KEY POINTS:
So far, so not so bad. So far, the tumult in world financial markets does not appear to portend anything too dire for the real economy in New Zealand.
So far, it represents a move in the right direction, towards rebalancing an economy which has for some time been seriously out of kilter.
Investors have lost their appetite for risk.
As the prevailing mind-set has shifted from "never mind the risk, look at the yield" to "never mind the yield, look at the risk" a lot of the heat has gone out of the carry trade which had pushed the kiwi dollar to stratospheric heights.
The kiwi was trading yesterday around US69.5c. For exporters that is a lot better than the US81c the currency hit a month ago.
But it is still high by historical standards. The kiwi has been above US70c for only 6 per cent of the time since it floated in 1985, and on a trade-weighted basis the currency is still 7 per cent above its level a year ago.
The kiwi dollar is the economy's insurance policy, says Westpac chief economist Brendan O'Donovan.
"If the global economy implodes our exchange rate will continue to drop like a stone, buffering the impact on exporters and dispersing the pain by making consumers take some of the hit in the form of more expensive imports."
Wouldn't a tumbling dollar be highly inflationary, especially as inflation in the domestic, non-tradeables sectors seems to have been stuck around 4 per cent for the best part of four years?
Not necessarily. First NZ capital economist Jason Wong makes the point that the big move up in the currency since the middle of last year had only a limited deflationary impact.
Between the June quarter last year and the June quarter this year the trade-weighted exchange rate rose 14.6 per cent but tradeable inflation, excluding petrol, didn't fall at all. It rose 0.5 per cent.
Importers seem to have taken the opportunity to fatten, or as they would prefer to say, rebuild their margins.
But that ought to mean less pass-through from a falling dollar to consumer prices as well.
Even if it does not, the Reserve Bank is likely to take a deep breath and "look through" any short-term spike in inflation.
It has long fretted, like everyone else, about long-term damage to the export sector from an over-valued dollar.
"The market has managed to engineer a weaker currency and maintain high interest rates at the same time, a desirable monetary policy configuration under current economic conditions," Wong says.
While the global rise in risk aversion has seen investors rush into the haven of US government bonds, pushing their yields lower, that has been offset by a widening of credit spreads - the risk premium which various categories of commercial borrowers have to pay on top of the risk-free rate Uncle Sam gets.
The net effect is that the one- and two-year swap rates which fixed-rate mortgages here are based on have been relatively steady.
That means that the hefty rise in effective or average mortgage rates which was already in the pipeline for those borrowers whose loans come up for an interest rate reset within the next 12 months is still coming their way.
Given the social effects of the housing boom/affordability crisis on emigration and birth rates, that is no bad thing.
All of this may be too sanguine, of course.
It may be that tightening credit markets and plunging share markets are barometers signalling foul weather ahead for the world economy and therefore for ours.
But there are reasons to think it need not.
A credit crunch, where good and creditworthy propositions can't get financing, is the sort of problem that central banks know how to deal with.
They will want to avoid moral hazard problems of bailing out participants in imprudent transactions.
And they will be conscious that the period of cheap money which led to the mispricing of risk over the past few years began with a massive monetary policy easing in response to the tech wreck and September 11.
But that does not mean they will stand by, arms crossed, and watch the world economy spiral into recession.
In any case, the world economy goes into this period of turbulence with a lot of momentum and growth well above its long-run trend rate.
It is also less reliant on the United States as an engine of growth than it used to be, though how much less is a matter of dispute.
Chris Caton, chief economist of BT Financial Group, notes that for the past six months economic forecasters have been revising down their expectations of US growth but revising up their forecasts for other economies.
"This is not proof of 'decoupling' but it does suggest the US isn't as important as it was. If the US falls into recession - a possibility but I think a remote one - we will discover how decoupled the rest of the world is. I think it will make a fair bit of difference."
Caton regards the steep declines in sharemarkets over the past few weeks as an excessive reaction to the woes of the US sub-prime mortgage market.
Because so much mortgage debt in the US has been securitised into ever-more arcane instruments, it is not clear exactly whose capital is at risk when dodgy home loans go bad, or how leveraged those investors are.
Not only is it uncertain who is holding the baby, it is not yet clear how heavy the baby will turn out to be.
Federal Reserve chairman Ben Bernanke has estimated that up to US$100 billion ($144 billion) of mortgage debt has gone or will go bad. "Even if he's wrong and it turns out to be $500 billion, when you look at the $4 trillion of wealth lost on equity markets since July 24, it's hard not to see that as an over-reaction," Caton said.
In New Zealand the proportion of mortgages with a loan-to-value ratio above 90 per cent has risen from around 8 per cent early last year to close to 10 per cent now, ANZ National Bank says.
But the great majority of this debt sits on the banks' balance sheets and tends to be to the self-employed who have volatile earnings rather than borrowers with very poor, or no, credit history. Instead it seems to be in the finance company sector that investors have been learning the same old lessons as their counterparts in Wall Street hedge funds:
* You need to understand the risks you are taking on. Transparency matters.
* You can only expect returns that outperform the market if you take on extra risk.
* Leverage is great in a rising market but it is just as powerful in amplifying losses when a market turns south.
