Will a Trump presidency shock New Zealand's economy or could it be vulnerabilities in the Chinese economy?
Will a Trump presidency shock New Zealand's economy or could it be vulnerabilities in the Chinese economy?
An air of unreality surrounds the economic and fiscal update the Government released today.
It forecasts brisk economic growth averaging 3 per cent over the next five years, generating ever plumper surpluses.
It sets up an election-year debate about how to divide up those surpluses between tax cuts/income support, increased spending on public services, debt reduction and resuming contributions to the Cullen fund.
But by definition, the cheerful forecasts for economic growth do not allow for New Zealand being sideswiped by an economic shock from the rest of the world - the kind of shock that turns a lot of two-income households into one-income households and pops a property bubble.
The chances of getting through the next five years without such a shock are very low indeed.
Everything we know about his temperament and character indicates he is a disaster waiting to happen - the only question is when and in what arena. His election is akin to putting a child behind the wheel of a supercar and handing him the keys.
For example, hard on the heels of trampling over the One China policy, this week he has fired off intemperate tweets over the renminbi's depreciation against the US dollar - oblivious to the complexities of China's exchange rate policy and ignoring the effect his own election has had in driving US interest rates and the US dollar higher.
It does not augur well for relations between the two largest economies, nor therefore for the rest of us.
Then there is Europe.
Last weekend's Italian referendum adds political instability to that country's bitter cocktail of feeble economic growth, high unemployment and sky high public debt.
It increases the chances that a toxic build-up of bad debt in the Italian banking system will go from being a chronic to an acute problem, shaking the single currency's already rickety foundations.
If it is the harbinger of Euro Crisis II, The Sequel, it would only add to Europe's other challenges: Brexit, populism, refugees and Russian irredentist adventurism.
China, meanwhile, is sitting on a credit bubble. The ratio of private sector debt to gross domestic product (fast-growing though its GDP is) has doubled over the past eight years.
"The rapid increase in Chinese debt, continued pressure on the renminbi from capital outflows, and high house price inflation in major city centres indicate large vulnerabilities in the Chinese economy," the Reserve Bank says in its recent financial stability report.
"A disorderly unwinding of China's imbalances could particularly affect New Zealand banks' access to offshore funding markets, given that China is the second largest market for New Zealand exports." Against this international background, fragile at best, we need to look at our own finances (as a country, as a firm or as a household) from the standpoint of resilience.
How shock-proof are they?
A disorderly unwinding of China's imbalances could particularly affect New Zealand banks' access to offshore funding markets, given that China is the second largest market for New Zealand exports.
When the global financial crisis hit, at the macro level New Zealand had "policy space" to soften the blow.
The Reserve Bank was able to cut the official cash rate by 5.75 percentage points and still stay well clear of the dreaded zero lower bound. Only 1.75 percentage points is now available for conventional monetary policy.
Net public debt of 5 per cent of GDP, the legacy of 14 straight years of Budget surpluses, meant that when recession hit we were spared the panic about debt and perverse austerity measures which deepened the misery of some northern hemisphere countries. The current level of 25 per cent and downward trajectory means there is still a decent buffer there.
The real problem is with households. As a people we are much more inclined to borrow than to save.
The round numbers are that New Zealand households are net borrowers from the banks to the tune of $75 billion, and "other residents" (ie businesses) another $25b. The banks fund this by being net borrowers from non-residents (foreign savers) to the tune of $92b.
Access to that inflow of savings at tolerable interest rates, and the ability to lay off the risk that when it has to be repaid the exchange rate will have moved against us, are clearly vital.
"For now, banks are able to fund in international markets relatively easily at reasonable cost," the Reserve Bank says.
The more likely scenario is that there will be a shock that sees unemployment rise, incomes fall, foreclosures and forced sales jump, and a hit to household wealth generally that deepens the recession.
"However, they will become more susceptible to the risk that global market volatility could increase funding costs and reduce access to offshore funding. Offshore funding markets could be disrupted by a number of factors, including credit rating downgrades, a disorderly unwinding of vulnerabilities in China or Europe, and geopolitical risks."
On the other side of the banks' books is borrowers' ability to service their loans.
Statistics NZ reported this week that 99,000 owner-occupier households spend 40 per cent or more of their pre-tax income on housing (that includes rates and insurance as well as mortgage payments). Another 127,000 households that rent spend 40 per cent or more of their income on housing.
The Reserve Bank tells us that about a third of new mortgage lending is at debt-to-income ratios of more than six times.
That includes 17 per cent of first-home buyers and 30 per cent of other owner-occupiers taking out a new mortgage.
At a debt-to-income ratio of more than five times, it is 37 per cent of first-home buyers and 43 per cent of other owner-occupiers.
And these are nationwide numbers. The ratios are bound to be worse in cities where house price inflation is especially virulent.
So we have a situation where the combination of decent employment growth, exceptionally low interest rates and rampant house price inflation has a lot of households up to their nostrils in debt.
Looking forward there are two possibilities.
One is that the economy is not walloped by an almighty international shock.
In that scenario, banks are increasingly reliant on offshore funding, their funding costs are rising and mortgage rates inevitably follow.
The more likely scenario is that there will be a shock that sees unemployment rise, incomes fall, foreclosures and forced sales jump, and a hit to household wealth generally that deepens the recession.
