The dirty little secrets inside our nation of inflation
National blames inflation on Labour’s ‘addiction to spending’. Labour says it’s ‘a global thing.’ Both are mostly wrong & a little bit right. Neither can handle the truth: it’s a housing thing.
TLDR: Aotearoa-NZ’s record-high 6.9% inflation rate is our worst since 1990 and it’s all any politician, voter, consumer, business owner, economist and central banker can talk about right now. Fair enough. It’s a big deal.
The trouble is this great inflation debate is so full of denials, deflections, diversions and disingenuities that the truth is being lost in the fog of it all, even though it’s staring us in the face every day.
Our inflation crisis is actually just the same old housing crisis in a different guise that neither National or Labour really want to either address or fix. The dirtiest secret of all is neither do the median voters who decide who is in power and will decide again next year.
How did we get here and what’s being done about it?
It’s worth dissecting this week’s numbers to show the outsized role of housing in the inflation that is truly controlled and generated by us, and can be sheeted home to the Government, councils and the Reserve Bank. Which means ultimately us (because we vote for the policies and people who made the decisions that led to this). Or don’t vote at all, which in many ways is the real reason for this rolling tragedy without end.
Housing and household utilities produced 2.4 percentage points of the 6.9 percentage points of increase in the Consumer Price Index in the March quarter from a year ago, which means just over a third of the inflation last year was generated by the houses we live in or were being built. Almost all of the other two-thirds of the inflationary stimulus came from higher fuel and food costs, most of which are generated by global commodity prices, although there are some juicy supermarket and fuel retailing profit margins buried in that number too. (More on that later)
If housing costs are stripped out of the overall non-tradable inflation for the year, it was just 4.0%. Non-tradable inflation is the type not related to overseas prices and the part we can truly claim credit for, or be blamed for.
That housing and household utilities category is made up of rent, rates and, most importantly, the cost of buying a new house. The cost of living in an existing house you own isn’t actually measured, but the new house cost is actually the most important because it is the price set at the margin that then spreads back through rump of the entire stock.
Here’s another way to measure this.
Then there’s rent, which is an indirect function of the demand for housing and supply of housing. The value of an existing home and therefore the return a landlord will demand is also driven to an extent by the cost of building new supply.
Everything always, always comes back to housing
So what caused this explosion? Building materials costs? Construction worker wages? Property developer margins? Consenting fees?
It’s a whole melange of those things driven by the immovable object of a lack of supply being hit by a massive new and irresistible surge of demand, starting in mid 2020 and reaching a crescendo in late 2021.
It’s relatively simple to find where that came from. Prices go up when buyers can pay more and developers realise that extra demand means they can charge more. They know the market can ‘take it’ when they sell all the units off the plan, and that’s what was happening up until late last year when a couple of things changed, which are also the proof of the source of the demand.
The supply of money increased in the form of easy and cheap credit, and that is solely the responsibility of the Reserve Bank. Astonishingly, in retrospect, it removed the LVR controls that had been in place for seven years and had kept a relative lid on inflation. The central bank also slashed the OCR to 0.25% and proceeded to print $55b to buy Government and council bonds to lower long term interest rates. That translated into mortgages as low as 1.99% for almost a year. That was the spark that landed in the tinder box of tight supply. Here’s what the spark looks like in chart form.
House prices then ratcheted up 40% and destroyed another generation’s hopes of becoming home owners under their own steam, because everyone knows no politician or central banker can afford politically or financially to allow prices to then ratchet back down 40%. Those leveraged and tax-free capital gains are now locked in for eternity.
Labour shares responsibility with the Reserve Bank
It’s about now a defender of the Labour Government might argue that the Reserve Bank is independent and there’s nothing Finance Minister Grant Robertson could have done to stop the removal of the LVRs and the money printing. Sadly, for him and that next lost generation, that’s just not true. Robertson is not allowed to tell the Reserve Bank what to do with the OCR, but it was not the main culprit here.
Robertson signed off on the money printing and the removal of the LVRs, both of which required the agreement of the Government of the day. He was also warned by official advisers that money printing would cause a burst of house price inflation and a widening of inequality. But he and the Reserve Bank also knew that burst would create a ‘wealth effect’ that would support consumer spending and business confidence through the worst of Covid. That’s not a bug. It was the feature.
It was inevitable all that extra cash bidding for those units off the plan and the house and land packages would generate the 18% inflation in costs that came in the following year to 18 months. That’s how long it all takes to flow through. There is a saying among economists that inflation always and everywhere is always, always a monetary phenomenon. That is clearly the case here, and it could be argued globally.
Te Pūtea Matua (RBNZ) was not the only central bank printing money to lower mortgage and other interest rates, although it did do it for the first and hopefully last time during the Covid crisis, whereas the others have been doing it virtually non-stop since the Global Financial Crisis of 2008/09. The US Federal Reserve, the European Central Bank, the People’s Bank of China, the Bank of Japan and the Bank of England collectively printed more than $10t in the last two years. No wonder stock and property prices are rising fast all around the world, although ours rose faster than any other.
When Grant Robertson and PM Jacinda Ardern point overseas at food and fuel prices, they could just as easily point overseas at the money printing. But they don’t because they signed off on the money printing here too.
So what about the Government’s ‘splashing of all the cash’?
You may have heard the recent repeated and loud condemnations of the Government by the Opposition that the inflation is caused by Labour’s ‘addiction to spending’ and that somehow a tax cut is the solution.
It’s worth digging into both of those claims to see whether they stand up. In particular, whether National would have done any differently if it had been in the Beehive during Covid, and what it would do differently if it got into power now.
Firstly, National has accused Labour of spending too much, but has also said it would use the much-discussed $6b spending allowance if it was in power. It just says it would use it differently, and largely to fund tax cuts that will flow mostly to those earning more than $80,000 a year.
Here’s National Leader Christopher Luxon at a news conference yesterday:
“Listen Grant Robertson, you’re addicted to spending. Ultimately you need to get a return for that investment.
“The reality is the government has had a massive increase in government spending since it came to power. Some of it was necessary in respect to Covid, but there’s an assumption that every dollar spent is really wisely spent and that’s not the case. There is good and there is bad spending, and there is wasteful spending.” Christopher Luxon at a news conference, reported via The Spinoff.
Luxon didn’t identify wasteful spending, other than the Auckland to Hamilton passenger rail service Te Huia. It cost $100m to build and costs $7m in subsidies per year to run. The Government is forecast to spend $128b this year. That’s 0.07% of spending.
The bulk of the $20b in cash ‘splashed’ in 2020 and 2021 went to businesses and households with business and property assets, not consumers directly. That money went into higher profits, more leveraged investment in property and higher cash deposits in banks. Both National and ACT supported the spending of that $20b in wage subsidies and resurgence payments, along with the several billion dollars in specific support measures and investments in freight subsidies and tourism supports.
Luxon agreed that inflation was hitting the poorest hardest, but he has also opposed increases in the minimum wage and increases in benefits. However, he has proposed to use the same $6b allowance to pay for National’s tax cuts, most of which will go in dollar terms to those earning over $80,000.
“The cost of living does disproportionately impact lower income people but it’s also impacting the squeezed middle who don’t get any government assistance.” Luxon, referencing people earning between $55,000 and $70,000.
Luxon should have a closer look at the Working For Families tables at the IRD to check his ‘no Government assistance’ line. Someone earning over $70,000 with two children should be getting at least $130/week in support.
National gives no explanation of how its $6b of spending and tax cuts would be any less inflationary than Labour’s. And that’s it. Just a general wafting around of ‘better quality spending’ (‘but we won’t say what spending exactly or what we’d cut’). It is the easiest thing for any Opposition to do: accuse the Government of doing something badly, but not offering a detailed alternative. It’s cheap politics.
So what could be done differently?
The guts of the problem is that home buyers have been frenzied and full of FOMO because they know the way to get ahead in Aotearoa-NZ these days is to fight like the devil to get ‘on the ladder’ to start earning those juicy (unearned really) leveraged tax-free capital gains, safe in the knowledge the Government and Reserve Bank have their backs and the renters don’t vote enough to remove the key incentive: the lack of a capital gains or wealth tax.
That’s why prices exploded as soon as the credit was available. It’s because housing is not a place to live. It’s an investment class. Until a wealth tax is in place that does not change. None of the major parties are proposing one. Both National and Labour supported the money printing in 2020 and 2021 and neither complained when the LVR restrictions were dropped.
Where’s the pressure on price setters?
None of the parties have done anything either to address the profit margin expansion in supermarkets, building materials, banking and real estate services that is also partially responsible for the inflation.
National fought against law changes to toughen anti-monopoly rules while in Government and has been noticeably silent during the market studies into fuel, supermarkets and building materials. National did not criticise the Commerce Commission’s watering down of its recommendations to break up the supermarkets duopoly. It has said nothing about building materials and did nothing about it during nine years in power.
Labour is barely better. It was strangely quiet in support of the Commerce Commission’s draft recommendations to break up the supermarkets, and is only belatedly pointing the finger of inflation blame at Foodstuffs and Woolworths, and vaguely waving its hands about ‘doing something’ if things don’t improve. Labour’s measures on fuel competition were incremental at best and margins are now exactly where they were when Labour took office in late 2017. Profit margins on regular petrol have averaged 29c/litre since the start of the war in Ukraine, up from 24c in the previous month.
ACT, for all the consumers in its brand name, has said little about the effects on consumers of profit gouging by our biggest monopolies. A party that is all about promoting competition and the free markets seems to like monopoly power a lot.
The dirtiest secrets of them all
it suits Labour to blame ‘offshore factors’ because they are doing little to change the onshore factors that do exist, and highlighting the biggest offshore factor (money printing) would serve only to highlight the money printing here which it approved;
Labour won’t bring in a capital gains tax while Jacinda Ardern is PM and is unlikely to propose a wealth tax at next year’s election if Ardern is still in charge and Labour is still behind in the polls;
National wants to have its cake and eat it too by accusing Labour of splashing cash and being addicted to spending, without specifying how it would do things differently;
National has even committed to running exactly the same ‘loose’ fiscal policy of having a $6b operating allowance; and
the one irony is that a good chunk of its tax cuts would go to those owning homes who don’t need it immediately, and straight into the bank, which means not spending the cash in the short term might take a smidgen of inflation pressure off.
But that inflation relief wouldn’t last long. That saved cash from tax cuts can then be used as the next deposit on the 15th rental property when the banks start lending properly again.
Neither party wants to acknowledge the real causes of our inflation: explosive housing costs driven by leveraged investment demand and super-powered by monopoly power across most of the economy.
Why? Because challenging those median voters to give up their leveraged and tax-free capital gains would lose them the election. And challenging entrenched monopolies able to blather and blunt and block their way through and over regulation is just too hard. It requires too much concentration, stamina, mastery of the detail and time.
The tragedy is that the 800,000 or so renters who could change that median voter equation are too disillusioned, too tired from multiple jobs, too distracted and distressed by just getting through the day to first understand and then organise to change it.
It suits everybody, not just the politicians and central banks, to not to look too hard. If we’re being honest with ourselves, our inflation is at a 30-year high because:
we didn’t take the hard decisions over the last 30 years to have a broader tax base that included land and/or capital;
we chose low taxes over heavier investment in infrastructure for housing and transport; and,
we believed for ideological reasons that letting companies build monopolies was fine.
The brutal truth: leveraged home owners love inflation
The brutal truth is asset owners are doing brilliantly with the current state of affairs. They have leveraged tax-free gains using debt that currently has negative real interest rates. The inflation is eating away that debt even faster.
The same is true for a Government obsessed with ‘keeping a lid on debt’. Inflation burns away debt-to-gdp ratios at a great rate of knots, particularly when the fiscal creep enabled by unchanged tax (and working for families) thresholds are held fast.
The one comparison everyone has missed in this inflation panic is that the annual inflation rate is more than a percentage point above mortgage rates currently on offer and double the rate at which the New Zealand Government can borrow for a 10 year term.
That’s right. Mortgage rates are currently negative, once adjusted for inflation.
Government borrowing is effectively free, once adjusted for inflation.