March 19, 2013 by Dymphna 8 Comments

Down Under is a Good Place to Avoid Europe’s Storm

Today I want to talk about the affects that international economic events may or may not have on Australia’s economy and our own financial situations. I’m sure many of you are wondering what impact the recent bank activity in Europe will have on us, and particularly as investors in our real estate market.  Overall, I’d say that the news is looking pretty good.

Just so we’re all on the same page, over this past weekend, financial authorities in the Eurozone have decided to put in place a “deposit tax” on bank deposits in Cyprus.  That is, Eurozone financial leaders decided that whatever money depositors have in the bank in Cyprus, will be “taxed” up to 10 per cent.  The stated objective is to raise enough money to help the country “qualify” for another round of bailouts.  In fact, in response to the depositors’ outrage, the banks are now closed until at least Thursday of this week.

Europe is nervous

As you might expect, people in Cyprus are quite upset about having 10 per cent of every euro in their savings accounts being arbitrarily taken from them; as are foreign depositors who hold their money in Cyprus banks.  Needless to say, there has been a run on the banks in Cyprus.  People have tried to take what money remains, out of their accounts in Cyprus since they no longer feel that their money is safe there. Unfortunately, they are probably right.  But it’s not just people with money in Cyprus who are feeling the pain. Depositors in Greece, Italy, Spain and Portugal are also getting a bit nervous, too; and for good reason.

Some financial experts and economists are now saying that such a seizure of people’s money and the bank run that followed it could set off similar problems not just in the trouble spots in the Eurozone, but even is larger, more stable economies in Europe whose banking systems aren’t nearly in as bad of shape.  That, of course, would impact a much larger amount of people and nations.

But now to the big question:  “How will that affect us here, in Australia?”

Australia insulated from European trade

Well, that depends.  On the one hand, we’re fortunate in that what goes on in Europe from a GDP (Gross Domestic Product) perspective has actually very little impact here on the housing market. Bear in mind that I’m not talking about the stock market or how much it jumps and jitters; that’s a different subject and I don’t really care about that so much.  Stocks will indeed react to what happens in Europe.

But what I do care about is the real estate market. The big factors that will certainly have an affect on the property market are balance of trade and monetary issues such as where our currency sits, inflation and things like that. Regardless of what happens over there, Australia trades very little with Europe. The balance of trade issue is not really a big influence by itself on our economy.

The main effect that comes out of Europe will be its monetary policy.  By Europe continuing to prop itself up, so to speak, and doing its little dances with the euro itself, means that there is less money to go out onto the international market for the RBA to borrow and re-lend to us. So, yes, there will be less money on the international open market for Australia and other nations to borrow.  This means that there will be a contraction of money that is available to borrow.

How will Australia be affected by this contraction of the money supply?

Room to manoeuvre

Well, just like the law of supply and demand says, when you have less of something and there is still demand for it, the price of whatever that soemthing might be—in this case, money—goes up.  Those prices begin at the wholesale level.  This affects the wholesale price of money at which Australian banks borrow, doesn’t it?

The wholesale price of money is what the RBA pays for money on the international open market.  As I mentioned earlier, monetary issues definitely can have an impact on us because as the price of money rises—which is what interest rates really are—that effects businesses’ as well as investors’ ability to borrow, to expand and to hire. All of those things affect jobs, and jobs obviously affect the housing market.  So that’s the connection or the chain of command if you like, between the price of money and the Australian property market.

Fortunately, there’s some good news in there for us. In response to the rising price of money, reserve banks around the world try to lessen the impact internally, within their own shores. Today, Australia’s wholesale cost of money is about 3.5 per cent, so the Reserve Bank of Australia has plenty of room to maneuver in response to what happens in Europe or elsewhere. That means that Australia can effectively lower the price of money within the country to minimize the impact of the tighter money on the international market.  As it is today, the RBA has a lot of monetary cushion to lower that wholesale rate in order to lower the costs to us.

Australia a safe haven for money

Compare our interest rates with say, Japan, or even the United States.  Their wholesale price of money is only about one-half of one per cent!  They have very little room to maneuver with much less cushion to offset the effects of tighter monetary conditions. The result is that their economies will be much more affected by the rising price of money.

Another benefit that comes from our interest rates being so high relative to America and Japan, for example, is that international money is flowing to Australia.  Investors and depositors want higher earnings on their money, as you would expect.  But they also want their money to be safe.  Australia provides both of those benefits and so we’re seeing an influx of money flowing into the country because we’re also viewed as a safe haven.

Are there other problems that might come about from Europe’s financial storms?  Certainly. But it’s likely that for investors, being where we are is one of the best places we could possibly be to keep seeing profits and a steady economy.  More on that next time!