Drowning in a Sea of Panic

Is Breathless Panting Appropriate?

The world appears to be gripped by a spate of catastrophism where disaster is seen on every hand and from every quarter. Most of these catastrophies are figments of imagination, but they continue to provoke and fascinate, alarm and entertain—in the same way that horror movies do.

In New Zealand we have not escaped. While the gloss has gone off global warming as the catastrophe du jour—as the world has cooled over the past ten years—it has been replaced by a vision of an economic armageddon. Once more the world as we know it apparently is coming to an end. Several opinion leaders have been urging the rival political parties to “wake up” and realise just how dire our situation is, and to take appropriate action. If it were not so pathetic, one would almost die laughing at journalist, John Campbell's breathless panting, as he pleaded with the Helen Clark and John Key to demonstrate they had some understanding of just how serious things were. “Don't you realise we are all about to die,” one could almost hear him saying.

Even the normally measured Fran O'Sullivan—who has more than a clue about matters financial and economic—has succumbed, arguing that the urgent exigencies of the moment called for a “war cabinet” where both Labour and National would suspend political hostilities and work together for the salvation and protection of the nation.

Fortunately, calmer heads appear to be prevailing.
This is the time for a sober, yet sanguine approach. The real crisis has passed. It is very unlikely to return. The real crisis was the potential collapse of the global banking system that would have severely restricted, if not removed borrowing completely from the world economy. Sound, and well capitalised institutions would have collapsed. This, indeed, was a serious matter—and which, if allowed to play out, would have opened up the possibility of a nineteen thirties style of years of depression.

Given that central banks and governments acted in time, and largely in concert, this crisis has passed. Yes, as we have argued elsewhere, the regulatory regime governing financial institutions needs to be overhauled and brought into the reality of a globalised market place. Yes, greater disclosure and capital adequacy standards need to be enforced. Yes, there needs to be an end to an acceptance of “netting off” as a risk reduction tool for derivatives. Yes, there needs to be capital set against purported “off balance sheet” liabilities, and so forth. Yes, the central bank money spiggots need to be turned down, then off, and the excess emergency liquidity siphoned back out of the system. All this will probably come in due time—and it is not the sort of thing that can be done quickly. It needs careful consideration, lest it create even bigger problems.

But the immediate crisis has passed: governments and central banks have adopted a “whatever it takes” approach, so that in the end banks were able to start lending to each other again, which in turn meant that credit would still flow through the economy. The interbank lending market has now settled down.

So, we now face another “problem”—an economic slowdown, possibly of global dimensions. But this had to happen. Asset and commodity prices had got way beyond market equilibrium, due to the global monetary system being flooded with cheap credit for nearly two decades. Prices have now declined rapidly and substantially; both individuals and businesses are retrenching, spending less, laying off liabilities, cutting back. Economies will shrink as a result. But the end result will be a move to market equilibrium, where prices reflect real (not debt fueled) demand, and real (not debt fueled) supply. Capital will be scarcer; risks will be more threatening; economic activity will wane.

This is not a “problem”. It is a normal, and much needed correction. Eventually, our economy will return to a much more sustainable growth path—more sustainable because it will be based on production, not consumption. New Zealand is actually in not such bad shape. The consumption boom, fueled by rapid house-price appreciation, which in turn was fueled by easy credit conditions owing to Japanese, US, and Europeans being more than willing to lend to our banks, has ended. The price of money is likely to remain quite high for some time. But apart from the construction and related industries this was never economically productive: it was consumption driven.

The party is over, so now we can get down to producing the goods and services that a slower growing world will want to buy. And we have plenty. Yes the adjustment will be somewhat painful, but then so is vigorous exercise. Yes, the adjustment make take three or four years. But it is not the end of the world. John Campbell can stop panting. And we certainly do not need a coalition economic war cabinet.