How cheap overseas retailers are pushing up house prices in Australia

“Down, Down” might be the only place our economy has left to go if we can’t solve the imbalance between crazy low retail prices and crazy high house prices.

Australia needs a little bit of inflation. Without it, our economy is stuck with low interest rates and all the issues they create. But inflation is turning out to be very hard to generate.

The world’s discount retailers have discovered Australia. Aldi, Costco and Uniqlo were wave one of the discount invasion. Wave two is coming in 2017 and mostly involves Amazon. Every retailer already here is working hard to be able to compete.

Prices keep falling and the RBA is finding life difficult. Its job is to keep inflation in line. It should be between two and three per cent per year. But for a while now inflation has been below that range.

The RBA Board met on Tuesday this week to make their decision on interest rates. At the end of the meeting they made special mention of what was keeping inflation down.

“… increased competition from new entrants in the retail industry.”

You can almost imagine RBA governor Philip Lowe stomping round his office, muttering “bloody foreigners! Coming over here! Making our retail goods cheaper!”

Having low inflation is a problem. While of course we love low prices, overall the economy runs best with consistent predictable inflation. That’s what the RBA is supposed do. It is pledged to makes sure inflation is predictable: between two and three per cent.

THE HOUSE PRICE CONNECTION

Australia has a house price problem that is especially bad on the east coast. Unattainable prices are not only reducing the financial security of the young and causing rising homelessness, they have also created a debt time-bomb that is ticking away under our economy.

The RBA started cutting rates in 2008 and, after a brief stabilisation, that caused a second big uptick in debt. The less interest you’re paying, the more you can borrow.

One way to defuse the debt time-bomb would be with higher interest rates. The RBA would surely like to raise rates and strangle down house price rises. But here’s the rub — interest rates are how the RBA manages inflation.

To try to get inflation up, it sets official interest rates low. (To get inflation back down it would raise them.)

The idea is a low interest rate causes a surge of spending that pushes up prices, (while higher interest rates discourage borrowing and encourage saving, thereby taking pressure off prices). The problem is that it works great, but the prices that go up are mostly house prices, not consumer goods prices.

The RBA has kept interest rates low for ages and it was expecting a rise in inflation by now. Instead we live in a world of Down Down. Aldi is partly to blame — it sparked a giant price war among Woolies and Coles that is still going strong. That is big enough to show up in the national statistics.

As this next graph shows, food and drink inflation is far lower than it was in the early 2000s.

Meanwhile, clothing and footwear retail is cheaper than ever. I remember a pair of Nikes costing $100 in the 1990s. My latest pair cost less than that.

While some of the cost saving comes from moving production to China, etc, a second wave of clothing and footwear price deflation has been unleashed with the arrival of retailers like Uniqlo and H&M.

They churn out massive volumes of clothes at tiny prices, making up for in volume what they lose in margin.

And all this is before Amazon arrives.

IT’S A JUNGLE OUT THERE

To say Amazon is quite a fierce competitor is a bit like saying the Amazon is quite a big forest.

In the USA, Walmart is King. It has revenues of almost $500 billion a year, making it by far the biggest retailer in the biggest retail nation on earth. Its owners, the Walton Family, are one of the richest families in the world.

Walmart has nearly 5000 outlets and pays new staff less than $10 an hour. It is famous for being the cheapest and having the scale to stay that way.

So when Amazon decided to take on Walmart on price, the world paid attention. Amazon took the fight head-on. Reports suggested Amazon had an algorithm that went through and matched Walmart items on price — even when Walmart might be selling those items in bulk and Amazon wasn’t.

Another way to understand just how hungry Amazon is to win the price wars is to look at its profits. It really doesn’t have any. It made $38 billion in sales in the most recent three month period, but just $200 million in net profit. That’s around 0.5%.

Instead of raising margins high enough to turn profit, Amazon prefers to keep winning market share.

Whether Amazon will damage other Australian retailers remains to be seen. But the impact it will have on retail prices seems pretty clear: Down, down. And that is likely to make the inflation/interest rate/house price problem last even longer.

Jason Murphy is an economist. He publishes the blog Thomas The Thinkengine. Follow Jason on Twitter @Jasemurphy

Originally published as How Aldi is pushing up house prices