New Zealand and indeed many parts of the Western World have got themselves in a bind with inflation. To some of us it is puzzling that the central banks did not see that coming. Getting out of the current mess will be painful.
The final precipitating factor that has created the current situation is the specific monetary response to COVID-19, but the underlying flawed thinking was firmly in place prior to that.
For those who think the current inflation is primarily a consequence of logistics constraints rather than monetary policy, I will take up that issue further down. First, we have to understand monetary policy.
In essence, central banks have operated for a long time aligned to the theory that interest rates can be used to stimulate or dampen the economy when, in their opinion, economic demand is unnecessarily constrained.
Supposedly, there are multiple behavioural pathways to explain why this monetary stimulation should work. First, conventional theory has said for a very long time that low interest rates can be used to stimulate productive investment decisions by reducing the cost of debt. There is an obvious logic to that.
Second, low interest rates cause asset capitalisation rates to decline and this can be used to increase asset values. The consequent wealth feeling then encourages economic activity, with people deciding they can afford to spend more.
Standard economic theory recognises that low interest rates have potential to create inflation in consumer prices as well as in asset values. This arises when the demand induced by low interest rates exceeds the supply of goods. When companies are competing for labour, then not only do costs rise, but companies find they can increase their prices. This in turn leads to more wage demands. And so, an inflationary cycle is then in place.
Over the last 30 years, there has been a developing consensus within conventional economic wisdom that rampant inflation and the associated risk of stagflation were historical conditions relating to another time. In particular, an open global economy combined with digital technologies supposedly meant that those conditions were not particularly relevant to the conditions of the 21st century.
Somehow, it also became embedded in economic thinking that modest inflation was actually a good thing. Not only did economic growth tend to precipitate inflation, but supposedly there was reverse causation in that modest inflation could generate ongoing economic growth, well beyond short-term stimulation of economic activity. The evidence for that was always scanty, and arguably non-existent, but the notion took root.
Accordingly, the notion of increasing the money supply through quantitative easing gradually shifted, particularly since the so-called Great Financial Crisis (GFC) of 2008, from unconventional to conventional monetary theory. This paralleled a drift away from the notion that monetary policy was primarily a short-term fix to dampen economic cycles by letting air into and out of the economy, to a long-term pumping of the economy.
Some 18 months ago, I wrote here about the risks of too much quantitative easing. I am sure I was not alone in foreseeing an inflationary outcome that would become embedded in the system, but it was not mainstream thinking.
Changing behaviours
One of the weaknesses exhibited by economists is that they rely on models that encapsulate a rear vision perspective. The models may be sophisticated but the mathematics therein encapsulate historical behaviours.
When behaviours change, the models no longer work. And that is where we have been for the last 18 months, in large part hidden initially by lags between decisions and outcomes.
A key tipping point with asset inflation occurred when an increasing proportion of savers recognised that interest earned on money in the bank was providing a negative return after inflation. It wasn’t inflation by itself that was crucial, but the relationship between interest rates and inflation.
Many people came to the conclusion that they had to find another home for their savings. I was one of them. The options were the share market, crypto, or houses. And for many people, houses looked like being the least risky alternative.
If the economists had only put away their models and spent more time in the real world, observing and analysing what consumers and investors were actually doing, then they could have viewed the last 18 months with foresight rather than hindsight. Now we have to sort out the mess.
Here in New Zealand the key flaw was not the COVID-19 economic support provided by Government and funded through Treasury bonds. That support was fundamental in keeping society functioning during the COVID-19 crises of 2020 and 2021. The key flaw was the way the Reserve Bank stepped into the picture with monetary policy.
Treasury bonds were the obvious way to fund the fiscal deficit created by the COVID-19 support measures. If those bonds had been left in the market, with lesser amounts purchased from the market by the Reserve Bank, then that would have soaked up some of the plentiful liquidity.
If liquidity had become an issue, as it did for a period during the GFC, then the Reserve Bank could have supplied necessary funding. But alas, the Reserve Bank, with its models designed for another time, swamped the system.
Where has the inflation come from?
There has been a tendency within the current Government to claim that the current inflation is caused by logistical constraints in getting supplies to New Zealand, and that it is therefore transitory. If that were the case then it would be showing up primarily in the ‘tradables’ component of the consumer price index rather than the ‘non-tradables’. But that is not what the data show.
First a reminder of the definition of ‘tradables’ versus ‘non-tradables’.
Tradables are items that can be traded internationally, for which the prices in New Zealand are determined by international prices. Many physical products fit in this category unless they have a very short life. Accordingly, steel, aluminium, meat, butter, cheese, computers and pharmaceuticals are in this category.
In contrast, non-tradables are items that are not easily traded across international borders. Many services are in this category. Restaurant services are one example.
Also, some physical products like houses are essentially non-tradable, although some of the resources from which they are built are tradable. Accordingly, many items have both a tradable and non-tradable component within the CPI. For example, telecommunication services are 18 percent tradable relating to the imported equipment and 82 percent non-tradable relating to the internal servicing cost.
Overall, tradables comprise 40 percent of the CPI and non-tradables comprise 60%.
In early 2021, I wrote here as to how most of New Zealand’s inflation in the last 20 years has been in non-tradables. That means that it was generated primarily through New Zealand’s economic policies rather than a consequence of overseas events.
I reported how for the 20-year period from Quarter 4 (Q4) of 2000 through to Q4 of 2020, the prices of non-tradables increased by 84 percent whereas tradables increased by only 49 percent.
Over a ten-year period from Q4 2010, the non-tradables increased in price by 29 percent whereas the tradables increased by only 14 percent.
Over a five-year period from 2015 through to Q4 2020, the non-tradable inflation totalled 14.2% (average annual inflation of 2.7%) whereas tradable inflation totalled only 0.1 percent in total over the five years - effectively a big zero. Tradable inflation in 2020 was actually negative at minus 0.3 percent.
In 2021 the story has changed somewhat. First, non-tradable inflation over the nine months through to the end of September was 3.7 percent, with year-on-year tradable inflation of 4.5 percent. So internally generated non-tradable inflation has been increasing. That is a direct effect of Reserve Bank monetary policy providing excessive internal stimulation.
The other part of the story is that tradable inflation has also now taken off, increasing by 5.4 percent over the first nine months of 2021 and 5.7 percent year-on year. The three contributors to this are the international prices of products that are imported, plus transport costs, and with both of these mediated by exchange rates.
There is little that New Zealand can do about the tradable inflation that is now arriving. To a large extent, it will be imposed by events elsewhere in the world, where inflation is now at the highest rates in more than 30 years. Transport costs may decline but this will not be enough to change the upward direction.
The key mediating factor will be exchange rates, which themselves are influenced by interest rates. However, the recent decline in the USD relative to the NZD is yet to work its way through the system, so the overall likelihood is for exchange rate issues to drive further increases in import prices in coming months.
That means that non-tradable inflation, which is under the control of monetary policy, will have to be tightly squeezed to bring down the overall inflation rate. Even if the non-tradable inflation were to drop to zero, which would be remarkable, there is going to be considerable imported inflation.
The wicked problem
The current problem is what can be called a wicked problem, meaning that there is no painless solution. If inflation is to be reined in, then interest rates have to rise. That has potential to take the heat out of inflation, but it is also likely to slow down the overall economy. I see storm clouds ahead.
The alternative is to let inflation run. That will simply fuel the desire to get savings out of fiat currency. The options will remain as shares, crypto and housing.
There are two big costs of inflation, both of which become much worse when that inflation exceeds the post-tax interest return on fiat currency; i.e., the return on term deposits.
The first cost is that it distorts investment decisions. When these conditions are in place, the pathway to prosperity travels through leveraged land assets on which the debt is inflated away. Wealth generation arises from capital gain rather than income. This pathway is particularly attractive in New Zealand where, unlike in Britain, the USA, Canada and Australia, most capital gains are not taxed.
The second cost of inflation is that it leads to a transfer of wealth from savers to borrowers. Once on the property ladder, there are seldom any snakes to take one back down the slippery slide. The exceptions are the ultra-leveraged who think the sun never stops shining.
In contrast, those trying to get on the property ladder keep having their feet taken out from under them by savings that depreciate.
I often read how the younger generation need to be taught the rules of compounding and how to use those rules to lift themselves up. Well, those rules no longer apply. Here in New Zealand, for those who lack access to the bank of Mum and Dad, there is no longer a bridge across to the promised land. And there lies the seed, now flourishing greatly, of an increasingly polarised society.
So what is the solution?
Well as I said earlier in this article, all solutions are in the wicked category. People are going to get hurt.
Those who are young and qualified but lack access to the Bank of Mum and Dad will head off elsewhere. Those who are young and unqualified will have to stay and become more bitter.
It won’t be the first diaspora from New Zealand. I was myself part of the early 1980s diaspora in search of challenges elsewhere. It was a mix of push and pull, influenced by New Zealand’s pump-priming economic policies of the time that were destined to fail, but also pulled to some exciting challenges elsewhere.
Twenty years later, when an interesting opportunity to return to New Zealand arose, I had to think very carefully about rejoining an already polarised society with high wealth-earning disparities.
I did come back with my family, influenced by what we considered to be some outstanding compensating factors. But if I were still young, with those disparities now much greater, and if I had no access to a Bank of Mum and Dad, then I would now be heading off.
Putting off the medicine is no solution. We must get inflation below the post-tax interest return on fiat currency. Until then, the disease will simply get worse.
The starting point has to be to drop the target inflation to a range of no more than zero to two percent, or arguably even less. That is where it was set from 1990, then raised to a three percent maximum in 1996.
In 2002, the minimum rate was raised to one percent, implying that some inflation was always good. Thereafter, apart from making a two percent mid-point an explicit medium-term target, the only explicit change was to create a dual mandate with maximum sustainable employment now an additional requirement, albeit with no definition of what that rate might be.
My own preference would be a target range of zero to one percent. We do not need an economy with embedded inflation. Of course, inflation does create wealth for some people, but it is always at the expense of others. It does not create real wealth. And it definitely takes away from those who cannot get on the property ladder.
It is important to note that the target inflation rates are set by the Government and not by the Reserve Bank. The Reserve Bank has indeed played their hand badly over the last 18 months with excessive priming of the pump, but it is the Government that sets the overarching rules.
What will happen now?
There is considerable uncertainty as to what will happen now, in part because the Reserve Bank has a conflicting mandate covering both inflation and employment. How the Reserve Bank deals with that conflicting mandate requires insight into the specific thinking of Reserve Bank Governor Adrian Orr.
Bringing employment levels into the Reserve Bank mandate has conflated the role of monetary and fiscal policy. We need to go back to the old days when the Reserve Bank had a single role of maintaining the value of New Zealand’s fiat currency.
This is not in any way to diminish to importance of maximising employment levels. Every government needs to have a social contract to achieve this. But trying to get there through an inflationary monetary policy is flawed. Fiscal policy combined with infrastructure development where that is appropriate, is the pathway to maximise employment.
The bottom line is that we are indeed in a bind, with much of it self-created both internationally and in New Zealand by economists locked into models that inevitably build from a rear-vision mirror.
Here in New Zealand, it is particularly fortunate that primary industry exports are booming with dairy, lamb, beef, and kiwifruit at the forefront. Log exports to China have also been doing exceptionally well over the last 18 months, although that industry has hit some significant speed wobbles in recent weeks.
Overall, we are now in an environment of great uncertainty. Conventional wisdom from Treasury says that the economy will speed along in 2022. That may or may not happen given that the treasury models inevitably reflect how people used to behave in very different times. The one certainty is that many groups in society will continue to be left behind as inflation does its damage.
There is also very little evidence of productive income-earning investment, with housing having become the only game in town. This follows massive underbuilding during the years of big immigration. Alas, things could get quite rough in the broader economy over coming years, regardless of the medicine that we take.
*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. You can contact him directly here.
171 Comments
If the economists had only put away their models and spent more time in the real world, observing and analysing what consumers and investors were actually doing, then they could have viewed the last 18 months with foresight rather than hindsight.
The rate of interest – the price of money – is said to be a key policy tool. Economics has in general emphasised prices. This theoretical bias results from the axiomatic-deductive methodology centring on equilibrium. Without equilibrium, quantity constraints are more important than prices in determining market outcomes. In disequilibrium, interest rates should be far less useful as policy variable, and economics should be more concerned with quantities (including resource constraints).
No problem for mainstream economists. They use the deductive-axiomatic methodology, whereby you proclaim false axioms and add assumptions that don't hold to create a theoretical fictional world. When faced with big gaps between theory & reality they know which one matters: theory Link
A model based on deductive methodology is fine.
It is the hidden assumptions that are the problem.
Understanding econometric models requires proficiency in calculus and and understanding of statistical methodology.
Those who do not have this proficiency are excluded.
And those who do have this proficiency tend to be back-room people with limited first-hand experience of the world they are modelling.
Elegant mathematical models tend to involve lots of simplification of the real world.
KeithW
I think it is problematic incorporating "money" into econometric models.
In my view the 3 qualities of money have quite different ways of impacting an economy, as interest rates change and quantity of money changes.(and they are also interrelated.)
1/ medium of exchange... this is basic supply/demand. ( I agree with Dalio money + credit = demand)
2/ store of value ..... this is the realm of savings vs investment . ( Deferred consumption/ time aspect of investment )
3/ Unit of account.... this is the realm of inflation and relative value. ( normally units of measure are a constant.. eg. a metric length )
Throw in the idea that most money is Debt...and we have a quite complex relationship.... and have not even moved into the ways all this can impact and manifest thru an economy. ie.. the cause/effect relationships are not straightforward.
Central Banks and monetary policy have turned interest rates into a lifeless "Hammer" .... when , maybe, interest rates should be more like a "heart" that naturally adapts to the demands/need of the body . ( maybe not a good analogy... buts that all I got..as I type ).
The older I get .. there more I think an economy should be allowed to go thru its natural cycles of ebb/flow....expansion/contraction...death/renewal...etc.
I think Minsky nailed it when he said the longer the period of financial stability , the more the forces of instability grow...
A shame you don't apply the same skepticism to the runaway global warming hypothesis Keith! Direct effects of CO2 are well established but the assumptions around the feed-backs that equate to 2/3 of the projected warming are just that - assumptions. Assumptions made by government scientists whose kids private school tuition and mortgage depends on there being a problem.
Amusing that soil carbon is "too hard" to compensate farmers for but "the climate system - a coupled non-linear chaotic system, and therefore the long-term prediction of future climate states is not possible." is used as a basis to shape our economy with batshit crazy theories like zero carbon an banning natural gas exploration.
Foresight and hindsight is cherry picked to suit their biased vested narrative.
Can give number of examples, specially since the start of pandemic.
Even now after two years into crisis are still squeezing covid19/crisis as an excuse and for cover up.
No accountability.
"Once on the property ladder, there are seldom any snakes" except that given enough asset price inflation, everyone ends up on a snake unless they are in a position to downsize (boomers) or flee to the regions (extremely specific career sets).
Everyone else faces doubling their mortgage or worse just to get an extra bedroom, or a comparable house closer to a school, or heaven forbid, some sort of substantive upgrade. Young Kiwis who didn't overstretch and bought starter homes now face significant additional debt to move to a longer-term family home, while those who snaffled up as much debt as possible and went as big as they could from day one now face no such hurdles, as their homes have increased in value much faster.
So close, but reality plays out differently
I agree - contemplating an upgrade to the next level on the "ladder" myself but the cost is eye watering. Think I will just stay put. If you only own one property (your home) increasing property prices are of no benefit - I'd rather my house be worth what it was when I bought it four years ago, and the "next step" I'm looking at also be at the value it would have been 4 years ago.
Agreed - but with caveats.
'One of the weaknesses exhibited by economists is that they rely on models that encapsulate a rear vision perspective' - that has to be the sentence of the year.
But the other weakness - and it is of this article too - is not examining the Limis to Growth stuff; reducing resource stocks, reducing quality of same, reducing biocapacities to absorb, reducing EROEI, increasing consumption, increasing demand, increasing population. NONE of this is factored-in.
I foresee demand-driven inflation of (pricing of) essentials, and collapse of (pricing of) inessentials. I foresee an inability to absorb more debt, a reversal of growth, and a concomitant inability to 'inflate away' as we could in the supply-able past. But more and more, I see the possibility of mass-panic-induced runs on wealth (banks and shares and other 'investments') as folk try and turn them into something hold-able.
Where all still desperately waiting for Megan Woods to start rolling out pre-fabricated houses on cheap sections and finally Govern housing supply properly that people can afford $250K.
https://www.youtube.com/watch?v=_W2YDxVi02I&t=742s.
Hopefully we won't be all broke or dead by the time that happens.
Managing inflation will be painful is an under statement.
Unless they accept short term managed pain for long term gain, will not solve and should stop using covid19 as an excuse, spevially now after two years into pandemic.
Inflation by itself will not go away by wishfull thinking or by delaying with hope of miracle. This mess has been created by reserve bank and government and will have to face it as covid19 is here till 2024/2025, how long will they print and distribute money and try to manipulate to support the ponzi.
Agreed. Its either messy very painful hyper inflation for everyone that further extends inequity and massively punishes the conservative saver, or an asset reset that will only punish the speculative - aka the risk taker. Seems obvious on that basis, but Orr looks to fiddle while the tax paying middle NZ burns.
Perhaps this sheds some light as to why so many senior RBNZ staff are resigning at the moment?
I think the 'solution' to the wicked problem that we will see in 2022 will be a bit of a 'Mexican standoff.'
This has been my prediction for the past half year.
When there are major costs associated with any policy response to a wicked problem, a gentle halfway house is almost always employed.
The OCR will not be raised above 1.5-1.75 (I don't think it will get to 1.75 but that gives my prediction a buffer).
By raising it gently to that sort of level over the first half of 2022, some of the heat will be taken out of housing and inflation.
In addition the RBNZ will continue to jaw bone the market.
Other measures beyond monetary policy will continue to be utilized to take the sting out of the tail of inflation.
By doing these things, the RBNZ will be trying to reduce inflation while not destroying the economy.
My own view is that RBNZ will not be able to achieve either goal, because of its halfway house approach.
Low interest rates are great for banks governments but normal people who use one of these banks credit cards are getting charge any between 5% and 20% per annum if you have bad credit this goes up higher. So the banks get richer, this game is coming to a end as debt is so huge now that governments can not pay the interest on 2-3% raise ,and if it went up with inflation 6-7 % would be completely screwed. Not sure what is going to happen but Turkey could be the way for many countries or some global reset where no one owns anything and we are controlled financially
I’d vote for him. I know next to nothing about the guy but he speaks passionately about the need for change and seems to care about equality.
He understands what a shit show we’ve created with bad policy and a greed fuelled market.
That’s more substance than any other politician can offer currently , Brock for PM.
I enjoyed this article.
The trick when an asset bubble collapses is to not be tempted to save or bail out the protagonists because hands will get burned. As the Irish learned with their bank bailouts and NAMA it's easier and far cheaper to let rapid restructuring occur. Preserve the states remaining financial firepower to protect people while that happens.
Also fiscal policy can assist with controlling inflation by running a surplus. There is no reason now to run a deficit budget give the very low unemployment rate.
"The trick when an asset bubble collapses is to not be tempted to save or bail out the protagonists because hands will get burned"
Reserve Banks and Governments are so screwed that have no choice but to protect those taking risk /speculators to cover their blunder. First time in history Government and reserve bank are more worried than the person actually taking the debt as their credibility/power is at stake
An insightful and relevant read Keith. I really think the NZ leadership has failed the public terribly on economic management and inflation. I find the housing crisis tiring now, but it is also inextricably tied to inflation. People need to get their heads around what inflation really is and how that is related to the ability of commercial banks to lend into existence to bid up the prices of the relatively fixed housing stock. Now, people will say that it's not a major issue as those loans are extinguished over time. And that is true, but it is effectively robbing people of their time as more human labor needs to be exchanged in order to pay off mortgages.
As I've pointed out before, NZ is a high-cost consumer society (similar to Australia) while the rest of the developed world has had to shift towards lower cost retail formats that are suitable for the levels of disposable income. I've used Japan as an example where they have advantages of market scale, supply chain and manufacturing efficiencies, proximity to low-cost producers (China), and a different capitalist mindset (food companies will cut their margins in order to maintain price stability at the shelf to maintain market share). It is going to become increasingly difficult for many NZ businesses across the supply chain to survive as goods become simply too expensive. Anyone who has spent much time outside of NZ is always surprised about the depth of niche, cottage, and 'nice to have' consumer products in NZ supermarkets. Many of them possibly see the current environment as their day of reckoning.
You mentioned crypto and I also think that is important, particularly Bitcoin. Anyone who has taken the time to understand the motivations as to why BTC was created should understand that it was born partly as a response to the behavior of our ruling elite who use inflation (money printing) as a weapon against the people. By that, I mean to say inflation is effectively a tax on our time. People who have taken the time to understand the philosophical nature of BTC will know that its fixed supply gives it power as a store of value. Quite unlike the currencies of the West whose supply is constantly increasing without any thought to what that does to the value of the currency that people exchange their labor for. The boomers can be arrogant in what they think know through experience. But the emergence of Bitcoin is possibly a great example of how the younger generations are adapting to their own self interest.
Do you blog or contribute content anywhere? Your thinking is on the money.
Thank you. It's just my opinion related to my life experience, attitudes, and beliefs. There are many diverse opinions from the audience here that have merit. Interest dot co itself provides the useful content to stimulate discussions (like this great piece from Keith). By far one of the most underrated media organizations in NZ. It's unfortunate that many NZers have no interest in these topics beyond the surface. Because what we're seeing and experiencing right now, awareness and understanding of these issues are crucial.
The comments are what originally brought me to this site :D
Current inflation rate on BTC: 1.8%
Inflation rate programmatically set for 2025: 0.9%
Only currency with an unchangeable preset inflation rate and coin emission schedule that is not controlled by emotional humans.
Yes..and that is gold. There is a reason why China, Russia, India etc are buying up.
BTC or any other play software wont be part of the new order. It will be digital backed by physical gold, promoted by China.
They wont 'out' form the US dollar and gold is the chosen path.
Only currency with an unchangeable preset inflation rate and coin emission schedule that is not controlled by emotional humans.
Not entirely true. It was programmed by a human, and can in theory be reprogrammed. It is after-all nothing more than a piece of computing code.
You are correct. But to change any of the code requires over 90% of the nodes to signal for the change. Take the recent taproot upgrade (that i signaled for).
There are tens of thousands (probably hundreds of thousands) of nodes located all around the world, and one of the things we all agree on is that the maximum supply will not increase. Why would I agree to devalue my hard earned savings by printing more Bitcoin, its just doesnt make economic sense.
The only situation is if there was some catastrophic bug discovered or the network was dying. And even then I doubt it would get through.
If you are interested in learning what drives its value, let me know and I am happy to provide some reading material :)
Very eye opening article.
Developed countries that have a working monetary system will be the last to adopt it, but over 4b people live under authoritarian regimes or poor economic systems. Have you checked the BTC TRY (Turkish Lira) price yet? that's what happens when a currency is failing.
And El Salvador has indeed adopted it as a medium of exchange, but their primary goal is to skip the western union fees for remittances.
What do you mean when you say the game is over? As I understand it, you're predticing a lower OCR increase than forecasted, small to moderate drops in 2022, stabilizing in 2023 coupled with a reduction in interest rates. Maybe I've misunderstood something, but what game is over? Doesn't sound too bad to me..
Yes, but when I'm talking about 'the game' here it's not just the housing price game, it's the whole system, the whole debacle of the 'NZ economy' in 2021.
The game is over because there's nowhere left to go. The rules of the old game are no longer relevant.
Keith expresses the conundrum well as a 'Wicked Problem'.
Raise interest rates aggressively - kill the housing market and economy.
Raise interest rates gently or not at all - save the housing market and economy, but not 'really' the latter either (because inflation can obviously be bad for the economy).
Hence - the logic lands where I have landed, and for quite some time: moderate increases to the OCR, plus jawboning and other measures.
But even that is far less than perfect - it will be sub-optimal in addressing inflation, for example. And it means when there is another economic crisis (and there will be one!) in the next handful of years, the RBNZ has very little room to cut. Insufficient to save things.
So every which way you look at it, it is 'game over'.
And yes I said stabilising in 2023. But I haven't said it will ever boom again. The game relies on that, too.
So yes - game over.
"I often read how the younger generation need to be taught the rules of compounding and how to use those rules to lift themselves up. Well, those rules no longer apply. Here in New Zealand, for those who lack access to the bank of Mum and Dad, there is no longer a bridge across to the promised land. And there lies the seed, now flourishing greatly, of an increasingly polarised society."
How do the rules no longer apply?
Sure, stick your money in term deposits and you won't get ahead. But for example, the S&P500 went from 2050 in the last 6 years to 4600.
The truth that nobody wants to hear is that yes, in the last few years it has become harder to buy a house. But it is not impossible, if you follow the "rules" of budgeting and investing you can do it.
Or you can follow the advice often given on here, give up, it's hopeless. Leave NZ and if you can't leave then put all your savings into booze.
Or you think outside the square, and have the cohones to rise above peer-group criticism.
I built 135 squares in 2005, for 50k (ex labour, but it only took 2 people 2 days from pad-poured to lockable - a mate did the same 4 years ago 135 squares 2 people 2 weeks 135k walk-in). Most people don't think laterally - indeed, most people just don't think, they follow. Ooooh what would the neighbours think? (Who cares?). Ooooh what about resale? (Again, who cares? But, if you think it through; 50 or 135 k outlayed, you can't lose even if you're 'valued' 100k less than the neighbour - who outlayed 600k....).
But you miss the problem now, in that house prices are seriously into bubble territory, indeed they already were in 2007/8. I suspect you have a vested interest in kicking the can even further? Sorry, the road just ran out.
The thing with the SP500 (and shares in general) is that historically there was an incredibly high barrier to entry for most people.
It is only recently that fractional investing apps have made it accessible to the bulk of savers.
So yes the rules have changed. That $50 a week you had to save, can now be invested without the fear of losing 90% of it in brokerage fees.
Except that sticking your money in shares is *not* likely to have the same returns in the next ten years as it did in the previous ten.
Precisely *because* so many people have been doing it. Shares are massively overpriced; they are destined to deliver very poor dividends relative to their cost, unless there is a truly implausible rate of economic growth.
Zero-interest rate policy has pushed a wall of money into real estate and equities; anything to avoid zero. That wall of money has acted as a self-fulfilling prophecy for now, with price following inflows to provide the illusion that they are extremely valuable. There are very few unexploited niches; the yield-seeking machine of capitalism is thorough. Everything is priced for a level of economic growth that is unlikely to actually happen.
So what are the possibilities? Either a collapse in asset prices; or massive inflation to keep the *nominal* prices somewhat afloat, which is another way of saying, destroying the purchase power of everybody to protect asset-holders. Sadly, that's the most likely outcome for political reasons.
There are no simple suggestions. This is because we, both in NZ and internationally, have created a wicked problem. But it is particularly in NZ where we have created the housing bubble that has now disenfranchised those who have recently or will soon enter the workforce, and who don't have access to a Bank of Mum and Dad.
KeithW
The best option would be to allow - nay, encourage - a collapse in the nominal value of assets. The 'pain' would be borne perfectly according to one's level of wealth.
But that's unlikely to be *allowed* to happen, unless something surprising happens at the next election.
So you would encourage those who want to buy a house to hope that there will be a collapse in the nominal value of assets?
I would encourage people to follow the "basic rules" of budgeting & investing. It is possible to buy a house in NZ still, don't follow the majority of peoples advice on here and give up.
"The 'pain' would be borne perfectly according to one's level of wealth"
- wildly and obviously inaccurate ( the simplest example would be an FHB who just took up a large mortgage ).
Regardless of how "fair" the division of pain would be if asset prices collapsed no one ( including the poorest ) would escape the collateral damage to the economy.
Your suggestion is a rough equivalent of " let us drop a nuke on each of the banks' headquarters - the bastards deserve it " ( I partly agree ) - the problem is that we will have blown the rest of the city away in the process.
You're right -- those who have taken on a large debt relative to income would suffer disproportionally.
But making us all hostages to FHBs - a relatively small number of people - is a really convenient reason to never change the status quo. As long as the bubble is propped up, there'll always be a new entrant to 'protect'. Would you accept Turkish-style inflation to save FHBs? I assume not. So at what point do you draw the line? I would have drawn it long ago.
Re your example the other day - you said your imaginary couple on low incomes might be able to save 200K after 8 years (lots of big assumptions there - are you taking into account student loans, plus there's lots of single people out there, or couples who are couples for only a few years etc etc - anyway, let's leave those for now...).
Then what?
Let's say they buy a 2 bedroom townhouse in Auckland for 900K.
They will have a 700K mortgage. Let's say it's a 30 year term at 5% interest (less than half of long term average, but I'm being generous :)
That's $870 pw, accounting for insurances, rates, maintenance allowance and quite possibly residents association / body corporate fee, let's say $1000 pw.
That's pretty big outgoing. Even assuming an above average household income of 150K, that's somewhere between 45-50% of after tax income going on the mortgage. On the basis of your example of a lower income household, that could be like 70-80%...!!
Even if a couple could miraculously afford that through very tight budgeting and having a non-life (and forget about having kids?), would a bank even think for a second about lending on that basis?
"Re your example the other day - you said your imaginary couple on low incomes might be able to save 200K after 8 years (lots of big assumptions there - are you taking into account student loans, plus there's lots of single people out there, or couples who are couples for only a few years etc etc - anyway, let's leave those for now...)."
Yeah a lot of big assumptions, that's assuming that that couple stay on minimum wage the whole time. Also assuming no Kiwisaver contributions so no match by employer so really the deposit would be higher.
Why would they pay that much for a 2 bed townhouse in Auckland when you can buy one for $700,000?
Why wouldn't they get the "back my build rates"
we can talk what if's till the cows come home.
You said it was impossible to buy a home in NZ, you said that young people should flee overseas or give up.
My message is that yes, it is harder than ever to do, but it can be done. Have hope, don't listen to the defeatists.
HouseMouse: "it is impossible to buy a house in NZ"
Kjeldorian: "Here is how you can do it, and examples of houses you can afford in NZ's most expensive city."
HouseMouse: "I don't like those houses"
It is impossible to buy a house as a FHB if you refuse anything but a mansion on the beach at Takapuna.
It has been explained on here that average wage earners cannot afford a house in Auckland just to save deposit takes 10 years by the time you have completed that you will need another 10 years to save as house price’s double every 10 years or that’s what people say on here regularly. Please explain who will buy them at this ridiculous prices.
Let's see what he/she says...
My take on it is that they are absolutely trivializing the huge challenge confronted by FHBs.
They seem to be part of the gang (Yvil, P8 etc) that acknowledge it's harder these days, but only a 'little' harder...totally in lala land and divorced from reality.
Exactly. What is the consumer economy supposed to do when up to 80% of household incomes are tied up in 30 year mortgages?
Ignoring all that “smashed avocado” BS for a moment - what is the point of buying a house if you can’t afford anything to put in it, a newish used car, the kids’ uni education, or even afford kids at all?
The prosperity enjoyed by the Boomers was precisely *because* the consumer economy flourished and people had some discretionary income. Otherwise we are no better than industrialised peasants who exist to pay the bankers.
"My take on it is that they are absolutely trivializing the huge challenge confronted by FHBs."
As i've said to you countless times. It is harder than ever to buy a house but unlike you I believe it is still possible and there is hope for people. You have stated that it is impossible and people should go overseas or give up. That is terrible advice for people.
I know one thing for certain; if you think something is impossible, it is.
A thoughtful and insightful article. As a small, open trading economy we are somewhat limited by the monetary and fiscal settings of our much larger trading partners (Dornbusch and Mundell). I agree on the tradables vs non-tradables tension as that has contributed enormously to rising property prices.
I disagree on targeting 0-1% inflation, announce that and Kiwi will go through parity against the A$ and completely destroy our export sector. Kiwi's heading offshore for work and travel has always been a thing, we are highly regarded. Perversely, many return with the funds to outbid locals.
It's been clear for some time that NZ has been a global outlier in not having either stamp duty on purchases ot a tax on residential property investment, just think what that could have raised and achieved if spent wisely
Te Kooti
You must be assuming that a low inflation rate will lead to a big inflow of capital causing the exchange rate to rise. But that is not inevitable. A starting point would be to have different buy and sell rates for the OCR. The margin between the two only has to be minor to dampen crazy short-term flows. This was how it used to be until recently. As for long-term flows of capital, they will only occur if there are long-term investment opportunities for that capital. There are also other tools available to the Government and the RB, including stipulations as to the proportion of capital that the commercial banks have to source internally.
KeithW
The magnitude of change you propose would require a significant tightening in monetary policy and trigger large capital inflows, there is a lot of empirical evidence of this. There doesn't have to be any genuine investment opportunities for this capital as it is largely funded through forward FX, just ask the SNB about how destructive large capital inflows can be.
If there are no genuine investment opportunities, then we have to be talking about short-term speculative flows. Genuine FX contracts for risk management will be bi-directional driven by exporters and importers. The FX premium will be a function of short-term money rates. The NZD has been a remarkable plaything of international financial speculators for many years, consistent with a neoliberal money-trading framework. There are tools to dampen the speculative element thereof.
KeithW
It's not to say there aren't any investment opportunities, rather that macro speculators aren't lookingat them as they are playing the positive carry game and generally stick to short dated fixed income. They take the carry and pick up on the appreciating currency.
Kiwi's heading offshore for work and travel has always been a thing, we are highly regarded.
Do you have any evidence of this 'high regard'? I can understand that Kiwis are liked in the Anglosphere because there are cultural similarities, but to suggest we're any better workers than other people is just the ol' Kiwi exceptionalism shining through.
You haven't worked abroad I assume. Australian recruiters are very active in NZ, you will find Kiwi's all through the UK and US in a variety of roles (ANZ & NAB CEO's are Kiwi's). NZ has a good general standard of education and generally a good worth ethic. At may be as simple as the fact that any person with the get up and go to travel for work is better than the average local.
OK. That's not what I call 'evidence'. That's subjective experience. I know the 'Big Four' like Kiwis in senior management. And as you point out, Aussie banks like them too. However, I'm not sure that heading up PwC or ANZ is a sign of how good NZers are. These are usually companies linked to institutional strength and mate-ship. The fact that 'some' Kiwis can operate in such environments does not make us superior.
I didn't say they were superior, I said they were highly regarded - not the same thing but you knew that.
Sorry. I was just challenging that they were more 'highly regarded' than other nationalities. For ex, take a look at Indian CEOs who run Silicon Valley companies.
I was fascinated by the recent reporting in which Simon Bridges (as opposition Finance spokesman) quite correctly pointed out that Adrian Orr is a moron and - if elected - National would not seek to renew his contract. Only to be shut down by his new boss Christopher Luxon who claimed that the independence of the Reserve Bank placed it above politics.
We are apparently living in a world where the independence of the Reserve Bank is seemingly valued more than its competence.
Yikes.
I remember back in 2020 I pointed out that only the aforementioned would drop LVRs and deliberately blow a reckless asset bubble. This resulted in a personal email from "Ed" saying that "Just because someone doesn't agree with you does not make them a 'moron'."
With all that has since transpired, it now seems clear who was on the right side of history. Even the National party has figured it out.
Yes. As BL notes, it is not acceptable to to insult someone just because you don't agree with their position. You can critique their view, but an bald insult is not acceptable. I know in this case you are just repeating someone else's alleged insult. But just because their MO is 'attack' still doesn't make it acceptable.
If you're addressing me, it wasn't an insult - mine or anyone else's.
I watched what happened to democracy (think; Canty Regional) in the Key years. And this fellow has been groomed.
Mind you, one has to understand where humankind is on the Limits to Growth trajectory, to understand how inappropriate more of the same is.
:)
it is puzzling that the central banks did not see that coming
There are two possible options: (1) they're dumb and did not see it coming; or (2) that they've engineered it deliberately and are just acting dumb in front of the masses. To be absolutely honest, I don't really know which one!
Personally, however, I just plan for the opposite of what graces the front covers. Businessweek declared inflation was dead in April 2019.
Orr/Robertson/Adern "Look at that country, it's alot worse than NZ. This is a global issue and we're doing well compared to others."
Yes. This is particularly annoying. They refuse to answer questions directly and often use 'look over there' and try to point out that the problem is not isolated to NZ. While that is true, the response is used to divert the answer away from the question 'so what are you going to do about it', which never gets answered.
This is the way they deflect the question on housing, inflation, child poverty, increasing homelessness and crime.
I never understand if they have to only compare with other countries or past data to do the cover-up why these guys are there?
Unfortunately, we have no option, on one side we have the queen of lies and deceit from labour and on the other hand a property investor from National who will keep his personal interest prior to the country.
Look at a chart of building consents and you will quite clearly see that national caused the supply problem and labour have almost fixed it. Labour have also done a lot on the demand side via capital gains tax and rental tax. But really the big issue has been caused by the independent reserve bank.
No way. Not letting you off the hook on this!
The ramp up in supply, especially in Auckland, is to a large extent a product of the Auckland Unitary Plan which was initiated and finalized by the Key government. It's to a certain extent also a product of cheap money, with the RBNZ cutting the OCR.
Helen Clark's government did next to nothing on housing.
The ramp up was way too late. The time to be building those houses was after the GFC when builders were going under due to lack of work and leaving the country. But English went on austerity drive instead, insisting we needed to get debt back down. They should have had the state building houses during the downtown.
I agree with this one - hindsight shows pretty clearly that the government needed to smooth out the effect of the crisis on building and infrastructure, to protect our capacity to keep building and housing our people. (sorry PDK)
It is going to be needed again in 12-24 months time.
While Economists angst and gaze at their navels, the only concrete answer for young Kiwis is to leave NZ. There is no future for them here and there will not be for a very long time. NZ is a very dangerous place to put any faith in their future well being.
The whole CPI/OCR that the RB is required to use is very deeply flawed. Briefly
1 It does not take adequate account of house price inflation and in fact encourages it.
2 In an economy with increasing productivity prices should drop and consumers enjoy the benefits of this. The RB model absolutely prevents this and all it,s measures are aimed at increasing prices. it absolutely discourages increasing productivity and healthy competition. Look around.
3 The RB stimulation measures have a strong correlation with unproductive and damaging fixed asset speculation; and a very weak correlation with stimulating investment in productive growth of the real economy.
4 The price increase stimulation from the RB shelters price increases from inefficient producers and shields them from the very beneficial forces of healthy competition.
The whole model needs to be thrown out and a totally new model developed. This will not happen over night or without uncomfortable consequences so again I repeat that the safest place for young Kiwis is outside the NZ economy. The longer the government delay addressing these issues and kick the can down the road, the more the consequences will accumulate and greater the final disaster.
"with stimulating investment in productive growth of the real economy.
4 The price increase stimulation from the RB shelters price increases from inefficient producers and shields them from the very beneficial forces of healthy competition."
No, that's not ' well put' - it's more of the bollocks the piece was on about; the chanted mantra based on rearward looking.
‘Demarcation between the ‘haves’ and ‘have-nots’ is increasing, with societal consequences.”
Brilliant summary Keith. Thanks for your contribution.
It is ironic that inequality has rapidly increased since 2017. If you have owned housing assets you have got a lot richer. Those without assets have got poorer.
Labour has traditionally redistributed wealth to increase equality & help the poorest members of our society get out of poverty. Clearly Labour needs a new leadership team as this current lot have failed miserably.
No comments allowed on this type of article below.
People are more afraid to express a view, where does this end up? the country is politically divided. I dont think Kiwis get the serious implications of this. Divided we fall.
Government's rejection of advice on age-adjusted Māori vaccinations among multiple breaches of Te Tiriti o Waitangi.
https://www.stuff.co.nz/pou-tiaki/300482666/government-breached-treaty-…
Do you think that the extent of China's oppression only runs to private websites limiting the comments they accept?
We are not even in the same category as their treatment of the Uighurs, for example, and it's insulting to suggest we are. Both to us and to those truly being oppressed.
Interesting read and i agree there is pain to come for many. Although i think the government will take the easy path and continue to debase the currency.
To my mind if we had restricted immigration to more reasonable numbers 12 years ago, and correctly weighted the CPI regarding housing costs. We would be in a stronger more equitable place.
Covid has simply highlighted the folly of relying on cheap foreign labour.
Or the folly of expecting a civil service on autopilot to make meaningful change. Tax rates the same as they were a decade ago. Immigration with no hint of the infrastructure to support it. An inflation measure we all know is not fit for purpose. But changing stuff and doing things is hard, and you get paid even if you just leave things as they are for years at a time - so why bother?
Great article. One comment, shouldn't the following paragraph read 'decline in NZD relative to the USD' as opposed to the below?
"However, the recent decline in the USD relative to the NZD is yet to work its way through the system, so the overall likelihood is for exchange rate issues to drive further increases in import prices in coming months."
Inflation combined with higher interest rates sounds like a good thing to me. It will be much easier for people to save for a house with pay rises and higher interest payments, and it’s hard to see houses going up much with higher interest rates. Of course paying a mortgage will be harder, but hopefully rates go back down by then, or perhaps the 5 year rates go back to being cheaper than the short term ones like it was when I bought our house.
Treasury bonds were the obvious way to fund the fiscal deficit created by the COVID-19 support measures. If those bonds had been left in the market, with lesser amounts purchased from the market by the Reserve Bank, then that would have soaked up some of the plentiful liquidity.
Syndicate and tender participating banks purchase the government securities and credit the Crown Settlement Account with a record of what they owe - source.
I owe you + you owe me + magic banking laws = Money out of thin air
The easy option is too tempting for all concerned, never mind its unsustainable, thats SEP......and it starts at the top.
We all want the easy life and for someone else to do the work....and when we run out of willing/able labour we import more, be it directly or indirectly.
A short lived rentiers paradise.....until it all collapses in a screaming heap.
People have been handed capital gains that look like Lotto prizes. Some, if anywhere near retirement have cashed up and left the workforce. Interest rates are the cost of money. If you raise the cost of an item, you will most likely lower the demand. You can set the price of money where you like, but ultimately money lenders still need customers. The interest cost of money has doubled from around 2% to 4% recently. There are a lot more passed in auctions now. Don't forget, some of those previous large selling prices have been for land that is being developed. With regard to the homeless, perhaps more money could be spent on mental health issues as well as more affordable housing.
Love your work Keith but I wish you wouldn't legitimise crypto with statements like "the options were the share market, crypto, or houses." I have nothing against block chain but crypto as we know it is a fools game.
If I were in charge I think I would be doing the same thing as Orr, I believe he is simply matching the Fed, who's goal is to inflating the US out of debt. A divergence strategy from the Fed would be destabilising.
User73,
I had no intention of fostering the use of crypto. But lack of confidence in fiat currencies under the control of governments is what has created the space for crypto currencies to prosper. If governments and central banks took their responsibilities seriously there would be no space for crypto.
KeithW
Great article Keith.
‘’The key mediating factor will be exchange rates, which themselves are influenced by interest rates. However, the recent decline in the USD relative to the NZD is yet to work its way through the system ........’’.
Given the magnitude of monetary financing in the U.S. I’ve been wondering why the $U.S. is holding up so well. According to this article it could be due to a shortage of dollars in the Euro Dollar market Dollar Illiquidity — The Ironic Yet Ignored Spark for the Next Crisis - Matterhorn - GoldSwitzerland
Well explained view backed by facts. The casual mention of our "most capital gains are not taxed" environment reflects the mindset of the whole fiscal management agenda: tread carefully with those who want tax free earnings but cane the nurses and supermarket workers on every dollar they make. Until earnings are taxed equitably those who underpin our social fabric will be disadvantaged. And of course the lions share of the bank of mum and dad is generated through untaxed capital gains. But as we know in our greed economy, those who want two slices of bread are more than happy to see others with none, and will vote accordingly. As Pink Floyd said "hands off my stack"
Thanks for an excellent, understandable article Keith. Economic factors like inflation are not easy to understand and, frankly, I think even economists claiming to really understand them are probably deluding themselves. That might be a bit harsh but I am mindful of the story that related getting 5 economists in a room and asking a question about economics. It story says there would be 6 replies because John Maynard Keynes always changed his mind!
I am particularly taken by your comments on models, especially with your consideration of assumptions which are allowed to pass from one set of conditions to another unrelated set of conditions. Of greatest concern to me is modellers coming to believe in their results (model outputs) rather than validating them against the real world before drawing their conclusions. It is often a costly application of the logical fallacy post hoc ergo propter hoc. It is not, however, necessarily restricted to models which are elegant mathematical formulations, as you suggest. It also applies to models which are based on statistical analyses of historical data. My thought here is that while applications of Machine Learning and Artificial Intelligence can be extremely useful to apply information from historical data they also give wrong results if the functions applied to neural network cells are poorly or incorrectly chosen.
This is not, of course, limited to economic models. In my opinion it is important that you keep reminding your readers about the limitations of modelling while, at the same time, encouraging modellers to be much more circumspect about the output of their models.
Orthodox economics has been influenced by many great minds - Smith, Ricardo, Marshall, Keynes, Robinson, Schumpeter, Fisher, Marx, Galbraith, Friedman, Samuelson are a few that come to my mind. There are many more.
Economics is a messy behavioural discipline with great complexity. Specific theories are attempts to create meaning and insights in relation to that dynamic behavioural complexity.
To claim that there is not much truth in orthodox economics would seem to be a delimiting place to start. And the notion that some new alternative theory could be the pathway forward without building upon (and modifying) existing theory would seem to be somewhat 'brave'.
KeithW
There are many highly intellectual heterodox economists who do take issue with orthodox economics and who do give us an alternative perspective. Economists such as Bill Mitchell, Stephanie Kelton, L.Randall Wray, Warren Mosler, Steven Hail, Steve Keen, Michael Hudson and Pavlina Tcherneva.
These are some that have a public profile and can be found online. it would be worthwhile for you to spend some time listening to what they have to say and even to purchase their publications.
Bill Mitchell has his own blog, http://bilbo.economicoutlook.net/blog/
Others can be found at the Levy Economics Institute, https://www.levyinstitute.org/
Michael Hudson has his own website, https://michael-hudson.com/
They all have their own lectures based on MMT and which can be found on YouTube and many are set in university lecture halls. MMT is no longer some fringe economic theory, it now has worldwide followers and many in NZ.
Treadlightly
I can assure you that I am familiar with the writings of Bill Mitchell, Stephanie Kelton and others who write about MMT.
The writings of MMT economists have been helpful in communicating insights that governments with control of a fiat currency can always create money to reduce and even eliminate government debt. This has always been understood within mainstream economics, but has not been widely understood by those who have not been trained in economics.
However, within mainstream economics there is also a clear understanding that 'there is no free lunch'. This links closely to the concept of opportunity cost.
Keynes was possibly the first to enunciate the concept that deficit spending was a useful strategy to deal with cyclic downturns where there was high unemployment. If Keynes was not the first, then he was certainly the one who developed coherent arguments for this. But unemployment is a much more complex issue in a specialised world where some skills are in shortage and others are over supplied than was the case when Keynes was developing and enunciating economic theory. That would seem to be something that the MMT proponents need to wrestle with some more.
Friedman was notable for his focus on the quantity of money. However, in modern economies it has become much more problematic to define the quantity of money, and there have also been confounding issues related to the speed at which money circulates. Hence the current emphasis on interest rates as the mediating factor.
Given the current global inflation - which the MMT proponents did not appear to see in advance, but which some of us did see in advance - the pathway forward using MMT has become more clouded.
KeithW
MMT is not all about deficit spending to support full employment. It is in the main a lens through which we can view the operation of sovereign currency issuers as Bill Mitchell describes it. It gives us a view into the workings of the central bank and also commercial banking and how they are interrelated. I have to say that I have never heard a New Zealand economist ever show the slightest understanding of any of this. They still seem to believe that banks only lend out deposits and that QE gives them extra money to lend. They also believe that taxation and borrowing finance government spending which is entirely back to front and they display no understanding of sectoral balances or where private savings come from.
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