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nflation, Wage Stagnation & A Housing Crisis – Capitalism in full swing
(This article was first written back in 2019, pre pandemic and the invasion of Ukraine. Inflation fuelled by low interest rates and growing inequality already had us on this trajectory, just most people didn’t know it yet and those that should of known turned a blind eye. Profits were too big to pass up and so the problem has ballooned.)
Before anything else it is fundamental that we look at the nature of how inflation and deflation operate. Stay with me don’t hit the snooze button just yet, I will get there as painlessly as possible.
When someone is talking about inflation and deflation they are talking about the “exchange value of money” (Varoufakis 2017, 142), in reality this means “its relative abundance or scarcity” (Varoufakis 2017, 143) or in my understanding lots of money circulating or very little money circulating.
Inflation – Is created by more money being pumped into the system increasing trading capacity within the economy. The more money in the market the less it is worth and so prices go up.
Deflation – A decreasing amount of money being distributed in the economy. Less money to trade with causes it to be worth more so prices drop as its value increases.
Yanis Varoufakis in his 2017 book Talking to my daughter about the economy; explains this in the context of a POW camp where they used cigarettes as the currency to trade for other things like chocolate, coffee or tea.
In the camp each prisoner gets say 10 cigarettes, 200g of coffee, 20 tea bags and 200g of chocolate and the prisoners want to trade amongst themselves they work out prices to help trading go smoothly and as such they create a market price for their items. Remember the cigarettes are the currency (money) in this equation. So, they may start with something like 2 tea bags is worth 1 cigarette, 50g of coffee or chocolate. But as markets are subject to change what happens if say the next month extra cigarettes are delivered and the prisoners now have 20 cigarettes to trade with, the cigarettes lose some of their value due to their ‘abundance’ so now their trading power has decreased resulting in paying 2 cigarettes to get the same 2 teabags and so on. Then the opposite could also happen if say at the end of the month there are less cigarettes circulating because they have been smoked. This would create scarcity, which means their value goes up, trading power increases and the same one cigarette may now buy you 4 tea bags. The scarcity caused the price to change as trading power increased.
What we gain from this example is that exchange rates fluctuate due to the supply in the market of currency.
However, be careful to watch out for how easy it is to misunderstand this, as is often the case when people think that more land releases will lead to cheaper and cheaper prices. Although true to a certain point this does not convey the whole picture and process. It often starts with a statement like this; releasing more land for development will make it cheaper. New land releases certainly start off with cheaper prices, then comes the second land release and prices have elevated slightly, third land release and you can’t believe you missed the first because now prices are really starting to soar.
So, what happened here to cause this after all wasn’t more meant to mean the value went down? The answer is yes, but as mentioned earlier under inflation, if the supply of the commodity goes up like in the POW camp with cigarettes then the cost of the commodity goes up too as the trading power has increased causing the exchange value to inflate the price. The driving force behind this is the huge injection of money that came from all those new loans being granted. The new loans have generated a means for inflation to occur as now there is more money in the overall system (the economy) and the price of houses go up NOT down which is commonly misunderstood. This can mark the emergence of a bubble, especially when it does not stay relative to wages.
Banking and Capital Adequacy Ratio CAR (previously Capital Asset Ratio)
Most people don’t think about or ever question where the money from their bank loan comes from, they assume that this is money that the bank already had, not always so. In actual fact banks can legally create money to loan a customer “at the stroke of a pen or a few buttons on a keyboard” (Varoufakis 2017) it is “the bankers’ magical power” (Varoufakis 2017). This ability of the banks to legally conjure money into existence is what is referred to as Capital Adequacy Ratio (previously Capital Asset Ratio) in Australia or Fractional Reserve Banking in the US. Very neat and somewhat distracting language that causes most to overlook how bank loans operate.
So ultimately more land supply will lead to more bank loans which pump more money into the economy. The problem with house prices sky-rocketing in this manner is that so do the loans, over time these huge loans are devaluing money generally. An asset bubble doesn’t distribute wealth well and so the growth needed to offset the loan amount isn’t generated. Wages can’t keep up, the value of money declines, the bubble bursts and people get hurt.
It is important to understand how inflation and deflation should correlate with interest rates. For that we look again at the example of the POW camp. As Varoufakis tells us even in the POW camp they created bankers.
If a prisoner acting in the role of banker is offering an interest rate of 20% as Varoufakis explains but expects a larger shipment of cigarettes to arrive next month causing inflation by the exchange value dropping by 10%, then to keep his profit at the same level he must then raise his interest rate to 30%. As his profit would be calculated by the ‘real interest rate’ being 20% minus 10% (due to inflation) adjusting the profit down to 10%. The banker then to maintain the profit margin increases the interest rate to 30% so that it is 30% minus 10% thus maintaining the 20% profit.
This is how interest rates are meant to work if undisturbed.
The difference between the real-world economy and the POW camp economy as Varoufakis points out is that the POW camp operated without outside interference. Whereas the outside world economy has many interferers.
It is worth noting that even though low interest rates can seem like a great opportunity to borrow money at a low cost, what they can represent is a deflated or deflating economy.
Sometimes interest rates are deliberately reduced to try and stimulate the economy with increased borrowing of credit. The theory is the injection of money will generate more spending and the economy will grow enough to keep up with the debt. Within in our system though one must remember that we have other forces coming from Capitalism that can simultaneously function in a way that reduces spending power, such as wage suppression.
The sky-rocketing cost of living doesn’t lie but CPI might
Consumer Price Index doesn’t really relate well to the real world as it is a bit like a mixed basket of mystery. CPI is made up according to the persons putting the commodities in the basket at any given time even though they use a formula the formula is subject to change at the discretion of the disruptors within the system. Due to this it can have huge variations in composition and discrepancies emerge rendering it fairly useless tool for measuring inflation in real terms.
In other words, it may not relate well to the real economy you live in. Because when they say what the level of inflation is you cannot be guaranteed they have included things like housing in the basket and even if they have, have they given it sufficient weight as a percentage of the basket makeup, who knows? it is subject to change and this is not mentioned nor the formula revealed at the time of stating the CPI. Unless you look it up each time it is unclear how relatable and therefore useful as an indicator of inflation it is to your life.
This is my real life example that illustrates just how useless this tool can be in real terms; I rented a 3 bedroom house for $180 per week in 2000 and inflation rates according to CPI have on average sat at 2.63% for the period of 2000 to 2017, twice going as high as 5 per cent over this period (ABS). We can take the rent I paid in 2000 of $180 and for the purpose of this equation I will use the average inflation for the period of 2.63% to compare what CPI tells me the rent should be today to what realestate.com tells me I will actually pay. To do this calculation requires a simple maths equation of $180 + 2.63% = $184.73 (this gives me the amount after rent increase for the first year according to CPI). I then take the $184.73 + 2.63% = $189.59 to get the second year increase and identify what I should be paying according to CPI by the third year and so on. The process must be continued 17 times to arrive at what should be the market price for this rental come 2017 in relation to what CPI tells me.
The short version of this equation is $180 + 55.52% equalling the grand total of rent that should be paid by 2017 of $279.94. Anyone out there still paying this for a 3 bedroom? (only a very few I suspect and certainly none where I was paying it, that being Byron Bay, my unaffordable hometown). In any case a look on realestate.com tells me that this property would now net a rent price of approximately $750 per week (this was 2017 now it is $850-$900 for the same sort of rental I once occupied).
What this tells me is that the CPI is completely unreliable in real life terms when it comes to being able to gauge true inflation in real terms for one of the most essential items like housing. Which I would think should rank high enough in the formula basket to give a good indication of where inflation is actually sitting. For fun try also using this formula on your electricity bill and again you will find how it falls short.
GDP is unable to indicate the true health of the economy because GDP disregards the health and well-being of the people.
The other indicator that is often used to measure the health of the economy is Gross Domestic Product GDP. Like CPI though I find it to be useless and here’s why; “It is fundamentally flawed as a measure – because it counts financial transactions only, it ignores significant areas of activity” (Ian Lowe 2016, Lucky Country? Reinventing Australia) Professor Ian Lowe goes on to explain this by comparing domestic tasks with commercial, in this example if we are a carer for a loved one even though this activity is hugely valued within society it does not count towards GDP. “However if a person brakes the headlights on a car this is counted towards GDP and therefore if they were to smash every window as well they would be a minor economic miracle” (Lowe 2016, 145). What he is clarifying here is that GDP only measures activities within society that have been commercialised irrespective of whether they have consequences that are harmful to people. They do not predict or pick up on the fall out that may come from spending on things that have caused harm to people and the economy needs people to exist. In this way it is a short-term view of spending that doesn’t account for future turmoil that may be caused by the type of spending that is occurring. In the most extreme example war is good for the GDP but just wait for the impact on human lives before you go announcing that the economy is doing great because GDP is high.
Historical road trip
I will now take you down a little history road trip just to point out that Australia has in fact had a housing collapse in the past. This will tie into the boom and bust economic cycle that we have created.
1890’s depression and the largest housing crash in recorded Australian history.
Gathered from RBA Two depressions, one banking collapse authored by Chay Fisher and Christopher Kent, June 1999:
- National investment grew in the lead up
- Wealth gained by agricultural and mining allowed for the money to be transferred into the cities
- Need for housing increased as population boomed at a “rate of 3.1 per cent from 1871 to 1881, and 3.4 per cent from 1881 to 1891” to contrast it currently sits at 1.8 per cent (Lowe 2016)
- The view emerged that you couldn’t lose money on property (sound familiar)
- Credit far out-stretched deposits and “bank advances as a share of deposits rose over the 1880’s”
- From 1892 to 1898 bank trading banks deposits fell 20 per cent
- “Historically one of the major causes of financial instability has been rapid increases in bank lending in conjunction with unsustainable rises in asset prices”
Gathered from an Australian financial review article January 6, 2016 by Stewart Oldfield – Why the great Australian property crash of 1891 could happen again:
- City blocks in Melbourne increase 100 per cent in 1887, Increases of up to 80 per cent in Sydney from 1880-84
- The housing crash came in 1891 when prices fell by about 50 per cent “In the suburb of Prahran, prices peaked at an average of more than 1000 pounds in 1888 and fell to 520 pounds by 1898.”
What we see from this is that although the economy seemed to be doing well and people believed that they could not lose on property it did go down and they did lose on property. The question then becomes could it happen again?
Going back to the Two depressions, one banking collapse research paper, there was one sentence that particularly stood out to me it was “Historically one of the major causes of financial instability has been rapid increases in bank lending in conjunction with unsustainable rises in asset prices.” (Fisher & Kent 1999).
Debt comes before surplus (Varoufakis 2017), most people need a loan to buy a house, so credit is given, debt is created and more money is injected into the system. This happens over and over again many millions of times, prices go up due to inflation and the loans become bigger and bigger.
Debt of course is not all bad it can drive investment but not when you have other economic forces going in the opposite direction. Such as wage stagnation, over time resulting in an actual decline in real wages or in other words the available amount of money to repay the debt.
Retail and Hospitality workers make up the largest industry share of workers at 17.3 percent (Vandenbroek. March 23, 2018. APH.www.aph.gov.au) of the paid workforce and they have suffered government policies that in effect have reduced their wages.
Now you might not work in this sector and think well so what, I don’t work in that area that’s not my problem it won’t affect me. However it actually does, we’re all in this together and here’s how; Let’s say for example you own a home, are university educated, earn a good wage and have a mortgage you can service easily. How does someone else’s pay cut effect you? Well a huge amount of people remember 17.3% of the workforce who had already suffered 15 years of wage stagnation that priced them out of the housing market years ago are now left them in the rental market with the tremendous strain of paying rising rents on a shrinking wage. Maybe you are thinking yeah but I don’t own an investment property how does this affect me if they don’t pay their rent?
This is how it unfolds; House prices have been going up and with them rents have been going up and up to meet the new loan obligations. While wages for 17.3% of the working population have been going down. That working population will struggle to make ends meet including paying rent, their wage has not kept up with the rate of house inflation for over a decade. Now they begin to go backwards. When such a huge mass of people are struggling to pay their rent then the amount that was loaned to the landlord for the rental investment becomes very risky.
Wage suppression is just one example of recent income loss that is working as an opposing force to house inflation. There are many more such as government austerity measures on welfare recipients that act as an impediment to meaningful employment. These too flow onto the rest of the economy and not in the ‘great we saved the tax payer some money’ argument that is often toted out. It’s more like the more suppressed an economy the more depressed it becomes, with a devastating overflow effect.
Austerity measures for the poor create a ripple effect that reach the employed house owner with a well-paying job. Bringing it back to, we are all in the market together.
The reason these cuts from wages or welfare effect you too has to do with recycling, “just like any ecosystem, a modern economy cannot survive without recycling” (Varoufakis 2017), basically what is meant by this is that for a large number of business’ requiring employees for production they must pay wages and then these wages are recycled back into the system by way of purchases.
When you restrain this process through wage cuts and welfare cuts you are restraining the very system that supports you. Making it harder and harder for ‘little fish’ to survive impacts on the ability for this ecosystem to feed the ‘big fish’ as the little fish will eventually not even be able to afford the essentials such as we have been gradually seeing for over a decade now, in what is referred to as the ‘housing affordability crisis’.
This happens slowly and people tend not notice at first. Even though it is there to see as homeless rates are rising around the country 14% nationally and rough sleeping 20% (Baker. “Sydney’s tent city: One year on, where are they now?”. August 17. www.sbs.com.au).
Trickle down economics (Capitalism in full swing)
A book that will change your life is Payback (Debt and the shadow side of wealth) by Margret Atwood, it will shine some much needed light on the history of money and the creation of wealth. It will also help you to understand how we have ended up with such ghastly ideologies still prevailing such as; “The trickle-down theory of economics” (Atwood 2008, 102) that has us believe money given to the rich will flow down the economic chain. When in reality we get rising inequality, financial crisis’ and wars. Tax cuts to the wealthy are a favourite of the trickle down economic theorists.
Profits go up and wages stagnate resulting in a fall in real wages as has happened to hospitality workers due to the loss/reduction in penalty rates. This disaster of a policy we now see transferring to a mass exodus from the industry, “grind the peasants too much and they cease to yield”(Atwood 2008, 138).
Don’t even get me started on negative gearing and the contribution it has made to soaring house prices. Never in the history of its miserable existence has this trickle down economic bungle of a policy ever benefited a renter!
Unfortunately this isn’t a new story and through a historical lens we see that “if there are no more little fish, the population of big fish collapses” (Atwood 2008, 138). This relates to housing when a mass proportion of the population experience an uncoupling of housing affordability to income, causing an extreme imbalance.
It is not by accident but rather design that financial institutions and employment bodies lose their equilibrium, the profits are too lucrative to pass up and money transforms into power, growing evermore. Until those with the money have the power to be unaccountable and this absolute power corrupts, always. Think back to the 2008/2009 GFC and the huge bank bail-outs
Some things have certainly changed since I first wrote this article in 2017 and they are worth noting. However even though the pandemic and war in Ukraine have had inflationary effects it is more that they have exasperated a pre-existing condition rather than caused it. Distracting us from the bigger picture especially in countries like Australia with its looming asset bubble in housing. The most critical takeaway I believe from a bigger picture perspective of the rising cost of living crisis is that we live in an economic system designed to fail because it puts profits before people.
In ending I leave you with these final words of wisdom “money isn’t the only thing that must flow and circulate in order to have value: good turns and gifts must also flow and circulate…for any social system to remain in balance”(Atwood 2008, 171). It’s worth remembering I think as we search for ways to regain some balance in our economic systems.
The real market
I woke up crying
as the machine pulled
out the life next door
unsatisfied were the owners
of number seven’s beach shack
that sat unobtrusively
They took the trees
with such ease,
these natives gave
so much shelter
Now are exchanged
for a double block
of buildings that
will emit spoil
The soil is already
in protest as it
is picked up by
a howling wind
that has come
to take it away
This slope is slippery
as it falls away
to keep it grounded
the community falls away
Renting the dream
The roof caved in last night
Even though I had paid
Paid for your service
Paid for your dream
I barely know your name
The one I paid the way for
Your decision is my disruption
And still I pay
It will take time
It will take patience
It will serve up the returns
It will become derelict
I imagine this day
Will not be for me
It will be your returns
For a loss of propriety
I imagine the day
My day to trample
Bought at your loss
Celebrated as savvy
I just wish
We could imagine better
Better to provide security
Better to divide prosperity
Bubbles are built to burst
This comes as no surprise
Can’t change the nature
Can change the device
A grounding sensation
Growing from a place to call home
The dream we all have
Even when uprooted
They remain attached as memories
Melancholy plays their tune
Sweet and sometimes bitter
Aching to find fertile ground
A place to hang a hat,
A home of ones own
They wander weary from purpose
I have known this journey
Packed the bags, paid the toll
Searched the hills, followed the streams
To find a place, a home
Still the roof is rented
Denying the roots stable ground
Soon all that will be left is rot
Money bought up my hometown
Money displaced communities ground
On holidays in fantasy land
They bought a house
Not a home
It stands alone
Empty of the soul
As no roots laid the ground
One can only have one home
And home they always go
Leaving a community uprooted