House Prices, Interest Rates and Money

By   /   June 21, 2015  /   12 Comments

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In essence, Wheeler has diagnosed that we need to take on more debt to maintain the health of our economy. We need money to move more, and to sit around less.

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On 11 June, Reserve Bank Governor Graeme Wheeler reduced the Official Cash Rate (of interest) from 3.5% to 3.25%, with a promise of more reductions to come. Not a big deal in itself, but an action imbued with plenty of meaning. In essence, Wheeler has diagnosed that we need to take on more debt to maintain the health of our economy. We need money to move more, and to sit around less.

Generally this action has been welcomed, but the caveat is that most commentators believe that this will further boost the Auckland housing market.

The reality is that banks must earn income through lending and gathering interest from their customers. Otherwise, to pay interest to depositors, they would be running Ponzi schemes. (Ponzi finance is borrowing by a middleman to pay interest, as distinct from earning interest to pay interest.) So the banks, in order to earn interest, would be lending into the housing market regardless of the rate of interest.

What the reduced OCR (Official Cash Rate) does is make it easier for banks to make loans to businesses who do not have the security that property gives (albeit deceptively) to mortgage lending. What banks need to do – for their sake as well as ours – is to find business borrowers who are neither property speculators nor dairy farmers.

From 2003 to 2008, the OCR was raised from 5% to 8.25%. It had no impact whatsoever on rising house prices. If fact the rising OCR, perversely, probably fuelled the property speculation of that time. By discouraging lending to the tradable sector in particular, adversely affected by an exchange rate whose rise was linked to the high and rising OCR, the banks chose to raise the proportion of their lending that went into the housing market. That in turn increased the (artificial and temporary) capital gains on housing, thereby making interest rates of over 8% increasingly acceptable both to speculative house buyers and to banks blinded by what they saw as increasing collateral.

In those days, around 2007, ordinary bank deposits were fetching 8%. (Some people even felt that an unearned 8% was less than they were entitled to; they got greedy and went for 10% at Hanover.) Someone had to pay those 8% interest rates. The interest payers included the highly leveraged mortgagors thinking they were clever property wizzes. Clearly the bubble wouldn’t last. (The interest payers also included the poor customers of the money shops.)

Lending to people on the security of financial assets is insensitive to interest rates. Lending to productive businesses is much more connected to the rate of interest. Lower interest rates enable banks to better perform their social function – of facilitating the moving of money through the real economy of goods and services.

At 3.25%, wholesale interest rates in New Zealand remain far too high. When we think of debt as simply trade across time – which is precisely what debt is – in the 2010s’ global environment we have too many people not wanting to buy stuff today but thinking they might want to buy stuff tomorrow. It means that the true price in New Zealand of spending today is closer to 0% than to 3%. Indeed, in the world as a whole, negative interest rates are required to get people to buy today what today’s employed workers are producing.

Speculators are people who think that assets such as city land are just a way of making money as if money was actual wealth. They are people who already have more money than they can usefully use, so they use it uselessly to gather unto themselves even more money that they cannot usefully use. Rising house prices in cities such as Auckland are a consequence of global inequality, not local interest rates.

Money is a technology, not a commodity. Money works best when it is not overpriced, and when it is possessed by people who will spend it. Watch this space for more about what money really is, and isn’t.

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12 Comments

  1. dave brown says:

    Pouring more money onto the fire is not the answer, that just leads to more money chasing existing commodities.
    The root of the problem is long term falling profits which means that money leaves the circuit of production and ends up in speculation in land, shares etc.
    Money has value only if it can be exchanged for commodities. When the conditions for profitability cease so does the production of commodities.
    https://thenextrecession.wordpress.com/2015/06/01/theres-a-long-term-decline-in-the-rate-of-profit-and-i-am-not-joking/
    Capitalism is on its last legs, destroying more than it produces, and destroying civilisation and nature at the same time.

  2. Mike in Auckland says:

    “From 2003 to 2008, the OCR was raised from 5% to 8.25%. It had no impact whatsoever on rising house prices. If fact the rising OCR, perversely, probably fuelled the property speculation of that time.”

    I remember that time well, and it was due to the false perception that we were going to get many years of endless economic growth, with great job security, that let people continue rely on the economic forecasts by most, to keep borrowing, no matter what.

    As inflation was also higher, this put it all into a different perspective, compared to the realities we have now.

    The Global Financial Crisis happened due to very generous lending in many countries, which was in the end not sustainable, and hence we had the property investment and housing crash in the US, then in some countries in Europe, and the serious financial troubles of so many banks and especially some over-leveraged finance companies. Of course the latter, and some banks used debts as financial vehicles, to on-sell, allowing many to buy new “investment” papers, that turned out be be based on little security and asset values.

    I remember all the talk, the almost daily newspaper reports, about “labour shortages”, about the need to even let unskilled or low skilled workers immigrate. There was also increased immigration, but at the same time increased emigration, to Australia, as there were many better paid jobs to get as well.

    What the Reserve Bank did now with lowering the OCR was rather an act of desperation, a step that is like a two edged sword. It allows easier borrowing, also for those wanting to get into housing, with some negative effects that may push prices up further, but it was done, because of the economic risks due to low commodity prices hitting the rest of the economy.

    As it is, New Zealanders are rather highly indebted, not so much the government, although that is also growing, but especially privately, and far too much goes into mortgage debt and lending for private real estate.

    Again New Zealanders are trapped, that is the ones that lend and heap up more debt, whatever will happen, we will face immense risks. Globally there is economic slowing in China and some formerly praised new, rising economies like Brasil, South Africa and Russia. India also has challenges. Look at the oil producing countries, including Nigeria, facing shortfalls of incomes.

    Europe is facing a Grexit, with unforeseeable consequences. While there are some signs of “recovery”, it is based on rather weak figures.

    So some worry about deflation, which will be a disaster, also for New Zealand, although otherwise “blessed” with better resourced banks (at the moment, the Australian ones that is).

    A bursting housing bubble would put the whole economy at risk, as suddenly people would have less equity, and still have to pay of much debt. Commodity prices are hardly likely to recover soon, look at dairy. Private debt per capita remains high, and creditors will want repayments.

    We face low economic growth, and less export earnings, and high demand in housing, which most locals can only afford by going into debt. Increased investor and buyer demand from overseas is set to continue for some time, so this will drive prices for homes in Auckland even higher. The rest of the country may be less affected, but the regions face less economic activity, as farmers stop spending, and are focusing on paying off debt.

    So more borrowing, yes, but it will not solve the core problems New Zealand has, being so overly dependent on a few commodity exports, including tourism and tertiary education as “service” exports.

    What I see is more real estate, farm and local business sales to overseas investors, and New Zealanders in ever increasing numbers becoming tenants in their own land, nothing else, as we have neglected the local, regional development and the internal economy, also failed to further diversify.

    Just juggling with interest rates and the currency will not solve the major problems, although these are important factors also. The lower currency will increase costs of imports, which is good for exporters, but will cause a pinch in the mostly urban consumers’ pockets.

    I dread to see where this journey is heading, as we have a government that is rather plan-less and like headless chickens, too busy chattering ideological slogans and leaving it all to a flawed market to sort out. Times we have are reason to be worried about. If that what we had the last few years, a Christchurch rebuilt and short dairy boom, and a bit more tourism, is supposed to have been this “rock star economy”, gosh, what will the coming tough and harder times look like?

    Consumer confidence is now heading “south”, and as economics is 50 percent “psychology”, we are heading into a downward spiral of sorts.

    • Draco T Bastard says:

      I dread to see where this journey is heading, as we have a government that is rather plan-less and like headless chickens

      Oh, they have a plan and as far as I can make out it’s proceeding as they wish it, they just haven’t told us what it is else they’d never be voted into power.

  3. Draco T Bastard says:

    Money is a technology, not a commodity.

    True and that needs to be broadcast loud and clear to the populace.

    Money works best when it is not overpriced, and when it is possessed by people who will spend it.

    The correct ‘cost’ of money is zero. This has been known for thousands of years and is why all major religions ban usury. This is a lesson that we need to relearn.

    Speculators are people who think that assets such as city land are just a way of making money as if money was actual wealth. They are people who already have more money than they can usefully use, so they use it uselessly to gather unto themselves even more money that they cannot usefully use.

    And there we have the real problem – the rich. As I say, no society can afford the rich. It is the one thing that simply cannot be afforded. All income needs to be spent in near real time to keep the economy moving.

    This gives a very narrow band of practical income ranges. To little income produces poverty, too high an income produces excessive accumulation which results in increasing poverty.

    • mikesh says:

      Interest is not the “price of money” as many claim, but the price of borrowing. Lending is a service which interest pays for, though whether this “service” contributes anything useful to productive processes is doubtful.

  4. Jo Planet says:

    Ii seems to me the comparatively well off PM has a good idea of how the money game works but it appears the govt. has a lesser idea of the importance of real issues : poverty, refugee quotas, climate change, sustainability, alcoholism etc etc. In any case there is IMO a clear need for a more evolved global currency system – one that addresses these real issues.This was much discussed on the internet a few years back when around the world the bank lending and real estate bubbles burst … and will be discussed again if another major eco/economiccollapse occurs. In the meantime the tolerance for the 1% … and the inequality gap … continues.

    • Richard Christie says:

      Ii seems to me the comparatively well off PM has a good idea of how the money game works but it appears the govt. has a lesser idea of the importance of real issues

      Not at all, I think Key just knows a few smart arse recipes and systems that enable him for personal gain to rort a system that he doesn’t even fully understand.

      • Aaron says:

        Maybe a metaphor will help here: A parasite on a leaf knows how to suck the juice out of the plant but it doesn’t know anything about how the plant grows.

        Likewise Key the money trader only knows how to suck money out of the economy for his own benefit. Growing the economy is as big a mystery to him as growing a plant is to the parasite.

        Hence why he runs the economy like an asset-stripper – it’s the only thing he knows how to do.

  5. Jack says:

    The money situation in the US seems alarming.

    If the fed keeps printing off dollars at the rate they are doing so. We will feel it shortly. It is only a matter of time!

  6. […] was good to see a commentator (Draco) to my last week’s posting on The Daily Blog (House Prices, Interest Rates and Money, 21 June 2015) agree that “money is a technology, not a commodity”, saying “all […]

  7. […] was good to see a commentator (Draco) to my last week’s posting on The Daily Blog (House Prices, Interest Rates and Money, 21 June 2015) agree that “money is a technology, not a commodity”, saying “all […]