KEY POINTS:
In January 2007, I posed the question - just how would New Zealand cope with a "perfect storm"?
A perfect financial storm involved a sharp fall in residential and commercial property prices, higher interest rates, a continued appreciation in the dollar, a balance of payments crisis caused by
a changed perception of New Zealand's credit worthiness and a short recession if householders decided to chop up their credit cards.
Heading into 2008 it is clear that the New Zealand economy weathered the past 12 months without apparent pain but there are volatile waters ahead.
If the United States heads into a recession, as suggested by former Federal Reserve chairman Alan Greenspan, it will result in a dampener on global markets as consumers stop spending. US magazine Forbes points to modest job creation, manufacturing figures well below their June 2007 high, the housing slump, falling consumer expectations, and decelerating earnings growth as indicators that suggest a recession may be ahead. But others suggest Forbes is off-beam. If the petrol prices retreat below US$3 (NZ$3.9) a gallon and sub-prime mortgage defaults slow, the US could come through without too much impact on its giant consumer market.
In New Zealand, residential property prices receded a little during 2007, but there has not been the sharp fall that would have pushed debt-leveraged house owners into negative equity.
The screams of anguish from the mortgage belt were relatively muted as the Reserve Bank raised interest rates again and again. But the constant dribble of New Zealanders to Australia gathered pace as the year wore on. The rising cost of funds for businesses has to some degree been offset by the business taxation changes.
The value of the Kiwi dollar fell sharply when the sub-prime mortgage market crisis rocked global debt and currency markets.
But in post-Christmas trading it was back up nudging US77c and expected to go higher again if the Federal Reserve cuts interest rates to arrest America's continuing housing slump. This possibility will again act as a magnet for Japan's voracious investors in uridashi instruments and could push the Kiwi above US80c.
The big questions for 2008
One hot topic should be just how big an impact the Government's emissions trading scheme will have on inflationary expectations.
Reserve Bank Governor Alan Bollard will continue to keep interest rates high to brake Labour and National's pre-election auction and stop both parties from dishing out tax cuts of Australian proportions. Pity. But this does not necessarily mean the hammer will be stayed after the election.
In 2009, when greenhouse gases from energy and fuels are brought into the Emissions Trading Scheme, petrol prices and electricity prices will rise by 4 per cent and 7 per cent respectively, according to the central bank's estimates. But the impact won't be restricted to the direct electricity and petrol prices; it will flow through to consumer prices across the board.
The big question for the Reserve Bank is: Does it treat the impact as a one-off event caused by the need to meet international obligations? Or does it continue to hike interest rates to try to drown out the price rises?
The debate deserves to be settled well before the election.
Does anyone (apart from the Reserve Bank) really give a toss about the balance of payments?
Former Reserve Bank Governor Don Brash once wrote a counter-intuitive article questioning whether balance of payments deficits really mattered. The received wisdom for years has been that overseas investors would eventually go dog on the New Zealand economy and withdraw funds once they cottoned on to how indebted we actually are.
Bollard even sent officials to Japan to warn investors about the impact of a balance of payments crisis on the value of their funds here.
The current account deficit continues to go from bad to worse hitting $14.2 billion in September (8.3 per cent of GDP). But investors still keep putting funds here.
After 10 years of the Reserve Bank warning about the imminent risk of capital flight, the central bank should ask if there hasn't been a paradigm shift. In a world awash with funds New Zealand is still a safe bet.
Will the New Zealand dollar resume its rightful value?
The Kiwi dollar now seems set (once again) on a strengthening path. But it is unclear whether its trajectory is caused by problems in US markets.
One issue gaining increased currency is the impact of global dairy prices on the Kiwi dollar. The commodity boom has pushed the price for whole and slim milk powder higher. The world dairy export trade is also priced in US dollars.
The twin effect of the commodity price rise and recent strengthening of the Kiwi dollar against the greenback will increase the flows to our farmers. The interesting question is whether that strengthening plays in the baseline value of the Kiwi itself.
Carbon pricing price safety valve
We live in a strange world where people (this journalist for one) can be accused of running a campaign on carbon prices just because they seek clarity over the costs and benefits to our economy.
Thank goodness for lobbyists such as Catherine Beard of the Greenhouse Policy Coalition who pointed out that New Zealand's Kyoto liability has climbed a further $252 million to nearly $1 billion.
This calculation was based on a carbon price of $21 a tonne. But Beard points out some carbon credits are currently trading at $32.
The only way the Government can come up with a lower figure is to take a portfolio approach to buying credits with some that are at greater risk of non-delivery and therefore cheaper to buy.
The point at issue is that the Government's Climate Change Bill does not include a price safety valve to prevent economic damage. The place to sort this out would be within an Australasian emissions trading market where both countries adopt a common price safety valve.
This is so important that it should not be left to the Finance and Expenditure Select Committee to sort out. It should be top of mind for the first bilateral talks between Finance Minister Michael Cullen and Treasurer Wayne Swan.
* Fran O'Sullivan wishes readers a prosperous new year. This column returns on January 27.
