China

Offshore demand for houses

Michael Reddell China, Housing

What to make of the housing data released by the Labour Party, and of the subsequent debate?

I’m writing this partly to help clarify my own thoughts.

First, can the data be relied on?  Well, no, but then no one really suggests that it can be.  Even if we assume that the data Labour obtained are reported accurately, they are still only a partial snapshot, and report something that is likely to be aligned, but not that closely, with the subject of interest –  purchases of residential property in Auckland by non-resident investors.  It isn’t ideal, but then neither are other contributions to the debate (eg searches on juwai.com, or anecdotes from people on either side of the debate).  There is a reasonable argument that there are no particular grounds for official statistics to be collected in this area.  But if so then informal statistics and surveys are likely to be the best there is.   And for those who do favour official data collections, well they are being put in place but the results won’t be available for months, since the data requirements don’t come into effect until 1 October.

Frankly, it seems reasonable to suppose that buying by non-resident Chinese is a material part of the market at present.  If so, that is not a normal state of affairs.  Generally, people do not buy individual residential properties in other countries as a part of a balanced investment portfolio.  In particular, they do not buy such property in small cities at the end of the earth.   People might, on occasion, own holiday houses abroad.  The super-rich might have second houses in great world cities such as New York and London.  But normal middle and upper middle class people in developed market economies don’t generally invest for their retirement in rental properties in faraway cities.  Apart from anything else, monitoring costs are high.  In fact, when people do own residential rental properties they are usually owned in locations quite close to where the owners themselves live.

In the 175 years since British government was established here, I expect this is the first time we’ve had this particular debate in New Zealand.  And it is a different debate than one around immigration and housing.  Reasonable people can differ about how much immigration we should have, and even where we might welcome migrants from, but if we are going to allow people to settle here they need to live somewhere.

“Capital flight” is a different issue.  In Latin America, Africa, and now China, people who have acquired money in ill-governed countries – many of the gains themselves might be ill-gotten, but many won’t be – want safety and security for themselves and their families.  That might be protection against a rickety domestic financial system.  Or it might be protection against the current ruling elite cracking down on political enemies (as much of Xi Jinping’s recent “anti-corruption crackdown” seems to have been).  It might just be protection against the risk of a substantial depreciation in the local exchange rate (which would probably be an appropriate course of action in China now, from a Chinese perspective).  In countries where many forms of capital outflow are illegal, people have to take what routes they can.

So, I think people who talk of offshore-Chinese interest in residential property abroad as something we just have to get used to, or an inevitable feature of globalisation, are wrong.   This demand is a function of the failure of China, not its success.  There was never a time when British or American savers were managing their investments by buying houses in Sydney or Auckland.  They were well-governed countries with rule of law protections.  China, to date, is not.

People are also wrong if they suggest something odd in singling out Chinese purchasers.  In most places around the world, the issue at present is about Chinese-sourced flows –  and, of course, unlike many of corrupt countries from which capital has previously flown, China now has one of the largest economies in the world, so any spill-over effects potentially matter more.  But if it were Russian or Argentinian buyers (which it isn’t, and has not ever been here), it would be just as much an issue.

Which is why I thought the intervention of the Race Relations Commissioner in this debate was particularly unhelpful and ill-judged.

But why might non-resident purchases of houses in Auckland matter? And to whom?  I’d argue that they matter only because laws and administrative practices make new housing supply so sluggishly responsive to changes in demand.   There is apparently substantial Chinese buying interest in Houston too, but when housing supply is much more responsive to changes in demand, foreign interest in local properties is largely beneficial to the local economy and its permanent residents.  It is, in effect, just another export opportunity.

But things are different when supply is so sluggish – and when it is mostly government policy that makes it so.   If supply were sluggish enough, even a few percentage points of additional demand could have material implications for house and urban land prices.  I’d be surprised if anything like 20 per cent of demand in Auckland was from non-residents, but if the true number is five per cent (which wouldn’t surprise me) it could still be making a material difference to prices in the current rather over-heated environment.  The Reserve Bank’s current and proposed lending restrictions are only likely to increase the relative importance of such offshore demand in explaining continuing price increases.

If most of any offshore-purchased houses are quickly put back on the rental market, offshore demand does not affect the availability of accommodation in Auckland.  If anything, it would probably drive further declines in rental yields (though not in nominal rents).  But it would still put home ownership further beyond the reach of New Zealand citizens and permanent residents living in our largest city.

The implications would be more serious if (and we don’t have the data) any material proportion of the offshore demand is being bought and left (largely) empty –  perhaps occupied two weeks a year if the owners take a holiday here.  Again, if housing supply were responsive, this demand would be pure gain (as at a holiday resort town), but in a city with tight housing supply restrictions (imposed, maintained and administered by central and local government), such demand would represent a reduction in effective accommodation supply, with consequences not just for the affordability of home ownership, but also for rents.  In that case, there are gains from offshore demand for the immediate sellers of the property (at least if they are leaving Auckland) but the distributional consequences for the wider Auckland population look pretty awful.  It doesn’t affect existing home owners, but the young and the poor typically end up worse off –  and in Auckland, as David Parker has noted, those on the margins are disproportionately of Maori and Pacific backgrounds.

Bernard Hickey has suggested that offshore demand should be welcomed if it is accompanied by large scale apartment building, perhaps directly financed by Chinese capital.  I’d have no objection at all to such investment, although as one who is a little sceptical of the estimates of the scale of any “shortage of physical houses”( the issue is mostly a land price issue), such a huge building programme could well sow the seeds of a subsequent collapse in Auckland property prices if the offshore demand for Auckland property proved not to be a long-term phenomenon.  Real overbuilding tends to be more economically damaging than simply price overshoots.

In the longer-term I suspect (hope?) the offshore non-resident demand is a second or third order issue.  Indeed, it may not be an issue at all.  A more liberalised Chinese financial system would allow savers to diversify their holdings offshore through much more efficient investment vehicles.  And Auckland is still a small city (and not exactly London, Sydney or San Francisco), compared to most of the others in which Chinese investors are reported to be interested, suggesting that demand would reallocate away from New Zealand if prices in Auckland got too high.  In the medium to longer-term, it is still likely that the interaction between tight land use restrictions and high target rates of inward migration  (which permanently boosts the population and demand for housing) will be more important for house and land prices in Auckland, and housing affordability.  As I remain sceptical that housing supply can (politically) be substantially liberalised –  I’m still curious to learn of any overseas examples where the controls have been substantially unwound –  winding back the target level of inward migration needs to be discussed.  It would be a more useful place to focus policy debate than overseas purchaser restrictions (and easier to implement effectively).  Again, this is an issue that should be able to be debated without accusations of “xenophobia” or ‘racism” being flung around by the great and the good.

I favour a relatively unrestricted environment for foreign investment, putting foreign investors on the same footing as New Zealand citizens and residents (though not as more favourable footing, as ISDS provisions have the effect of doing).  Most of our current restrictions appear unnecessary or counter-productive.

But when the government makes it hard to use urban land and increase housing supply, we are moving into a world of considering second or third best policy options if there is a large sustained source of offshore demand to own New Zealand houses.  Policy should be made in the interests of New Zealand citizens and permanent residents, and it is not clear what interest of New Zealanders is served by allowing an unrestricted inflow of offshore demand (if indeed it is substantial).  I heard David Mahon on Radio New Zealand this morning suggesting that even raising the issue would adversely affect our image in China, highlighting some deep “latent xenophobia”.  Perhaps it will affect our image, but I rather doubt it will affect how much milk powder is sold, or the price at which it is sold.  And when the country with the largest population in the world is both sufficiently ill-governed that many of its people just want to get their money out any way they can (after one of the biggest, and least disciplined credit booms in history), and just sufficiently liberal that there are some legal vehicles for those outflows, it is not inappropriate that other countries’ citizens might be wary about the implications.  China  –  and the choices of the Chinese rich – matters for other countries in a way that Zaire mostly did not.

Are there easy answers?  I doubt it.  People talk of the Australian policy of allowing non-resident purchases only of new houses – which sounds not totally implausible in principle, but doesn’t appear to have worked that well in practice.  If the government is confident that its registration scheme will produce robust data, perhaps an “offshore investor levy” –  akin to Treasury’s dubious “Auckland investor levy” –  could be considered.  But I suspect any such provision would run into problems with provisions in any number of our free trade agreements.  The same might go for banning non-resident purchasers altogether (eg from anyone without New Zealand citizenship or residence).

I’m not sure what the answer is, in a third best world.  But in this debate, I reckon the medium-term interests of people needing accommodation in Auckland, and wanting to buy their own home, need to be the policy priority.

And good quality debate around what could be an important issue isn’t help by sloganeering from people on any side of the issue.  I rather liked the guidelines for debate that Bryan Caplan and David Henderson have posted on Econlog in the last few days.  I’d add just one other –  to win a debate, and deserve to win it, one has to engage with the strongest arguments of those on the other side, not the weakest.  Attacking straw men perhaps has its satisfactions, but doesn’t really advance understanding, or the cause of good policy.

China matters to New Zealand, and to the world

Michael Reddell China

Not infrequently one hears our political leaders sagely warning against the risks of over-dependence on trade with China.  From those of a more historical bent, one sometimes hear talk of parallels with our historical dependence on UK export markets.

My impression is that those warnings and comparisons are mostly misplaced.  In practice, comments often centre on the dairy industry –  a sector in which the overwhelming bulk of domestic production is exported.    New Zealand’s dairy industry is the eighth largest in the world, but New Zealand is the largest dairy exporting country.   Decades ago, almost all our dairy exports went to the UK.  But perhaps more importantly, there were then very few other possible export markets at all. There wasn’t much global trade in dairy products.   People sometimes worry that our exports are concentrated in whole market powder, a product which New Zealand produces more of than any other country, and China consumes (and  currently imports) far more than any other country.  But even this seems overstated as a vulnerability, since the world dairy market seems (in aggregate) to be able to do quite a lot of substitution between products.  One way of seeing this is simply to look at how closely the prices of skim milk powder and whole milk powder move together.  Skim milk powder is a much less important product for New Zealand (and China).

powder prices

China matters to New Zealand, as it matters to the rest of the world, largely because it is now a large economy.  In PPP terms, China’s economy is estimated to now be around the same size as that of the United States.  That is a somewhat misleading comparison, overstating the absolute economic importance of China (since most of China’s GDP occurs domestically at its –  much lower –  domestic prices).   But equally comparisons of GDP at market prices tend to understate the importance of China, and are complicated by year-to-year exchange rate fluctuations.  Another way of seeing the importance of China is to look at the contribution to total global growth.

This chart is drawn from the IMF WEO database, using PPP-based nominal GDP data.
contributions to world gdp growth
On this measure, in the decade to 2004, China, the US, and the euro-area countries accounted for similar shares of global growth.  In the last five years, the euro area has accounted for very little of the growth in the world economy while China has accounted for more than twice the US’s share of global growth.   Again, it probably overstates the importance of China’s growth, but even if one could get some “true” numbers as the basis for comparisons, the stark change in the share of where world growth is occurring would remain.

And, if anything, simply using the make-up of world GDP as the basis for comparison probably understates the importance of China’s demand in the last few years.  In addition to showing strong growth in GDP (domestic value-added), China also recorded a very sharp reduction in its current account surpluses (while those in the euro-area have increased).  As recently as 2007, China was recording current account surpluses of 10 per cent of GDP.  China will have accounted for a larger share of the growth in world demand since 2009 than its share in the growth of world production.  Much of it was credit-fuelled, driven by policy choices that appear to have actively worsened credit standards across the economy   –  but as far as the rest of the world was concerned, it was still demand at a time when that was what the West was short of.

Of course, these data are only to 2014, and China’s growth now appears to be slowing quite rapidly.  If growth slows to, say, 3 per cent, China will still be contributing as much to the growth in real global GDP as the United States this year.  But the impulse effect of such a slowdown in growth might be quite large.

In absolute terms, China is still probably not quite as important to the world economy and financial system as either the United States or the euro-area.  In part, that reflects the less developed financial system, and the weaker connections between the Chinese financial system and those of the rest of the world.  For good or ill –  mostly probably the latter – the Chinese government has the ability to mask more problems for longer, and even to use policy more aggressively to actively counter the effects of a slowdown (at what might prove to be a considerable longer-term cost to the efficiency of its own underperforming economy).    If one is looking for risks of an economic explosion in the next few years, one would have to focus on the euro-area.  But what is happening in China is both hard for outsiders to interpret, and likely to be very important to the state of global demand.

Developments in global dairy prices matter enormously to New Zealand.  Developments in China matter a lot.  But they are (largely) two separate issues.  China matters to us (and other countries) primarily because, like Europe and the US, it is a very large economy, not because of the volume of direct trade with New Zealand.  China also looks like a rather rickety economy, and one which continues to fail to deliver living standards for its people that match those generated by market economies, whether in East Asia or the West.

China: the composition of the RB TWI really doesn’t matter for monetary policy

Michael Reddell China, Exchange rate, Reserve Bank

The BNZ’s Raiko Shareef has a research note out looking at the impact of including the Chinese yuan in the Reserve Bank’s trade-weighted index measure of the exchange rate. He argues that the inclusion of the CNY will increase the sensitivity of New Zealand’s monetary policy to developments in China.

I think he is incorrect about that. China has, of course, become a much more important share of the world economy in the last couple of decades. It has also become a much more important trading partner for New Zealand. Both of those developments, but particularly the former, mean that economic developments in China, including changes in the value of China’s currency, have more important implications for New Zealand, and other countries, than they would have done earlier. The Reserve Bank recognised the importance of the rise of China in setting monetary policy, and assessing developments in the exchange rate. But the Bank was quite slow to include the CNY in the official TWI measure. There was a variety of reasons for that, some more persuasive than others. But as far back as 2007 the Bank started publishing supplementary indices that included the CNY. If the Reserve Bank had used the old TWI in some mechanical way, then perhaps it would have been misled, and perhaps there would have been policy implications from the change in weighting schemes, But not even in the brief bad old days of the Monetary Conditions Index was the TWI used mechanically for more than a few weeks at a time. Every forecast round, the Bank comes back and goes through all the data, not just a reduced-form equation feeding off a particular TWI.

In the new TWI, the CNY has the second largest weight (20 per cent), just behind that on the Australian dollar.(22 per cent). But for the time being, that is likely to be high tide mark for the weight on China’s currency. Here is what has happened to goods trade – imports from China have kept on rising, but export values have plummeted (mostly on the fall in dairy prices).

chinatrade
A bigger question is one about what the appropriate weight on the CNY (and other currencies) is. I’ve argued that the CNY is important to New Zealand not because in a particular year we happen to sell lots of milk powder there, rather than in some other market, but because China is a large chunk of the world economy.  If we had no direct trade with China, it would still matter quite a bit.  In that sense, I reckon the new TWI understates the economic importance of the USD and the EUR, and overstates the importance of the AUD. We trade a lot with Australia, but Australia has very little impact on the overall external trading conditions our tradables sector producers face.

There are no easy answers to these issues. In a sense, that was why the Bank settled last year on a simple trade-weighted index. It wasn’t necessarily “right”, it wasn’t what everyone else did, but it was easy to compile and easy for outside users to comprehend. And without spending a huge amount of resources, on what was (probably appropriately) not a strategic priority, it wasn’t clear that any more sophisticated index would provide a better steer on the overall competitiveness of the New Zealand economy.

An issue of the Bulletin, written by Daan Steenkamp, covered some of this ground last December.

As already discussed, the new TWI has appreciated much less than the old TWI over the past decade or so. It is natural to ask whether the difference has, or should, affect how the Reserve Bank interprets or assesses the exchange rate. For example, are recent judgements about the ‘unsustainability’ of the exchange rate around recent levels affected? The exchange rate, however measured, is never considered in isolation from everything else that is going on in the economy. The Reserve Bank has, for example, recognised the rising importance of Asia in New Zealand’s trade and has taken that into account in its analysis and forecasting over the past decade or more. Exporters and importers deal with individual bilateral exchange rates, not summary indices. And New Zealand’s longstanding economic imbalances have built up with the actual bilateral exchange rates that firms and households have faced over time. How those individual bilateral exchange rates are weighted into a summary index therefore does not materially alter the Reserve Bank’s assessments around competitiveness and sustainability. Applying the macro-balance model (Steenkamp and Graham 2012) or the indicator model of the exchange rate (McDonald 2012) to the new TWI there are inevitably some changes, but the conclusions of those models, about how much of the exchange rate fluctuations are warranted or explainable over the past decade or so, are not materially altered.

There is no single ideal measure of an effective exchange rate index. Different TWI measures are useful for different purposes. In trying to understand changes in competitiveness it is likely to be prudent to keep an eye on them all. Developments in specific bilateral exchange rates will also have different relationships with economic variables and will be useful for different types of analysis. The focus of the Reserve Bank’s approach is on assessing the impact of the exchange rate on the competitiveness of New Zealand’s international trade, and the implications for future inflation pressures. Developing a full indicator of competitiveness, that reflected the specific nature of New Zealand’s international trade, and in particular the importance of commodity markets would require a very substantial research programme. It is difficult to be confident that the results would offer a materially better summary exchange rate measure than the simpler approaches the Reserve Bank has customarily adopted.

Of course, if China continues to grow in significance in the world economy, and if its currency becomes more convertible and is floated, it will become increasingly important to New Zealand. At the moment, the risks around China look somewhat the other way round – the influence of China may be more about the nasty aftermath of one of the biggest, least-disciplined credit booms in history. Growth looks to have fallen away much more than many (including the Reserve Bank) seem to have yet recognised.  But whatever the correct China story, the influence on New Zealand has little or nothing to do with how the Reserve Bank’s trade-weighted index is constructed.