Is the rock star economy actually very fragile?

(First published in the Nelson Mail and Manawatu Standard, May 20. Please note: this was published before Bill English delivered his Budget speech.)

Conventional wisdom has it that New Zealand is doing well economically, at least by international standards.

Calling us the rock star economy, as one over-excited bank economist did in January last year, might be overdoing things a bit. But we certainly came through the global financial crisis relatively unscathed compared with most northern hemisphere countries.

Share market investors have enjoyed a couple of very good years, although the gains don’t seem to have trickled down to wage earners (funny, that). We’re even enjoying the rare pleasure of getting the jump on Australia, where the mining boom has run out of puff and the economy is contracting.

The economy is frequently cited as the main reason National won a third term. Economic growth is strong and Finance Minister Bill English is seen as a prudent manager who has kept things stable during a period of international turbulence, even if he has failed to deliver the surplus National kept promising.

(Why National placed so much emphasis on achieving that surplus, when it looked shaky from the outset and was never likely to be more than paper-thin anyway, is a mystery – but politics, like economics, isn’t always easy to understand.)

You can be sure that English will use his Budget speech tomorrow to tell a positive story, despite having no surplus to boast about. That’s what governments do on Budget Day. Between elections it’s arguably the most important event in politics: an opportunity for governments to set goals and put the best possible gloss on their achievements.

But whatever English might say tomorrow, and no matter how enthusiastically his colleagues might applaud him, I can’t help worrying that the New Zealand economy is highly vulnerable.

I suspect I’m not entirely alone in this. Reserve Bank governor Graeme Wheeler, a man not given to making extravagant statements, talked only last week about the threat posed to the banking system by the stratospheric rise in Auckland property values.

Wheeler said the risk of a sharp fall in Auckland house prices causing a “significant” rise in bank loan losses had increased in the past six months.

His words were typically restrained. But when someone like Wheeler talks about the stability of the financial system being at risk, we should sit up and listen.

There are parallels here with the conditions that triggered the global financial crisis in the United States. There, people ill able to afford mortgage payments were encouraged to borrow heavily to invest in houses.

When property values collapsed, those purchasers were left “underwater” – burdened with homes that were no longer worth the money they had borrowed to buy them, and unable to service their mortgages.

In simple terms, banks couldn’t recover their money. The resulting crisis destabilised the entire international banking system. It was a central cause of the global recession whose effects are still being felt.

It would be a cruel irony if, having escaped the worst effects of the global financial crisis, New Zealand now experienced a similar financial shock, albeit on a far smaller scale, because of the overheated Auckland housing market. But that seemed to be what Wheeler was suggesting.

It wouldn’t be the first time. In fact it happened as recently as 1989 when the taxpayer had to bail out the BNZ, which had succumbed to the euphoria of financial deregulation and pressed money on everyone who showed up at the door.

But the Auckland housing boom isn’t the only risk – in fact may not even be the biggest risk – to our “rock star” economy.

The elephant in the room is the dairy industry. Wheeler mentioned this, too, pointing out that many dairy farmers are heavily indebted and facing negative cash flow because of the slump in dairy prices.

The average farmer is milking 100 more cows than six years ago but making no more money, according to a speaker at a recent conference.

Our international competitiveness has been severely eroded. More forced sales of dairy farms can be expected – another serious issue for the banking sector.

Who saw this coming? Certainly not the farmers and investors who borrowed huge sums assuming the dairying bonanza would continue to deliver fat profits. And probably not the government either, which seemed happy for New Zealand to become heavily dependent on one industry as long as it delivered economic growth.

What makes matters worse is that vast tracts of land have been converted to dairying from other uses for which the land was better suited. The environmental cost, which is borne by all of us, has been enormous.

The possibility that after all that, the perceived economic benefits of the dairying boom may have been largely illusory is too dismal to contemplate.

Oh, and did I mention that if the banks take a big hit because they’re over-exposed to the dairying sector, the rest of will inevitably suffer too, one way or another?

But then what would I know? I’m not an economist.