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.

As I said to my long-suffering spouse ...

(Published in the Nelson Mail and Manawatu Standard, March 4.)

On the radio a few weeks ago, I heard the chief economist for one of the major trading banks chiding New Zealanders for having lived beyond their means for the past 20 years.

He pointed out that New Zealand was running a large current account deficit – which means we spend a lot more than we earn – and that we must achieve economic growth by earning rather than spending.

I thought this was pretty rich, coming from a senior spokesman for a sector that in recent years has done all it could to encourage people to borrow and spend.

At the same time I felt vindicated, because I have been saying for years to anyone prepared to listen, which usually means my long-suffering spouse, that the supposedly buoyant economy of the past few years was largely an illusion, fuelled by debt.

Economic activity in New Zealand has been driven by consumption rather than production. Much of that consumption has been financed with credit provided by banks and dodgy finance companies, many of which no longer exist. The result has been a huge burden of national debt.

Oh, I should also mention the other result of all that credit: a crazily overpriced property sector – again, driven by banks and other lenders – which is only now slowly regaining equilibrium.

All that money we ploughed into property was money that could have been invested in the primary industry sector – still this country’s ace card, though people seem unwilling to grasp it – or in the small, sophisticated, export-focused niche enterprises that New Zealanders do so well.

I am old enough to remember the days when you had to grovel to get mortgage finance and bank managers would laugh you off the premises if you had less than 25 percent deposit to put on a house. When banks start thrusting money at people who have no savings record but want to buy expensive homes, it’s surely a warning sign as ominous as the proverbial Wall Street shoeshine boy giving share tips.

I sometimes wonder whether it might still be true, as Robert Muldoon famously said, that most New Zealanders wouldn’t know a deficit if they fell over it. As a nation we are probably more economically literate than at any time in our past, yet we are still easily gulled.

Because the government’s accounts were in pretty good shape, at least until last year, we convinced ourselves the economy was healthy. Naturally the government, eager to be re-elected, was happy for us to remain in a state of delusion. In the meantime, private debt was running out of control.

While the booming property market made a lot of people giddily rich on paper, the export sector – the real source of prosperity – has been under-performing for years. Our productivity is lousy by international standards, our per capita GDP having steadily fallen behind that of other OECD countries.

Hardly anyone paused to dwell on these disconcerting facts, for two reasons. The first is that we were too busy taking overseas holidays, speculating in property and indulging in a spending binge – all on borrowed money.

The other is that we had a Labour government that had little understanding of business or appreciation of its importance. It was too busy pursuing its Utopian social agenda.

It probably didn’t help that the “experts” to whom the media habitually turn for economic analysis are mostly bank economists who are not necessarily well-placed to provide a balanced, “big picture” view of the economy, and whose views are inevitably conditioned by the interests of their employers.

Having said all that, it’s clear that New Zealand seems to be in a much stronger position to cope with the global financial downturn than many larger economies.

Though they stand accused of behaving irresponsibly by placing their profits ahead of New Zealand’s economic interests, our banks have been well managed to the extent that they are not falling over, unlike those of Britain and the US.

And despite woeful prognostications, I note that most of our listed companies are still announcing profits – and in some cases, quite healthy ones.

A sense of perspective is helpful. There’s no reason to panic because some companies’ profits have dropped. At least they’re still making money, which is more than can be said for the likes of General Motors.

Much has been made of the plight of Fisher and Paykel, which is said to be an “iconic” New Zealand company. But I fail to see why the taxpayer should bail F&P out, as has been suggested.

F&P has enjoyed many good years. For decades it prospered behind the walls of Fortress New Zealand, which kept prospective overseas competitors at bay using tariffs and other protectionist measures.

The great Kiwi whiteware company showed its appreciation of this generous treatment by ruthlessly pursuing a policy of retail price maintenance, which prohibited appliance dealers from discounting F&P products, and by refusing to allow retailers to stock competitors’ products. The consumer was well and truly suckered.

Recessions may be painful, but they do serve the useful function of weeding out companies that have become inefficient or lost their way. As for GM in the US, so for Fisher and Paykel here. The company took a gamble relocating much of its manufacturing overseas (so much for loyalty) and lost. Why should taxpayers have to pay for its miscalculation?

As it is, the world economic crisis is penalising the very people who have done all the right things – those who have saved and invested prudently. These people will be doubly punished in the coming years for the folly of those who were not so careful.

Not only have returns on their investments slumped, thanks to deflationary pressures pushing down interest rates as credit shrinks, but conscientious savers will share the tax burden arising from state bailouts of failed institutions and massive public spending on infrastructure as governments try to protect jobs and revive floundering economies.

In their desperation to forestall complete collapse, governments the world over – New Zealand included – are sending out signals that run counter to logic. By guaranteeing deposits in dodgy institutions they are undermining natural market forces such as risk, which serves as a vital check on foolish behaviour.

I’m no economist, but this seems crazy to me. If we must have a recession, let’s at least use it to purge the economy of tired, incompetent, greedy, complacent and untrustworthy enterprises.

That will lay the foundations for a healthy economy to carry us through to the next crisis. This is the “boom and bust” cycle by which capitalism – which is still unarguably the economic system most capable of delivering prosperity and freedom – periodically recharges itself.