A man wears a face mask as he stands along the waterfront in Wuhan in central China where the novel coronavirus broke out. Photo / AP
A man wears a face mask as he stands along the waterfront in Wuhan in central China where the novel coronavirus broke out. Photo / AP
COMMENT
In economics, they call it an exogenous shock. A fancy term, which means: Something outside the economy shatters the current situation. I am not an epidemiologist. I am totally unsure of the threat posed by the coronavirus. I don't even drink that type of beer. But this virus isan external shock. And it exposes the vulnerability of our rock star economy.
I am a seasoned investor. I have endured the Asian crisis of 1997. The dotcom bubble in the early 2000s, Sars, the Global Financial Crisis of 2008. This current threat could blow over. It depends on transmission rates and mortality levels.
The problem is a deflationary spiral. The New Zealand economy is very vulnerable to such a scenario. We have been warned about this repeatedly by the Reserve Bank and the IMF and other external commentators.
We have used huge amounts of borrowed money to bid up the prices of our existing houses. Our private debt levels are very ugly. The problem is, higher house prices do not generate new businesses, higher incomes or more employment or economic wellbeing. It's just higher debt and higher house prices. A game of pass the parcel. Overseas buyers have had an impact on house prices but they are unlikely to be the main driver.
So when an external shock like a potential pandemic strikes, this makes our economy very vulnerable.
China is our main trading partner. If this trade link is severed, it could get very ugly. Tourist numbers will plummet. They already have. Our dairy industry would slump. Firms such as SkyCity, Auckland Airport, Air New Zealand, A2 milk, Synlait and Tourism Holdings will suffer. They will lose a huge chunk of customers. This is starting to happen.
A big drop in demand for our exports will have a huge impact on total demand in our economy. As demand falls, firms will lay off staff.
As confidence falls, people and firms cut spending. The economy moves into reverse. A nasty deflationary spiral can emerge. Especially for people who owe a lot of money. Unemployment rises and wages and prices fall, even for houses. Unfortunately debt levels remain. It's a very ugly downward spiral.
We narrowly avoided this scenario in 2008. Largely due to the Reserve Bank slashing interest rates and then the Keynesian stimulus of the Christchurch rebuild after the earthquake. We dodged a bullet back then.
John Maynard Keynes identified this deflationary scenario as the main cause of the 1930s Depression.
As the economy shrinks, it implodes on itself in a vicious downward spiral. Central banks become impotent. Lower interest rates make little difference because no one is willing to borrow or spend.
Keynes identified the only solution to a deflationary spiral as increased government spending to keep the economy afloat. In the 1930s, President Roosevelt adopted such policies in the United States. He built hydro dams and highways and invested in other huge infrastructure projects to create jobs and employment and confidence. Countries such as Sweden did likewise and were spared the worst of the Depression.
Peter Lyons. Photo / Supplied
I am being a doomsayer. This crisis may well blow over as health authorities swing into action. I really hope that is the case. I hope we muddle through, as usual.
But this crisis does expose the vulnerability of our economy. An economy based on debt and housing inflation and the stimulus of migration is not sustainable. I hope we do not pay the ugly price of our illusionary prosperity. If we do, we need to be very clear about the only avenue to prevent complete economic despair.
Otherwise we have learned nothing from history.
• Peter Lyons teaches economics at St Peter's in Epsom and has written several economics texts.
