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Prepare for an Australian house price plateau
Topic Started: 5 Dec 2013, 09:42 AM (5,177 Views)
Strindberg
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barns
6 Dec 2013, 12:00 PM
It's a simplistic example but in reality they can rely on borrowing back the loan issuance as it has to go somewhere - 1 persons loan is another's deposit. Of course, it's more complex to manage than simply borrowing back the same amount but, so long as they remain solvent, they can always access the interbank market and the RBA (as a last resort) if they are going to come up short overnight. They can rely on this being the case in the normal course of business so are free to lend without pre-funding, it's kind of like signing a contract to buy a house when you know you have a funding line available to draw-down at the appropriate time.
Even if they have access to the interbank market and the RBA that's only a temporary fix if their loan issuance level continues to exceed the net new deposit level. So they borrow overnight to meet an obligation arising from a 25 year mortgage loan they issued that day.... and they borrow again the next day.. .and the next. Sooner or later, conditions will arise when interbank lending dries up especially if a bank is seen to be making excessive use of that facility implying that it has a long term funding problem. Confidence will fall and depositors will withdraw their deposits ala Northern Rock.

PS - just a reminder that I'm posting these thoughts partially, but not wholly, as an Aunt Sally.
Edited by Strindberg, 6 Dec 2013, 12:22 PM.
Housing costs to Income broadly unchanged since 1994 - re-ratified here
The People of Australia have the highest median wealth in the World
2002-2012 10 year house price growth the SLOWEST since 1952-1962
"There are two kinds of people in this world: ones that fiddle around wondering whether a thing's right or wrong and guys like us." (Hugo to Gagin in Ride the Pink Horse)
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Count du Monet
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The credit boom of the first decade was due to the amount of money coming the middle east and other parts of the second world. It won't be repeating any time soon.

The banks function like this, they are in constant motion. Cash inflow is from depositors and loan repayment. Cash outflow is deposits leaving and new lending. If the cash reserve dries up they can reduce lending activity. Although this has consequences for the general market.

Posted Image
Edited by Count du Monet, 6 Dec 2013, 12:30 PM.
The next trick of our glorious banks will be to charge us a fee for using net bank!!!
You are no longer customer, you are property!!!

Don't be SAUCY with me Bernaisse
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Sydneyite
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Strindberg
6 Dec 2013, 12:14 PM
barns
6 Dec 2013, 12:00 PM
It's a simplistic example but in reality they can rely on borrowing back the loan issuance as it has to go somewhere - 1 persons loan is another's deposit. Of course, it's more complex to manage than simply borrowing back the same amount but, so long as they remain solvent, they can always access the interbank market and the RBA (as a last resort) if they are going to come up short overnight. They can rely on this being the case in the normal course of business so are free to lend without pre-funding, it's kind of like signing a contract to buy a house when you know you have a funding line available to draw-down at the appropriate time.
Even if they have access to the interbank market and the RBA that's only a temporary fix if their loan issuance level continues to exceed the net new deposit level. So they borrow overnight to meet an obligation arising from a 25 year mortgage loan they issued that day.... and they borrow again the next day.. .and the next. Sooner or later, conditions will arise when interbank lending dries up especially if a bank is seen to be making excessive use of that facility implying that it has a long term funding problem. Confidence will fall and depositors will withdraw their deposits ala Northern Rock.
I think this is exactly how it works. This is why there are "deposit wars" from time to time - you don't want to be the guy with ever growing overnight interbank lending requirements every day, and a bunch of nice term deposits coming in can give you a nice buffer of reserves to smooth things out for a while. This is also why you securitise etc sometimes as well. Of course this is also exactly why the variable interest rate on your mortgage is variable! It's the ultimate banking game of borrowing short and lending long.

PS: The fact it works like this is also why systems are prone to financial crises / liquidity crises type events. We saw this acutely in the US after the Lehmans collapse. We *almost* saw it in Australia - before the government deposit guarantee in 2008, large deposit flows had started from the smaller banks into the bigger banks (who were seen as safer). This would have meant the small banks getting into exactly the situation you describe with increasing net funding shortfalls each day and growing - they were having to curb/stop lending as a result and could have easily become insolvent (ie do a Blackrock) - the guarantee restored confidence and the market got back to it's "normal" state of equilibirium. But there was a short period of constrained lending still in Australia at that time and we nearly topped over the edge - purely because of confidence based on the US events vs a specific local "real" factor.

Quote:
 
PS - just a reminder that I'm posting these thoughts partially, but not wholly, as an Aunt Sally.
Fair enough.
propertymogul
6 Dec 2013, 11:14 AM
Elastic
6 Dec 2013, 11:09 AM
Given that loans create deposits, then all credit (money) should have an equivalent loan.
How then do reserves get created, which apparently is money that doesn't have a corresponding liability?
I know that in the US the Fed makes sure there is adequate reserves in the system to ensure lending isn't constrained.
A very good question Elastic, essentially what I was trying to get at but couldn't word it as well. I don't know the answer but would be very interested to hear the answer.
I believe the new reserves are essentially created by the RBA as/when needed/demanded by the level of economic activity and demands from the activities of the banking sector that we are discussing. They talk about this in many papers published on their website.
Edited by Sydneyite, 6 Dec 2013, 01:00 PM.
For Aussie property bears, "denial", is not just a long river in North Africa.....
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Count du Monet
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Sydneyite
6 Dec 2013, 12:52 PM

I believe the new reserves are essentially created by the RBA as/when needed/demanded by the level of economic activity and demands from the activities of the banking sector that we are discussing. They talk about this in many papers published on their website.
In general no. The RBA has averaged creating 6.5 more cash pa for the last 20 years since the full implementation of basel one. During the GFC they printed 15% more cash, but they made up for this by printing almost nothing for the next few years.

Amongst all the floating currencies there is a permanent blood drip of 6.5% currency creation pa. They called this reducing inflation from the much higher rates of printing in the 70's and 80's. The movable levers they are left with is the interest rates and expanding the central bank balance sheet.
The next trick of our glorious banks will be to charge us a fee for using net bank!!!
You are no longer customer, you are property!!!

Don't be SAUCY with me Bernaisse
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Sydneyite
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Count du Monet
6 Dec 2013, 02:10 PM
Sydneyite
6 Dec 2013, 12:52 PM

I believe the new reserves are essentially created by the RBA as/when needed/demanded by the level of economic activity and demands from the activities of the banking sector that we are discussing. They talk about this in many papers published on their website.
In general no. The RBA has averaged creating 6.5 more cash pa for the last 20 years since the full implementation of basel one. During the GFC they printed 15% more cash, but they made up for this by printing almost nothing for the next few years.

Amongst all the floating currencies there is a permanent blood drip of 6.5% currency creation pa. They called this reducing inflation from the much higher rates of printing in the 70's and 80's. The movable levers they are left with is the interest rates and expanding the central bank balance sheet.
That statement is contradictory! You say "in general no", but then go on to prove that in fact for the past 20 years the answer is in fact "in general, yes"! :re:
For Aussie property bears, "denial", is not just a long river in North Africa.....
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Count du Monet
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Sydneyite
6 Dec 2013, 03:48 PM
That statement is contradictory! You say "in general no", but then go on to prove that in fact for the past 20 years the answer is in fact "in general, yes"! :re:
Are you happy with 6.5% more being printed on average every year, or do you want more?

You can check the figures yourself.

http://www.rba.gov.au/statistics/tables/xls/a01hist.xls?
The next trick of our glorious banks will be to charge us a fee for using net bank!!!
You are no longer customer, you are property!!!

Don't be SAUCY with me Bernaisse
Profile "REPLY WITH QUOTE" Go to top
 
Sydneyite
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Count du Monet
6 Dec 2013, 03:58 PM
Sydneyite
6 Dec 2013, 03:48 PM
That statement is contradictory! You say "in general no", but then go on to prove that in fact for the past 20 years the answer is in fact "in general, yes"! :re:
Are you happy with 6.5% more being printed on average every year, or do you want more?

You can check the figures yourself.

http://www.rba.gov.au/statistics/tables/xls/a01hist.xls?
6.5% is fine - the amount of new cash is demand driven anyway, and is set essentially by nominal GDP growth (which is in turn driven by underlying inflation and population growth).

Remember the question being asked was, where do the *new* reserves come from over time? Your answer supports my answer, you have just quantified things.

PS: I know you think the amount of printing is pre-determined/fixed by some secret central bank agreement, but I don't buy this. It's demand based - BUT, of course the RBA tries to manage the demand by controlling inflation and maintaining continuous trend GDP growth, hence resulting in a fairly consistent amount of new money creation on average per year over this past 20 years of relatively stable inflation and economic growth.
Edited by Sydneyite, 6 Dec 2013, 04:15 PM.
For Aussie property bears, "denial", is not just a long river in North Africa.....
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propertymogul
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Sydneyite
6 Dec 2013, 12:52 PM
I think this is exactly how it works. This is why there are "deposit wars" from time to time - you don't want to be the guy with ever growing overnight interbank lending requirements every day, and a bunch of nice term deposits coming in can give you a nice buffer of reserves to smooth things out for a while. This is also why you securitise etc sometimes as well. Of course this is also exactly why the variable interest rate on your mortgage is variable! It's the ultimate banking game of borrowing short and lending long.

PS: The fact it works like this is also why systems are prone to financial crises / liquidity crises type events. We saw this acutely in the US after the Lehmans collapse. We *almost* saw it in Australia - before the government deposit guarantee in 2008, large deposit flows had started from the smaller banks into the bigger banks (who were seen as safer). This would have meant the small banks getting into exactly the situation you describe with increasing net funding shortfalls each day and growing - they were having to curb/stop lending as a result and could have easily become insolvent (ie do a Blackrock) - the guarantee restored confidence and the market got back to it's "normal" state of equilibirium. But there was a short period of constrained lending still in Australia at that time and we nearly topped over the edge - purely because of confidence based on the US events vs a specific local "real" factor.


Fair enough.

I believe the new reserves are essentially created by the RBA as/when needed/demanded by the level of economic activity and demands from the activities of the banking sector that we are discussing. They talk about this in many papers published on their website.
With the new reserves created by the RBA, can you explain the mechanics of that for a simpleton like me? With Elastic's question, how do reserves increase (and by reserves, I believe he meant deposits/capital without a corresponding liability, that is my understanding anyway), I would imagine all reserves "created" by the RBA have a corresponding liability, i.e. double entry accounting. The more I think about this, the more I'm stumped, I can't think of a way for new money to be created without a corresponding liability. However, if that is the case there is never any net increase in wealth, which can't be correct. Perhaps my understanding of how the RBA creates reserves is inadequate, I would have thought it would be done by either 1 - overnight lending to banks, in which case banks owe them the money (corresponding liability), or 2 - issuing bonds, in which case the RBA owes money to the counterparty to the bonds (i.e. once again double entry accounting, no net change in balance sheet). Is there another way?
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Elastic
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The situation in the US with the Fed buying bonds is creating massive amounts of excess reserves. I tried analysing the RBA's balance sheet to see if they hold any government bonds but it wasn't clear to me. This would potentially be one method of expanding reserves.
It's also worth mentioning that when Australia was first settled, the governor had a big stack of coins which they used as the first currency. This money had no corresponding liability. It was spent into existence by the governor. It was only later when banks were formed that double entry bookkeeping and fractional reserve banking developed that the money supply was able to expand. At least that's the way I understand it.
Only a rat can win a rat race.

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