Analysis by Keith Rankin.
Stories last week from Radio New Zealand:
Expert analysis: low interest rates vs soaring house prices, Nine to Noon, 15 April 2021.
And refer to:
- Arthur Grimes: How to fix a broken Auckland? Add 150,000 homes to crash prices by 40%; The Spinoff, 4 July 2016
- Bernard Hickey: PM says Arthur Grimes’ call to build 150,000 new houses in Auckland to produce a ‘supply shock’ that drives prices down 40% is a ‘crazy idea’, interest.co.nz, 4 July 2016
The first ‘podcast’ listed above includes interviews with two highly competent economists, University of Auckland property economist Michael Rehm, and former Reserve Bank monetary economist Michael Reddell. The hologram of another such economist, Arthur Grimes, was present also. The interviewer is Kathryn Ryan, certainly one of our more intelligent journalists, more prepared than most to dig a little, though prone to asking questions heavily laden with assumptions.
Kathryn Ryan to Michael Rehm: “Do you believe house prices will correct [ie, in times of low inflation, ‘fall substantially’], and how?”
Michael Rehm: “I have long believed that house prices will correct … around five years ago Arthur Grimes called for, with what seemed like madness [ref. John Key asking: “Where you’d get a 150,000 homes from overnight, I don’t know?”] at the time, for house prices to be engineered into a 40% drop … if we’d done it back then we’d be in a much better or healthier position now … house prices are completely out of whack with respect to fundamentals, especially incomes.”
It is tempting to interpret Arthur Grimes’ 2016 article as a King Canute exercise, in the true historical context of Canute’s best known act. Canute (aka Knut or Cnut) – King of England 1,000 years ago – is chronicled as having commanded the incoming tide to recede as a demonstration of the limitation of kingly powers; the message was meant to be that, despite being a king (and, I understand, a rather good king; grandson of Bluetooth, he was Cnut the Great, creator of England as a distinct polity), there were substantial limits to his and any other king’s powers. Unfortunately, Canute’s actions have been misinterpreted as Canute actually believing that the ocean could be turned back, and that he was the man who could do it. Grimes’ article, if not understood as satire, appears as advice to John Key to ‘turn back the tide’ by ‘flooding the market’ [please excuse the contradictory metaphors!]. Key, like the real Canute, was aware that he did not have such power; Key also strongly suspected that turning back the ocean by flooding the market was not entirely a good idea, even if it was possible.
Dr Rehm seems to believe that the Key-led government really did have the power five years ago to turn back the tide 40%, and that Key could have done it over a short time period; ie much less than the six years that Grimes mentioned. Further, Rehm is, in an important sense, historically wrong. In 2017, Phil Twyford – a foolish prince rather than a wise king – did believe that he had the powers of the mythologised Canute, and launched KiwiBuild to its inevitable failure. The Labour-led government of New Zealand did actually try to do something like what Grimes had satirically requested. Indeed, that attempt was just about the only genuine policy initiative of the 2017 to 2020 coalition government.
Ryan goes on to ask a couple of long questions, which include an assumption about the role of immigration in the 2013-16 house price inflation, and a reference in Rehm’s writing to a “Ponzi scheme” analogy, though she may have been confusing a Ponzi scheme with a the manic behaviour that fuels a speculative ‘mania‘ or ‘bubble’ (refer Kindleberger and Knoop).
Rehm’s main response – his ‘following the money’ point – was a good one; the price inflation this century of “land-house packages” – in the regions as well as in Auckland and Wellington – was most determined by the “pumping of money” into the real estate sector. He blames commercial banks’ competitive lending policies, rather than interest rates or immigration or financial greed, to explain why “house prices are so disconnected from fundamentals”. [By ‘fundamentals’, Rehm means house tenants’ rents, and is correctly indicating that house price movements should follow movements in house rents.]. But he largely missed the international dimension of this money supply problem, which has included loans into New Zealand banks (eg ANZ Australia lending to ANZ New Zealand, and a high connectedness of many NZ residents to foreign sources of finance). Of particular importance is that Rehm has studied the pre-2008 real estate bubbles, and he therefore was aware of the need to downplay the role of very low interest rates in stimulating land-house bubbles.
Indeed, Rehm noted that, from the very first years of this century, there was a substantial change in monetary flows, though did not explain this change. My knowledge of countries’ changing financial balances since the 1980s indicates that – especially in the United States and the United Kingdom – the corporate sector became a ‘saving/lending’ sector rather than a ‘borrowing/investing’ sector. This meant that there was immense pressure on the household sector to absorb the supply of loanable funds that was no longer going into the businesses. That pressure on households still exists, and is exacerbated by government policies aimed at helping ‘first-home buyers’ onto the ‘property ladder’.
Re Michael Reddell, he, like Arthur Grimes, emphasises land supply at cities’ peripheries, and, in a return to satire, believes that in Wellington there is plenty of easily developed land along its hillsides; land “not much use for anything except housing” [at least he acknowledges that alternative land uses represent an important part of the cost of housing, though he failed to mention such things as water supply]. Like Rehm, and correctly, he notes that easy “monetary policy” (read ‘low interest rates’) is not to blame. And he correctly notes that what we call “the cost of a house” is mainly “the cost of the land under it”.
Reddell’s bugbear is “land-use regulation”. He says that “you have got to fix up the land market”. He fails to acknowledge the central axiom of classical liberal economics, which is that land by its very nature is scarce and that, as a consequence, rising populations raise the rental value of land and hence the price or ‘cost’ of land. While Michael Reddell is correct to note that land prices in much of New Zealand (and Toronto, Canada) are presently higher than can be attributed to any laws of economics, the solution is not to – like the mythical Canute – try to use demigod powers to conjure up more residential land. Even the Dutch – history’s premium land conjurors – understand the limitations of a land expansion strategy. All land, when repurposed, incurs an opportunity cost. In practice – in Auckland, and in Wellington’s residential corridors – it is the best horticultural land that is lost to land sprawl. (I understand that the Maya in Central America tried the same thing close to 1,000 years ago; subsequently their civilisation collapsed due to urban expansion undermining their food supply. Ancient Rome had to conquer Egypt to avoid the same problem.)
Ryan: “How does this central bank and government – who are working parallel to each other – exit this huge period of quantitative easing that has inflated asset prices everywhere, it’s the stock market as well. What is the endgame, the bond buying, the Reserve Bank prints money and buys government debt with that money through the secondary market; that keeps a lid on the cost of borrowing. Basically, that’s the means by which the government can spend and borrow. That stimulus is massive. At what point does it begin to have negative consequences?”
Reddell essentially bats the question away. Both economists already substantially (and correctly) downplayed easy monetary policy as any kind of problem. But the widely-alleged ‘big post-stimulus reckoning’ remains a big problem in the minds of many journalists, and indeed much of the public at large. With regards to the substantive ‘endgame’ question, Michael Reddell noted that it’s not really a problem; once the United States economy picked up in 2015, the Federal Reserve simply eased up on their monetary easing. I would note, though, that premature attempts from 2010, in the European Union including the United Kingdom, to force an endgame through fiscal consolidation (aka ‘austerity’) created substantially more problems than they solved.
The key problems embedded in Kathryn Ryan’s assumptions were: (i) that loads of printed money were going directly to the government (Reddell, properly, refuted that) when in fact it was only going into the ‘secondary market’ (pushing up the prices of existing bonds); and (ii) that there was in 2020 a parallel monetary and fiscal stimulus, whereas in fact there was only a monetary stimulus.
The New Zealand government, indeed, is fiscally austere to its core. Even with the opportunity to address substantial social and economic problems last decade by borrowing at record-low interest rates (and using its balance sheet to facilitate local government borrowing), the government – irrationally – has refused to budge; it has neither invested in our people nor our capital. Rather our governments have left the masses of available money to the land speculators to do with it whatever they have wanted to do; to create illusory wealth, and to borrow against that wealth to create a society characterised by unsustainable middle class imported consumption.
It’s actually too late now, given the supply chain and skilled labour constraints that New Zealand faces. Inflation – maybe substantial inflation – is likely to become a problem this decade; not inflation as a monetary phenomenon, but inflation as a ‘supply inelasticity’ problem. It is not only land in New Zealand that is supply constrained. New Zealand has become unbelievably dependent on (and cruel to) the foreign labour which Immigration New Zealand now belligerently seeks to keep out of New Zealand. And food supplies are not as secure as we might assume. The best horticultural land is under threat, and the need to export food to pay higher prices for our imported supplies is placing us in the traditional Third World predicament. The benign ‘terms of trade’ environment that has blessed fortune on us in the first two decades of this century is about to change.
Academic tunnel vision occurs when academics assume that the big truths – especially the truths required to drive public policy – derive only from their own discipline; they advocate remedies which involve extradisciplinary costs which they have not considered. We observe that both economists and public health academics hold to such siloed visions which discount wider truths understood through other academic disciplines. In present specialised times, this optical malady extends to academic sub-disciplines; for example, monetary economists versus agricultural economists, with the former ignoring truths which the latter could easily supply.
These other Radio New Zealand podcasts, below, add to the commentary about the issues I have raised.
I provide no comment on these, other than to note that the 1989 New Zealand Reserve Bank Act was intended to cement into the public mind the monetarist (Friedmanite) proposition that “inflation is everywhere and always a monetary phenomenon”, a quote mentioned by Kathryn Ryan in her interview with Michael Reddell. While that supposition about inflation was dangerously false demagoguery in the 1980s, these simplistic notions haven’t entirely gone away. High inflation, like physical pain, is a symptom of something being not quite as it should be. In a sense, it’s is an aspect of the market economy’s immune system; pain from a fever, for example, is a side-effect of the body’s immunological response. Inappropriate anti-inflation monetary policies suppress the pain, the inconvenience, or indeed the natural cure. Such policies rarely address the underlying problem; indeed euthanasia – voluntary or involuntary – is one way of suppressing pain, a method regularly applied to domestic animals, for whom euthanasia is deemed an effective low-cost pain remedy. Friedmanite monetary policy was not unlike euthanasia, and, by and large, was applied to problems that were in the process of self-resolution.
- Food growing land being eaten up – report, Nine to Noon, 16 April 2021
- Reserve Bank’s independence under attack? Afternoons, 15 April 2021
- The role of banks in NZ housing market, Afternoons, 16 April 2021
And below is an important story relating to the actual demand for housing; a story that came out at about the same time as Arthur Grimes’ article:
- Generation Zero willing to forfeit quarter-acre dream, NZ Herald, 24 Jun 2016
Keith Rankin, trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.
contact: keith at rankin.nz