Headwinds to a Borrower

Back

By Ben Pauley

CCCFA. Inflation. Interest rate hikes. House prices. LVR restrictions. Debt to Income ratio. COVID-19.

These are just some of the more high-profile worries and considerations for borrowers in our great nation at the moment. New Zealand was recently ranked the highest nation for financial freedom– imagine how bad the rest of the world must be!

At Lateral Partners, we speak about these everyday, musing to each other about what the impacts could be on the property market, economy, our business, mood of the nation and anything else loosely related.

What is the answer? We don’t know. Much like trying to predict the weather, we can make an informed guess, but in the end we are just as likely to see rain as we are to see sunshine.

Borrowing in New Zealand in 2022

Our informed guess, however, is that New Zealand borrowers are in for a tough year. New Zealand, as with most of the world, has been in an enormous credit expansion bubble in the last 24 months that has seen significant increases in money supply and asset prices. For borrowers, the going has been good and they have embraced what is on offer. Household debt has increased ~$24bn from Jun 20 – Jun 21 (11.3%). The problem with bubbles like this is that they tend to favour those that own assets, and punish those that do not. If you own property, you have seen a huge increase in your personal (paper) wealth. If you don’t, you have fallen further and further behind.

The response to this property fuelled wealth gap, covered more in depth in our upcoming blog, has been increased regulation and policy to temper house price inflation and help those yet to climb on the ladder. We have seen cut-backs in high LVR Lending, reductions in the LVR, and tax changes to property investment, all aimed at stemming this growth and increased lending regulation. All impacting people’s capacity to borrow.

Impact of Inflation

The expansion in credit and money supply has also, naturally, led to an expansion in the cost of living. We have been writing on this risk for a while now, and recent inflation data seems to confirm this trend. If the government produces more money than goods, it is a natural conclusion that prices will go up. So what’s the answer? Increase the minimum wage or decrease the stimulus and price inflation?

Inflation is no good thing, it reduces the value of your hard earned dollar, in turn impacting on your standard of living. As maintaining a lifestyle costs more, you either trim it back (less coffees, dinners out, movies) or you save less. Too much inflation and you quickly realise the debilitating effect on the morale of people.  It also has an unfair effect on those who earn less as they have less to spend.

The issue with inflation is that it doesn’t just go away. Increased costs to a business owner are passed onto the consumer. The employees then see their costs go up and ask for a pay rise, with low unemployment it is cheaper to acquiesce than go back to the market. These costs then go back into the business and the cycle continues. Inflation begets inflation.

Combating Inflation

To combat inflation, the general economic theory is to reduce the supply of money. If it reads that more money equals higher costs, then less money should equal lower costs. To draw money away from economic activity, the government simply increases the rate of return to have your money in savings (term deposits etc.) and thus taking money out of economic activity (circulation). The effect of this is that money is withdrawn from economic activity and therefore prices and the cost of living should fall.

However, it’s not that simple in reality.  You will recall above that we commented on the levels of debt we have taken on as a nation. What happens if that debt costs us twice as much, or even three times as much as it did when we took it out? I think we all know the answer to that question. This is the balance the government and reserve bank now need to manage – how do they combat inflation without damaging the borrowers? Can they?

The answer is uncertain.

We do not know what will happen. We do know that either path has its bumps, blind corners and ungainly tree roots that we can stumble over. We do know that both pathways will likely spell uncertain and difficult times ahead. The good news is that you can manage your risk effectively and get good outcomes. The better news is that we are here to help you do that.

Got questions? Get in touch with us, we'd be happy to help.

Please read our Disclaimer Statement for more information.