros, and use it to finance higher imports. It would partially replace countries’ need to accumulate reserves. Given its relatively small scale, more SDRs would also help to sustain and accelerate recovery of the world economy, without leading to inflationary pressures. And by reducing the need for countries to set aside foreign exchange reserves, it would also facilitate some reduction in global imbalances.

New measures to increase the effectiveness of SDRs themselves are also needed. One way would be for the IMF to use these SDRS to finance lending to countries that need short-term financing, due to balance of payments constraints, as happened recently in Greece and Ireland. Eventually SDRs could become the main, or even the only, mechanism for IMF financing.

Further, when crises occur in many countries simultaneously, as happened, for instance, during the 1998 east Asian crisis, IMF lending could be totally financed by new SDR issues in unlimited amounts. If and when the world economy recovered or boomed, SDR issues could then cease, or even be reabsorbed. Thus the IMF would have a greater role in creating official liquidity, in a way that curbed both recessionary and inflationary trends at different times.

All of this would make a contribution to enhancing global stability, without altering in any fundamental way existing monetary arrangements. And the dollar would continue as the main currency for private transactions, making this change more acceptable to the US.

The G20 showed its effectiveness in responding to the financial crisis. The question today is, with the passing of the worst and emergence of large divergences in perspectives, can the G20 again demonstrate the leadership the world needs? A swift expansion of the SDR system would show this continued leadership. More importantly, it would also ensure greater stability and more sustained growth in the world economy.

There has been much discussion over recent months about whether Australia’s house prices are too high, and indeed whether there is a house price ‘bubble’. This notion is typified by the Economist magazine’s regular update suggesting that Australia’s house prices are up to 50 per cent overvalued against standard naive measures.

Our view is that these metrics are indeed too naive to be useful. Typically they take a measure of housing prices to income or to rents and compare the current level to a 15- or 20-year average. This ignores a large structural adjustment that occurred in the Australian housing market between 1997 and 2003. This transition involved lower interest rates, better-anchored inflation expectations, and increased availability of housing credit. Without some reversal of these structural changes – which is a virtual impossibility – we do not expect Australian housing prices to fall.

Indeed, we expect them to track sideways in the short term and then rise in line with household disposable incomes – consistent with recent history. Since late 2003 the dwelling price to income ratio has been broadly stable at between 3.5 and 4.5 and has averaged 4 (see chart). As we are forecasting growth in household disposable income per household of around 5 per cent per annum over the next couple of years (as a result of strong employment and wages growth), we also have in mind that house prices will grow at this pace over the next couple of years.

Supply features of the housing market support this assessment. Most forecasters, including official agencies, suggest that Australia has an undersupply of housing. This assessment is most simply made by comparing growth in the number of dwellings to population. As we pointed out above, since 2006, population growth has exceeded new supply of dwellings, which is the first time this has happened in the postwar era. This will put a floor under housing prices and is a key reason why we have little concern about a sharp (or large) house price decline.

More fundamentally, we do agree that housing is fairly expensive in Australia, though we see good reasons for this.

First, the quality of the housing stock is high. Australia has the largest dwellings in the world, and they are of high quality. Estimates suggest that the average Australian dwelling is 214 square metres, and real expenditure on new dwellings is now 60 per cent higher than it was 15 years ago, reflecting the increase in both the size and quality of dwellings.

Second, well-located dwellings are in particularly limited supply. This reflects that most dwellings in Australia are on relatively large blocks of land, there are fewer apartments in Australia than in many other nations (particularly in the suburbs close to city centres), and there is little appetite from local government authorities for significant change in this regard.

Third, public transport from outer suburbs in most cities is generally of fairly low quality, limiting the distance which people can productively live from the city centres and further enhancing demand for property in the centre of the cities.

Lastly, there is a lack of affordable land at the fringes of major cities. This is due to state governments seeking to front-load infrastructure costs into the land release price and also some issues with land investors holding large swathes of land in anticipation of future capital gains – and not being prepared to sell this land in adequate quantities in the short run to meet demand.

Importantly, despite relatively high levels of household debt in Australia, the households that hold this debt can still service mortgages. Less than 1 per cent of mortgages are in arrears in Australia, which is internationally low. This of course reflects that the Australian economy had a relatively mild downturn, with housing prices falling only 3 per cent in 2008 before rising around 20 per cent over 2009 and early 2010 and leveling out subsequently. It also reflects that the unemployment rate has remained relatively low.

However, there are other reasons why levels of household debt should not be a large concern. The key one is that 75 per cent of all household debt in Australia is held by the top 40 per cent of income earners. If we look even deeper, we find that only a small proportion of households are truly in a vulnerable state regarding their ability to continue to service their mortgages. Vulnerable households – in this case, ones that have a loan-to-valuation ratio of 90 per cent or above and also use more than 50 per cent of their disposable income to service their mortgages – constitute less than 2 per cent of all owner-occupied households with debt in Australia.

Slower housing credit growth in recent years, due partly to lower housing turnover, has also meant that the Australian mortgage book is ageing. This reduces the risk of repayment problems, as households with a longer history of repayment tend to be better risks. The credit foncier model of repayments suggests that these households are now repaying a greater amount of principal and less interest, so that households have built up equity in their homes and could run this down in a crisis.

The structure of the mortgage market and tax system in Australia is also such that most households are ahead of schedule in their mortgage repayments. This would provide a buffer in the case of a negative income shock to households, such as increased unemployment.

In the event of a large negative shock to the Australian economy, there are also a number of contingencies built into the system that would somewhat protect the housing market. These were vividly displayed during the GFC. The RBA would cut interest rates, the fiscal authorities would boost spending, and the exchange rate would depreciate. As we discussed above, with most of the mortgages at variable rates, the monetary transmission mechanism is very powerful, and very low net government debt – it is forecast to peak at 6 per cent of GDP in 2012/13 – means the government also has significant capacity to spend.

Overall, with strong prospects for the Australian economy, on the back of high commodity prices driving a mining investment boom and rising incomes, we expect that housing prices will continue to grow at a modest pace over the next few years. We view the risk of a sharp fall in housing prices as very low.

I have been hearing self-appointed experts say for a couple of years now that there is a housing bubble, and that property values are going to fall from the sky. We are all doomed, and everybody should sell their property now, or risk facing massive losses.

If you say something for long enough, eventually, that fact will become true. However over a period of a year or more, then these “experts” should admit they got it wrong, and the media should pay scant attention to them.

Of course that won’t happen. Headlines like “Housing prices to remains stable” won’t sell newspapers now will they?

The fact is that housing prices (let’s take Melbourne for example), will not drop appreciably. And there is a simple, basic reason underwriting that. Supply and demand.

So instead of guessing, maybe let’s look at who and what controls supply, and who controls demand.

Supply variables are:

(a) Physical barriers such as water, cliffs, freeways, etc (which we can do little about)

(b) Labor and materials cost (which are set by the market)

(c) Financiers – by way of access to funding for developers and builders

(d) By far the biggest controller of supply are zoning and planning restrictions. Daylight second.

These of course are controlled through the local councils (through zoning ordinances) and the State Government, through their Melbourne 2020 vision and their masterplan.

The adage “they are not making any more land” is not applicable. Smaller lot sizes creates more lots, and higher densities creates more living accommodation, albeit airspace. And the sole controller of this is local and State governments.

As to supply, let’s not forget that the Victorian government (via VicUrban) are by far the largest holder of residential land around Melbourne.

So they almost completely control the supply of vacant land, and by extension control land prices through controlled land releases. They are understandably, increasing lot prices with each stage to maximise their asset sales.

The State government also encourage interstate and international migration (both of which are very strong), thereby increasing demand for housing in a market where rental vacancies are still quite low. So they are the largest controller of demand as well.

I can’t see VicUrban decreasing land prices. Nor can I see the State government discouraging new investment or migration to the State. So there will be no change to this balance.

And if land underpins property values, and land prices around the fringe remain stable (as a result of the majority of land being held by VicUrban and a couple of large scale developers), how can the value of a property that is a piece of land with a house on it drop? Especially if it is more centrally located that the fringe areas so tightly held? And if house and land prices are supported through land prices, then apartment prices will be supported through house and land prices.

There is so little thought gone into claims the market will drop. Either that, or people just do not understand the asset class.

We are not in an asset bubble. There will be no bursting, as there is no bubble to burst. Unless the State Government goes bankrupt and has to liquidate its assets at firesale prices, at best there will be a stagnation of pricing.

If you still don’t believe me, consider what will happen if prices drop:

• If prices do drop by the 20 per cent or more that doomsdayers are saying, people who are renting now will see that owning is now suddenly so affordable compared to the price of rent, that demand will spike and prices will rise again as a result of sellers who want to maximize their sale price.
• If prices do drop by 20 per cent, then the first home buyer in the suburbs who has just purchased their first house and land package for $400K (which cost $220K to purchase the land and $180K to build), will now own a property that is worth $320K. The land is still worth the same amount – the State government (nor privately owned developers for that matter), are not going to drop land prices.

The impact of this is that builders will need to build new houses now for $100K which was formerly being built for $180K. Let’s say the average builder margin is 18 per cent, the raw cost of materials and labor alone is about $152K. Builders will be out of business in a hurry, as they would be losing $52K on the contract for the above example. The result – no new housing built.

So when we see an ever increasing population, in a market where rental vacancies are already low, and no new stock being built, what will happen to demand? It will increase rapidly, and again support housing value.

The only other single controller of property prices are banks. They can control a false market by creating demand from buyers by way of how easy it is to obtain credit, and how cheap it is. Which is exactly what happened in the US.

Getting credit in Australia is not easy for a buyer. It really never has been. It is hard. And it is certainly not cheap. The brakes have been applied in full for nearly three years. So there has been no false market lifting property prices over this period. Yet, prices still increased. And strongly. Which suggests that the banks carry little weight in determining current housing prices.

Over the past six months, it has loosening slightly which should further increase demand slightly.

Forget about statistics. Statistics are just numbers. They explain nothing. Anyone that claims that prices must decrease just because the numbers are unsustainable is not thinking.

It is ridiculous to compare the “affordability” of housing (an inappropriately named measure in and of itself in its current format) from one country to another. Not all countries have the same lending policy, the same interest rates, the same deposit requirements, the same loan term, the same control measures, the same population changes in percentage terms, or the same taxation (impacting on after tax income which can be contributed towards debt servicing; as well as Australia’s negative gearing laws which in turn attract investors to housing).

Buyers rarely pay cash for their property. Most people need to borrow. Finance as a result is integral to housing prices, and always will be. But as a buyer, what would you rather buy?

• A house for $300K with 20 per cent deposit and 20 per cent interest rate? (where repayments are over $5,000.00 per month); or
• The same house for $500K with zero per cent deposit and zero per cent interest rate? (where repayments are only $1390.00 per month)

The latter – because the actual property price is not how much you pay to purchase the property – the actual price is how much is costs to get into the property (the deposit) and how much it costs you on a regular basis (your mortgage payments).

If interest rates were zero per cent, demand would skyrocket. But they are not. The standard variable rate is about 7.8 per cent amongst the majors. That is not a low rate. So access to easy finance is not the variable setting the market. Supply and demand is.

And when mortgage payments are comparable to rent, people will be attracted to ownership almost every time.

Despite being hard at work on the second edition of Debunking Economics , the latest Australian GDP figures caught my eye and have given me an important opportunity to update the Credit Impulse data for Australia, which has implications for both employment and asset prices – and especially house prices.

For those unfamiliar with the term, the Credit Impulse is the change in the change in debt, divided by GDP. It plays a major role in driving economic and asset market performance because, in our credit driven economies, aggregate demand is the sum of income plus the change in debt. Consequently, the change in aggregate demand is the sum of the change in income plus the acceleration of debt.

Therefore, a constant level of aggregate demand requires constantly rising GDP – which is unlikely in itself – and constantly accelerating debt. The only rate of acceleration for which this is possible is zero: debt (in real terms) would have to remain constant for constant growth in aggregate demand to be possible.

Since instead debt growth is volatile, the economy is necessarily cyclical: a period of accelerating debt must be followed at some stage by decelerating debt – otherwise debt would become infinitely larger than GDP.

A large part of why Australia got through the GFC so well – so far – is that government policy encouraged the Credit Impulse here to stop falling and turn around far earlier than occurred in the US.

If this relationship is a bit difficult to grasp, the comparison of debt-financed demand makes it clearer: whereas the US was hit by serious de-leveraging, Australia stopped just shy of de-leveraging and then re-levered its way back to debt-financed prosperity.

 The debt-driven boost to aggregate demand was the major reason that we sailed through the GFC. The role of the First Home Owners’ Boost (which, as regular readers know, I refer to as the First Home Vendors’ Boost because of who it truly benefited) in motivating this is obvious when one compares the trend in mortgage debt before it to what happened after: there was an effective turnaround of over 8 per cent of GDP, pumping an additional $100 billion into the economy. It also meant that while US mortgage debt was plunging, ours was exploding – and of course driving house prices up with it.

The most recent data for Australia now implies that the China boost has taken over this role of keeping the Australian economy buoyant, though whether this will avert a downturn as the housing sector slows is a moot point: on a yearly basis, the Credit Impulse has peaked and is now turning back towards zero, but on quarterly basis (the bars below show change from three months ago every month, scaled to an annual rate of change), the Credit Impulse has been negative for six of the last nine months, but positive for the last two months.
The reason is this “changing of the guard” from the household to the business sector. Whereas household borrowing – motivated by the FHVB – counterbalanced a dramatically negative pulse from the business sector, now the business sector – motivated by exports to China – has switched from decelerating to accelerating debt.

That doesn’t mean that business debt is rising however – just that it’s falling less rapidly than it was when the GFC first hit. Business debt continues to fall relative to GDP, and now that the FHVB is over, household debt is also headed down (though just to confuse things slightly more, it appears to have headed up slightly in the last month).

Not only does Australia have a two-speed economy, from a Credit Impulse point of view, the faster half (business borrowing, especially by the export sector) is far more volatile.

The slow part that actually got us through the GFC (the household sector, and especially mortgage debt) is now decelerating (though again, the next month’s data might show a positive.)

Just as the rise in mortgage debt was what drove prices up, this decline in the credit impulse from mortgage debt is the real reason that Australian house prices are now falling (though of course the first swallow of the end of the house price bubble is not falling prices but rising inventories of unsold properties).

This is as good a place as any to knock the property spruiker furphy that underlying demand from population growth exceeding dwelling construction needs is the cause of house price rises in Australia (whereas for the rest of the world they’re happy to blame irresponsible lending now that all the other bubbles have burst). This is the correlation of new lending to the change in nominal house prices.

When we look at the change in mortgage debt and change in house prices, we get a pattern to support these findings.

And the following correlations apply: it seems that changes in mortgage debt lead changes in house prices by about eight months to a year.

So a reasonable statistical case can be made that mortgage debt and house prices are correlated, and mortgage debt leads house prices. What about the spruiker’s case that population growth exceeding dwelling construction is the real reason?  

And here’s the correlation data: it’s the wrong sign, trivial in magnitude, and considering leads and lags makes the correlation worse, not better.

So get used to it: mortgage debt drives house prices, and growth in mortgage debt is now ending. The recent falls in house prices are just the beginning.

In the aggregate, Australia’s debt ratio is now headed down again, after the fall was temporarily reversed by the FHVB.

How far this will go remains to be seen. On the historic record, it still has a long way to go.

NOW CONSIDER WHAT’S HAPPENING ON THE GOLD COAST:

Gold Coast property is facing oversupply conditions, with banks and major lenders exposed to falling values, according to an insolvency firm speaking at an Australian Financial Review property conference.

KordaMentha partner Mark Korda told the conference more than 2,000 apartments worth around $2 billion were up for sale, with few buyers meaning just 300 apartments were selling on average each year.

Mr Korda said there was anywhere between a five and seven-year supply of apartments on the market, with developers and property investors no longer able to rely on cheap money to snap them up, according to the AFR.

National Australia Bank head of property Andrew Balzan confirmed it was more difficult for investors to get finance, with the bank less likely to lend to the Gold Coast apartment market, according to the report.

The global economy is poised to enjoy decades of robust growth, as a number of poor countries play “catch-up” to the rich industrialised countries in terms of income and living standards, according to Citigroup’s global chief economist, Willem Buiter.

In a major new report, Global Growth Generators, Buiter nominates 11 countries that are most likely to drive global growth – and generate profitable investment opportunities – over coming decades. These ’3G’ countries are Bangladesh, China, Egypt, India, Indonesia, Iraq, Mongolia, Nigeria, Philippines, Sri Lanka and Vietnam.

As Buiter notes, all of these countries are currently poor, so their catch-up growth is likely to span decades. A number of them (Nigeria, Mongolia, Iraq and Indonesia) are also well-endowed with natural resources. And all – except China – enjoy favourable demographics.

As well, Buiter says that other countries, such as Mexico, Brazil, Turkey and Thailand, will likely enjoy rapid growth. But these countries need to make some economic adjustments, including boosting their domestic savings and investment levels, before they qualify for the 3G list.

Buiter, who is a former member of the Bank of England’s monetary policy committee, has a “fairly optimistic” outlook for real global GDP growth over the next four decades. He expects the world economy to grow in real terms by 4.2 per cent per annum between 2010 and 2050, which would boost real world GDP from $US72 trillion to $US380 trillion (measured in 2010 dollars).

The fastest growing regions will be Africa (which is forecast to grow real GDP by 7 per cent annually between 2010 and 2050), and developing Asia (5.4 per cent). Other regions such as central and eastern Europe, the former Soviet republics, Latin America and the Middle East are also likely to enjoy solid growth.

In contrast, the industrialised nations will see much more subdued growth.

Buiter notes that broad and sustained growth in real GDP per capita in today’s poorer economies will “much reduce the – often enormous – gap between their per capita incomes and those of today’s richest economies, i.e. we expect catch-up or convergence in per capita incomes.”

There will also be a shift in the balance of global economic power. North America and Western Europe’s share of real global GDP will likely drop from 41 per cent of global GDP in 2010, to just 18 per cent by 2050. On the other hand, developing Asia’s share of real global GDP is likely to jump from 27 per cent to 49 per cent by 2050.

China, Buiter predicts, will overtake the United States to become the world’s largest economy by 2020, only to in turn be eclipsed by India by 2050.

Buiter points out that sustained and widespread GDP growth is a fairly recent phenomenon, and that for most of human history improvements in living standards were virtually imperceptible. Indeed, there were long periods of time where living standards were steady, or even declined.

But more recently, a number of poor countries – mostly in East Asia, but also in the Middle East and elsewhere – have started to catch-up, reducing the gap between their living standards and productivity levels with those of the industrialised world.

Buiter argues the big game-changers have been globalisation – which has allowed for the freer movement of goods and factors of production – and the spread of the free-market economic model. Former communist and centrally planned economies have embraced some form of a market economy, as have other inward-looking poor countries that previously emphasised economic self-sufficiency, and whose intrusive regulation stifled economic activity.

These two factors only reached China in the 1980s, and for India, the former Soviet Union and the former central European countries in the early 1990s.

But, he says, the convergence process – as poorer countries catch-up with the richer countries in terms of productivity and income per head – will take decades.

“Despite the spectacular growth in China since about 1980 and in India since the early 1990s, real convergence of economy-wide productivity and income levels has barely started, with China’s real per capita GDP at barely 20 per cent of that of the US and India still well below the 10 per cent mark.

“There are, given the right institutions and policies, decades of catch-up growth in prospect even for China, and generations of catch-up growth for India. Many other countries in East Asia have also reached but a fraction of US per capita income levels. Some of them, such as Thailand, have seen fairly high per capita growth rates in past few decades already. Others, such as the Philippines, have not. All of them could potentially look forward to decades or generations of fast growth – as could many poor countries in other regions, particularly in Africa. “

Buiter says there are a number of factors that are favourable to high rates of economic growth, such as having a young population, having high quality institutions, promoting an open market-oriented economic structure, and encouraging foreign companies to invest directly in the country (which introduces superior technology, know-how and expertise). In addition, he says, it is important to focus (limited) public spending on infrastructure, health and education, and to encourage high levels of local savings to fund investment (relying on foreign savings can be risky).

Despite his relatively upbeat outlook for the global economy, Buiter warns that the path ahead will be “bumpy”.

“There will be busts as well as booms. Beware of any proclamations of an end of volatility. Poor policies, conflict and natural disasters will change the growth equation for some countries in a negative way.”

Still, he has little doubt “that the prospects for broad, sustained growth in per capita incomes across the world have not been as favourable as they are today for a long time – possibly in human history.”