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Why property price are sky high, wages stagnant and there's market bubbles

Have you ever wondered why business and finance feature so prominently in the news?

If you ask people whether they find those sections of the paper interesting you’ll receive mixed responses at best.

The fact is though businesses play a vital role in the economy. And understanding the relevance of economics and finance to everyday news and events puts you ahead of the pack.

Here are just a few issues confronting Australians and how, by understanding the economics of them, you can gain a better appreciation of them.

Power bills

The central problem: you’re paying too much for basic usage of electricity and gas.

Why? Successive governments have failed to prevent the big gas providers exporting more gas overseas. The gas companies do this because prices have been favourable. But it’s left a domestic shortage.

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The economics: rule number one in business is profit maximisation. The big energy companies aren’t doing anything other major companies haven’t been doing for generations.

However, government plays a role in this too. What we’ve see over the past month or so is government intervening in the free market (to re-direct gas back home). That’s highly unusually – especially for a conservative government.

But how do you cut folks’ energy bills without forcing the gas providers to redirect their stock back onshore (and boosting supply)? Short answer is you can’t. That’s why the prime minister has met with the gas providers several times to persuade them to ‘help him out’.

Government has a clear role in the economy. This is a good example though of how bad government policy can affect every household in the nation. Has the economic model been broken? Not at all. It’s playing out exactly as you would expect.

Low wage growth

Another issue causing angst among a big cross section of Australians is low wage growth.

The central problem: you likely haven’t had a pay rise in years.

Why? Well it’s not because businesses aren’t profitable. Business conditions, according to the National Australia Bank, haven’t been this good since just before the global financial crisis struck.

The problem stems from two main factors. The first is the casualisation of the workforce. People with part-time and casual jobs have far less bargaining power during wage negotiations. The second relates to the economic engine itself. Economies around the world are struggling with low inflation. With low inflation comes slow economic growth (and subdued consumer spending). That in turn prompts business owners to withhold pay rises and bonuses. It’s a vicious cycle.

Also read: Is this Australia’s answer to Bitcoin?

Economists say the economy is out of whack, and that inflation is not, at this point in the cycle, responding as it ought, or as it normally does.

I don’t agree.

The economics: the central issue here is confidence. Believe it or not, it’s never really returned since the collapse of one of the world’s biggest investment banks, Lehman Brothers, in 2008.

Central banks around the world rushed to slash interest rates to next to nothing to save the global economic system from a depression (and boost business confidence). While that strategy worked to a degree, it created, as you would expect, significant distortions in the financial system. Property prices sky-rocketed, as did stock markets.

Also read: Forget Bitcoin, There’s an $8 trillion bubble in global markets waiting to pop

While money has rushed in a few different directions, it hasn’t moved towards workers. Businesses have chosen not to invest in labour. Contracts, on the whole, have remained short term and casual. This is especially true for millennials. The reason of course is that businesses are afraid to commit to workers is that they’re not confident the ‘good times’ will last.

Do workers deserve a pay rise? Absolutely. Are they likely to get one? Probably not… not until business confidence returns. When that happens, I suspect we will be able to say the legacy of the 2008 financial crisis is over.

Market bubbles

In the wake of the financial crisis, global interest rates dropped to nothing. It was necessary to spur economic growth. It resulted, however, in a trillion dollars stock and property market binge.

The central problem: many property markets and share markets around the world are dangerously overvalued and vulnerable to a correction.

Why? Investors are faced with a very simple choice: squirrel money away into a term deposit and earn 2 – 3 per cent per annum, or invest in the stock market and earn north of 5 per cent per annum. Interest rates have stayed low enough, for long enough, that investors have been lured away from what are considered ‘safe’ investments for some time now. The trend has ‘stuck’.

The economics: there are legitimate reasons for the lofty stock market valuations. In the case of the US, if tax cuts are implemented, the value of many companies will rise. And in Sydney’s property market, for example, a lack of supply, increased immigration, and record low interest rates, have all helped property prices remain elevated.

For the market bubbles around the world to pop, interest rates (which are still driving most investment decisions) will need to rise sharply, or there needs to be some kind of – what economists call – exogenous shock. At this point neither is likely to happen any time soon.

Will there be market crashes? Probably. Are they around the corner? Well let’s see what happens to interest rates, and US economic policy.

It all makes sense, but it still sucks

There is nothing particularly crazy about many of the extraordinary and quirky things happening in the world of global finance at present. Sure, we’re seeing financial extremes, but even with a brief analysis of the causes of these problems, you can see it makes perfect sense.

One thing you can be certain of are the laws of economics: supply and demand; profit maximisation; and fear and greed (maximising utility). Let them be your guide.