# Wealth distribution in New Zealand – 2018

The Department of Statistics recently published wealth distribution figures for New Zealand. According to Stats NZ, the median household net worth in the year ended 30 June 2018 was \$340,000, up from \$289,000 in 2015. The increase was mainly driven by an increase in property values over the last three years.

% of net wealth held by % of Households – 2018

According to the survey, the top ten percent of households hold 53 percent of total wealth in New Zealand, which is unchanged from 2015. The top one percent of households hold 16 percent of total wealth in New Zealand, which is down slightly from 2015. New Zealand’s Gini Coefficient is approximately 0.33.

The Lorenz Curve
The Gini Coefficient is derived from the same information used to create a Lorenz Curve. The co-efficient indicates the gap between two percentages: the percentage of population, and the percentage of income received by each percentage of the population. In order to calculate this you divide the area between the Lorenz Curve and the 45° line by the total area below the 45° line eg. Area between the Lorenz Curve and the 45° line  ÷  Total area below the 45° line.

The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income, and
1 = maximum inequality where all the income of the economy is acquired by a single recipient.
* The straight line (45° line) shows absolute equality of income. That is, 10% of the households earn 10% of income, 50% of households earn 50% of income.

In 2010 China’s Gini coefficient was 0.61 which was one of the world’s most unequal countries however officially it has been falling for seven years from 0.49 in 2008 to 0.46 in 2015. Rural incomes have grown more quickly that their urban counterparts – in 2009 the average urban income was 3.3 times that of a rural worker but now it is 2.7 times. Many of those living in rural areas actually work in cities but are prevented from living there because of the strict residency system. Also companies have now been looking to the rural areas for cheap labour.
But at the top end you would get the impression that inequality of wealth is extremely high – wealth = what you own, as opposed to what you earn. China has more dollar billionaires (596) than the USA (537). Research has shown that 1% of the population control a 1/3 of China’s assets.

# Auckland house prices 73.8% overvalued against income.

Whilst there has been a lot of talk about Auckland’s flattening house prices the city is ranked only behind Hong Kong (94.1%) as the most unaffordable city in the Economist’s ‘cities house price index’ – house prices in Auckland are 73.8% overvalued compared to the average income. This figure is ahead of Sydney, Amsterdam, London, New York, Paris and Vancouver – see graph from The Economist – showing how housing is basically unaffordable in proportion to earnings.

There are 3 reasons why house prices globally have been accelerating at such a high rate – Demand, Supply and the cost of borrowing.

Demand
Regional population growth in Auckland has been significant and although is slowing it still has the fastest population growth in NZ. With the influx of people and the housing construction more jobs become available which in turn attracts workers from other areas. Furthermore foreign investors have played their part in increasing demand although this has reduced over the last year with the government putting in place regulations with home ownership.

Supply
Housing has become particularly scarce with supply unable to keep up with demand. But recent consent figures for 2018 show that 13,000 were issued in Auckland compared to 10,000 in 2017. Auckland was previously building too few houses relative to population growth, leading to a worsening housing shortage as indicated by a rise in the estimated number of people per dwelling.

Low interest rates
Since the GFC economics has been dominated by fiscal and monetary policies to stimulate aggregate demand. Tax cuts have added to consumers bank balances but it is monetary policy that has been particularly prevalent with record low interest rates encouraging consumers to borrow money and buy property. Furthermore with the stock market becoming a fickle location for investment investors sought the so-called safety of the housing market and in many cities did particularly well.

But prices are starting to level off and in some cities falling in a response to variety of reasons – rising  yield on treasury bonds – tighter regulations on overseas buyers – uncertainty about Brexit – China tightening up on capital outflows of the super-rich.

Source: The Economist – Buttonwood – November 10th 2018

# Brexit and New Zealand’s trade with the UK and the EU

The impact of Brexit on New Zealand depends on what kind of exit agreements are reached between the UK and the European Union. The published provisional deal includes a transition period which runs until the end of 2020. During this time, existing trade conditions for third parties (such as New Zealand) will continue. Below are tables showing the trade relationship between New Zealand and both the EU and the UK. The benefits of two way trade with the EU outweigh those of the UK – US\$23,273m against that of the US\$5,640m

March 2018 – New Zealand’s total trade balance was a surplus of \$4.0 billion in the year – this surplus is up \$1.3 billion from the trade surplus in the year ended March 2017.
Total exports of goods and services were \$78.0 billion, while total imports were \$73.9 billion.

China (\$15.3 billion) and Australia (\$13.9 billion) were the top export destinations.
The European Union (\$13.4 billion) and Australia (\$12.1 billion) were the top import sources.

Dairy products and logs to China were New Zealand’s top two export commodities by destination, earning \$4.0 billion and \$2.6 billion, respectively. This was followed closely by spending by visitors from the European Union (\$2.2 billion) and Australia (\$2.1 billion).

New Zealand’s negotiations

New Zealand is in negotiations with the UK over a FTA. According to New Zealand Foreign Affairs and Trade NZ wants the following from a FTA:

• Removing tariffs and other barriers that restrict the free flow of goods between our two countries
• Making it easier for traders of all sizes to do business in the UK, including services exporters
Strengthening  cooperation and dialogue with the UK in a variety of trade and economic fields
• Reflecting our goals including progress on gender equality,  indigenous rights,  climate change, and improved environmental outcomes.
• Some key areas in which we will be seeking even closer cooperation with the UK under the FTA include:
• High quality primary sector and goods access to the UK’s market, such as for meat, mechanical machinery and equipment, fruit, pharmaceuticals, forestry, dairy and wine
• Helpful conditions for investment and services providers who operate between the two countries
• Commitments on progressive trade issues including environmental and labour protections, indigenous rights and gender equality.

Sources:

• Parliamentary Library Monthly Economic Review – December 2018.
• New Zealand Foreign Affairs and Trade.

# Glossy projects vs Maintenance – Governments need to get the basics right.

Since the GFC economics has been dominated by fiscal and monetary policies to stimulate aggregate demand. Monetary policy has in particular been reinventing itself with low interest rates not being enough to stimulate demand and the introduction of numerous rounds of QE.

Other policy areas might lack the excitement of delving into the unknown but are just as important to an economy. Maintenance of a country’s infrastructure, assets and government accounts are essential to the long-term development but government’s tend to avoid them as they are not creating anything new and therefore not recognisable by voters. A new hospital, school or major road grab the headlines and inform the electorate that they have been busy putting tax payer money to good use. Maintenance lacks the glamour of innovation.

The US after the GFC did spend a lot of money on new vanity infrastructure projects but these were in sparsely populated areas. However, it was busy cities that really needed their transport infrastructure upgraded and you would think this would be a priority for governments. In the US the fraction of existing road surfaces that are too bumpy has risen from 10% in 1997 to 21% in 2018. Invariably if infrastructure is not maintained it causes significant costs for an economy and in some cases fatalities – the recent bridge collapse in Genoa, Italy. One of the issues for economists is that the typically used measure of an economy, GDP, doesn’t take into consideration the cost of wear and tear. In order to do this they must work out the lifespan of each asset and decide on its depreciation. Some are similar to light bulbs which means they work until they blow – economists refer to this as the “one hoss shay” case. This is based on a poem where it imagines a horse-drawn cart built so well that it never broke down until it eventually fell apart. victim of a “general flavour of mild decay”. Other assets are more linear in how they depreciate in that they lose the same amount each year. Japan assumes that houses lose 4% in value each year and that is why Japan’s consumption of fixed capital is high – 22% of GDP – see graph from The Economist.

Too often governments, and organisations for that matter, preserves day-to-day spending by cutting maintenance and investment. Finance ministers might invest more in maintenance if the resulting boost to public wealth became more transparent. Furthermore if all government departments had to account for all the capital tied up in their operations, they might feel obliged to be more productive with it. New Zealand seems to be the only country to update its public-sector balance-sheet every month, allowing for timely assessment of public-sector worth. So instead of impressing voters with ideas and glossy projects, being boring might actually do some good. Economists tend to be good at this.

Source: The Economist – October 20th 2018

# OECD – GDP per capita – New Zealand falls to 22nd.

New Zealand has enjoyed a high standard of living and solid economic growth in recent years. However, during this period New Zealand has also exhibited a comparatively low level of productivity growth relative to our OECD peers. Broad-based evidence of this can be seen in New Zealand’s Gross Domestic Product (“GDP”) per capita. This metric measures output per New Zealander and is standardised into US Dollars for all countries. On this metric, New Zealand has consistently trailed the United States, Australia, Canada, Great Britain, France, Japan and the OECD average.

In 2017, New Zealand was ranked 22 of 48 countries surveyed by the OECD, compared with 9th place in 1970 and 20th in 1993. Over the last 50 years the world has seen much stronger growth in exports of manufactured products and slower growth in exports of primary products. And New Zealand’s competitive advantage is still in primary products. We are now on the brink of a technological revolution that will alter the way we live and work. The fourth industrial revolution is all about embracing the digital revolution. Our low productivity levels are a bit of a conundrum and the reasons for this are varied and subjective. Source – ANZ Bank

OECD GDP PER CAPITA (2017)

Source: Organisation for Economic Co-operation and Development (“OECD”)

# New Zealand’s Terms of Trade – Milk Powder v Oil

The recent history of New Zealand’s terms of trade has been largely linked to dairy product export prices although in a longer-term context the price of imported oil has been paramount. Today we can see that the price of powdered milk (export) and the price of brent crude oil (import) are heading in the wrong directions. Powdered milk prices are falling and brent crude oil prices are rising which makes for an unfavourable terms of trade – see graph. This is not a good sign for the terms of trade which reached its peak in March this year.

What is the Terms of Trade.
The terms of trade index measures the value of a unit of exports in terms of the number of imports it can buy, or the purchasing power of our exports. This is similar to comparing the number of sheep exports that will buy a typical imported family car, from one time to another. The formula is:
Formula: Terms of Trade (TOT) =

Export Price Index (Px)           x   1000 (base year)
Import Price Index (Pm)

• An increase in the TOT (e.g. from 1050 to 1200) is called “favourable”
• A decrease in the TOT (e.g. from 1050 to 970) is called “unfavourable”

A “favourable” (increase) in the TOT may come about because the average:

– export price rose and import price stayed the same
– export prices rose faster than import prices
– export prices stayed the same and import prices fell
– export prices fell but import prices fell faster

The index number that results tells us whether merchandise export price movements have been favourable relative to import price movements. An increase in the terms of trade from 1000 to 1100 represents an increase in the purchasing power of our exports of 10% which means, other things being equal, we would be able to buy 10% more from overseas. As a country we would be wealthier. A decline in the terms of trade would result in the opposite situation.

Limitations of the Terms of Trade

Terms of trade calculations do not tell us about the volume of the countries’ exports, only relative changes between countries. To understand how a country’s social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.

The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. An example of this is the high export price suffered by New Zealand exporters since mid-2000 as a result of the historical mandate given to the Reserve Bank of New Zealand to control inflation.

In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

Evaluation

• A decline in the terms of trade is not necessarily a bad thing. For example, a decline in the terms of trade may occur due to a devaluation in the exchange rate. This devaluation may enable a country to regain competitiveness and increase the quantity of exports.
• The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand.
• Some Less Developed Countries (LDCs) have seen an improvement in terms of trade because of rising price of commodities and food post 2008. It is not always LDCs who see a decline in the terms of trade.
• It is important to distinguish between a short term decline in terms of trade and a long term decline. A long term decline is more serious for reflecting a fall in living standards.

# New Zealand keep triple A rating but what does it mean?

Moody’s credit rating agency continued with a Aaa rating of New Zealand’s economy. They expect the coalition government will remain committed to fiscal discipline, with the Budget staying in surplus. The high strength of New Zealand’s institutions was a key factor in underpinning the credit rating. There are three main rating agencies in the global economy – Standard & Poor’s, Moody’s and Fitch – below are the ratings that each company uses.

Conflict of Interest and the sub-prime crisis of 2008
Rating agencies are paid by the people whose products they grade and they are competing against other rating agencies for the business. Subsequently the rating agencies were being played-off against each other by the bankers in this market and this led to a systemic decline in standards and willingness not to check the underlying information as thoroughly as possible for fear of losing the deal. Even the rating agencies themselves admit mistakes were made is assessing sub-prime debt and that there were issues to do with data quality from their sources of research. However one has to consider whether the world have been better off if credit rating agencies had not existed as pension funds, bond funds, insurance companies etc would have had to do a lot more of their own research on what they were buying.

Remember before the credit crisis AAA investments mushroomed between 2000-2006 see graph below.

But consider the following:
Bear Stearns
– rated A2 a month before it went bankrupt
Lehman Brothers – rated A2 just days before it collapsed
AIG – rated AA within days of being bailed out
Fannie Mae & Freddie Mac – AAA rating before being bailed out by the government
Citigroup – A2 before receiving a bail out package from the Government
Merrill Lynch – A2 before being sold to Bank of America

A2 is considered a good investment grade

# Global Dairy Prices down but why does NZ have such high milk prices?

On the 21st August the GDT Price Index continued its decline and dipped 3.6pc, with an average selling price of \$3,044 per tonne. Whole milk powder was down 2.1% at \$2,883 – see graph below:

How does the GDT work?

GlobalDairyTrade trading events are conducted as ascending-price clock auctions run over several bidding rounds.  In each auction a specified maximum quantity of each product is offered for sale at a pre-announced starting price. Bidders bid the quantity of each product that they wish to purchase at the announced price. If the price of a product increases between rounds, to ensure their desired quantity a bidder must bid their desired quantity at the new, higher price. Generally, as the price of a product increases, the quantity of bids received for that product decreases. The trading event runs over several rounds with the prices increasing round to round until the quantity of bids received for each product on offer matches the quantity on offer for the product (as shown in the diagram below). Each trading event typically lasts approximately 2 hours.

Why are prices so high in NZ?

Fonterra is responsible for 30% of the world’s dairy exports with revenue exceeding NZ\$20 billion and is New Zealand’s largest company. With New Zealand being one of the biggest producers you would expect prices for New Zealand consumers to be lower than what they are – a litre of fresh milk in Germany was selling for the equivalent of \$1.51, compared to \$2.37 in New Zealand.

Milk being inelastic in demand and is an essential part of the typical family shopping basket. Up until 1976 the price of milk was set by the government and producers were subsidised the loss that they incurred by a set price. The subsidy was completely removed in 1985 and by 1993, milk could be sold at any price. In January 1994, two litres was selling for the modern equivalent of \$3.95. Consumer NZ estimates that for every \$3.56 bottle of milk (an average retail price at present), about \$1.19 would go to the farmer, \$1.91 to the processor and retailer and 46c to GST.

Who gets what?

Because Fonterra take over 80% of what farmers produce it is difficult for the market to decide what an appropriate price to pay farmers. Therefore they work out what they believe is the highest sustainable price it can pay its farmers. It looks at the global dairy trade auction price and operating costs and capital costs to determine the farm gate price.

GDT price – Operating Costs – Capital Costs = Farm Gate Price

So farmers in New Zealand are at the mercy of the global market not how much is demanded in NZ supermarkets.

NZ Supermarket Prices

Supermarkets buy their milk from local distributors, either direct from Fonterra or other processors such as Synlait, or from suppliers who had value along the way. They then add their own costs to give a final price to the consumer but New Zealand food retailing effectively is a duopoly. Milk in Germany is much lower in price because of the high levels of competition with multiple chains operating there. In New Zealand however the price consumers pay reflects the concentrated nature of the market. Domestic milk market is dominated by one big supplier, Fonterra (see graph below), and two big supermarket chains – Foodstuffs and Progressive Enterprises – which means there’s little competition for your dairy dollar.

# Global Debt – 225% of GDP

The New Zealand Parliamentary Library publish a very good monthly economic review and in the July edition the topic of the month was The International Monetary Fund’s Global Debt Database.

The IMF publish their Global Debt Database which provides the gross debt levels since 1950 for 190 advanced economies, emerging market economies and low-income countries. It covers 99% of global GDP in 2016. Currently, total debt levels have reached a new high, standing at around US\$164 trillion, or 225% of global GDP with USA, China and Japan accounting for more than half this figure – \$92trn out of \$164trn – see table.

The big change is China with debt having gone from \$5trn to \$26trn in the space of 10 years – this equates to 3% of global debt in 2007 to 15% in 2016. Private debt has nearly tripled since 1950.

Government vs Private Debt in New Zealand

New Zealand government debt has been on its way down which is in contrast to its private debt – see figures and graph below. Not surprisingly the IMF is concerned about private debt and the effects of the country’s inflated housing market despite the strong economic outlook. They said “Household debt remains high under the baseline outlook and would amplify the impact of large downside shocks, notwithstanding recent improvements in its risk structure after macroprudential policy intervention. Such shocks could also trigger a disruptive housing market correction,” The main risks to New Zealand are an economic slowdown amongst developed countries and China, the fallout from increasing protectionism and the Mycoplasma bovis cow disease.

Source: New Zealand Parliamentary Library – Monthly Economic Review – July 2018

# Dairy debts make NZ Banks vulnerable

New Zealand dairy farmers are making banks worried about their ability to keep up with their mortgage payments. Four recent issues haven’t helped the cause:

1. Falling produce prices making it harder for farms to service debt
2. Mycoplasma bovis cutting productivity and profitability of the sector
3. Regulatory changes  – restrictions on foreign ownership and therefore reducing the value of dairy farms
4. Environmental regulations – increasing operating costs for farms

Whilst the last two might improve the long-term sustainability of the dairy sector they could reduce the profitability of highly indebted farms and their equity buffers.

Banks are closely monitoring about 20% of their dairy farm loans because of concerns about the borrowers’ financial strength. Although a dairy downturn is unlikely to threaten the solvency of the banking system, it does weaken their position if there is another external shock like another GFC. Bank lending in the dairy sector has been consistent over the last few year years but the proportion of loans on principal and interest terms has increased from 6% in January 2017 to 12% in March this year.

Although the average mortgage for most farm types has decreased in dollar value over the past six months, the average mortgage amount increased in the dairy farms – see graph below. The average mortgage for dairy farms is the highest at \$5.1 million for the first time since the survey began in August 2015.

The table below shows the average current mortgage by sector over the years shown. Dairy farmers continue to hold the largest proportion of mortgages in excess of \$2 million. They are also more likely to have a mortgage over \$2 million – 62.5% of all dairy farms – and \$20 million – 3.4% of dairy farms.

Source: Federated Farmers of New Zealand – Banking Survey – May 2018