Our Financial Ball & Chain

When will the New Zealand recession end?

Listener: 27 June, 2009.

Keywords: Macroeconomics & Money;

If the international recession is going to go on for some time (Economy, June 13), what about New Zealand’s? The forecasters expect New Zealand production to hit its lowest point towards the end of this year. Subsequent growth will be lower than labour productivity, so unemployment will peak later, perhaps at the end of 2010. The unemployment rate may be misleading, for it excludes people who become jobless but are not defined as unemployed because they are not actively seeking work, which the international measure requires.

Output per person is not expected to recover to the 2007 peak until at least 2012. On this mechanical test, the recession will last about five years. It would be shorter than the Rogernomics recession, when it took seven years to return to the previous peak. Those who claim that this is already the worst recession in their lifetime (presumably they were born after 1935) have forgotten the 1987 to 1994 one; perhaps they were among the rich who got tax cuts, which maintained their income growth while the rest of the nation suffered.

As well as using these statistical measures, the June 13 column on the international economy looked at the imbalances. In New Zealand’s case, we have a pretty good idea about the sectoral balance sheets, which summarise the assets and liabilities of individual economic units.

Many households are carrying too much debt relative to their assets. Some have seen a sharp reduction in the value of their assets as house prices have fallen, while others lost their investments in collapsed financial companies. Moderate balance sheets may be undermined by the fall in income that comes with unemployment, which is why many people are trying to reduce debt. But this means they are saving more and consuming less (the buzzword is “deleveraging”), causing consumer demand and production to be weak. The forecasters think household balance sheets will not sufficiently recover until at least 2013.

House prices need to come down relative to consumer prices. In April 2007, I thought it might take until 2015 to get back to trend. They may be falling faster than that.

The Government’s fiscal strategy pointed out that although the debt level in the government balance sheet is low, it is rising sharply and the debt-to-assets ratio is projected to increase until about 2016. That is really bad news, because it limits the ability of the public sector to support the private sector.

Most businesses (outside the non-bank financial sector) are thought to have entered the recession with strong balance sheets. However, they will feel the pressure from poor economic growth and higher unemployment, which means lower profits and more bad debts. The farm sector may be an exception. Some farmers are already heavily indebted, and are depending on the good export prices and favourable exchange rate most forecasters are assuming. The external outlook may get worse than predicted.

Hopefully, all the weak non-bank financial institutions have fallen over, and the remainder have good-quality balance sheets. But if the recession goes on for too long, some more may struggle.

The balance sheets of the trading banks are thought to be strong, even if bad debts start to mount, although they could face difficulties if the farm sector gets into trouble. The Government can bail them out if, say, they can’t roll over their offshore debt (because of turmoil in the international money markets). But that just shifts the problem from the private sector to the public sector.

Collectively, the domestic sector balance sheets are reflected in the foreign balance sheet of the assets and liabilities owned offshore. As credit-rating agencies have told us, New Zealand’s net foreign liabilities are too high – over 100% of the annual GDP. We demonise the agencies, but the international banks that are lending us tens of billions dollars don’t rely on them. They do their own credit rating.

The Government hires the agencies to tell us what the banks’ internal assessors think. So, an agency assessment reflects what our lending sources think. We are beholden not to the credit-rating agencies but to the international banks we borrow from. That is true for any debtor. It is going to take many years to escape that shackle.