Avoiding the Inevitable

Not a Pretty Sight

Only a fool tries to avoid the truly inevitable.  A wise man will face up sharply.  In our days we are governed by men who are fools.  They are trying desperately to avoid the inevitable.  Their one excuse is that the voters want them to.  They know full well that if they faced up to the real economic situation facing New Zealand and the rest of the developed world there would be riots in the streets and they would be voted out at the first opportunity.  

Their approach, therefore, has been to practise the equivalent of palliative care.  Maintain huge deficit spending increases, trim back at the edges, sell a few assets so we can temporarily pay off a bit of debt, make the patient feel as comfortable as possible, and wait.  Hope for a recovery that will allow us to trade our way out of the recession, thereby avoiding a genuine depression.  Kick the toxic can down the road for our children and grandchildren to deal with.

The Governor of the Reserve Bank, Dr Alan Bollard sounded almost plaintive yesterday as he lamented the parlous state of affairs.
 

New Zealand's debt and asset price boom is acting as a big drag on the economy, and house prices still look "overvalued and expensive", according to Reserve Bank governor Alan Bollard. And New Zealand may be dealing with the aftermath of the large increase in private debt for "quite some time" yet, he says.

The Minister of Finance, Bill English recently warned that New Zealand may well limp along for another fifteen years, telling us that things were really bad "out there".  This is inevitably what happens when debts are excessive and palliative care is the policy.  Palliation locks in a long, lingering recession.  Blame a generation of voters and politicians brought up on a diet of demand rights and redistribution.  It prevents both governments taking and voters allowing the requisite painful medicine. 

"It looks as if the accumulated debt is acting as quite a sustained drag in New Zealand and other advanced economies," Bollard said in a speech in Auckland yesterday, pointing to a still "tepid recovery". Per capita GDP was still 3 per cent below its peak reached almost five years ago.

Five years on from the start of the global financial crisis "the picture is far from clear". The persistently tepid recoveries across advanced economies, including New Zealand, remained a surprise, he said. The run-up in debt and the disappointed expectations of borrowers who paid high prices for assets were "clearly playing some role in low rate of growth of productivity and GDP", he said. Two years ago the Reserve Bank had expected the official cash rate to be back up to 5.75 per cent by now, but it remains at just 2.5 per cent, and some believe it may need to be cut because of global risks. 

The problem is the cleft stick upon which Bollard is hoist.  One fork is excessive debt which makes recovery slow and tepid and painful.  The other fork is the Reserve Bank's policy of very low interest rates (to try to stimulate economic growth).  The risk is this: it will not take much for housing-besotted New Zealanders to decide the way ahead is to lever up even more to use appreciating real estate to pay off their debt hangover.  The adage is: you have to spend money to make it."  Take on more debt to pay existing debts down.  The conduit will most likely be a debt fuelled, demand driven housing market bubble. 

When New Zealand made its Reserve Bank independent in the 1980's its sole concentrated focus was to drive inflation out of the economy.  The RB reasoned at the time that inflation expectations were more critical than actual inflation.  Until people stopped buying, selling, and borrowing with an expectation of forthcoming inflation, the economy would remain overheated with persistent inflationary pressures. 

In New Zealand there is an almost universal expectation that residential house prices always rise.  They may stay level for a time, but they will bound ahead.  The palliation policy has reinforced that expectation, not crushed it.  Palliation is feeding future inflation expectations; residential housing will be the bubble of popular choice--as it always has been.  Bollard, again:

But crucially in New Zealand house prices had not come down "very much or for very long", unlike in the United States, Spain or Ireland. The median household wealth in the US fell about 40 per cent in the three years to 2010, mostly from falling house prices. House prices in the US had not risen as much as they did in New Zealand.  Bollard said that "our sense is that real house prices are still somewhat overvalued: They are certainly well above historical levels and look expensive by international standards, relative to incomes or rents."

With a huge debt hangover and a tepid productive economy it is only a matter of time before Kiwis start to reason, "Let's buy and sell a few houses to reduce our debt and get ahead."  All that cheap money has to go somewhere, and it ain't going into the productive sector.  Auckland house prices are already starting to ratchet up.  Early signs of fever can be seen. Housing inflation expectations have not abated.

That's the problem with trying to avoid the inevitable.  Better to force de-leveraging now by putting up interest rates--before it's too late.  Sure it will mean lots of economic pain and suffering for three to four years.  But that's a place that neither voters, nor politicians, nor the Governor of the Reserve Bank want to go.  Palliative care it will be--plus a long, lingering recession in the productive sector, coupled with a residential housing boom and a fresh debt-fuelled bubble.  Not a pretty sight. 

But New Zealanders still prefer this course of action.  Things will need to get a whole lot worse before we are prepared to face up to the depression we have to have.  It's not an easy pill to swallow for those who believe that the government's fundamental responsibility is to expropriate people's property to take care of "Me".