It’s refreshing to hear a new perspective from the Reserve Bank on the aftermath of the Global Financial Crisis and the challenges it presents to the New Zealand economy.
New Governor Graeme Wheeler is correct to say that Quantitative Easing cannot be seen as the silver bullet to restoring global prosperity.
One of the ironies of monetary policy however is that not only was it responsible for underwriting the credit explosion that led to the GFC, but also in order to mitigate the damage to the real economy imparted by the balance sheet restructuring that was needed on bursting of that bubble, loose monetary settings are at least a prerequisite.
So loose money was the disease and is now at least part of the cure.
While Mr Wheeler doesn’t accredit any of the quantitative easing that’s occurred in the major economies as having generated economic growth, he has avoided considering the counterfactual of what might have occurred without accommodating monetary conditions.
The logic of easy monetary policy settings being both the disease and part of the cure, tests most people until they appreciate the human cost of an austerity-driven correction to large imbalances.
The downside of austerity was last widely seen in the Great Depression (although Greece is getting a taste right now), and despite that being a long time ago, the consequences of the dual of tight fiscal and monetary policy is etched permanently.
The new Governor points to New Zealand’s excessive debt as the home-made driver of our doldrums and postulates that until that corrects, the populist dream of an export-led, currency-supported expansion will remain elusive.
A theory that holds indebtedness can be held responsible for over-valuation of the currency, is curious and worth exploring.
You might be forgiven for believing excessive indebtedness to foreigners would actually deter further capital inflows and weaken the currency, albeit raising interest rates as a consequence. Certainly the Latin American debt crisis led to that outcome as has indebtedness of Spain, Ireland, Italy, and Portugal . So a theory that holds that on the contrary, high debt pushes the currency up, is novel and Mr Wheeler might like to explain the above exceptions.
Our strong currency is not a sign of international creditors and investors being in any significant way, deterred from New Zealand borrowers at present – indeed they’re loving it. If they’re so happy to fund these borrowing levels at the interest rates we’re happy to pay, where does that leave an argument that holds our borrowings are our downfall?
Our creditors aren’t worried so perhaps Governor Wheeler knows something the markets don’t – like we aren’t using our borrowings wisely. I’ll come back to that theses.
Perhaps there is another reason for the “high” currency, coinciding with high external indebtedness? While the improved trade balance, on the back of strong terms of trade has certainly supported the “high” currency of recent years, that support is waning now. There may be another cause.
Isn’t it more likely that it’s our reserve Bank-set interest rates that are underpinning the currency? We have an official rate of 2.5%. In Europe, the US, Japan, and the UK the cash rates are all under 1%. Of our major trading partners, only the Australians have a rate above ours, at 3.25% – and we are relatively weak against the Aussie right now. Yet overall our TWI is, we agree, pretty high.
If we accept, heaven forbid, it is actually our official interest rates that are responsible for keeping the TWI up near the tops of the post-float range (gosh it’s been 28 years since we floated), the obvious question is whether our central bank’s approach to inflation control is seen by the markets at least, as just a little zealous for the current climes. In other words the interest rate carry we are paying (the gap over other central bank rates) is seen as a no risk, gift from the people of New Zealand to the world’s investors. They can’t get enough of this.
To confirm this as a possibility we need to examine whether the Reserve Bank is running a monetary policy that is regarded by foreign investors as simply too tight. In other words what is the capital market’s view of our inflation prospects?
Certainly over the last six months our CPI inflation has been running between 1 and 1.5%, compared to US and Australian inflation running in the 1.5-2% zone, the UK and Euro zone in the 2.5-3% zone. So prima facie at least, there is evidence that our Reserve Bank is running relatively tight monetary policy – it has inflation lower than elsewhere and yet has got rates higher than elsewhere. And that, at least in the foreign investors’ mind, means it’s offering money for nothing.
So despite denial from Reserve Bank spokespeople, it’s absolutely the case that this might be a credible explanation for our “high dollar”.
Now let’s turn to this argument by Governor Wheeler that until we get our debt levels down the upward pressure cannot come off the currency.
While I’ve suggested it’s not immediately clear why the market doesn’t agree with him that our borrowing levels are too high (otherwise they’d not be so keen to lend would they?) we can agree that our big external debt has to a large extent been raised by the banks and lent on to our housing market.
We also know that house prices in New Zealand are at record levels compared to incomes, and that the previous two Governors bleated on about this in public ad nauseam but did nothing to address the one fundamental cause that was within their control. That of course was to reverse the RBNZ direction to the banks (who the Reserve Bank guarantees as we found out when push came to shove during the GFC) that they should attribute the lowest risk weighting to mortgage lending. With that directive from those last two Reserve Bank Governors, we ended up with lenders falling over themselves to send the funds they raised offshore into the property market – with unsurprising effects in terms of the misallocation of investment to that sector, high inflation in property prices and building costs.
The handiwork of a poorly managed Reserve Bank has much to atone for.
So the new Governor might express this as the debt level being too high. To the extent we have misallocated the capital we have raised, productivity is low, income generated is low, and GDP growth has been nobbled. So we have missed the economic growth bus, not because as he suggests the high borrowing has pushed the currency up, but rather because we have misallocated the capital raised to a low productivity endeavours. The new Governor then has it half-right – the high debt has caused trouble.
More importantly though the Reserve Bank has the power to reverse this self-fulfilling trend of rising external debt fuelling property values, fuelling more debt and so on – the well-known bubble that has yet to burst.
It can do that simply by changing its prudential policy that currently asserts that mortgage lending is the lowest form of risk lending by the banks and they should give it priority.
Given the RB guarantees lenders to the banks it can hardly, in the face of that policy, point the finger and credibly charge that there is too much debt dependency by New Zealanders.
Who’s encouraging the banks to raise the debt and lend it out this way?
The central bank prudential policy lies at the heart of the ailment.
It has a choice – either remove the bank guarantees or change the risk weighting banks can ascribe to mortgages. The latter would raise the mortgage rate, lower the demand for that kind of borrowing and see the banks have to look to lend more to businesses in order to make a bob.
Looks to me like that outcome would see a quality of lending that would align more with sustainable economic growth.
What I’ve wondered for years now is why the prudential policy the Reserve Bank applies to the banks isn’t conditioned by ensuring a level playing field for all types of borrowers?
On what economic theory does it arise that mortgage lending is the least risky? We’ve had heaps of it and our economy is stuttering as a consequence.
So in conclusion there are a couple of things the new Governor needs to establish credibility on
(a) Why is the “high dollar” not due to our relatively high official cash rate/ low inflation duo?
(b) In light of the explosion in property prices, where is the justification for the Reserve Bank to instruct commercial banks to lend on mortgage in preference to all other lending?
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Gareth Morgan is a businessman, economist, investment manager, motor cycle adventurer, public commentator and philanthropist. This opinion piece was first published on his new blog garethsworld.com and is reprinted here with permission.
23 Comments
The new Governor seems to be like another automate. Hold the ship steady and we will reach our destination, (of which he is not exactly sure where) unless we hit the iceberg beforehand.
The fact that he recognised that there WAS a financial crisis but do not recognised that THINGS HAS CHANGED is a great display of cognitive dissonance. Can it not have occured to him that new situation requires new thinking and action DIFFERENT from the past ??
I can summarised the whole of his speech as " There is a new situation out there, but there is nothing I can do about it ! Whatever happens next is not my fault..."
The amount of capital the banks have to put aside for a loan depends on two things. 1) the probability that loan will go into default (i.e. probability of default = pd), and 2) the loss that would occur if that loan defaults (i.e. loss given default = lgd). The higher the pd and/or lgd, the higher the amount of capital the banks must allocate for that loan. For a housing loan, the value of the mortgage security held helps to keep the lgd lower than for a normal business loan which may only be partially secured or unsecured. So when a housing loan defaults, losses are generally low as long as the property held as security has been valued accurately (that why leasehold apartments caused a lot of problems for the banks). Defaults on business loans can result in much higher losses.
The answer to that perennial question is: naked politics. I know that is heresy and even unlawful, given all the statutory provisions to keep politicians hands off the RB. The inconvenient truth is that New Zealanders demand big houses and big mortgages and no government is going to allow the RB, or anyone else, to stop them on their parliamentary shift. Much of modern governments social and economic policy is designed to this end, though it is dressed up in other words.
Ergophobia
But, but, but, Gareth, What about the Bankers? Bless them. Someone's got to stick up for them. They're people too. It's all very well coming up with clever ideas to look after everyone else, but Bankers have rights, you know.
You mean to say that mortgage debt isn't extra, super, once in 10,000 years, AAA rated safe? Next thing you'll be telling us is that sovereign debt isn't risk free. Phowee, I say.
I'm sure that nice new man at the RBNZ knows best. You just pipe down and stop criticising your betters, you hear?
Gareth,
A pretty good article, but with a couple of significant different possible interpretations of the facts and outcomes.
The establishing of our very high debt along with asset sales has surely absolutely been the cause of an over valued currency (where otherwise standard currency movements from trading would have the current account in balance, not in massive deficit.). These investors have had to buy NZD to make their investments; thus causing the appreciation of the NZD. And that then causes a vicious cycle; we sell less, and import more; needing more debt to fund that. So investors enjoy some yield, as you say, and while the music keeps going, are safe enough with capital retention as a minimum. (In many cases I believe we've gone out of our way to guarantee it in fact, with them having first call on the best mortgages.)
So lowering the OCR is a way to lower investment in; but would likely have unintended consequences of boosting demand for credit here, along with another housing bubble, as well as dissuading local savers. (Given inflation of 0.8%, it still might be the right answer I accept). Nevertheless, your whole argument rests on the RB determining that lending for housing and farms is now not safe, and lending to businesses is. It is tempting to believe their statement that property lending is safer, is more a statement of obvious fact, rather than a direction. A defaulting business is worth nothing; the house as collateral is usually worth at least the loan amount. They could change this direction; but if I was a bank, I would ignore the change in direction.
Other tools like CGTs or your property taxes may well reduce demand for debt; but probably would not discourage the foreign supply. Their impact on the exchange rate would likely at best be limited.
Before long in my view you get to the answer that some controlled money printing, replacing the foreign money, is the least bad answer in a world where the rest of the world is printing with gusto. It would give you the looser monetary conditions you rightly argue for, but without the other consequences noted above. As a minimum you stop the free gift from the people of NZ to the rest of the world that you highlight.
Separately I could challenge at length the idea that because foreigners are willing to lend you money at low interest rates, you should always take their money. That does leave you very highly indebted, owning nothing, and deeply exposed to the rent or interest rates increasing over time. At a macro level, with a high exchange rate, the country has no choice but to blow the difference on trinkets, trash, and travel. Until the music stops. Best to manage that music stopping ourselves.
Spot on StephenL. It is surprising that someone of Gareth's intellect can't see that it is the inflow of imported capital to sustain our current account deficit that is causing the high exchange rate.
There is a looming disaster headed our way, the ongoing and rising CA deficit is completely unsustainable. Although Bill English admits he's concerned, for the most part the pollies won't even discuss it, much less take any action to mitigate the damage.
Stephen L and Kiwidave - If the exchange rate is lowered wont all that imported capital cost more to pay back?
Kiwidave you pointed out yesterday that between $12 to $15 billion or approximately $8k per household flows offshore from profits made here. If we want to keep profits and earning in NZ shouldn't we deregulate banking or at least allow another type of banking such as the Family banking model in the USA?
It is currently horrendously expensive to establish a bank in NZ and we do don't have enough competition or choice for NZ owned and operated banks. The family bank model in the USA is very cheap to set up.
A large number of small banks can't threaten the economy to the same degree as large banks. Simple rules for registration such as must be a citizen or resident of NZ and Directors must be NZ based. Low start up fees. IT platform to the RBNZ to fulfill requirements. No derivatives trading on Family Bank mortgages etc.
notaneconomist,
That a lower exchange rate will cause capital equipment to be more difficult for an exporter to pay back is a common and understandable misconception, so I wouldn't be as tough as nic, and say "well duh". I believe John Key recently made the same error.
Assuming the equipment is bought in say USD, and costs $1 million USD, then right now it would cost NZD1.25 million. With a 20% depreciation, it would indeed cost more~NZD1.5 million. But suppose it was used to process milk powder for which you received USD1 per kilo, then you will still only need to produce 1 million kilos of the powder to pay it back, because you will now be getting NZD1.50 per kilo, instead of NZD1.25. Hope that makes sense.
On your banking ideas; they could well work; although I'm not sure who has the appetite to kick them off.
Personally I believe the Aussie Banks (and KiwiBank) do a good job running our financial plumbing; and more or less in allocating funds to people for mortgages, loans etc. Where they make unreasonably high amounts, in my view, is in their arbitrage in borrowing funds offshore to onlend here many times over as they create new money. Its this latter bit I would to a large extent disintermediate them from; by having our Reserve Bank create the same funds they are creating, charge the interest the foreigners are charging, loaning the funds out through the commercial banks for them to do what they are good at.
Hope that also makes some sense.
Regs
Lowering the exchange rate would help, as has been pointed out. Our debts are, fortunately, denominated in NZ$ while our earnings are in another currency.
Profits to the foreign owned banks are only part of the reason for our intractable CA deficit; there's also the offshore owned major retailers, breweries, shopping malls, parking companies, power companies, telecommunications, forests, farms, hotels, miners - you name it - where I live the rubbish collection is done by an Aussie outfit, FFS! Most of these were former Kiwi businesses.
As well as all that there's a wad of interest payable to foreign lenders.
We are in this position thanks to decades of spending more than we earn - now we haven't got the capital. That's been the process; borrow and spend or flog off what you have got and piss the proceeds away.
How long will we be able to borrow in NZ$ to "fund" all this? When we can't borrow in our own currency at low rates she's pretty much all over for our economy. Welcome to Argentina.
Having followed these blogs for the last few months since returning to NZ. There seems to be a big argument against increasing the capacity of our cities to build more houses (increasing supply) to bring down house prices. There would be many ways to do that from Hugh's Texas MUD model to Bernards print money to build state houses like we did in the 30s. But we cannot even get to the step of deciding what is the best method because we cannot even agree that it is a problem, that it can be solved this way or even that there is any point doing it.
People like Olli say there isn't a problem, that it has always been hard to buy a home. Well look at the statistics, 1990 a 75% home ownership rate and homes were at a traditional 3 times income level. Now home ownership rate 65% and homes cost 6 times your income. So there is a problem.
Others like Gareth Morgan argue that there is a problem but it isn't caused by supply constraints it is caused by bad monetary policy, that it is just a demand thing. But why cannot it be both? Prices of anything are determine by the combination of supply and demand factors. We know in New Zealand the supply of housing affects its price because we have seen Christchurch lose some 10,000 houses and house prices and rents have gone up 20 to 30%. Further we know that cities that have less supply restrictions on building new houses do not have the same house affordability problem, even though they share the same monetary policy. Hugh's housing affordabilty statistics from the US clearly show this.
Then there are those who argue that there is no point in solving this problem because we are heading for environmental armagedon. In Western society there has always been a minority who hold doomsday beliefs. It used to religiously based nowadays with the decline in traditional religions it is environmentally based. It is hard to argue against because you are aguing against fanatics. Luckily it is just a minority who are negative about the future, the majority are optimistic. Combining that optimism with collective effort will allow us to solve our problems.
A cut and paste of my post from Olly's thread. Be an optimist and jerk (for you fallacious tactics)all you like but you are wrong, the numbers say it is so.
The world population reached a very important inflexion point in 1961 when the rate of growth turned negative for the first time ever. The rate of growth is still getting less each year and given that they look backwards, it is possible the population has already peaked. That isn't a prediction, that is the the seneca effect in action.
The comment wasn't directed at you. I do not believe there is any point in discussing with you or your other doomsdayer bloggers.
I was hoping to get a discussion going with those who think their is a problem with housing affordability that is worth saving. Maybe even Gareth Morgan might notice and start to amend his views.
One thing I have noticed since returning to NZ is people seem to have entrenched views and are not prepared to listen to others. There seems to be no mechanism for building a concensus to resolving our problems.
Of course there is a problem with housing affordability but it depends of if you want to discuss the symptoms or the causes.
Cause one: Unearned income, that is people making money of the efforts of other peoples labour. The predominant and contemporary method is through Usury & housing, or the charging of interest on mortgages. It is mathematically demonstratable that interest causes a redistribution of wealth (M.V)+i=P.Q Now if you look at the fact that population growth is declining, there are less new people unemcumbered by debt entereing the system, the ponzi scheme this is housing is in its final throws.
Cause two: Resources getting scarcer and thus more expensive. 1961 wasn't peak resources, but is was peak EROI, that meant more work for less money and this has had a direct impact on breeding. The Senenca effect is biological, and humans are biological and thus will follow the rule. From that point it isn't a big step to realise that disconnecting the money supply from a resource(gold) is a logical step for those running the show, convenient they did this in 1971 eh?
Do you think that resources are infinite? Then I suggest you peruse the USGS (reputable) website for mineral information to back up your theory. Try looking at the reserves of the following metals and compare to consumption levels. Chromium, Lead, Silver, Copper, Cadmium, Nickle. If you want to continue "growing" then consumption of these minerals will go up and chew into those reserves faster.
So others are entrenched in their doomsayer views but you are not in your uh prozac enhanced view....makes perfect sense...
really it does...
Personally Im always ready to listen to others that can demonstrate no political and in some cases extremist libertarian bias, see the overall picture and supply facts and data to backup what they say.
Otherwise its just hot air and very probably wrong.
regards
I do not want to be disrespectful. I apologise if I have been abusive in tone. We just have a difference in opinions. Maybe you are right about peak oil and resources in general being near their peak. Maybe it will be a game changer. But we haven't reached that point yet. I prefer to take an optimistic view and deal with the problems in the here and now.
I am not associated with any political party and i am certainly no libertarian or even neoliberal.
On a national basis the earthquakes took out a very small percentage of households, it must be less than 1% but has caused a significant rise in rents and house prices in Christchurch and I believe it is a factor in Auckland's house price boom too. So a small change in house holders per house can have an affect on the price.
I am only arguing that we build enough houses to maintain stable prices. Not some dramatic reduction in house prices.
With regard the increasing shortage of oil and resources and it is a fact oil prices are high and unlikely to fall again. But I do not see that as the sole cause of house price rises in New Zealand, as I do not think monetary policy is the sole cause of price rises. It is a factor but you only have to look around the world and realise there are plenty of cities that are exposed to the same resource costs and monetary conditions that manage to keep their houses affordable.
You're correct Brendon that with regards to housing most commentators are fixated on a single supply or demand issue when in Auckland's case in particular it is a bit of everything and no single measure will solve the problem by itself. Just like a business best increases its profits by increasing income and reducing costs, we need an increase in supply as well as a reduction in demand.
The irony is that the RB inaction Gareth talks about is caused by previous RB and govt inaction. Once a problem, in this case too much debt against property, becomes too big and painful to correct, the default mode becomes extend and pretend hoping it will go away by itself. This govt is explicit in its commitment to keeping property values elevated. It and the RB know the damage to the banks that would result from any significant correction. This is their primary concern. But to prevent this they have to allow the problem (debt and interest transfers to Australia) to get bigger - fixing a debt problem with more debt, papering over the cracks, hoping asset inflation will more than offset debt growth. In their minds it has worked to this point and they will continue to double down until it doesn't.
Changing the weighting from property towards business loans will not help. As someone else said, you can't blame the banks for preferring property - they will likely get all or most of their money back in a forced sale. A business and its assets become almost worthless in the same situation.
Alan Bollard all but committed RBNZ to Australia's 4 Pillar policy, keeping the big banks fat and profitable, not crimping their credit creation or margins in any way, to "protect" them. As Gareth notes they also still have an implicit guarantee from the government. The OBR seems to have been deferred indefinitely and compliance with new Basel criteria extended by years.
Gareth, a very good article, could'nt agree more.
I would like to make this comment
You can NEVER sort out the problems in the economy long term while you keep messing with the money supply. All as you get is and expansion of money and a boom then a contraction of the money and a bust - IT MUST STOP
Further those that control the money supply always benefit the most.
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