After the sunshine comes the economic storm
Cheap money sustained us through Covid — now it’s time to pay the price
Many a pundit has been made to look foolish by New Zealand’s seemingly ever-increasing house prices, but the forces of gravity look pretty solid this time around.
It has truly been a summer out of the box. Continuous days of nearperfect weather have helped put the trials of 2021 behind us. We’ve all enjoyed our times at the beach, lake, or in the garden.
Unfortunately, ahead of us the storm clouds are clearly gathering. We all know about Omicron, but a less talked about weather system is likely to have a longer lasting impact on our lives in 2022 and beyond.
The sad fact is that the world economy is facing darker days ahead. Despite appearing to have skated smoothly through the pandemic, the pressures have been building up. Ironically, the very medicine that has made the pandemic seem so economically benign has created the pressures we now have to deal with. Like much in life, in economics it seems you can take your lumps now or later — but you will have to take them.
The most obvious problem remains inflation. Pretty much everyone now accepts that central banks and governments overshot the stimulus response. Inflation is not transitory as was the collective hope of policymakers last year. In the US it has now hit 7 per cent, the highest level in 40 years. Federal Reserve chair Jerome Powell has finally admitted inflation represents a “real threat” to the US economy. Not before time.
Back here things are not yet as bad, but we are doing our best to emulate our American friends. Inflation for the September year was just a tick under 5 per cent, with much of that occurring in the most recent six months. There is every chance we will be much closer to 7 than 5 by the middle of this year.
Inflation is bad enough, because it erodes the purchasing power of ordinary people and hits the poorest hardest. But the medicine needed to treat inflation presents its own significant problems.
In order to bring inflation under control, interest rates have to go up, and all the signs suggest a more aggressive set of rate hikes than many were envisaging even six months ago. In the US they are now expecting four interest rate increases this year, while here in New Zealand our largest consumer bank has just upped its expected interest rate increases by a further percentage point, and now expects the OCR to hit 3 per cent.
That may not seem high compared to the bad old days, but debt and mortgage levels are much higher too, and small increases in interest rates can hit borrowers hard in the pocket. New Zealand’s household debt levels are at record levels courtesy of all the ultra-cheap money that has been sloshing around. People with big mortgages are likely to start feeling financially squeezed over the next 18 months.
At the same time, asset prices are going to come under downward pressure. Indeed, that is already happening. In America the sharemarket has had a tough start to the year, with all three major indices significantly down and the Nasdaq entering correction territory. Here at home, the NZX is off around 5 per cent since the start of the year.
They all may bounce back in the short term, but there is no getting away from the fact that ultra-low interest rates have meant ultra-high stock prices, and when the former ends the latter must end too. Many would rightly say that asset prices had become completely nuts and a downward correction is a good thing. That won’t stop the hurt though.
Even now many US stocks are priced well above their pre-pandemic levels. The best we can probably hope for is an orderly adjustment downwards over the year, as asset prices adjust to higher interest rates. However, given the stratospheric prices that stocks have reached, the potential for disorder remains high and the reverse wealth effect will be significant.
Which brings us to house prices. Many a pundit has been made to look foolish by New Zealand’s seemingly ever-increasing house prices, but the
forces of gravity look pretty solid this time around. With absolutely no immigration over the past two years, it’s clear our housing market has been driven by the same interest rate mechanism as other asset prices. That’s about to change. Rightly or wrongly, New Zealanders seem to make their house purchasing decisions mostly on the serviceability of their mortgage, and the price of each 100k of debt is rising. If the house market declines it might not be all negative, but it will be a big drag on our economy.
The last big storm cloud looming is the Chinese economy. For those watching closely, a combination of regulatory aggressiveness and a sagging property market is tarnishing the China growth story. Property represents nearly 30 per cent of China’s economy, and the property market is starting to look very sick. Your view on China depends on whether you believe the Chinese government can keep spinning all the plates that keep China out of
recession. They’ve been able to so far, but the imbalances keep getting bigger.
China matters to us because we are selling even more to them than we were two years ago and their economy is driving much of the world-wide boom in commodity prices, including food. Without tourism and international education, food prices are largely keeping us afloat.
Given all these risks, prudent governments would be starting 2022 with a plan to constrain government spending where they can to take pressure off interest rate increases, take steps to increase competitiveness and encourage competition in consumer markets to lower prices, and make it easier for firms to do business.
Unfortunately that isn’t the mood around much of the world currently. Governments seem to believe their policy decisions in all areas need not be concerned about economic consequences and our own is no exception.
Indeed, our Government makes matters worse through its highly reactive approach to issues (think the Covid response), and its huge mistrust of the private sector (think Covid again and issues like MIQ , rapid antigen testing, and vaccination). It’s a fair guess the economy is hardly on the Cabinet’s radar currently.
The Government’s economic team should stop the self-congratulatory economic back-slapping of the last six months, roll up their sleeves and think about how we are going to encourage more business investment and grow our way out of this pandemic. Otherwise the coming storm could mean a long, unhappy period of economic underperformance and all the negative effects on wellbeing that
come with that.