Thursday, March 23, 2006

Brian Fallow: When the debt man cometh

We will hear this morning how much deeper into the red New Zealand sank last year in its dealings with the rest of the world.

The median pick among forecasters is that the current account deficit hit $13.6 billion for the year or nearly 9 per cent of GDP.

That would be an unsustainable number, a recoil-in-horror ugly number, the prospect of which is one reason the exchange rate is, at last, dropping.

The current account balance is the difference between what New Zealand earns from the rest of the world through trade in goods and services and in returns on investment overseas on the one hand, and what the rest of the world earns from us on the other.

Economists can also show through some fancy algebra that it equates to the difference between domestic investment and domestic savings or, in other words, the extent to which we rely on other people's savings to fund investment here.

The shortfall has to be laid at the door of the household sector, not business or the Government.

The Reserve Bank estimates that households collectively are spending $1.14 for every $1 of income.

The savings rate, or in our case dis-savings rate, cannot be measured with any great precision.

Any errors in estimating households' incomes and outgoings accumulate in the difference between them.

But we can be pretty confident the figure is negative and that the trend has deteriorated markedly during the past few years.

It is an apparent paradox that while households have been living beyond their means, they have also been getting richer.

In fact, the latter is the reason for the former. Homeowners, seeing the market value of their housing equity rise, have been ready to borrow and spend some of that increase.

Spicers Household Savings Indicators, released this week, showed that the net worth of the average New Zealand household increased $10,000 during the December quarter to reach $326,000, up 13 per cent from the end of 2004.

The increase in household assets was driven by a 17.7 per cent rise in the value of the housing stock.

Not all of that is house price inflation, of course. There was some physical increase as well. But, in the latest quarter, higher house prices accounted for 3.8 of the 4.3 per cent overall increase.

By contrast, households' financial assets increased only 0.7 per cent in the quarter and 5.2 per cent over the year.

Household debt increased 15 per cent but at $137 billion, the vast majority of it mortgages, it equates to only 27 per cent of the value of housing assets and 21 per cent of all household assets.

The aggregate household balance sheet then is not heavily geared.

But averages are misleading. If Sam Morgan walks into a bar the average net worth of its patrons jumps but it does not make the rest of them any better off.

Only about a third of households are owner-occupied with a mortgage and some of them are much more indebted than the average.

Data from the Household Economic Survey indicates that the average housing costs (interest, principal repayments and local body rates) for owner-occupiers with a mortgage are around 25 to 30 per cent of their disposable income.

But one in 10 devote more than half of their disposable (after-tax) income to home loan payments.

They could be seen as lying fairly low in the water and at risk of being swamped should some wave come along like the loss of a job or the forced sale of a home in a marriage break-up.

Arcus Investment Management chief economist Rozanna Wozniak says the rise in house prices has given people a false sense of security, particularly as so much of their wealth is tied up in owner-occupied housing which cannot easily be freed up in retirement.

Excluding owner-occupied housing from the net worth calculation almost halves it - $117,000 instead of $326,000 - and the latest year's increase is then only $7800 not $37,000, Wozniak says.

And the evidence is mounting that the long-heralded housing slowdown is finally at hand.

Real estate turnover over the past three months was well down on the same time a year ago.

Then there is the you-can-run-but-you-can't-hide effect in fixed rate mortgages. More than 40 per cent of them have less than a year to run and those borrowers will face higher interest rates when they are renewed, the delayed effect of nine rises in the Reserve Bank's official cash rate since early 2004.

Fewer new jobs are created as the economy slows.

And the net inflow of migrants, while up last month, is still well down from the peak three years ago.

The net gain in the year ended February was 8270, the weakest for five years. It was down from 11,130 the year before and 41,560 three years ago.

Australia remains the most popular destination for Kiwi emigrants, attracting 34,500 over the past 12 months, which was nearly half the total outflow of 71,100. It supplied 13,400 people in return.

Wozniak points to New Zealand's inferior showing on a number of economic statistics to explain the exodus.

Australia's per capita GDP is 25 per higher than New Zealand's in purchasing power parity terms.

That reflects the fact that their labour productivity has grown more than twice as fast as ours over the past 15 years.

Average full-time weekly earnings (before tax and with no overtime) is $1150 a week across the Tasman, $370 a week higher than in New Zealand.

But even after Australia's own housing boom, the median house price is only 18 per cent higher at NZ$354,000, versus $300,000 here.

The mounting cost of servicing debt is not just an issue for households but for the country as a whole.

This morning's current account number will be as bad as it is not only because of a trade deficit but because of the ongoing cost of servicing the country's net foreign debt, which at the end of September stood at $134 billion.

In the year ended September that cost $10.2 billion or 6.7 per cent of GDP.

You might say it takes three and a half weeks' worth of output from the entire economy each year to pay the rent.

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