Foreign investment: The price of everything, the value of nothing

I often get told that economists see the price of everything, and the value of nothing.  But judging by many of the comments about foreign bond and house purchases, this sort of affliction is widespread across society.  If people overseas are bidding up, and thereby overpaying for, New Zealand houses and bonds, then this is a good thing for the New Zealanders on the receiving end.  This is a benefit, and a significant boost to wealth, which too many people seem keen to ignore.

Now I recognise that there are a group of people who merely dislike the sale of assets to foreigners because they are either a closet racist, or simply xenophobic.  If this is your inclination scroll straight through the rest of this post as I’m not talking to you.  This post is simply written to people who are concerned about the welfare of New Zealanders given that house prices are high, and the exchange rate is elevated – both potential side-effects of rising flows of capital from overseas.

The more buyers you have for an asset, and the deeper their wallets, the higher the likely price that will be paid for the asset.  But what does a higher price really mean?

Let us start off with the case of a “bubble”.  I have heard people far and wide scream about bubbles in the housing market and bond markets.  So let’s start off assuming that there is a bubble, and work from there.

Thinking about bubbles

If we accept there is a bubble in these markets and the bubble is the result of foreign buyers rushing in and overpaying New Zealanders for New Zealand assets then this provides a very interesting situation.  Once the bubble is over, the price of the asset will fall back to its “fundamental” level.  The funds the foreign buyer paid the New Zealander will be sitting in the New Zealander’s hand, while the foreign buyers would have made a loss on their investment.  I imagine even our xenophobic friends who I asked not to read this piece would be comfortable with this situation –and yet this is the situation I see many people complaining about.

If the bubble is as I have just described, then this is a wealth transfer to New Zealand residents from the rest of the world – they are giving us the funds to invest in other things and buy consumer goods, and we are complaining about it.  People are complaining because they see a price, but they are looking past it to see what real value exists.

You may justifiably feel that this isn’t the whole story.  Even if the foreigners selling to New Zealanders are just giving wealth to domestic residents, the price of housing is still higher.  As a result, when New Zealanders buy houses from other New Zealanders during this period, the price they are paying is higher.  In the case of housing some buyers must pay more, and some do not get the chance to buy at all, given this bubble.  This is the cost that has been widely flaunted in the media.

While this cost does exist, and should be recognised, it is simply a transfer between New Zealand residents.  When we take into account the wealth sent in from overseas, then in net terms “New Zealand” is still wealthier.

Now this isn’t necessarily enough for society to believe it is “fair”.  Some people may have insufficient income to find somewhere to affordably rent or purchase.  This is an issue that people are justifiably concerned about.

However, if this is the case right now it is not the result of foreign buyers – it is the result of the chronic underbuilding that has haunted Auckland since the collapse of the finance companies.  A bubble in house prices should stimulate house building and actually push rents lower – but it is the lack of a supply response that has made housing unaffordable.  In that environment, affordability has become a real issue in Auckland – and one that should be dealt with by looking at issues of supply, rather than trying to arbitrarily blame people like the Reserve Bank and the tiny market of foreign investors.

Bubbly bonds?

In the case of bonds no-one seems particularly concerned that they can’t own their own little piece of New Zealand government debt.  Instead the complaints are based around the higher New Zealand dollar stemming from these bond purchases!  A higher New Zealand dollar which is reducing returns to exporters.

But the New Zealand dollar only rises on the back of foreign purchases of New Zealand government bonds when the New Zealand government is busy borrowing  – it isn’t the “bubble in bond markets” that is behind the lift in the currency, it is the general capital flows (and corresponding current account deficit).

As I’ve mentioned before, the currency is merely a price.  And this particular price gives us just a murky signal of things that are going on around us.  The demand for New Zealand dollars so that foreigners can buy New Zealand bonds off New Zealand residents is symptomatic of the fact that investors overseas are currently willing to accept very low rates of return from investment – making New Zealand bonds incredibly attractive.

But what happens if things are going a step further and there is a bubble in bonds and other New Zealand assets?  Well, in that case bond and asset holders are getting a windfall gain – and the new foreign owners of the bonds and/or assets are the ones who lose out.  As the inflow of capital behind the bubble only occurs over a short period of time, the impact of the currency should only be transitory, acting as a very short term transfer between exporters and importers (if neither got around to hedging currency risk).  Exporter’s long lasting concern about their low rate of return is a separate issue to this one.

Selling assets for the long-haul

So we’ve ruled out really caring about bubbles stemming from foreign investment.  But what about if it is here to stay and foreign buyers are persistently willing to invest in New Zealand?  Well there are a few points that should put you at ease:

  1. They have to pay an upfront capital cost to buy the land and other inputs – this will at least represent the opportunity cost associated with what a New Zealander would have done with it.
  2. They have to follow New Zealand laws and taxes.
  3. They have to trade with New Zealanders, such as by hiring staff within New Zealand – again completely within our own legal system.
  4. They are also people – people who are undertaking a legal trade that makes both the New Zealand seller and this foreign buyer better off.  Even if we were uncouth enough to not care about their feelings, hurting domestic residents to stop someone overseas improving their lot in life seems excessive.

Foreign capital flows are a concern in countries without strong legal or financial systems – but this isn’t New Zealand.  If we believe there is a “social dividend” for our land, introduce a land tax as part of our tax system.  If we believe in environmental regulation, set up and enforce environmental regulation.  The nationality of the owner has nothing to do with this.

There is a final fear that allowing investment will see New Zealanders become a nation of worker bees, or tenants on their own land.  For this to happen, all New Zealanders would need to sell up their capital and then consume it all.  And then take any labour income they earn, and consume it all – never ever investing or even saving.  Putting it this way, it seems not only impossible, but an unintentionally insulting way to look at New Zealanders.

Foreign investment and the associated capital flows have been a net positive for New Zealand in the past.  Let’s not forget this as we try to figure out what policy to set in a post-Global Financial Crisis world.

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