New Zealand Deleverages

Following Standard and Poor’s November downgrading of New Zealand’s sovereign credit rating from AA+ stable to AA+ negative, the New Zealand Government recently warned that its budgetary situation has worsened amid deleveraging by New Zealand households.

Finance Minister Bill English foreshadowed a New Year review of government spending in the wake of figures showing the budget deficit running at NZ$4.4 billion just four months into the fiscal year, which was NZ$1.9 billion worse than expected…

“Some of this is due to New Zealanders saving and investing more, and borrowing and spending a bit less… The reality is New Zealanders have been saving at quite a significant rate, as opposed to dis-saving that we saw take place between 2000-2008, so tax revenue’s been lower and on that basis there’s a slightly bigger hole,” [Prime Minister] Key said.

Key said Finance Minister Bill English had been surprised by the extent of household savings over the year.

“I think that’s a reflection of the international environment that people see. When you see pictures of the austerity packages, the cut-backs, the unemployment rates in the United States, Ireland, Greece and Portugal, then people rightfully so are cautious,” Key said. “We’ve seen a great deal of cautious behaviour this year. How quickly we revert to type [to more spending] I don’t really know because it will depend on what the economic outlook is like globally over the next few years,” he said.

“We spent quite a long period of time where there was a consumption-led boom right through the back end of the 90s and right through the 2000s up to 2008. So it might be a period of time where we save. That’s a good thing by the way. Our external liabilities [are] by far our biggest issue that we worry about,” Key said.

That New Zealanders have cut back on spending is hardly surprising and is typical of an economy deleveraging after an asset bubble.

Throughout the 2000s, global credit conditions were benign and household debt levels and asset prices rose continually. These conditions made New Zealanders feel richer, spurring consumer confidence, spending and employment growth. This process can clearly be seen by the below RBNZ chart, which shows a rapid rise in household net worth up until 2007. The bulk of this increase in wealth came from ballooning home values, which comprises the overwhelming majority of household net worth.

But the process of debt feeding asset prices feeding confidence, consumer spending and employment growth went into reverse after house prices began falling in late 2007, in response to the Global Financial Crisis (see below chart).

In real terms, the reduction of New Zealand housing values since 2007 has been even more severe, with housing values relative to GDP falling from around 3.5 times in 2007 to around 3.1 times as at June 2010 (see below chart).

With household net worth declining in real terms, New Zealanders have begun reducing consumption and repaying debt, as evident by household debt to disposable income falling from 159% in 2008 to 154% currently (see below chart).

Deleveraging has only just begun:

Once expectations of stagnant or falling asset prices set in, the process of household deleveraging can become irrepressible.

As home values drop, net worth falls, which limits the willingness and ability of households to consume. The quality of bank assets (i.e. housing loans) also deteriorates, making banks less willing to lend to both households and businesses. With reduced credit flowing into the economy, spending, jobs, asset prices and company profits decline. This makes households even less willing to borrow and consume and erodes banks’ asset quality even further.

So just as rising debt and asset prices provided a boost to New Zealand’s aggregate demand, consumption and jobs growth up until 2007, falling asset prices and debt repayment have detracted from aggregate demand, consumption and jobs growth since then.

Unfortunately for New Zealand, the process of deleveraging is likely to continue into the foreseeable future. A recent ANZ consumer confidence survey encapsulates the current situation:

The underlying message remains one of caution in regard to spending behaviour. We can see elements of clear support for spending diffusing through the economy via labour income growth and high commodity export prices. However, such support is facing headwinds from the deleveraging backdrop and the listless housing market…

Households continue to have anaemic expectations towards house prices over the coming years. House prices are expected to rise 1.5 percent per year on average, down from 2.3 percent last month. A glass half full view would centre on it being a positive number. However, with households expecting general inflation to average 3.5 percent, the underlying message is one of expected declines in real house prices.

With the wealth effect not driving consumption, spending needs to come from income generation. Income generation across the economy at present is reasonable. But households appear strongly focused on rebuilding precautionary savings.

This, as caution prevails, suggests their wallets won’t be opening up wide in advance of Christmas.

The National Bank’s December property report expressed similar pessimism:

“[T]he general spirit across most indicators remains one of sombreness with balance sheet repair the prime focal point. It’s hard to see this changing in the early part of 2011…”

And the debt-fuelled housing party that ran until 2007 has now turned into one giant hangover:

Welcome to the grind of 2010. Depending on where you live, your economic certainty and size of the mortgage, you may be cruising along happily, or having sleepless nights.

Whatever your position, you are unlikely to be as asset-rich today as you were in 2006 or 2007. All the signs are that New Zealanders have cut back on spending and chiselled away at their debt, but house prices everywhere are down on their highs and, if inflation is taken into account, the slide is substantial…

For people happy in their homes, on top of the mortgage and intending to stay put for years, these things don’t matter so much, though a decline in paper wealth will hardly have them clicking their heels and planning an add-on bedroom or new drapes and carpet…

But many of those caught up in the hype of the market – perhaps investors and first-home buyers – have lost their equity, or much of it. Some have been ruined in mortgagee sales, and many others are probably wishing they had kept flatting…

The message there is clear: many of those areas got well ahead of themselves in the boom, with demand fuelled by investors chasing cheap property and panicked first-home buyers seduced by the argument that if they didn’t get in then, they’d never be able to afford a home.

When the economy soured – threatening job security and drying up easy finance – demand disappeared and prices began to slide…

The latest surveys show homes are now as affordable as they were in June 2004, as a combination of falling prices, rising wages and tax cuts bite. But homes here are still expensive on an international basis when put alongside household income, so no one should be betting on real term capital gain in the next decade.

So true. Although New Zealand’s official house price-to-income ratio has fallen from a peak of 5.6 in 2007 to 4.7 currently, it is still well above its long term average of 2.9 (see below chart). Accordingly, it would appear that house prices have a lot further to fall relative to incomes.

Let’s also not forget that New Zealand, like many other developed nations, has a rapidly ageing population. In fact from 2010, New Zealand’s total dependency ratio – the ratio of the non-working population, both children and the elderly, to the working age population – is projected to worsen progressively as the baby boomer generation enters retirement (see below chart).

This increase in the dependency ratio will, other things equal, crimp New Zealand’s economic growth and consumption, and act to reduce asset values. In fact, according to a recent Bank for International Settlements working paper, New Zealand can expect population ageing to reduce house price growth by over 40% in real terms over the next 40 years compared to what would occur if New Zealand’s age structure remained neutral (see below chart).

Clearly, the days of credit-based growth are over for New Zealand. Instead, economic advancement will need to be earned the old-fashioned way: through hard work, innovation, and productivity growth.

Australia, too, will deleverage, although our day of reckoning is, for now, being delayed by China’s insatiable demand for commodities. But given the recent spate of bearish reports on China and the collapse of home and retail sales in Australia, I get the feeling last drinks have been called and our debt-fuelled party is coming to an end. And any China-induced slowdown in Australia will be equally painful for New Zealand, given Australia and China are its first and third major export destinations.

Could 2011 be the year when the Australian ‘miracle’ economy joins the pack? Only time will tell.

Cheers Leith

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.


  1. ED you are exactly right but what I think is going to be the final blow to the wound is China collapsing or slowing down significantly in 2011. All the emerging markets are about to come to a head with all their debt and over leveraging on property. The effects of this on Australia are going to be massive. This is a very interesting video I saw today.


  2. Merry Christmas, Leith.

    I greatly appreciate your analysis. I hope we will be seeing more great posts from the unconventional economist in 2011.


  3. Hi

    quick question:

    "The reality is New Zealanders have been saving at quite a significant rate, as opposed to dis-saving that we saw take place between 2000-2008, so tax revenue’s been lower and on that basis there’s a slightly bigger hole"

    how does this cause a loss in tax revenue?

  4. Another fantastic post Leith. Always interesting and plenty of factual rebuttals here to the usual spruiking.

    Double incomes the cause? Figure 5 puts that to bed, unless women really didn't work until 2002.

    Historical and inevitable stable increase? Figure 1 shows that stable increase kicked up a notch in 2002.

    They're not making any more land for the growing population? Last 2 figures deal with that.

  5. I'm also tipping 2011 as the year deleveraging sets in here. Businesses are clearly hell-bent on deleveraging and it appears households are in the early stages.

    As Leith succcinctly points out, this feeds back into the supply chain and then into the financial system so it could take a while for the data that's currently "surprising" mainstream economists to morph into something that their brainwashed minds can understand.

    Mark my words, Steve Keen will be vindicated over the course of the next decade.