New Zealand does not have many resident bears (economically speaking). Bernard Hickey is about the only one. The vast majority of economists and investment market sages have a pollyannaish "she'll be right" attitude, possibly because they believe so strongly in the competence and power of the State to make things right.
It is refreshing to read Hickey. He has a happy knack of pointing out the elephants in the room which his colleagues have chosen not to see or to dismiss and inconsequential. Here is his most recent column in the NZ Herald.
Bernard Hickey: Why I'm a grumpy whinger
9:50 AM Friday May 27, 2011
It's been just over 4 years since US banks began reporting heavy losses on sub prime mortgages, triggering the worst Global Financial Crisis in almost a century. Since then financial markets have been on the brink of total meltdown at least twice and countless bailouts and collapses have cascaded through the global economy and into New Zealand.
But the world hasn't ended and many believe the worst is over. I should be celebrating like everyone else.So let me explain why I'm still staggering around like a bear with a sore head.
Firstly, the context.
Many times over the last four years I've been told to stop with all the glooming and dooming and just accept the world will eventually be a better place reasonably soon. Our Prime Minister John Key is just such a beacon of positivity and belief. . . . At least three times in the last four years it appeared as if the storm was over and we could all get back to normal levels of growth and economic activity.
Firstly, there was a patch of confidence in late 2009 when the markets were stable, the oil price was down, China was growing strongly and American house prices were rising. Then the European Debt Crisis blew up in January 2010 after Greece begged for a bailout, causing chaos on European financial markets. Then things seemed again to calm down in late 2010 before Ireland was forced to accept a bailout, raising fears again about financial market stability. Meanwhile, America was forced into a second round of quantitative easing or money printing because its economy just wouldn't grow fast enough to reduce unemployment, despite interest rates being near 0 per cent for over 2 years.
Finally, in early 2011 some hope appeared again on the horizon. China had managed to avoid a big slowdown, America seemed to be growing again, stock prices were back near three year highs and Europe had settled down somewhat. Even New Zealand seemed to have turned the corner. Commodity prices were rising and unemployment had stabilised. Then a big earthquake destroyed the centre of New Zealand's second biggest city, Japan's economy was driven back into recession by a devastating tsunami and the European crisis blew up again. America has slowed down again and even as I write this financial markets are bracing for another round Greco-Roman debt turmoil.
It seems as if every time some light appears, another even darker cloud scuttles into view .. . .
So why so glum?
The global economy's basic problems have not been fixed. The bailouts and 'reforms' have actually made the system more exposed to catastrophe while failing to deal with the debt overhang and an imbalanced system of trading and capital flows. Too Big To Fail banks are even bigger, but now they have actual or implied government guarantees to backstop their gambling.
China is still racking up massive trade surpluses with America that is being funded by Chinese lending, while hot money fresh off the zero per cent printing presses races madly around the world in search of a return.
Some asset values are being pumped up to unsustainable levels and America is exporting inflation as fast as it can print it.
Here's 5 reasons why I think the Global Financial Crisis is far from over, why economic growth could take another decade to get back to anything like 'normal', why New Zealand will be lucky to avoid the fate of Ireland and Greece, and why I'm sticking to my view that house prices will not recover to their 2007 peaks until 2018 (although I admit they probably won't fall much more than 15 per cent in nominal terms)
1. The developed world is groaning under a debt mountain
America's total debt to GDP ratio is the most sobering thing I've seen the last 4 years. It expresses the weight of the problem facing the world's largest economy.
Essentially, America has borrowed beyond its means for at least 20 years, pumping up share prices into bubble territory at least once and inflating its housing market to disastrous levels. Their debt-to-GDP looks like a mountain that has been climbed up and now needs to climbed down from very carefully. The last time debt-to-GDP was anything like this was before the Great Depression and World War II. It took massive public stimulus, artificial and brutal restrictions on personal consumption and then a sustained period of economic growth with inflation to bring it down.
How does America get out of this mess without either an almighty restructuring (ie haircuts on debt and huge losses for banks and pension funds) or massive inflation to lift the denominator in the debt to gdp ratio, essentially defaulting by devaluing the currency? There has been a little restructuring, but mostly the toxic assets have been shifted from private to public balance sheets in the hope that growth will solve all the problems.
When it didn't, the US Federal Reserve turned on the printing presses. It is near the end of its second round of Quantitative Easing or QEII. Many believe it will have to restart the presses in fresh rounds of QE III and QE IV. As recently as today prominent economist Brad Delong said just that. . . .
2. That debt is only sustainable while interest rates remain at record lows
What happens when short term interest rates are raised by central banks to fend off inflation? And what happens when long term interest rates are driven up by bond market investors?
One way to get a sneak preview of what happens to an economy after a housing bubble bursts and the debt is not restructured is to look at the experience in Japan after its property bubble burst in the early 1990s.
Its short term interest rates dropped to zero almost 15 years ago and every time the Bank of Japan tried to raise them the economy ground to a halt. They were then promptly cut back to 0 per cent again.
Anyone remember the Reserve Bank of New Zealand's interest rate hikes in June and July of 2010? They took the wind right out of our sails because we are so indebted.
3. New Zealand households have a lot more deleveraging to go
The government and many economists assume that consumers will get right back on the debt bandwagon and start spending again soon. This year's budget assumed just that.
There's even a hint of pleading in recent comments from various bank executives about the need to start borrowing again. Westpac NZ CEO George Frazis said New Zealanders needed to move from 'caution to confidence'. There's a reason we don't want to borrow much more. Everyone knows that they're up to their gills in debt and that any move in floating mortgage rates up to nearly 8 per cent, which is what is implied in the Reserve Bank's March Monetary Policy Statement forecasts for the 90 day bill rate, would make life very difficult.
They are also sceptical about the promise of higher house prices needed to make any gearing up profitable. It's been four years now since house prices peaked and in almost every area except for central Auckland they have shown little signs of life. So what is a normal level of debt? Where might it go over the next couple of years?
This Reserve Bank chart of New Zealand household debt to disposable income shows it rose to around 150 per cent by 2007 and hasn't dropped much. Our servicing costs have dropped, but only because the OCR has been cut to 2.5 per cent. I think it would need to drop back to something like 100 per cent to be something like normal. I've asked the Reserve Bank and Treasury what they think normal might look like. They don't have a view, but I think this de-leveraging (or at least a stall in the leveraging growth) will be enough to keep New Zealand's growth lower and slower for longer. About a decade longer.
4. New Zealanders won't be able to fund new debt out of income growth
New Zealand's economy has a structural problem. We have borrowed so much from foreign creditors and sold so many assets to foreign owners that the interest payments and the dividends [to foreign investors] are making us poorer every year, even though we're producing more. The effect of the foreign drain on New Zealand's GDP from interest payments and dividends has grown from around 3 per cent of GDP in 1987 to around 8 per cent now.
It shows that our Gross National Income per capita (the portion of our production we get to keep after paying the foreign master) has actually been falling since 2003. Unless there is a turnaround in our propensity to sell assets and borrow offshore I think this will continue to be a handicap on growth for some time to come.
As it is, the government is borrowing more than $10 billion offshore this fiscal year and plans to sell down state assets to raise up to a further $7 billion, although it is giving locals first crack in these asset sales.
Meanwhile, our largest companies and land holdings such as Crafar Farms and Dairy Holdings (two of Fonterra's biggest suppliers) are still being sold overseas at a great rate so we can continue to live beyond our means.
As recently as last week the Treasury forecast our current account deficit would rise back to 6.9 per cent by 2015. That is banana republic stuff, as former Australian Prime Minister Paul Keating once said.
5. Peak oil will constrain growth globally and here for some time
Sharply higher oil prices in recent months have again thrown a road block in the way of a recovery in both the biggest developed and the fastest growing emerging economies. Production of the cheapest oil has clearly peaked and the introduction of big new demand from China (an extra 200 million cars will clog its roads within five years) will further inflate oil prices.
It will take years if not decades to find cheap alternative energy sources to power our modern economy. Meanwhile, growth will be slower than it has been in the past.
So why do I get out of bed every morning?
I'm actually very optimistic about the future. It will just be different from the last decade or so. I just don't think we will repeat the same old story of the last decade of never-ending and strong growth powered by rising house prices and increasing foreign debt.
I think New Zealanders, but not necessarily our government, have got the message. Despite all the temptings of the bankers, we are sitting on our wallets and buckling down to repay debt. People are changing habits of a lifetime and we are heading towards some sort of balance.
Our government will eventually get the message and seriously try to balance the books. We are fairly socially cohesive and have an enormous wealth of physical and human resources to call on. Our IT and technology exports, which don't rely on scarce resources and also generate high paid and interesting jobs, are now over $5 billion. We have a beautiful country with plenty of talent and goodwill. We're the second most peaceful country in the world and have the fourth best standard of living in the world.
Unlike at the same time after crash of 1929, there is not an obvious prospect of any sort of global conflict.
Lots of bright, well intentioned people are working very hard to get us all out of this hole. It may mean we all consume a bit less and spend less time grasping for more.
Meanwhile, in my own little way I'm trying to help create some of these interesting jobs that compete with imports and foreign owned companies (Google/Facebook/Fairfax/APN) to try to help us balance our books. I hope, also, that we're providing some useful information and a platform to debate these issues and improve the quality of decisions made by borrowers, savers and a few policymakers. Interest.co.nz now has nine full time 10 staff, more than triple what it had three years ago. We're also profitable, debt free and growing. We even moved the currency, albeit in the wrong direction! See Gareth Vaughan's article here on China's sovereign wealth fund preparing to lend/invest NZ$6 billion to/in New Zealand.
But mainly, I have fun every day 'fomenting happy mischief' as David Farrar at Kiwiblog might say.
It's just that my form of fun is spending all day grumbling about the state of the world.
cheers
It would seem that Bernard is a bear on the outside and a Pollyanna on the inside. It's just that you have to be patient for a decade or so. How robust are Bernard's green shoots?
Have New Zealanders really got the message over debt, or will they jump in again as soon as times seem better? After all, thanks to the government's relentless spending increases we have not had the recession we really needed to have. And for many, many people debt driven consumption is a lifetime habit.
The comparison with Japan seems a bit facile. Japan's deflation occurred in significant part because Japanese were (and are) net savers. They did not have high household indebtedness to begin with. Japan's problem has been in large part due to its crony capitalism where banks and corporates kept far too many dud assets on the books at hugely overinflated prices, supported by its government's relentless drive to spend, spend, spend to prevent the recession it, too, really needed to have. It was a matter of saving face. We expect that our interest rates will rise very sharply, very quickly in the next three years--forcing the recession the government has so desperately tried to prevent. It will likely entail a good deal of disemboguing before the nation's economic stomach settles down again.
The occasion is likely to be an offshore development such as: a severe economic correction in China when the government is forced to cut back on its relentless spree of infrastructure investment; political success to the Republicans in the US enabling a genuine cut in the US deficit; or the European debt crisis getting so severe countries leave the EU, or are declared insolvent. There may be others. Any one would do.
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