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Part One of the Bubble Series
I have seen both the Main Stream Media, and Social Medial whip up the “news” of the apparent risk New Zealand is in for a (for lack of better words) bang and a crash. This news came from a Forbes commentary piece from a person who predicted the Global Financial Crisis of late last decade. You can see the Forbes piece here: “12 Reasons Why New Zealand’s Economic Bubble Will End In Disaster.”
Personally and in my opinion New Zealand is not heading to an economic disaster from its own doing. The only way we can end up in such an economic disaster if one of three things were to happen:
- World War Three
- China AND the USA both fall over
- Total mismanagement of the Economy similar to Muldoon’s dying regime in 1984
Now the first two we can’t do anything about and in any case the entire World economy would be screwed over as well. Number three could still occur but neither National nor Labour are as that reckless as Muldoon was in 1984 (including calling the election half if not fully pickled).
So what could happen to New Zealand’s Economy?
Well it still runs the risk of facing a correction or “adjustment” either from our own doing or from an external influence – but not as disastrous as the Forbes piece makes out. Looking at the 12 points (in several parts) I will go through and see what our perceived risks could be.
Using the Forbes piece as the section headings:
1) Interest rates have been at all-time lows for almost a half-decade
Yes they have been and only know is the Official Cash Rate (OCR) starting to cycle up. Long story short and is taught in Economics 101 the country has two means of accelerating or slowing down an economy as it cycles through. Those cycles are known as:
- Boom
- Recovery
- Recession
- Depression
Our Economy has gone through the first three regularly with the last time in being in a Depression being the Great Depression
As for the two means available to guide the Economy through the above cycles, they are:
- Fiscal Policy
- Monetary Policy
Fiscal Policy
Fiscal Policy is the act of the Government spending taxpayer monies into either maintenance of the State apparatus (reflected through the Ministries and Departments), or Capital Expenditure on things like roads, hospitals, and say a new frigate.
A loose Fiscal Policy means Government has increased expenditure thus pouring more money into the Economy. More money (I am keeping this basic) fuels the Economic engine room and gets things (or keeps them) moving. Consumers and businesses have a tendency to spend more when there is more money being put into the Economy. Loose Fiscal Policy is usually seen when the Economy is a Recession or early stages of Recovery to stimulate the Economy along through keeping the Economic Engine going with more money.
A tight Fiscal Policy means the Government is cutting back its expenditure (including Capital investment) in doing its part in not flooding the Economy with money. Usually the Government will start running Budget Surpluses (rather than Deficits in Loose mode) and this is done so the Economy does not overheat and run away. Overheating and run away Economies will cause Interest Rates to go up further than necessary as the Reserve Bank (using Monetary Policy which I will go through in a moment) battles increased and much higher inflation. Inflation is expected but higher and run away inflation is bad as your (real) purchasing power decreases with the money you would otherwise have (So that $100 that got you $100 worth of goods might only get $90 worth of goods after inflation). Tight Fiscal policies are usually seen in the Boom phase of an Economic cycle.
So that is how Government through Fiscal Policy can “control” an Economy as well as have an Influence (but not direct control) over interest rates.
Monetary Policy
While Government influences Monetary Policy via setting the inflation target (1-3%). The independent Reserve Bank of New Zealand via the powers given under the Reserve Bank New Zealand Act (1989?) uses the Official Cash Rate (the “main” interest rate) to control both the money supply in New Zealand as well as inflation levels.
Again I am being brief here – you have either tight or loose Monetary Policy depending on where we are in the economic cycle. As a rule of thumb when we have a recession or depression the RBNZ sets a loose Monetary Policy which means lowering the OCR – which in turn lowers interest rates and makes debt cheaper to “service.” This puts money and credit into the Economy and (well usually) stimulates it along (like adding extra fuel to a boiler). We have been through a recession and are in the early to mid stages of recovery after the Global Financial Crisis. As a result of the GFC (and Christchurch) the RBNZ set a loose monetary policy to keep the Economy stimulated rather than fully seizing up. And for the most part this has worked with New Zealand coming out of the GFC rather unscathed.
As New Zealand is now in the mid stages of recovery and (well) bubbling along well the RBNZ will start looking at tightening up Monetary Policy via increasing the OCR (the main interest rate). A tight monetary policy seeks to increase the OCR in order to take money out of the Economy in attempts to slow it and inflation down. Tight Monetary Policies occur in the latter stages of the Recovery Phase or the Boom Phase (the top of the cycle). As interest rates go up the cost of debt (through servicing it) increases as well as the interest rates on savings. Naturally people claw back their spending when the cost of debt is high and/or will funnel their money into savings further taking money out of the Economy. These actions act a natural brake to the Economy before it (you usually want to avoid this) keels over into a Recession (two Quarters of negative growth).
As how Fiscal and Monetary Policies affect the New Zealand Dollar on the Exchange rate is something I will touch on in Point 12 (the fourth post in this series).
Situation right now with our interest rates and respective policies
As the Forbes piece has pointed out we have low-interest rates – which is now starting to cycle up as we enter the mid-stages of the Recovery economic cycle.
This chart from the Forbes piece shows where our main Interest Rate has been:
You can see where our Official Cash Rate has spiked with the Booms and tapered off with either slow downs or outright recessions. Before the GFC that started hitting New Zealand in 2008 the country was running a loose fiscal policy (under the dying Clark-Labour Regime) but a tight monetary policy. The tight monetary policy would have been to slow the economy and inflation down (inflation was getting above the 3% maximum limit) however, the Government at the time (and stupidly) ran a loose fiscal monetary policy which caused the Economy to overheat and subsequently force a tighter monetary policy. Normal conventions prior to the GFC would have been both a tight fiscal and monetary policy.
Anyhow the GFC hit and New Zealand plunged towards a recession. We also had the (still current) Key-National Government enter power that initially continued loose fiscal policy to keep the economic engine room running as you would in a recession. Obligingly the RBNZ also loosened the monetary policy in its attempts to also keep our economy going. And for the most part it worked. New Zealand did suffer a sharp recession initially but we were able to pull out of it very quickly and now we are in pretty good shape compared to most if not all our major trading partners – including the Australians now.
Fast forward to today and we see the Economy in the mid stages of the recovery (although nowhere near the boom phases yet). Leaving aside the World Economy (as that is still not going anywhere at the moment) you will see the New Zealand economic engine is running well but starting to heat up with all this money floating around thanks to both a loose fiscal and monetary policy. The Government is already moving to a tight fiscal policy while the RBNZ has just started tightening up its monetary policy to make sure we don’t overheat.
The early tightening as I see it should keep New Zealand bubbling along well but not running away and causing a bubble to go bang as we all stop spending and send ourselves back into a recession. One thing that also would stave off a bubble bang is the fact corporate balance sheets are not showing a lot of debt (something Forbes missed), our household debt is down from 150% to 100%, and our Government debt is still considered low compared to the OECD. Meaning? High debt will usually entail high interest rates to try to bring the Economy back under control as we are over-spending and extending ourselves. When we over-extend then you run the very high risk of a bubble going bang as the USA found out the hard way. Right now apart from consumer debt our debt levels are relatively low and are keeping that way for now. This as a final result is assisting in keeping interest rates down and why looking at the OCR we are not heading for a “disaster” as has been pointed out.
2) Property prices have doubled since 2004
And here is the accompanying graph:
Source: http://www.forbes.com/sites/jessecolombo/2014/04/17/12-reasons-why-new-zealands-economic-bubble-will-end-in-disaster/
Yes our house prices have gone up – you need not remind Auckland of that. But I do note the fastest increases were prior to the GFC and under the Clark-Labour Regime when we are last in an economic boom and the Government back then failing to bring the boom under control. When the Global Financial Crisis did hit there was a drop in prices and we saw a case of negative equity (your house is now less than the total mortgage) which resulted in a flood of mortgagee sales from overextended people. Negative equity is a normal but nasty correction when people are playing literal silly buggers and overextending themselves so you could say it was coming. Since we have come out of the GFC house prices are rising again as we move through the recovery phase (also backed up by a loose monetary policy), although we are seeing a levelling of prices again owing to the Loan-Value Ratio restrictions.
It was because my wife and I were in a good financial position as well as being financially literate that we got our first house back in 2011 in Papakura. Interest rates were low and so our debt service costs were low (meaning we could pay more back on the principle than if we bought while interest rates were at say 10%). Also we did not over-extend ourselves with the mortgage (our mortgage was at 4.0 times our total income rather than 7.0-12.0 times some people get themselves into (3.0 is the number deemed affordable)) and we can not be in a position of negative equity unless the World Economy does fall over (taking everyone else with it).
Back to housing prices; they have been saying for over a decade now that we have a housing bubble and we are going to be in for a major correction. Two recessions later we still have that cursed bubble that is not going away fast. And that is because of more structural problems with the housing market – something that is trying to be “fixed” here in Auckland.
Minister Nick Smith said it would take about a decade for housing prices to reach “affordable” levels again. And he is right – at least for Auckland. Ironically to keep the housing market back under control and not cause a full run away falls back to the responsibility of Auckland citizens and the Auckland Council. Cue the Unitary Plan! If the Unitary Plan post 2016 allows for liberalised planning rules (especially around those development controls) the freer market will operate between the supplier and the demander (so the developer and the resident). When the freer market operates you remove one of the major costs of housing provision (regulation (the other is land and construction costs)) and your housing becomes more affordable to residents. This in turn (as you people to be mobile but without the penalising costs) would assist in keeping the housing market ticking along rather than racing along and overheating as it did between 2002 and 2007. A ticking along housing market means we should not be over-extending ourselves on debt which always leads to a hike in interest rates and soon after a “correction.”
Unless we have a major population boom or the Unitary Plan essentially becomes a NIMBY’s document to stifle Auckland what Nick Smith said is most likely to happen – thus no economic disaster caused by the Auckland housing sector.
3) New Zealand has the world’s third most overvalued property market
Most of that is covered by the first two points above. Not having a true freer market with housing provision is certainly driving up house prices beyond where they need or should be thus mortgages are higher than they should be. That said deliberate over-extending on housing debt through more irrational choices is setting yourself up for a nasty shock even in a minor correction. Again for Auckland the best way to bring the property market back into line is again via the Unitary Plan. Use the Unitary Plan to allow the freer market to work so again the demander and supplier can work out true housing provisions in a given area in Auckland.
As I said in Point Two: Unless we have a major population boom or the Unitary Plan essentially becomes a NIMBY’s document to stifle Auckland what Nick Smith said is most likely to happen – thus no economic disaster caused by the Auckland housing sector.
This brings to the end of Part One of this series. In Part Two I will be looking at Parts Four to Six with part’s three and four looking at the rest of the respective points from the Forbes post.
Finally at the end of series I will tie it all up in how I believe we are not heading towards an economic disaster.
In the meantime Bernard Hickey has summed up what I am attempting to point out in my series. You can listen to him here: http://www.radiolive.co.nz/Bernard-Hickey-on-bubbles-interest-rates-and-Genesis-shares/tabid/506/articleID/43727/Default.aspx
Terms used:
- RBNZ: Reserve Bank of New Zealand
- OCR: Official Cash Rate
- GFC: Global Financial Crisis
All those terms can be found in Wikipedia
Talking Southern Auckland 