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Economic Analysis by Tony Alexander.
[caption id="attachment_3709" align="alignleft" width="150"] Tony Alexander, BNZ economist.[/caption] Last week I wrote about the weakness in world sharemarkets in terms of specific factors. These included losses for energy sector businesses because of the structural decline in oil prices, slowing growth in China and worries about debt and capital outflows, weakness in the Japanese economy, and worries about the impact of tightening US monetary policy. But there are wider issues in play which also lie behind the growing disquiet. One of these is the ineffectiveness of very loose monetary policies in recent years in stimulating growth in Europe and Japan. Another rapidly rising worry is the inability of loose monetary policies to boost inflation, and the growing uselessness of central banks maintaining 2% inflation targets when they seemingly no longer have the tools to much influence inflation. Related to that is concern that as they keep easing to aim at a target they are no longer able to hit the flood of cheap money will cause asset bubbles and collapses bringing new economic woe. Related to that is the realisation that central banks have very little ability any longer to insulate their economies when not just cyclical but shock-driven downturns come along. So as the monetary policy backstop disappears from investor and business expectations the risk is that investors rush to less risky assets – bonds – and businesses build even greater cash buffers and hold off on investments. This big picture loss of monetary policy effectiveness means come the next wave of shocks countries will need to rely upon fiscal policies – but from governments with already large debts. The way out is structural economic reforms aimed at boosting the ability of economies to adapt to change. But such reforms bring short-term pain, there is no appetite in Europe or Japan to inflict or accept such pain, and out of this will come a long-term redirection of capital away from those parts of the world toward America, Australasia, and the rest of Asia. These big shifts mean we should expect continued bouts of extreme financial market volatility.When The Barrel’s Empty The global financial crisis was caused by an over-supply of over-priced houses causing plummeting prices and huge losses for those who financed the excess construction (the builders had a boom!). The situation arose because of an official policy by the US Federal government to boost home ownership in the 1990s encouraging a relaxation of lending standards, blind eyes being turned to such laxity, and the US roller coaster encouraging similar surges overseas. Home buyers borrowed too much, banks lent too much, investors financed bank lending too willingly, and central banks and rating agencies miscalculated the riskiness of the lending products. Egg on everyone’s face in other words from too much credit flying around. As house prices corrected downward and the falls backwashed into securities backed by house values investors dumped such products, banks recorded huge losses, investors backed away from banks, and for about six weeks over September – October 2008 the world stood on the cusp of a new Depression as the global banking system seized up. Courtesy of hefty injections of cash by central banks, major interest rate reductions, and eventually easier fiscal policies we saw a 1930s repeat avoided and green shoots appearing in March 2009 in the form of economic indicators falling at a slowing pace in the United States. After that a huge sigh of relief around the world caused sharemarkets to recover, housing markets to rise, confidence levels to soar, and currencies of risky countries such as NZ to jump sharply. We soared from less than US50 cents in early-2009 to over 76 cents by year’s-end. Then things started to falter as the life giving gasps of breath of 2009 as economies surfaced from beneath the waters gave way to laboured breathing as attention turned to high government deficits and debt levels, Greece of course, the unwillingness of businesses and households to borrow and so on. To counter this post-GFC weakness central banks decided the best thing to do to spur things along would be to pump more credit into the world economy through direct money printing and sustained, falling, interest rates. Basically, the central bankers decided to engage in a hair of the dog that bit them exercise of recreating the loose credit conditions of pre-GFC while at the same time working with banking sectors to boost capital bases and lending practices ready for the next crisis. As monetary policies stayed loose however the economic outcomes failed to reach levels desired by all, yet each time a new bout of the heebie jeebies went through investors the fear and selling quickly turned to buying as central banks eased policies even further. In fact things eventually reached the stage whereby bad economic data would be greeted by rising share prices in anticipation of lower interest rates and more money printing. Money looking for a home and ending up in shares and commodity futures. But all that cash sloshing around the world had some major deleterious impacts. As investors sought yield in a low interest rate world assets like residential property prices got bid back up again along with commodities – witness our dairy boom. And as investors, finding themselves flush with cash, kept firms afloat which pre-GFC would have been closed down and their parts flogged off, excess quantities of goods appeared – especially in China which engaged in a huge series of stimulatory packages from 2009. Worries about deflation resulting from excess production and altered consumer, business, and wage earner price-setting behaviour led to more easing of monetary policy, more cash, more over-valued assets, more excess production. And investors started to act on the new reality of sustained low inflation and central banks not likely to raise interest rates much for a very long period of time. They flooded into low yielding bonds. And as this was happening imbalances in some markets like oil and dairy products brought logical big falls in prices. And at the same time China’s economy lost the puff created by the mother of all stimulatory programmes focussed on construction from 2009 at the same time as the period arrived for it to transition from growth driven by exports, manufacturing, and fixed asset investment to services and consumption. Unfortunate timing. Which brings us to late last year. An environment of the following.
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- -Worries about the impact of the first US monetary policy tightening since 2006.
- -Worries about global growth as China continued to slow.
- -Worries about unstable capital flows associated with expectations of a probable big devaluation of the Chinese yuan.
- -Worries about major asset and profit write-downs in all businesses associated with the energy sector.
You will find current spot rates here. http://www.xe.com/currency/nzd-new-zealand-dollarIf I Were A Borrower What Would I Do? Personally I would fix three years at 4.49%. It is true that rates may go lower if the Reserve Bank eases monetary policy again. But there is some upward pressure on bank funding costs offshore currently because of worries about European banks. Plus the NZ economy does not need a boost from even lower interest rates, as evidenced by the strong growth in retail spending discussed just below. The only argument in favour of lower interest rates comes from inflation persistently under-shooting the target range. But the RB will not feel the need to lower rates to try and boost inflation if it believes doing so will not in fact boost inflation. Offshore the easiest monetary policy settings ever seen are not lifting inflation and wages growth is slowing in the UK, Japan and Europe therefore there seems little reason for believing lower rates here would suddenly alter pricing behaviour. In addition there is no evidence that people are worried enough about deflation to put off buying durable and discretionary items. That is a key argument against letting deflation development – that people will stop buying to wait for lower prices and the longer they wait the weaker their spending, the deeper the recession, the further the price falls and so on in a Depression spiral. We are not in recession so that deflation link is completely different from the environment we all think of and fear when saying deflation must be avoided, the 1930s Great Depression. For Noting We consumers have been doing a lot of spending recently with strength assisted by falls in petrol prices, a tourism boom, strong population growth, reasonable jobs growth, and low interest rates. In seasonally and price adjusted terms core retail spending (no cars or petrol) grew by 1.4% during the December quarter after rising 1.1% in the September quarter. Full year growth was a very strong 5.8%.Spending growth on durable goods was even stronger at 3.6% for the quarter and 10.6% for all the year.