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Asset price bubble a worry

By Henry Thornton - posted Tuesday, 5 June 2007


House prices have soared, share prices have rocketed, resource company shares have glowed in the dark, but consumer prices are subdued. The graph (see below) shows the extent of the dislocation between asset inflation and consumer inflation in Australian markets.

Take a moment to reflect on the magnitudes involved. Each price index is set at a value of 100 in June quarter 1986. By March 2007, consumer prices have slightly more than doubled, implying annual goods and services inflation of 3.8 per cent.

Over the same 21 years, average Australian house prices have risen by 450 per cent, the share price index has risen by a similar 480 per cent while shares in BHP Billiton have soared by a massive 1,150 per cent.

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While the out-performance of BHP shares may in part, perhaps large part, be ascribed to the "China boom", other asset prices have risen by an order of magnitude faster than prices of goods and services.

This is a common theme around the world. China share prices have been rising almost vertically. In the mighty US, analysts worry about the next share price correction and the current house price correction. And in other nations, strong asset inflation co-exists with subdued consumer goods and services inflation.

Extreme asset inflation with subdued consumer inflation is a global phenomenon. Is it also a global problem? This is a big question for modern central banks and we encourage independent directors to ask RBA governor Glenn Stevens and his team for their answer at today's meeting of the board.

We need to be concerned because extreme booms in any market are followed by busts. The inevitable global asset price bust will create substantial misery.

This generation of policy makers has blamed loose monetary policy for past consumer inflation. The great damage created by past consumer inflation has led governments to give central banks a measure of "independence" and a mandate to fight goods and services inflation. This approach has been dramatically successful in all civilised countries.

A major part of the cost of consumer price inflation is the unemployment specifically, and unused resources generally, that accompanies the end of consumer price inflation. For example, the great inflation of the 1970s and 1980s in Australia was eventually killed by a recession that saw the measured rate of unemployment reach almost 11 per cent - with the effective rate far higher. Only now, half a generation later, is unemployment approaching an acceptable level.

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Past asset price inflation has had major adverse economic consequences. Think about the ending of the Dutch tulip boom, or of the great Melbourne land boom of the 1880s or of the US stock market boom of the 1920s, arguably the first global asset boom. In each of these examples, the boom was followed by a bust and in the third case the bust was, like the preceding boom, also global.

In trying to avoid responsibility for asset booms, central bankers will undoubtedly argue that asset inflation relative to goods and service inflation may simply reflect a change in the attractiveness of assets relative to consumption.

A version of this argument was presented in The Weekend Australian, attributed to a wealthy executive from Macquarie Bank, whose market price has itself risen dramatically.

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First published in Henry Thornton and The Australian on June 5, 2007.



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About the Author

Henry Thornton (1760-1815) was a banker, M.P., Philanthropist, and a leading figure in the influential group of Evangelicals that was known as the Clapham set. His column is provided by the writers at www.henrythornton.com.

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