TVNZ's Good Morning show asked me to try to explain the Euro-zone crisis in an interview with Rod Cheeseman today. The interview is above.
Here's the preparatory Questions and & Answers briefing I sent through to the show's producers in preparation for the interview.
Q. 1. What's wrong with the euro-zone?
A. There's 17 different countries in the euro zone that all have different budget policies and banking systems, but all use the same currency. This means that often the currency is out of synch with what's happening in different parts of the euro zone. For example, Greece, Italy, Spain and Portugal have all grown slower than Germany in recent years and really needed a weaker currency. Instead the sheer weight of Germany inside the euro zone meant the Euro was too strong.
Q 2. So what's going to happen to the euro?
A. There's a good chance it will break up some time in the next couple of years under the intense pressures on national budgets and banking systems because of these imbalances created by the euro. The threat of that break up is causing the European economy to slow down sharply, along with the weight of enormous debt in Southern Europe and the UK. A breakup that saw Spain, Italy, Germany or Portugal leave the euro could wipe out the region's banking system and cause a depression, say many economists.
Q 3. So what does it mean for New Zealanders?
A. Just 7% of our trade now goes directly to the Euro-zone so the impact of a Euro zone recession would not be direct. But there are plenty of indirect effects. The euro-zone is China's largest trading partner and China is the largest trading partner of Australia and New Zealand. China's economy is already beginning to slow down, in part because of the European problems. This will slow New Zealand's economic growth, which will put pressure on employment.
Q4. What does it mean for interest rates?
Interest rates are being cut all around the globe as growth slows and inflation recedes. However, if there was a financial system meltdown in Europe, that may increase the borrowing costs of our banks, and they may pass that on to us in the form of higher interest rates. Our banks are much less vulnerable to that now than they were in 2008 when Lehman collapsed.
Q5. What's the best/worse case scenarios for NZ?
A. The best case is that Europe continues to muddle through and returns to some sort of growth. That will help the global economy recover and take some downward pressure off commodity prices. The worst case scenario is a financial meltdown in Europe, the break up in the Euro zone and an economic depression there, followed by all sorts of political ructions. That would slow our growth further and increase unemployment. That might hurt house prices and push up interest rates.
Q6. Why are our banks less vulnerable than in 2008?
A. They have reduced their use of 'hot' money funding in the European money markets. Instead, they rely now more on long term bonds and local term deposits. Also, banks have put aside more capital as 'fat' in reserve.