Light at the end of the tunnel?

Huljich Wealth Management newsletter. 4 April 2009

In recent weeks, there have been a few signs that things are finally beginning to look up.  The price of New Zealand’s dairy exports in international markets has shown an increase for several weeks on end.  The share market has shown some signs of stabilising or even turning up.  March saw a sharp jump in the number of house sales in the Auckland market.  Most New Zealanders have enjoyed an increase in their disposable income, thanks to the Government’s 1 April tax cuts and benefit increases.  The Government has made it clear that it’s going to sharply increase spending on critical infrastructure, press ahead with overdue reform of RMA processes, improve Auckland’s governance, and review whether the electricity market is delivering in the best way possible.

All that is very encouraging. 

Being a major exporter of food puts New Zealand in a much better place than many other countries with a more “sophisticated” mix of export products: people can defer buying a new car or a new flat-screen TV set, but they don’t readily cut their food consumption.

It is certainly positive that the share market can absorb major equity raisings for companies like Fletcher Building and Nuplex – and a huge flow of funds into bond issues for companies like Fonterra, Contact Energy and NZ Post – and still feel reasonably buoyant.

And it is particularly pleasing that the new Government has not lost sight of the need to improve New Zealand’s longer-term growth potential while grappling with the more immediate problems posed by the recession.

But alas there are still plenty of reasons to be cautious.

Yes, house sales have picked up sharply in recent weeks, but it seems that this is in large part a result of new realism on the part of vendors rather than any huge increase in demand for houses: prices are still very weak and, because they are still high relative to average household incomes, there are good reasons to suspect they may continue to fall for some considerable time yet.  As long as house prices remain weak – or, worse, continue to fall – consumer spending will remain subdued, and that is clearly bad news for those companies dependent on continued strong growth in spending.

We are still hugely dependent as a country on being able to borrow in international capital markets.  This is a point which many New Zealanders have tended to ignore in recent years, no doubt largely because the government has been able to boast that it no longer has to borrow in those markets.

But even as the government has run surpluses (from 1994 until 2008), the rest of us – the private sector – have been borrowing like there’s no tomorrow.  Of course, most of us have simply been borrowing from our local bank, but because our local bank hasn’t had the local deposits to fund a large chunk of that borrowing, it has gone offshore to borrow the extra funds required.  As a result, by late last year (the latest figures available from the Government Statistician) the New Zealand banking system owed some $150 billion to foreign creditors.   In some cases, those creditors are the foreign parents of our local banks, and to that extent the risk of the credit being rapidly withdrawn is relatively low.  But in most cases, the foreign creditors are unrelated parties in international capital markets – and international capital markets remain very twitchy and risk averse.  It is very much more difficult for banks to borrow in international markets today than it was 18 months ago and, given the relatively short-term nature of banks’ offshore borrowing, that inevitably makes banks more cautious in their lending policies.

Our dependence as a country on the goodwill of international lenders also constrains the government’s freedom to maneuver: credit rating agencies have already expressed concern about the rapidity with which, unless policies are changed, government debt will grow in the years ahead – the consequence of both the sharp downturn in tax revenues as a result of the recession and the sharp increase in government spending arising from decisions made by the last Government.

But aren’t the major countries of the world committed to fixing this problem?  Well, if the results of the recent G-20 meeting in London are any indication, don’t expect a rescue from any kind of coordinated international action.  There were lots of fine words, of course, and perhaps that was inevitable given the brevity of the meeting and the very different perspectives held by major participants.  But when we look beyond the fine words, what was accomplished?

A proposal to tighten regulations on the remuneration of senior bank executives – yes, but there’s not the slightest doubt that bank boards, acting on behalf of very angry bank shareholders, have every incentive to change the structure of the remuneration of senior bank executives even without pressure from politicians.

A proposal to tighten regulation of hedge funds – yes, but it was not hedge funds which triggered the current crisis.

A proposal to improve the regulation of banks – yes, but contrary to much nonsense in the general media, banks have been tightly regulated for years.  Moreover, that banking regulation has been the subject of a great deal of international cooperation and coordination, as all those involved in negotiating or implementing Basel I and Basel II over the last 20 years know only too well.

A proposal to clamp down on tax havens – yes, but some of the most straightforward opportunities to evade tax exist in major countries such as the US.

A proposal to “spend a trillion US dollars” to boost the international economy – well, not quite.  Most of that proposal is to increase the funding available to the International Monetary Fund, but actual commitments to provide the funding to do that fell a very long way short of a trillion US dollars.

What was profoundly disappointing about the G-20 meeting was its total failure to take any tangible measures to stem the gradually growing tide of protectionism around the world, despite all the grand-sounding rhetoric.  We got the same rhetoric – in fact, on protectionism, even better rhetoric – when the G-20 countries met late in 2008.  But there has been no progress since then.  Indeed, we’ve drifted still further towards protectionism.  If you want to feel really glum about our prospects, reflect back on the effect which increased barriers to trade had on intensifying the Great Depression.  We’ve all got to hope that wiser heads than then will prevail this time.  But rhetoric isn’t enough.

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