High currency claims another victim

In early-2011, the New Zealand Savings Working Group (SWG) released a report, which explained the imbalances and damage created within the New Zealand economy by the credit/consumption binge of the 2000s:

New Zealand’s growth in the period leading up to the GFC (2002 to 2008) was associated with rapid credit expansion, fast growth in consumption, high external borrowing, low private saving, a house and farm price boom, high government tax revenues and spending, and static tradable sector growth. Growth on this basis was unsustainable and had several negative consequences including rapid growth of private-sector debt and a high NFL-to-GDP ratio…

There are important connections among these factors and the disappointing growth outcomes…

Easy access to credit (particularly for property financing) was associated with rapidly escalating farm and house prices.

The property boom in turn led households to feel wealthier and increase their consumption. Strong growth in nominal GDP buoyed tax revenues and encouraged often ill-judged growth in government spending.

High growth rates of private and public consumption created inflationary pressure that led the Reserve Bank to raise the official cash rate. This, in turn, pushed up the exchange rate.

This standard monetary policy response led to unbalanced growth: reduced exports and increased imports, with a rise in the proportion of domestic resources going to non-tradable production and a reduction in the proportion flowing to tradable production…

It is likely that the reduction in export competitiveness has, in turn, slowed productivity growth… [N]on-tradable industries such as construction and property and business services expanded rapidly and attracted labour and other resources at the cost of their availability to export industries such as agriculture and food processing…

Despite the Reserve Bank of New Zealand (RBNZ) collapsing the official cash rate to just 2.5% in April 2009, where it remains today, the New Zealand Dollar (NZD) remains near historical highs against both the US dollar and the trade-weighted index (see below charts).

With mortgage rates near record lows and the NZD remaining highly elevated, imbalances are once again growing within the New Zealand economy. Indeed, in November last year, the Bank of New Zealand (BNZ) released a research note warning of these growing economic imbalances, which were encapsulated by an -11% fall in exports over the year and the 33% increase in home sales:

[New Zealand’s]… external accounts are deteriorating… October exports were 10.9% lower than a year ago. This is fundamentally a result of lower international prices for NZ’s exports, with weakness amplified by a rising NZ dollar…

Meanwhile, October import values were up 1.7% on a year ago. The increase was driven by capital and consumption goods, with intermediate goods lower than a year ago…

…we maintain our view that the current account deficit will widen to 5.5% of GDP in calendar 2012, from the 4.9% it reached in the year to June 2012. We see further deterioration ahead with the current account deficit expected to pierce through 6% during 2013.

Part of this view reflects weaker export volumes following the past year’s pastoral driven strength and limited price gains in the face of ongoing strength in the NZ dollar. The view also reflects some import growth on the back of expected economic growth and improving domestic conditions including what we have already seen in the property market.

We continue to wonder how wide the external deficits have to get before the market takes note, likewise the rating agencies. The stark contrast between the 11% decline in export values over the past year and the 33% lift in house sales provide a vivid illustration of the current imbalances.

Cue broken record: beware the deteriorating external accounts.

The deterioration of the tradeable goods sector in New Zealand finally appears to be gaining some political traction (as does the price of homes), with the opposition parties launching an unofficial inquiry to develop “concrete ideas” to stem the decline in jobs and manufacturing exports. The opposition parties claim that some 40,000 jobs have been lost from the manufacturing sector in the past four years and that drastic policy action is required to reverse the trend.

One of the objectives of the Inquiry is to get the RBNZ to focus on other economic indicators, rather than just inflation targeting. While a change in the RBNZ’s mandate is highly unlikely, the opposition-led inquiry does seem to be winning in the court of public opinion, where manufacturers’ tails of woe appear to be resonating with the New Zealand public.

According to Radio New Zealand, manufacturing industry submissions to the inquiry have ranged from “large hi-tech companies to smaller, agricultural-based businesses. Their common refrain is that despite efficiency and technological gains, the overvalued New Zealand dollar made it increasingly difficult to turn a profit and is one of the biggest threats to their businesses”. Exporters also complained that they “do not compete on a level playing field with other exporting nations – and if nothing changes more manufacturing jobs would be lost”.

Gareth Morgan, author of tax reform book, The Big Kahuna, believes in no uncertain terms that bank capital rules favouring housing lending over business lending, combined with the tax-preferred status of housing (including no capital gains taxes and negative gearing), is responsible for the unbalanced nature of New Zealand’s economic growth:

The consideration given by the Reserve Bank to controlling the bias in its policies that favour housing over all other lending types is most welcome [see yesterday’s post for details]… It is 20 years late but until they deal to this, New Zealand’s economic growth will suffer, capital will be misallocated and incomes and job numbers lower than they would otherwise be.

Whether the Bank does it by addressing risk weightings or via equity to loan ratios is a second order issue but the important thing is it stops pussyfooting about and gets on with it. The damage already done through years and years of neglect on this issue is immeasurable and it will just persist until we get some sort of responsible policy from the RB.

What’s important for the Bank to come to terms with, is that this is not about averting yet another financial crisis in the banking sector, the issue is far more insidious than that – it’s about the economic potential of NZ being needlessly held back by an aversion by policymakers to address the two main drivers of the distortion in the housing market – RB prudential policy and the tax loophole housing ownership offers.

The tax issue is the responsibility of the politicians so don’t get your expectations too high…

But getting one of these reforms away is better than none so Deputy Governor Grant Spencer is to be congratulated for at least stepping up and highlighting the bad mistake that the previous two Governors have stubbornly resisted addressing.

Add New Zealand’s highly rigid urban planning system into the mix, which amplifies the deleterious impacts of these policies, and Morgan probably has a point.

Whatever your view, the high NZD appears to be killing the New Zealand tradeable goods sector, which risks leaving it highly exposed once the current housing mini-boom and commodity price boom subsides. There are lessons here for Australia, whose tradeable goods sector (outside of mining) is facing similar challenges.

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