Inflated expectations – Dennis Dorney

News and views from New Zealand

The state of the NZ economy seems to depend on who you ask. In recent months the government has been claiming that we have a ‘rock star economy’, a phrase created by a bank economist and picked up by the government as an endorsement of its economic policies. It is not surprising that the banks think all is well since they have once again reported record profits but a closer examination of the detail shows little that the government can be proud of. For most people the ‘recovery’ has passed them by.

The case for the prosecution depends on infrastructure activity in Auckland and Christ-church and overseas earnings from our dairy industry. The evidence however is that all of these factors have been mishandled and are doing more harm than good, especially to those parts of New Zealand which are too remote from these hot spots to derive any benefit.

I have mentioned in previous reports that a housing bubble, confined mainly to Auckland and Christchurch, has been building for some time to the point where houses are now too expensive for new-home buyers. This

is mainly due to a rapidly increasing population and a shortage of houses, due to government neglect in the case of Auckland, and to the earth- quake in the case of Christchurch.

Since it is not possible to provide large numbers of houses at short notice, the Reserve Bank has limited demand by forcing banks to require larger deposits on mortgages. The result has been a drop in house sales, especially in the cheaper end of the market, but the fundamental problem of too few houses remains.

However higher house and house utility prices has caused ‘inflation’ to rise. The one and only tool that the Reserve Bank has to fix inflation is to increase the Official Cash Rate (OCR), which after a very long time at 2.5% was raised to 3% in April, with a promise of more to come. If the restrictions on house buying leads to lower prices, the outcome may be mortgage holders falling into negative equity – again. Ever since the 2007 housing bubble burst there has been on average about 1000 forced mortgagee sales per year. Here we go again playing the same old tune.

The sad thing is that the image of the white knight, Reserve Bank, slaying the dragon of inflation is a myth.

Recently in response to an inquiry the Reserve Bank gave the conventional definition that ‘inflation is too much money chasing too few goods’. It might be permissible to refer to house price inflation because it is clearly true that the banks are shovelling too much money into too few houses, but in general what is called inflation should be more properly called dollar devaluation, which is rather different.

When new money is created by the banks, there is no corresponding increase in goods, which in any case are not in short supply (witness all the retail sales). Effectively this devalues the currency. It can be argued that the debt gets repaid so it is a zero sum game, but that cannot be said of the interest on the loan, which remains in circulation forever.

The Reserve Bank’s one and only tool against inflation therefore causes inflation and is ineffective. In the present context it will be highly damaging to the economy because the ‘inflation’ is limited to Auckland and Christchurch but mortgage holders everywhere will have higher loan repayments.

Also the overseas returns on milk products are sliding; dairy farmers will have to repay more on their loans, which amount to $32 billion and some will definitely be in trouble. This is the product on which our economy depends. So what was the inflation figure that Graeme Wheeler, Governor of the Reserve Bank, found it necessary to battle? In the first quarter of 2014 it was just 1.5%!

Something is sadly amiss in the world of economics.

In the case of Christchurch the rebuild following the earthquake, that is helping fuel the housing bubble, has another side effect which will hamper New Zealand for decades.

The earthquake revealed the structural deficiencies of much our past housing stock. The Government has been loath to get involved in meeting the cost of the rebuild and has left the bulk of the cost in the hands of the insurers. The rest of the costs it is sharing with Christchurch Council, which seems to be a brutal expectation to impose on a stricken Council.

Apart from leaving as much as possible to the free market, it has also decided that all buildings must be upgraded to meet higher earthquake- proofed standards. If a building cannot be economically upgraded, it will almost certainly have to be bulldozed.

This market-driven approach has produced serious unintended consequences. Most of the under- ground infrastructure, belongs to local councils, who cannot now afford to pay the premiums for those assets.

Some are self insuring, some not insuring at all.

Virtually all heritage buildings do not meet the required standards, and their heritage value cannot be assessed in purely commercial terms. These may not be insurable either.

Dunedin has a huge number and their value as a tourist attraction is immense but their private owners want a commercial return. Dunedin City Council, up to its neck in debt, can’t afford to buy them. What a mess!

Dennis Dorney is an ERA member living

in New Zealand