Finding the exit when there is no sign

In Australia the proportion of first-home buyers taking out mortgages is near a decade low and the proportion of rental investors near a decade high. Sound familiar?

Low interest rates in theory stimulate businesses to borrow, invest and make jobs. Money borrowed to buy houses does boost furnishing and appliance sales and some renovation and small business owners borrow against their houses for capital. But most mortgage borrowing doesn’t directly do much for productive investment.

Central banks have plunged official interest rates to near-zero in northern hemisphere rich countries through the past six years, on top of which they have been printing money like medieval monarchs. There is a lot of it sloshing round the world.

But much of the money has gone into houses in those rich countries. Job growth has been weak and real wage rates have stagnated or fallen. So demand for goods and services has not responded as pre-2007 textbooks said it would.

And much of the printed money has gone global. To quote Albert Edwards of Societe Generale, a global bank, much of what the Federal Reserve has been flushing into the United States economy has gone into arbitrage, that is, borrowing cheaply and lending a bit less cheaply wherever higher interest rates or easy capital gain can be found.

So a lot went into “emerging” economies where interest rates were higher. The likes of India, Indonesia, Brazil, Turkey and South Africa were awash with credit. Share markets boomed. GDP rose. That offset rich economies’ weakness.

Then on May 22 Ben Bernanke, outgoing Federal Reserve chair, mused aloud that he might start “tapering” off his $US85 billion-a-month purchase of bonds (notably mortgage-backed ones). Interest on United States government debt rose sharply. The financial flows reversed out of the “emerging” economies, stalling their economies and plunging their currencies. The good news is that, as a result, several of those countries’ governments now say they need to start structural economic reform.

But Bernanke took fright at the potential GDP-growth-constraining effect of rising market interest rates and didn’t start the “taper” as expected on September 18. Since then several of his regional chairs have stated widely varying views on when he should start, ranging from soon to not for a long while. The financial markets are in a frenzied limbo.

Like George Bush swashbuckling into Afghanistan and Iraq, explorer Bernanke appears to have had no exit strategy when he headed into the uncharted territory of quantitative easing (QE), the euphemism for printing money. He did indicate an unemployment figure of 6.5 per cent as the exit signpost but that is a fair way off: the figure is now 7.3 per cent, mainly thanks to 4 million having given up looking for jobs, and is falling at a glacial pace.

This is a bother because what Bernanke does and doesn’t do has global effects — and not just in vulnerable “emerging” economies. Some of his money washes up here, swelling competition for houses. The New Zealand dollar is the tenth most traded currency in the world, by far the most per capita.

Graeme Wheeler down at the Reserve Bank has set out to restrain banks’ enthusiasm for lending on houses by limiting how much of a bank’s total mortgage loans can go to people who have less than a 20 per cent deposit. This has the politically discomforting effect for a grumpy Bill English of channelling funds away from the most needy, of putting housing development financing in doubt and possibly generating an unregulated secondary market of the type that flourished when interest rates were tightly regulated 35 years ago.

Wheeler has yet to spell out his exit strategy, if he has one. The risk is that, like Bernanke, delay follows delay and/or measure follows measure. The spectre is the cold turkey New Zealand went through in 1984 to escape the dysfunctional shambles in the money markets.

A much scarier spectre is that of the post-2007 global financial crisis (GFC). Edwards warned of a risk that “the most wobbly domino falls and topples the whole precarious, rotten, risk-loving edifice”.

Such talk is no longer marginal. It is part of informed international commentary.

Financial Times columnist Gillian Tett drew on recent speeches by Lord Adair Turner, formerly head of Britain’s bank regulator, the Financial Services Authority, and Andrew Haldane, financial stability executive director at the Bank of England, to suggest that “the propensity of the over-leveraged system to have booms and busts, amid investor swings, has risen”.

For several decades rich economies have relied on ever-increasing levels of private debt to get their economic growth. Given that their growth rates have been limpid at best since the GFC, that suggests to Tett and others that the productivity of money has been falling.

In any case, debt cannot go on rising forever. The circus will stop.

At least houses are safe. Or are they? What’s your exit strategy?