Keywords: Macroeconomics & Money;
When I was invited to address you, it was suggested I should – in the spirit of the season – say something light. After all, we are about to break for a few weeks to be spent with family and friends and, hopefully, enjoying our favourite recreations.
But I am afraid the international financial system does not take any such break. It is quite possible that there will be another stage in the international crisis while we are on holiday; perhaps a major financial institution or productive business announcing its difficulties and having to be rescued. Any collateral damage may impact on your businesses. Over the holiday period, chief executives will be on call, as will the chairs of your boards. Let us hope that they will not be called.
Being a director is a very responsible duty, so I think it appropriate that I do not just wish you the season’s cheer, but reflect on recent developments in order to give you some framework to think about 2009.
We need to be cautious. Had I told you last year that Citigroup, which on some measures was the world’s largest bank, would have to be bailed out in 2008, because of its unsatisfactory balance sheet, you would have doubted my judgement. Yet last month it was, to the tune of a couple of hundreds of billions of dollars. We can but speculate what will happen in 2009, but everyone is cautious about getting mixed up with a financial institution which could prove just as problematic.
This international crisis began in August 2007, so it is now going its sixteenth month. In that time, the world’s central banks have flooded the world with liquidity making it extremely easy to obtain cash, but we dont seem to be anywhere nearer the end of the financial crisis.
The reason is, I think, this is not just a liquidity crisis which is about access to cash, but it is a balance sheet crisis for the assets of a business include items which have a longer maturity than cash. Many financial institutions have in their balance sheets assets which are described as ‘toxic’; which they cannot sell, for no one knows what they are worth, and so , for no one will buy them. And certainly we do not how much they are worth in total, No amount of additional liquidity will address their weaknesses.
The result of too many poor quality assets on balance sheets is that private financial institutions are unwilling to deal with others – central banks aside – on a long term basis, because they are not certain of the soundness of the counter-parties. Pumping additional liquidity into the system does not address this lack of confidence in those longer maturity assets in the balance sheets, and so the entire financial system is gummed up, except for very short term deals.
I do not think the world is going to resolve this fundamental problem, until it uses a Swedish type approach where each problematic financial institution is split into a ‘good bank ‘and ‘bad bank’, thus separating out the toxic assets, and enabling the good banks to function as confident providers of credit. For various reason the financial authorities in the key jurisdictions – the US, Britain and the European Monetary Union – have been reluctant to do this, and have instead made marginal responses which have not resolved the financial crisis.
Until there is some quarantining of the toxic assets from sound assets, the world’s financial system is not going to function properly. As Winston Churchill is alleged to have said, America will do the right thing, but only after it has tried everything else. That seems to be true for most monetary authorities,
Fortunately toxic assets are not a direct problem in New Zealand. Our trading banks do not seem to have any – although like all good banks they have bad debts for which they prudently make provisions. Insofar as there were any toxic assets in New Zealand, they were simple ones held by finance companies. Those finance companies with noxious assets have fallen over, and while that is disrupting, especially for their depositors, through a combination of good luck and good management their collapse has not impacted on the integrity of New Zealand’s core financial system,
New Zealand’s problem is its overseas debt, which has to be rolled over in the next year or less. Our roll-over requirements are huge for an economy of our size. One estimate is about $NZ90 billion over the next year. As long as there is an international financial crisis of confidence, even banks without toxic assets will have trouble borrowing offshore. A crucial analytic point is that the roll-overs involve US dollars, but our central bank can only issue New Zealand dollars.
I wont go through here the various options of how we might reconcile this imbalance, but let me just say I am confident that our Reserve Bank, with the support of the Treasury, is working its way steadily through them. They are not panicking, but I am sure they are worried. Think of them as swans, sailing serenely above the water line and paddling like fury below. We may be proud of, and confident in, the competence of our officials working on the financial crisis. There will be more officials than the RBNZ governor on call over the holidays.
But the swan is sailing against a strong international tide. Its inevitable that financial difficulties are going to impact on the real economy.
The New Zealand business cycle has been in a downswing for most of the 2008 year as a result of a slow down in export sales, stagnation of consumer spending and cut-backs in private investment, especially residential construction. The export growth slowdown partly reflects the high exchange rate of recent years. Recent falls will give it some lift, although firms may face supply-side restraints. In any case the world too is in recession, so there is a fall-off of export demand. The consumer stagnation probably reflects caution, and some consumers trying to get out of excessive debts. It aint going to be easy, especially as unemployment is rising.
So economic growth is unlikely to recover much next year, especially – as you will be already aware – because businesses are having trouble obtaining credit, compounding the normal cash shortage experienced in a recession. That means they will be further cutting back on investment and selling out of inventories, both of which have flow-on effects to other businesses and employment.
So the firms on whose boards you sit, face substantial challenges in 2009, even if the overseas authorities start to address the fundamentals of the international financial crisis. That is a good reason for directions, board chairs aside, to have a good relaxing break. You will be working hard and responsibly for the rest of next year. As one economist said to me ‘prepare for the worst, and hope for something better.’ And be grateful that those on call over the holiday season will look after our interests while the rest of us can relax. Go to top