June 2020
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Net Foreign Debt Wagging the Money Supply Dog

M3 Money Supply and Net Foreign Debt - Australia

Source: RBA Statistics

The graph above fairly clearly indicates that Net Foreign Debt (NFD) is a leading indicator for changes in M3 money supply. It looks like there is around a six month lag (give or take) between NFD moving and then M3 following suit.

The majority of foreign debt generated by Australia is not a result of business investing in productive capital but rather the major Australian banks servicing the demand for mortgage debt fuelled by the Australian housing bubble. We can see this influence clearly through this graph.

If you notice at the end of 2006 NFD begins trending downwards after a spike upwards, it was not until the end of 2007 that M3 followed suit. Both measures were trending downwards quite dramatically until in the middle of 2009 when there was a massive turnaround in NFD. From falling by $13.7B in the second quarter of 2009 NFD proceeded to increase by $37.7B in the third quarter, that is a $51.4B turnaround. A further $30.8B poured into Australia in the final quarter of 2009.In total over $68B was pumped into the Australian economy from foreign sources in just a six month period.

What would cause this you might ask?

The culprit was the First Home Owners Grant (FHOG) which was increased substantially in this period. With the help of high Loan to Valuation Ratios (LVR) this grant had the effect of enabling borrowers to add over $100,000 to the amount a bank was willing to lend. Little wonder then that the Aussie housing bubble was further inflated. House prices in large cities such as Melbourne rose at rates upwards of 20% per annum.

So again, after a big jump in NFD we see a big jump in M3. The FHOG had kicked the deflation can down the road by 6-12 months.

The FHOG was returned to ‘normal’ levels at the beginning of 2010 and already we have seen NFD drop back into negative territory. Where NFD goes, M3 follows.

I expect there to be one more quarter of positive M3 numbers before the deflation genie begins to peek out of the lamp again.

Or will the lamp be kicked down the road again?

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