Wednesday, December 8, 2010

A few thoughts on National Accounts - Household Income

I stumbled upon a few things that I think are relevant to my first post on the price-income calculation debate that I wanted to share.  Perhaps the most relevant thing is that - despite commentators and the RBA saying that the national accounts measurement of household income is the 'most relevant' to be used for the purposes of calculating affordability of house prices - there seems to be considerable data quality concerns about this metric. 

For example, the ABS published the following in its 2007 item titled "Spotlight on National Accounts: Household Savings Ratio":

As the difference between the Household disposable income and Household final consumption expenditure is relatively small, caution should be exercised in interpreting the Household saving ratio in recent years, because major components of household income and expenditure may be subject to significant revisions. Many of these series are based on annual indicators and in a number of instances the household sector is measured as a residual of all other sectors. (emphasis added)

The most worrying revelation in the above quote from the ABS is that the methodology for calculating the income attributable to the 'household' sector in the National Accounts appears to be "a residual of all other sectors" in "a number of instances".  Income that doesn't fit neatly into 'government' or 'commercial' income is therefore simply attributed to households?  This seems totally bizarre to me.  This clearly also impacts the reliability and interpretation of the official national household savings rate (which is actually the context for the above ABS quote/paper).

When calculating affordability of prices for any asset or consumption item (including housing) this suggests (at least to me) a strong methodological reason to rely much more on the direct household income surveys conducted by the ABS which actually quantify household's income available for consumption, as opposed to National Accounts data.  As discussed in my earlier post these income levels can be easily adjusted for subsequent wage inflation if the 2-3 year lag in the data is of concern.

Tuesday, November 30, 2010

CPI - Confusing Price Index

I am fairly busy on the home and work front at the moment so not a lot of time for a new (meaningful) post.  I wanted to post a link to a wonderful John Mauldin essay recently dissecting US inflation data

I am working on a similar piece for the Australian CPI data - which I believe from initial research to even more severely understate price inflation than the US in its imputed/equivalent rent component.  Note that I personally consider any version of CPI to simply be one indicator of price inflation, and never exhaustive.  Moreover, the financial crisis has shown the need to move beyond a total reliance on consumer price inflation in determining monetary policy - in other words to also consider asset price inflation and (more importantly) monetary inflation (i.e. the supply and 'value' of money).
I quote the key passages in Mauldin's essay below, but the overall thrust of his argument is that by ignoring the cost of housing in terms of asset prices, and replacing it with an imputed rent version of the cost of housing, CPI data were depressed through throughout the last decade.  This (likely) contributed to the Fed's policy of keeping the cash rate so low in the early 2000's (and therefore the subsequent house price boom and bust). 

Powerful stuff!!

Mauldin starts by questioning the current suite of inflation data showing moderate positive inflation in the US, and then goes on to say:

...What if the way we measured inflation was flawed in some regard? Let's play a thought game. Back in the early '80s there was some consternation about using the price of houses as a way to calculate inflation. Read this paragraph from the BLS website (emphasis mine):

"Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good. Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons, the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing. It was implemented for the CPI-U in January 1983."

Homeowner equivalent rent is 25.2% of the input when they calculate the Consumer Price Index (CPI). Thus it makes a big difference how you calculate the price of housing. It is extraordinarily difficult to find historical data on homeowner equivalent rent in the BLS database. You can find "shelter costs," which include energy, insurance, etc. and are 41% of the CPI, but for our purposes today I want to focus more narrowly.

I did find an old release that shows the index value for the year 2000 to be 198.7 ( The index value as of this October was 256.8. That means the rise in housing costs over the last decade was about 25% or roughly 2.5% a year, although in the last few years that number has gone deadline flat. And you can see that in the graph of total housing costs below.

CPI 10-Year Chart

But house prices went up by more than double that amount, and about 65% in the seven years from 2000 to 2007 (back-of-the-napkin estimate). That is an asset inflation of about 9-10% a year.

US House Price Index 1975-2010

What if we had been using actual home prices as the measure of inflation? Let's look at the year-over-year change in inflation for the last ten years:


Homeowners equivalent rent is 25% of the index. So take the home price rise, divide it by four, and add it to the inflation index. Inflation in the middle of the decade would have been running 4-5-6% and in 2005 would have been over 7%!

Would rates have been kept low "for an extended period of time" if we had still been using actual home prices? I rather doubt it - alarms bells would have been sounding. The Fed would have been leaning into the rise in "inflation." Thus no housing bubble would have developed. And then no credit crisis.  And the difference all stems from how you measure inflation. These details matter.


In the 1980s the BLS (under Reagan, so not a liberal plot!) decided a home was an investment and not a roof over our head. It also conveniently allowed for lower official inflation, which is what Social Security and other government programs are tied to. But that change had significant unintended consequences.

Monday, November 29, 2010

Persian Problems

Interesting analysis from Stratfor on the impact of the most recent wikileaks release of diplomatic cables.  While much of the media coverage has been on Arab neighbours urging the US to bomb Iran, the most interesting story at this point seems to be the open discussions of the Iranian's ability to fortify their nuclear facilities against conventional air attack. This prospect would be well known by the US and its allies, but the fact that this is being openly discussed arguably places even more pressure on the US to act quickly or else miss their 'window'. In a world focused on the Korean Peninsula, or European CDS, perhaps a bombing of Iran is the black (or is that grey?) swan we should be thinking about?


Sunday, November 14, 2010

Taleb on the Fed

Black Swan gold:

You may print, print, print and no effect. Just like a ketchup bottle you bang on with nothing coming out. And what can happen, is you keep banging on the ketchup bottle and it all comes out. This is the problem with non-linearity. The economics establishment isn't understanding that. Why are we listening to Bernanke when he didn't see the risks before? (1:20)

Australian Greens: Populism 1, Economic Credibility 0

Laurie Oakes interviewed Green's leader Bob Brown this morning.  Full transcript here.

We will amend any Government bill or else introduce our own discreet legislation to put a 24-month lid on the banks doing what they've done in the last week again. We think that they should be prevented from going beyond the Reserve Bank increases in the coming 24 months. Or if the Reserve Bank puts the interest rates down, they should be required to go at least as far down as the Reserve Bank...

...Let's make it for 24 months. It can be reviewed then. It's reasonable. I think Australians would welcome it. The banks are going to continue to flourish. But let them be tied to what the Reserve Bank judges as a fair and reasonable interest rate rise, or drop, in the coming 24 months. I challenge both the big parties to get behind the Greens this week in Parliament to put this in to law.

Kiss goodbye to any pretence of the Green's adopting responsible and credible economic policy as a 'balance of power' Party.  Preventing banks from setting the risk margin on loans for housing loans is the epitome of inefficient government intervention, and will have significant knock-on consequences (not least of which will be the transfer of net interest margin to other sectors of the economy such as SME lending).  Brown also shows extreme (deliberate?) ignorance in stating that the RBA decides what a "fair and reasonable interest rate rise" is.  What hogwash.


Update - just saw this potential legal assault on the banks variable margins for 'uncertainty'.  This might well be legally valid (indeed common sense would indicate it is), but again the consequences of this will simply be to require borrowers to be charged even HIGHER margins to compensate for the funding risk the banks run in funding a mortgage book.  This would be catastrophic for Australian banks whom are so dependent on offshore funding sources, and compound the withdrawal of lending in the already challenged Aussie housing market.

Saturday, November 13, 2010

The End of the Fed

Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.
       -  Winston Churchill, 1942

Winston Churchill's famous words might well apply to the US Federal Reserve.  Or at least the Tea Party, contrarian traders, libertarians and gold bugs would have us believe this is the case.

There is a lot of chatter on blogs and in trading rooms in New York about the imminent appointment of Ron Paul to the House Committee on Domestic Monetary Policy.  For those who are not au fait with Ron Paul, a recent article in Vanity Fair provides a good summary of Paul's political history.  The mere existence of such an article in Vanity Fair however, says even more about how mainstream Paul's ideas about fiat money, libertarianism and constitutional interpretation have become.

The irony of the author of "End the Fed" becoming one of the major legislative overseers of the Fed has not been lost on the mainstream media either.  See this recent story in CNN for example.

Paul has been coy in talking about how he will use leadership of this committee to push his agenda, but it is clear that he will at a minimum make life tough for the Fed (and Bernanke in particular) and uncover a range of practices that are currently poorly understood by the markets and the general public (for example the international swap lines the Fed has in place with Central Banks of other nations).   It is widely thought that Bernanke's testimony to the same House Committee in 2009 will be raised again (at least for rhetorical purposes).  In this testimony Bernanke provided an answer to another member of Congress from Texas in which he said "the Fed will not monetize the debt" (which of course is exactly what many critics claim QE2 is now doing).  Look at 48mins on the video below at this link on c-spam.

This blogger thinks developments in this area are of paramount importance to how 2011 will play out - probably even more important than the fiscal compromises arrived at in Congress.   There are a handful of 'triggers' one could see causing things to take an unexpected turn next year - this is one of them.  At a minimum it is going to make QE3 harder than some might currently be assuming is the case.

Lies, Damned Lies and Housing Statistics 2

I promise this is a more succint post than the last one!  Interesting to see that the REIV had to 'revise' the paltry Melbourne auction clearance rates last week because a number of agents had failed to report 'unsuccessful' results.  This highlights the flaw with so much of Australia's housing statistics - they are dependent on real estate agent voluntary reporting of information.  It's like asking a punter to determine the photo finish of a horse race!

In a similar vein I could only laugh at Brisbane's auction results today.  Reporting a clearance rate of 8% (or 2 properties sold out of the 21 auctioned), one property sold for $930k prior to auction (denoted "SP"), and the other is denoted "SN" indicated sold prior, price undisclosed.  Why would you try to sell a house in Brisbane via an auction on these numbers... but perhaps more importantly why would anyone have faith in any of these statistics?