Why cash is still king 7 years after the GFC

In a world with easy credit and awash with cash, asset prices have markedly increased. Capital needs to find a return. In a low growth world, it is driving down yields and increasing asset prices. That includes shares, bonds and property.

Evidence is everywhere - the share market has doubled since its low in 2007; Auckland house prices are up over 30% in the past 3 years; global bond prices continue to factor in low yields. The yield on assets is at historically low levels all around the world. We’ve been printing money, yet 7 years into the experiment nothing much is working. Europe is struggling with growth, and that now includes Germany. Australia is looking lacklustre and in New Zealand we’re running inflation at only 1.00%. Everywhere debt levels have continued to increase, creating a bigger problem for the future.

So what happens if there is a rush back to quality and in particular the US dollar? What happens if the US economy recovers when the rest of the world still looks messy? There is a risk that capital rushes out of emerging markets, and out of higher risk economies like New Zealand. As money rushes out of economies it creates a liquidity crisis that drives down currencies and drives up interest rates. It is the lack of liquidity in a crisis that markets tend to under-estimate every time. What might seem to be liquid today is not necessarily liquid tomorrow. By definition, if everyone is selling in a market then there is no market and there is no liquidity.

New Zealand was largely insulated from the 2008 crisis. We had Australia going through a resources boom, a soft commodities boom driven by China, the Christchurch earthquakes, and significant capital inflows from offshore. What if inflows from China stopped? What if the NZD drops or the USD takes off? What if immigration stops due to increasing unemployment? What if we have another Asian crisis triggered by capital flight from emerging markets? What if this all happens just when we have a lot of off-plan property flooding the market? 

I know these are just “What ifs” without answers but nobody really has answers. At a more simplistic level, is it possible for more people to want to sell property than to buy? Is there really a shortage of property, or is it simply sentiment and too many people wanting to be landlords? Property is driven by sentiment which combined with a lack of liquidity is a recipe for a car wreck. The last person buying into the market dictates the value of property. What makes a Chinese immigrant pay $1.7m for a property in Takapuna that sold for $850,000 four years ago? If the world entered into another major correction how much would the next Chinese immigrant be prepared to pay for a similar property? (I’m betting nowhere near $1.7m.) That same Takapuna property has a gross yield of 3.50% and that won’t be increasing anytime soon. With a deposit of $1.2m and borrowing $500,000 the owner will generate a 0.50% net cash return on their capital ($7,000 per year).

It’s easy to create an economic doomsday scenario, which may or may not ever eventuate. In this article I’m not suggesting the market will collapse, I simply don’t know! It’s hard to plan in a world with lots of uncertainty. At the end of the day you have to get on with life. But risk is risk and it needs to be managed or at least considered. Falling asset prices (no matter what type of asset) shouldn’t cause too much pain provided you are not forced to sell at low prices, which basically means over leveraged. From my perspective, the main insurance policy is making sure you have access to plenty of cash. In uncertain times the old adage “cash is king” is more relevant than ever.

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