Getting Ahead of the Game

The crisis of rocketing house prices has now reached such proportions and threatens such a calamity that it has forced an unlikely consensus to emerge.  After months, if not years, of treating the problem as one of a long-term deficiency in supply, those responsible for resolving it are now accepting, one after another, that the crisis has been caused, and is still being exacerbated, as I have argued for years, by an excess of demand.

The finger is now being pointed at a range of factors – the high rate of immigration, the speculative activities of overseas buyers, the preponderance of investors as opposed to homeowners in the market.  These are, of course, all explanations of where the demand originates, but there is greater reluctance to acknowledge just how that demand is manifested.  It is one thing to have the demand for housing property – quite another to have the wherewithal to do so.

Even on that issue, though, we see a recently emerging consensus as to where the problem lies.  The wherewithal, as the Reserve Bank, the Prime Minister, and a growing number of commentators now seem to agree, is supplied by the banks.  It is their willingness – indeed eagerness – to lend unlimited sums for the purpose of house purchase that has fuelled the rise and rise in house prices.  Hence, the measures announced by the Reserve Bank to restrain bank lending and the Prime Minister’s urging of them to do so.

Perhaps the most unlikely recruit to this consensus is David Hisco, the Chief Executive of our largest bank, the ANZ.  He points to the 47% of the Auckland housing market now accounted for by speculative investors and – by implication at least – to the volume of new money created as loans advanced by the banks to such borrowers.  This diversion of funds from what could be productive investment to non-productive purposes is one of the causes of the problems experienced by our productive sector, and those problems are exacerbated, he says, by a further consequence of current monetary policy – our over-valued dollar.

He identifies the crucial issue as interest rates.  The fact that our rates are higher than those elsewhere is the major factor in propping up our dollar at a damaging level – damaging that is to the market share and profit margins available to those trying to sell our products into international markets, including our own.  The comparatively high return available to overseas participants in the “carry trade”, by virtue of our high interest rates, leads to increased demand for New Zealand securities which pushes up the value of the dollar.

The Reserve Bank has been reluctant to bring interest rates down to international levels for fear that lower mortgage rates will further inflame the housing market.  The only escape from this dilemma is to reduce interest rates (and, hopefully, the exchange rate) in the interests of the economy as a whole, but to restrain mortgage lending through other measures – hence, the recourse to “macro-prudential measures”.

Mr Hisco seems to prefer, as a means of cooling the housing market, direct restraints on lending, such as loan-to-value and possibly debt-to-income ratios, rather than the current high interest rates, and in this he is almost certainly right – though, while that is probably better for the economy as a whole, it is not immediately clear why it should suit his particular interests.

If he hopes that lower interest rates might stimulate investment and therefore economic activity, he is likely to be disappointed.  Overseas experience has shown that, in today’s conditions, low interest rates do not do much, if anything, to prompt faster growth – or higher inflation.  If the promised return on investment is low or nil, there is little incentive to borrow, however low the interest rate may be.  As Keynes said, cutting interest rates then is like “pushing on a piece of string”.

What all this means is that our monetary policy is producing outcomes, as Mr Hisco seems to agree, that are exactly the opposite we want.  We have high interest rates, an overvalued currency, a perennial trade deficit, a raging asset inflation in the housing market, and an economy that depends for growth on that asset inflation and on borrowing, rather than on rising real production.

The problem is not just, in other words, one of housing unaffordability, serious though that is.  That issue is in one sense just a symptom of a much wider set of weaknesses that beset the whole economy.  At the heart of those weaknesses is a monetary policy that is almost entirely dictated, not by our elected government or even by our own Reserve Bank, but by four Australian-owned privately owned and profit-driven companies.  It is the power we have granted to those companies – the four big banks – to create money out of nothing and to do so in order to maximise their profits by lending as much as they can on mortgage that distorts our whole economic performance.

Mr Hisco is no doubt genuinely concerned on behalf of his bank about the growing possibility that the whole shaky structure of debt and asset inflation will come crashing down.  But it may also be that his real purpose was to get ahead of the game and to head off what is now really required – a complete re-appraisal of the role played by the banks and of the monetary policy that their drive for profits imposes on us.

Bryan Gould

22 July 2016