Part 1: Government Spending, Inflation and Interest Rates

29th Jun 2021 | Ben Pauley


It’s been a while since our last blog update. There has been a lot going on behind the scenes at the Lateral Partners HQ. Harnessing the strengths of our Lateral team and the elation of newfound change, the future is looking really bright.

Plenty has changed beyond the borders of our business as well. There have been tax hikes on personal incomes, tax changes on rental properties, changes to social housing policies, continued growth in property prices, travel bubbles, and much more. What is of the most interest to me at the moment is the continued domestic and foreign government spending, subsequent borrowing and talk of inflation.

Government Spending

Never before has the world seen such a level of spending and borrowing by governments. New Zealand set some major records of their own over the last year but paled in comparison to some of the major countries of the world. The US, for example, has announced so far this year approximately $7 Trillion (yes Trillion) dollars of stimulus spending. To put that into perspective, it is approximately twice their annual tax revenues and excludes spending on core government services and policies. It amounts to a little under $20k per person for a population of over 400 million. The Federal Reserve’s balance sheet has grown by 78% this year alone and over 1,600% in the last 20 years…

Commentators have spoken about whether this will cause inflation with differing outcomes. Unemployment in the US has skyrocketed. A recent set of job numbers missed the mark by about 600,000 people and most of the recent employment seems to stem from people returning to jobs that were stopped during Covid 19 (restaurants etc). Some believe that the high levels of unemployment will stymie the inflation and that any increases in prices being seen now are just transitory (short term). It won’t.

In New Zealand, we have seen over 50bn of government spending with most of this fuelled by the government borrowing against the Reserve Bank’s balance sheet. This number may seem small in comparison, however, when measured against New Zealand’s annual tax revenues it is comparable to countries like the US.

This money has been poured into many admirable initiatives. Benefit spending, infrastructure, the defence force, and underwriting of bank lending to the private sector. By far the biggest beneficiary of the money spending has been property.

House Price Growth

This level of spending and money printing (as that is what the Reserve Banks do) inevitably causes inflation. There is no avoiding this. House price growth was the first cab off the rank, we have seen some home values increase >25% over the last 12 months.

Has the population increased by >25%?

Have we had a reduction in housing stock of 25%+?

The answer to both of these is no. On the contrary, we have seen relatively minor population growth compared to 5 years ago and one of the largest increases in housing stock over the last 20 years. What has ballooned in the last 12 months has been the money supply by way of cheap and available credit.

This is what has fuelled house price growth. There have been some hangovers on housing stock from underinvestment historically, however, this in itself has not caused the level of price inflation we have seen in the last 12 months.

Kianga Ora have been handed an additional $2bn to spend on property nationwide. Retail banks have seen record levels of volumes and lending. Community Housing Providers have seen huge increases in passing rents as they take on further stock from the private market. All of this has flowed into property and demand.

House prices have inevitably risen.

What Does This Mean?

People who own property have seen their ‘wealth’ increase substantially over the last 12 months. The average homeowner in Auckland has seen their home increase in value $210,000.00. For context, the average household income in Auckland is approximately $85,000.00. Property has been the big household ‘earner’.

At the same time the cost of the debt to hold that asset has fallen almost by half with interest rates as low as 2.25%. This has left families feeling wealthier as their cash flow increases & they feel more secure in their financial position.

The average punter has then sought to take advantage of this and taken on further leverage. Why not? It’s cheap and they have the equity. This leverage goes into further property (investment), the share market, a new car, a boat, a holiday.

More Soon…

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