Dr Bryce Wilkinson: Our over-inflated housing market

OPINION:

What happens to even the best juggler when ball after ball is added to his load? Sooner or later, collapse is inevitable. Spilling just one ball could spill the lot.

That is what the local and global financial situation looks like currently. Governments and central banks are juggling with our future prosperity. They are getting themselves into increasingly precarious financial situations, in trying to sustain economic activity and inflated asset prices. The default of just one country, Italy for example, could trigger the next global financial crisis.

Record asset prices amidst Covid lockdowns and disruption is a red light. Normally, asset prices fail in economic downturns, relative to inflation at least. For example, in 1981, New Zealand household prices were only half what they were against the consumer price index in 1975. Big increases in global oil prices had hit economic activity hard. Another example is the October 1987 sharemarket crash and the subsequent serious economic recession in New Zealand.

Yet last week Statistics New Zealand published new experimental quarterly estimates for income, spending savings, assets and liabilities for households and other sectors. Estimated household net worth in March 2021 was a staggering $450 billion (25 per cent) higher than in pre-Covid December 2019. That represents an increase of $231,000 per household.

Two categories of household assets produced almost 90 per cent of that increase in net worth. One includes land values, the other sharemarket investments.

Owner-occupied households will have gained disproportionally. Poor people own neither land nor sharemarket investments. Parliamentarians widely own property. The wealth redistribution is horrific.

We know why this is happening. Asset prices are widely at highs globally and domestically because central banks have flooded global financial markets with cash and lowered their control interest rates to as close to zero as they dare, and beyond.

In New Zealand, easy money and dreadful housing regulation limiting land supply has proven to be a toxic combination for house prices. Those who are benefiting know it is wrong, but are loath to allow the necessary changes. It is easier to blame foreigners, “speculators” or landlords.

Asset prices are also buoyant because governments are borrowing heavily from their central banks to put newly created money into people’s bank accounts. This has been going on in Japan from the 1990s and, since the 2007-8 global financial crisis, in England, North America and much of Europe.

Many governments have put their public debt ratios above 100 per cent of GDP. This is way beyond the 60 per cent ratio that the European Union specified as an upper limit in 1992.

Australia and New Zealand have been travelling down much the same path since Covid-19 struck. On Statistics New Zealand’s new estimates, central government has put so much money into the public’s pockets since December 2019 as to reduce its own net worth by $25b (a 12 per cent reduction). Our Reserve Bank more than doubled base money between December 2019 and March 2021. By one definition that is highly inflationary.

By keeping interest rates as low as they dare, the authorities penalise thrift and induce people to buy over-priced assets with borrowed money. Statistics New Zealand estimates that household interest income in the March quarter 2021 was 64 per cent lower than in the same quarter in 2020. Low risk savers have lost out.

The whole dynamic is based on the illusion that more money created out of nothing means more wealth and greater prosperity. Governments and bankers hope that if people believe they are more prosperous they might consume more and save less, for a while. Well, they might, or they might sit on it or chase up asset prices.

Today’s authorities may rest easier, but they have deferred rather than avoided the day of reckoning. That day arrives when people stop believing in the illusion. Economists do not think that easy money can increase future output and employment sustainably.

Given its global economic dominance, it is particularly troubling that the US government is one of the worst for spending beyond its income. The Organisation of Economic Cooperation and Development forecasts that its fiscal deficits, (federal, state and local combined) are running at a staggering 16 per cent of GDP this year. Its public debt in public hands is nearly 80 per cent of GDP.

The authorities are trying to juggle the goals of keeping the cost of government borrowing low, economic activity and asset prices high and consumer price inflation low. The bigger the debt and the easier the money, the bigger the risk the edifice is going to collapse if nothing changes.

Increasingly desperate authorities abroad are promising more and more often to “do whatever it takes” to sustain asset prices and household incomes. The US Congress found itself compelled this year to approve injecting trillions of more dollars into people’s bank accounts, funded only by central bank credit backed by nothing substantial.

This dynamic is unsustainable, but central banks appear to see no way of reversing tack. The US central bank tried before Covid struck, but ultimately failed. Many governments are now so deeply in debt that they cannot afford to pay materially higher interest rates on that debt.

Central banks are stuck. They are an arm of government. Bankers do not wish to get the blame for precipitating calamitous adjustment. Nor do governments see a way of reducing their fiscal deficits without destroying the illusion of healthy economic activity and prosperity.

Governments and central banks are in a debt trap of their own making. They have no credible plan for extricating themselves from their predicament. Yet the situation is clearly unsustainable.

Optimists assume continuing confidence in the system and respectable national income growth will lift government tax revenue. They hope against hope that governments will not spend all that increased revenue. They hope that people will continue to buy vast amounts of government debt at negative real interest rates.

Under such assumptions, fiscal deficits will gradually reduce allowing public debt burdens to fall relative to incomes. Some optimists even assure us that public debt never has to be repaid, it is simply rolled over.

Unfortunately, for the optimists there is a long history of governments defaulting on their obligations, directly or indirectly. New Zealand came very close to defaulting in 1938 and 1984, and periods of inflation have occurred at the expense of debt holders.

Credibility is critical to sustained confidence. We need to see the Reserve Bank of New Zealand set out a clear path or criteria for returning to pre-Covid settings.

The Government should also commit to a timetable for reducing the public debt to levels it deemed to be prudent before Covid-19. Of course, that will be unpopular. But adjustment delayed is risk of pain multiplied.

– Dr Bryce Wilkinson is a Senior Fellow at the NZ Initiative.

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