by The AFR View

The great unwinding of the property price bubble of Australia's biggest cities has begun. Falling house and apartment prices in Sydney, Melbourne and Brisbane will encourage young Australians who feared they would be forever priced out of the dream of home ownership. Yet this housing price deflation leaves behind an oversized burden of household debt – more than 180 per cent of household income – that has been fuelled by the cheap money policies of the world's central banks, including the Reserve Bank of Australia, in the decade since the global financial crisis.

And, while job growth has been surprisingly brisk, wages growth has been disappointingly slow. That's made it harder for households to pay off their debts without cutting back on their spending. Previously, they may have hoped that they could bank on the rising market value of their house inflating their wealth. Now this wealth effect is going backwards. To maintain their lifestyles, households have been saving less of each pay packet.

And, now, on top of painful electricity bills, they're paying more to fill up with petrol as global oil prices rise, and to buy basic groceries in the wake of the eastern states drought. And this is with the official price of money stuck at a record-low 1.5 per cent and the Reserve Bank seemingly paralysed by fear of what damage even a modest tick-up of interest rates could do to the over-leveraged economy.

At the same time, Australia's big banks are reeling from the battering of the royal commission into financial conduct, retreating to their core and becoming more risk averse. No one knows exactly what legal hoops they have to jump through to avoid breaching so-called responsible lending laws that put more of the onus onto banks to make sure their borrowers aren't lying about their income and expenses.

The Federal Court has refused to accept a $35 million precedent-setting settlement with the Australian Securities and Investments Commission that Westpac agreed to seemingly just to cut its losses.

ANZ chief executive Shayne Elliott this week warned that decades of double-digit housing credit growth had slowed to 5 to 6 per cent. Mortgage credit growth could retreat to 2 to 3 per cent, he suggested. And this is with unemployment in Sydney and Melbourne well below 5 per cent and mortgage arrears near record lows.

Also at the same time, Australia confronts further political upheaval, with the Labor opposition favoured to replace the unstable and divided Coalition government in an election by mid-2019.

Labor promises

Labor has promised to tighten tax breaks – on negative gearing and capital gains – that helped fuel the great Australian property bubble so it can raise the taxes required to pay for its promised spending spree on schools, hospitals and the like. The Reserve Bank has pointed to the interaction of an unreasonably generous capital gains tax discount with a more respectable negative gearing concession as driving the previous speculative dynamic.

But, whatever the merits of Labor's specific tax proposals, they are ad hoc rather than part of a coherent tax reform package that would sharpen the incentives to work, save and invest – and hence generate the productivity and wages growth that would help deflate the bubble in an orderly manner. In any case, the housing market now is deflating, not inflating, and so is exposed to any tax hit.

The great unwinding of Australia's housing price bubble has been orderly so far largely because of the unexpected national income bonus from higher commodity export prices, which have fuelled iron ore and coal export revenue – and led to big dividend returns to BHP and Rio Tinto shareholders. This, in turn, reflects a cyclical upswing in the American economy, boosted by Donald Trump's tax cuts, which have pushed the US jobless rate to its lowest since man first walked on the moon. But the economic upswing is germinating price inflation and prompting the US Federal Reserve to lead the global interest rate cycle higher.

This does not have to end in tears. But Australia's diverted national debate needs to focus on shoring up our defences in case it does.