Well,it’s been an interesting week on the world frontier: the tiny island of Cyprus nearly challenged the religious trust that your money is safe in the bank. Freezing assets in the bank one day and then returning them missing 10% could have caused a catastrophe across Europe. The PIIGS (Portugal, Ireland, Italy, Greece and Spain) will all require further bailouts in the future, and if the residents of those nations believe the next bailout will mean a tax on their savings then a bank run could ensue across Europe. However, the Cypriot parliament voted no to the tax and have put forward an alternative to guarantee deposits under $100,000 and amalgamate Laiki Bank with the Bank of Cyprus. The details still need to be confirmed, but it looks like for now Cyprus won’t default and will receive the much needed $17 billion bailout.
The events in Europe do not have an overtly large effect on Australia, but it can give us an opportunity to reflect on our own Australian banks (currently the market capitalisation of the big 4 Australian banks is larger than every bank in Europe put together). The big 4 banks are expanding their lending and size every year despite the GFC; according to Rams, as an extreme you can now borrow 120% of the full purchase price plus upfront costs if you have a guarantor.
Are our banks safer than those in Europe? The obvious answer is yes, but the fact is that for every $100 of savings, Aussie banks hold less than $1 of cash. According to the last ANZ Bank annual report it held $397 billion of deposits, yet it only held ‘Coins, notes, and cash at bank’ of $3 billion. To put that in context, for every $100 of deposits, the bank holds just 75 cents in notes and coins. Now, think about how much you’ve got in the bank. If you’ve got $10,000 in savings, it means the bank only holds $75 in its vaults as security. Banking has worked like this since its creation and rarely does this present an issue. However, besides your money not being as safe as it should be in a bank, inflation eats away at it and gives you (with low interest rates) returns that are stagnating at best.
In 1970, the median Australian house price was about $12,000. Today, the median house price for the eight Australian capital cities is $460,000. Now, although the average Aussie house today is bigger and better than a 1970s house, it’s not 37 times bigger.
So what does this tell us? From history, property is a great hedge against inflation as the prices rise with inflation and at the same time eat away at any mortgage, because your repayments decrease every year from the effects of inflation. If you take out a $500,000 mortgage and adopt an inflation rate of 2%, the mortgage is devalued to $408,000 after 10 years and that’s even if you make $0 worth of principle payments.