By Bernard Hickey
Watching the Reserve Bank and news about interest rates from overseas this week I kept asking myself the question: how is this all going to end?
How long can central banks keep pumping cheap and often printed cash into markets before something goes bang?
I have that uncomfortable feeling I get when blowing up a small balloon beyond its normal size at a children's party.
Every time I puff, I close my eyes tighter and wince harder.
That's how central bankers are beginning to feel all around the world.
How much air in the balloon is too much air?
It's a question Labour Finance Spokesman also asked Governor Graeme Wheeler in a select committee hearing after the central bank announced the big four banks would have to hold around NZ$500 million extra capital to back riskier mortgage loans.
What happens if New Zealanders keep borrowing more than they can afford to inflate their house prices?
When will international markets finally call time on New Zealand's foreign debt and punish us with a sharply lower currency and higher interest rates?
Wheeler had no definitive answer, but he shared Parker's sense of unease.
The Reserve Bank faces the same problem most central banks face.
Consumer price inflation is so low they can afford to keep stimulating with low to nearly 0% interest rates.
Inflation is so low in some countries they are worried about deflation and are now printing money.
All that cheap money is blowing up bubbles in bond markets, stock markets and property markets.
Central banks are nervous they could create another bubble the size of the one pumped up in housing markets in North America and Europe by 2008. That went bang and almost destroyed the global financial system.
New Zealand has a particularly tricky version of the problem.
Our lack of capital controls, our faster growing economy and relatively high interest rates mean foreign investors are pumping that freshly minted money into our economy, pushing up the New Zealand dollar to record highs.
This high currency is in turn pushing inflation down below the Reserve Bank's inflation target band of 1-3%.
Wheeler could cut the Official Cash Rate to try to stimulate the economy and drag the New Zealand dollar down, but that in turn would only blow more air into the Auckland property bubble.
Conversely, the bank could try to take some of the air out of that bubble by putting up interest rates. But that would just push up the New Zealand dollar even more. So central banks are stuck between a rock and a hard place.
They need to stimulate, but doing so is blowing up the very bubbles that caused the Global Financial Crisis to begin with.
In theory, this puffing and wincing and hoping the balloon won't go bang could go on for a very long time. For some reason, the rubber in the balloon seems very resilient this time around.
One reason is markets believe central banks and governments cannot afford for it to go bang and will print and stimulate and bail out banks to make sure it doesn't.
This week the Reserve Bank of Australia and the Bank of (South) Korea cut interest rates unexpectedly. Last week the European Central Bank cut rates and suggested it may do more. Central banks in America, Japan and Britain have printed US$6 trillion in the last three years.
This week stock markets in America hit record highs.
The hope is that eventually all this hot air will leak out of the balloon and warm up the room, creating some real economic growth with real jobs and wages growth.
This week's employment figures in New Zealand were promising, but were at least partly due to the biggest earthquake rebuild anywhere in the world in the last century, relative to the size of our economy.
Luckily, or not, we're the only ones doing that.
Yet fresh house price figures here also showed prices rising at double digit rates in Auckland and beginning to spread elsewhere. At current rates of growth, Auckland's average house price will hit NZ$1 million in 3 years.
Less than half the necessary houses are being built to keep up with population growth.
A house price equivalent to 20 times median income can only be sustainable if interest rates stay low forever.
This suggests the answer to the question: how long before the bubble goes bang? When interest rates start rising.
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This article first appeared in the Herald on Sunday. It is used here with permission.
18 Comments
Well done Bertnard! Good article, no copywrite... Brilliant!
At 20 times the average annual salary for the average home, how much higher can prices go?
Where I live, the average 3 bedroom home is $450k, and if one wants to live by the beach, one can expect to pay $1.3 million or more, depending on how close to the water one wants to be. There is a 2 bedroom "absolute waterfront" house, with a converted garage into a third bedroom, selling for more than $1.7 million. The advertisement says offers over this sum accepted...
The main employers in town are the hospitality industry, a couple of retirement homes, and tradesman providing services. The average annual salary in town is probably $30k, but most people commute to Hamilton to work for perhaps $60k. This has been the status quo for the past 10 years, and it is now starting to move up again after a minor adjustment in 2009.
My estimate is between 10 and 25 times the average salary for houses in the area. How long before people realise they can build a house themselves, with their own hands, in less time than what it will take to pay it off? A few sections on the mountain side are being developed on a DIY basis using alternative energy sources and milling their own timber, plus using a lot of recycled bits and pieces. It's not as hard to build a house as it is to spend 20 years of salary buying it. Of course, banksters and councils will have something to say about this, but there hands are tied when it comes to Maori Pa land. Go figure...
HGW
Anybody who thinks they know where interest rates will go is havin themselves on. But I think it's all very scary.
Some have decided to borrow like there is no tomorrow -- and hope. Quite a viable business model very similar to the former finance companies. And if it all goes tits up ? - Well you can blame "circumstances" Never mind the little old ladies whose savings have been destroyed. And can't afford to turn on an electric heater in winter.
We conceal those under that strangely innoculous term "haircut" Actually it's more like "decapitation" of hard working people.
But what to do Bernard ? We have to deal with it and no decision is a decision. My approach with low interest is to use that opportunity to drive down debt. Lot's of passive income under my direct control and not in the grip of financial services industry - yes property.
Those highly geared might just find their skill in walking the tightrope will not count for much if somebody comes along and cuts the rope.
Not trying to make a prediction here. But people should be worried about it.
Hmmmmm - incoherent? - yes is not the wrong answer.
Federal Reserve Bank of Chicago President Charles Evans: “You talked about monitoring markets at great length. A major cause of the recent financial crisis was the failure to identify the housing bubble, and you spoke on that. Could you expand a little bit more on what's being done to identify current and future asset bubbles, and are you optimistic that we've identified them and nothing like that is going on at the moment?”
Chairman Bernanke: “Well, our monitoring -- there's really two parts to it. So the first is that we do, in fact, do what we can to try -- I would say the word ‘bubbles’ is a freighted word. And let me just say we try to identify situations where asset valuations relative to fundamentals are historically anomalous, where, for example, in the case of housing, we would have seen house prices relative to rents as being much higher than historically normal.
So we have an extensive program to try to assess whether major asset classes are in fact within historically normal ranges… In the stocks and equities, we look at dividend rates and earnings and the equity premium, those various kinds of standard finance indicators. In corporate debt, we look at measures that would help us assess the amount of default risk and therefore to assess whether spreads are appropriate or not. In more complex instruments like structured credit products, we look at a variety of things, including the terms and conditions. Are we seeing, for example, as we are in some cases, covenant-lite types of agreements in certain kinds of structured credit products. So we do try to identify, much more so than in the past, whether major asset classes are deviating in terms of their price or valuation from historical norms.
Now, that being said, two comments. One is that I think it would be hubristic to believe that we could always identify such deviations. On the one hand, sometimes changes in price-to-earnings ratios are justified by some fundamentals. You know, Microsoft stock is worth more than it was some time ago, and this may still yet prove to be a bubble. But so far so good, right? At the same time -- it’s not evident that having a misalignment or historically unusual relationship is a problem, though it may be. But of course, we can also miss changes in valuation that are, in some sense, not fundamentally justified.” Read article
Bernard - Congratualtions. Whilst I often disagree with the slant you on place on much of what you write, I welcome seeing an article from you that is so spot on. This issue is the single most importantant issue that will dominate informed lives over the next decade of more. How it plays out will define all of our lives, particulalry the younger generation who are being indirectly forced to purchase their biggest asset at inflated prices due to volumeous and sustainably cheap money - a publically stated plan by the likes of the Fed Reserve who indirectly dictate the level of rates, and money in the system, globally
The RBNZ's recent announcement of increased capital requirements for banks on high LVR loans should be a massive signal to the higher leveredged borrowers - affordablity is currently just possible, but barely, because of historic low mortgage rates, but for the reasons you discussed, they can not remain there. The RBNZ's move is a prelude to them raising rates, probably early next year but who knows the timing, which will change the demand/supply dynamic that the property bulls go on about - it will produce new supply to the market as many bail, or are forced to bail, and the RBNZ is ensuring that whilst you may be in trouble, the financial system will be able to handle it. They aren't trying to fix the housing market with the initiative, they're acknowledging that the housing market bubble will fix itself when they move rates.
And Kimy, there's so many holes in your proposed solution regarding bank incentivised/directed lending its not even worth debating. Won't happen so need to look at other solutions. Your million dollar suburbs comments are just talking staus quo, where record low interest rates make that somewhat possible. But at 5-8x multiples, and with somewhat higher interest rates coming, there will be less million suburbs, especially in the likes of Melbourne & Sydney where the multiples are even worse - its a case of doing what some others and Bernard are doing here, standing back, looking at the big picture of what central banks are doing, rather than being fixated on myopia
Brendon - I think the RBNZ is trying to work toward no bursting of the bubble, just a slow deflation starting earlier - but the jury and history is very much out on that one - lets hope they can, but personally I prefer to plan than hope.
But Kimy, whilst I totally agree with monetary policy offshore being a major cause of the problem, what I think you're misreading is that there's some solution that exists without a reversal of it at some point. The RBNZ knows it, even the Fed Reserve (THE major culprit) knows it, witness Friday night, just a newspaper article suggesting that they may be contemplating starting to ease back on QE took US long rates nearly 10 basis points higher. The RBNZ knows if have to tighten at some point and they're already starting to position the system for it as they should - it's still probably 6-12 months away, but they will be forced to act even if not everyone's ready for it - the consequences for those not ready by delaying further will be more terminal, so better a gradual process than a steeper shock.
Agree that interest rate rises are not the solution, the negatives out-weigh the positives. Higher interest rates give us:
less affordable houses due to higher borrowing costs;
higher NZD and the resultant negative effects on exporters;
more foreign money inflating the housing market as they profit on capital gains and exchange rate;
more money in Australian banks (80% of funding for lending is sourced on the international money markets, they'll charge more and have their costs remain the same).
Higher rates will dampen demand but not make housing more affordable, people live in Auckland because they have to, the demand will remain we'll just pay more for it.
Auckland has a supply problem, fix the supply and change first home buyers expectations (they need to learn that life starts in flats, apartments and terraces).
What interest rate response are you referring to Kimy ? - not the rise in bank bill rates from 2003 - 2007 from 5% to 9.30% when the RBNZ later admitted that they misjudged the extent of the housing boom over that period that eventually took the annual inflation rate to 5% ? Yes, when these things happen somethiing breaks (in that period alot of poorly lent finance companies) and you want to make sure it's not you. The RBNZ has a good memory of that period and will not want to repeat it by unduly delaying again, but it has some time on its hands yet - in the meantime it is positioning the market so that the move won't break the financial system again.
Understand what breaks QE, inflation. When it gets out of hand central banks can no longer use it as "kick the can down the road" measure and have to hike - fixed rates would have spiked well before then. Inflation isn't yet an issue, and won't be for some time, but remember markets are forward looking by a year or more - when they sniff it, you're dead.
"When there is a sign of healthy and robust economy"
Kimy... When has there ever been a sign of that..???
One thing we learnt from the GFC is that most of the so-called growth has been the result of unprecedented credit growth... just like a drug addict who needs a stronger and stronger fix.
The Cenrtal Banks failing was not in cutting off arms and legs...BUT in allowing the unfettered credit growth in the first place..
AND ... that is what u are advocating with ur strong views for lower intereste rates.... ( Another drug fix ...so we all borrow more and get "claytons" growth)
Have a look at the credit aggregates and money supply figures.... NZ is going thru another credit growth cycle..... we are heading towards what other countries are alreading going thru... We don't learn from others' experiences..
AND ..ur answer to our problems is lower interest rates.... ?????
http://www.reiv.com.au/Property-Research/Median-Prices/Million-dollar-suburbs
38 - million dollar suburbs.
How do you get over 100?
Still - its rather a lot - although only 2 over 2mill in Melb.
I can imagine the herald front page in a month or 2 when Herne Bay hits 2mill average.
SK.
Sydney
Point Piper $5,210,000
Tamarama $4,337,500
Bellevue Hill $3,300,000
Vaucluse $3,100,000
Double Ba $2,960,000
Dover Heights $2,490,000
Mosman $2,250,000
Longueville $2,235,000
Clontarf $2,125,000
McMahons Point $1,920,000
I did live in Double Pay - too many facelifts for my liking - everyone in a constant state of suprise.
Bernard ..
Good article ..
Good analogy - almost ..
Trouble is, the spivs will always come out with bigger and better balloons
Here they go - they're at it already
The "whale balloon"
Yes, however when there is a full head of steam, it takes more than a rate. What else would happen if rates were to go up
Remember the 1980's, when interest rates at aprox. 18% 1st mortgage etc.
Swiss franc loans, interest capitalised loans, house purchase via vendor 2nd or 3rd mortgage...
People bet and lost the farm on things like:
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=104…
RJI attracted a special breed of shareholder. Its annual meetings attracted thousands and the atmosphere was like a religious revivalist meeting or a political rally.
The company took time to fall. In its 1989 half yearly report, it published two lists detailing the pre and post-crash position of the 43 listed property companies. Three were already defunct, 14 were in receivership and five taken over. Their combined market capitalisation had fallen from $5.8 billion to $1.3 billion.
Even though RJI had lost 41 per cent of its value, it boasted it was the only one to prosper as it was 10 times the value of the next largest player.
"We are on target for another record year... shareholders can confidently anticipate further growth...," the company said.
Within 18 months it joined the others on its knees and although it avoided total collapse, its shares joined the penny-dreadful class.
Sir Bob describes the pre-crash environment in 1980s as "glorious times of optimism and excitement after the stultifying preceding years".
"There's been a great deal of hyperbole about that period.
"The salient mistake lay in the public fervour which brought irrational share-prices.
"I have that uncomfortable feeling I get when blowing up a small balloon beyond its normal size at a children's party.
Every time I puff, I close my eyes tighter and wince harder.
That's how central bankers are beginning to feel all around the world.
How much air in the balloon is too much air?"
Now that hits a central cord, right on the nail.....just like a boom cant go on for ever, nor can long periods of low interst rates in the modern economy....
Well there are exceptions, the post WW2 periods and in the 60s going up to thw 1st oil crisis ...
Which out of interest do we see parrell comparioins with the current period?
Very good article Bernard. There is a good chance that QE will be reduced in the last quarter of this year from the FED. Its likely to be a gradual reduction rather than a complete stop as there is a risk of how the markets will react to this. At this time we do not know if there will be a change in the money flows into New Zealand that has been keeping the currency high will change or not. However this change in reduced appetite for money printing could potentially change th dynamics of the kiwi or bank lending rates.
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