Exports drive the economy, not house prices

11th Oct 10, 5:45pm by Roger J Kerr

It is shaping up to be a very quiet period indeed in the local interest rate markets over coming months. The largest moves that will affect borrowers and investors may well be changes in credit spreads as US investor price NZ corporate debt at a different level (that is, a lower level) than what local bank and retail investors have been commanding over the last two years.

Credit spreads can only contract when offshore investors provide the debt funds to local borrowers at a cheaper margin to the borrower.

Outside credit spread contraction, the underlying short and long term swap interest rates appear destined to travel across the page until either the US Treasury Bond market correct upwards in yield or the RBNZ are forced to revise their 2011 GDP growth forecasts back up on the realisation that the high export prices are lifting economic activity in the big export industries.

Both these occurrences may happen sooner than what most pundits think.

The debate in the US interest rate, FX and equity markets right now is how big the second round of quantitative easing in monetary policy (“QE2”) will be to boost the US economic recovery.

Given the massive numbers being bandied about, there is significant room for the markets being far too optimistic on the likely impact, particularly if underlying US economic data improves over the intervening period.

It is quite significant, in my view, that the US 10-year Treasury bond yield has not moved lower than 2.40% over this last week, whereas the Dow Jones share index has skyrocketed to 11,000 and the USD currency has been thumped in the markets.

The FX and equity markets may have over-anticipated the positives here and the bond market may have already priced-in QE2 already. Therefore a move upwards in US Treasury Bond yields on QE2 being delivered in some form in early November by the Federal Reserve seems more likely than further decreases to 2.00%.

The Treasury bonds reached 2.00% at the height of the GFC in early 2009 when the world stopped and banks were collapsing. The financial and economic picture today is much improved from that time; therefore it is hard to see 2.00% being reached again.

Exports drive the economy, not house prices

I have commented previously with the RBNZ’s seemingly pre-occupation with the residential property market as the sole driver of the NZ economy, thus inflation and interest rate tracks.

Export prices, thus production, have always driven GDP growth in the NZ economy and that strong correlation will continue in the future. Nothing has changed with the NZ economy to alter that economic reality.

Export product prices and the terms of trade index are currently at record highs and point to +4.00% GDP growth next year, not +2.00% as many forecasters are now predicting.

The other RBNZ assumption I have a slight problem with is that all the extra income coming into rural areas over the next 12 months (particularly from the diary milksolids payout) will be applied to repay debt and will not be spent on consumer or capital items. There is a statistic that points to 80% of the dairy industry debt being in the hands of 20% of dairy farmers.

A good part of that 20% is dominated by investment syndicates owning the big farm conversions to dairy in Southland and Canterbury over the last five years.

Those guys will be under pressure from their bank lenders to reduce debt levels.

However that is a minority of farmers, the vast majority of owner/operator farmers will be spending a good part of their extra income and that will lift retail and other economic activity in the provinces over the next 12 months.

Eventually that boost in activity transfers into the cities as it has always done in NZ.

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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com

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31 Comments

by Andrewj | 11th Oct 10, 6:16pm 1286774160

I've taken to reading this guy. I hadn't thought about China raising interest rates;

My summary: If you hold shares, be prepared for some fireworks in the very near future, maybe starting next week. If if happens and you get caught, in my opinion you will have a chance to get out, as the markets will bounce, for one last time. 2011 will be a misreable year for markets, so you will need to hold the right assets, and those won't be shares in my opinion. The world is in trouble. The US is in huge trouble. China and Russia are sat watching. If the US fails, we are all in trouble, as the Chinese and Russians are ready to step in to the power void, China is already showing its true colours by economically attacking Japan (buying Japanese govt bonds to force the Yen up, and now withholding rare earth exports). They are the enemy along with Russia, so few realise this it is scary. Keep an eye on Chinese announcements these next few weeks. I have a sneaky suspicion they are holding back a key announcement on tightening/interest rates for just the right moment. I may be wrong, but I will be watching for that. A typical Chinese ploy to hasten the US's demise. I do hope the mid-term elections in the US produce a shift in power, so that the US can take the necessary steps to purge its system, and grow again. At least here in the UK we are on the right path, but I fear the Bank of England is just a Fed puppy, and will follow with QE if the Fed go that way.

Ah, where will it all end. Keep reading my blog to find out...

http://wealthadviseruk.blogspot.com/

by LloydM1 | 11th Oct 10, 9:58pm 1286787498

China are not looking to destroy the USA, this is only going to be a self inflicted bonus as far as the Chinese are concerned. The real target for the Chinese is Japan, as the Chinese will take revenge against them for previous atrocities. A weak USA will assist the Chinese with this.

China have already shown hostility towards japan, that was mearly a warning/test for things to come.

by Wolly | 11th Oct 10, 6:50pm 1286776217

"The financial and economic picture today is much improved from that time"......doh

Here you go Roger...go have a good read.... http://www.marketoracle.co.uk/Article23386.html

" the vast majority of owner/operator farmers will be spending a good part of their extra income and that will lift retail and other economic activity in the provinces over the next 12 months."....not friggin likely mate.....many will be well aware of the 'subprime' candidates in their area and will know there are some fat bargains on the way.....others will have had their opinions on govt stupidity reinforced and they will have their extra dosh out of Noddy dam quick....little will be left for any splurge in town and the rural folk are not blind to the retail sales funerals going on.

by PhilBest | 11th Oct 10, 7:34pm 1286778893

Roger Kerr says:

".........Export product prices and the terms of trade index are currently at record highs......."

Eh? Let's see the TREND, my friend, not the short-term blip. You'd have to be the most cock-eyed optimist to think that commodities are anything but a long term ticket to joining the third world economies of the world.

"Value added" in CITIES is where all the wealth creation in the world has been for the last 50 years. Where have you been, Roger, you and all the other cockeyed optimists in NZ?

There is a DIRECT connection between this, and the planned rationing of land and driving its price up for all CITY based industry and productivity - this merely hastens our transition to third world economy.

by Andrew in Finland | 11th Oct 10, 8:39pm 1286782780

Hard not to see that rising export prices for NZ is going to be the reality for some years to come. ANZ commodity index basket reached a high in may and was only 1% below that high this month. Grain futures began and ended limit up Friday. True many of these food commodities like soya bean are off the 2008 high but that was a massive spike higher and now we are reclimbing the terroritory of that spike.

From a simplistic point of view if all prices are rising then so are all incomes. So it will not be that simple and some prices will not rise for years to come while others skyrocket but it seems fairly certain that there is this trend of rising prices - no matter what enormously powerful deflationary forces are in play also. The depression and economic disaster seems likely to be an inflationary one which means that the commodity producers are likely to do ok out of it..

by mouse | 11th Oct 10, 9:06pm 1286784364

I hope you are right AiF - The important thing from here is that NZ Inc. Trades/Exchanges in sound Money... If we exchange via USD,GBP, YEN, Euro... we will import their inflation and subsidize their Profligate ways.

by Andrew in Finland | 11th Oct 10, 9:38pm 1286786326

Mouse

Most people are not interested in accumulating money. Instead they want tangible things like machinery, art, boats, hobby stuff or land and property - since people only hold the money for a short period of time, if another country wishes to produce claims to its machinery art boats etc for NZers i dont see what the problem is for NZ. NZers are unlikely to be holding USD while it devalues and they becomes poorer.

by mouse | 11th Oct 10, 10:07pm 1286788038

Currently AiF - if you Import Oil or derivitaves thereof, the transaction is completed in USD... where ever you live.

Saddam Hussein once tried to break ranks by setting up an Oil exchange where transactions were completed in Euros... sadly, it did not go down well with the US military industrial complex!

Do you travel to work by Car or, buy Stuff from the Supermarket.... you can be sure at least 75% of Transactional Value of your supermarket Trolley was done in USD... as it used to be seen as a safe store of value...

This concept for the last 70 years that USD is good as gold... is dying before our eyes.

Whilst Trade is conducted in a debasing currency... the Debaser is misleading you... in NZ we call it Stealing, Theiving... but not to their face if they are bigger and meaner than us... but we are not Fools.

by Andrew in Finland | 11th Oct 10, 10:57pm 1286791065

Mouse probably about 75% of my supermarket trolleys value is local taxes and profits for local middle men.

by Justice | 11th Oct 10, 9:18pm 1286785129

"I have commented previously with the RBNZ’s seemingly pre-occupation with the residential property market as the sole driver of the NZ economy, thus inflation and interest rate tracks."

Hope it hasn't taken you a decade to work that out? Roger, many of us wrote to Bollard and his minions about that very thing right back in 2003. We got fobbed off! Did YOU write? Bet you didn't.

by Matt in Auck | 11th Oct 10, 9:24pm 1286785499

Bernard / Hugh P - article please on what the Auckland elections mean for house prices.

My view is that this could prove a bad result for housing affordability. The left wing dominated Council is likely to favour the status quo approach of strict urban limits. and economically unfeasible intensification (that old socialist and urban limits promoter Mike Lee is in the Council)

the result? Inflating land prices

I've suddenly become a bit less bearish on Auckland property (more the mid term picture rather than short term, which I still think will be flatsiish next couple of years)

Unless the Govt's Urban TAG shock us and recommend the govt ban the use of urban limits

by Kate | 11th Oct 10, 9:44pm 1286786668

Given the new city sprawls across 140kms - just where are these limits imposed?

In other words, where can't be developed that makes sense to develop?

by Nomad | 11th Oct 10, 10:11pm 1286788306

Roger now you are thinking of importance of exports and recently you were begging for interest rate hikes which makes our exporters less competitive due to high dollar!

by Kunst | 11th Oct 10, 10:59pm 1286791161

Even some “Expert Authors” here are constantly preparing not much more then a “Greek Salad” - mixing in a little bit from everything - with no sensible economic overall concept.

by Sheep Shagger | 11th Oct 10, 11:20pm 1286792423

I think Roger is on the money. What is actually happening down on the ground here is an export led recovery. The dairy boys are going to be making shit loads this season at $7 plus, looks likely that lamb through the peak season is going to be $90 to $100, wool, beef up despite the currency.Input prices are steady to down thanks to the currency and lots of competition. There will be abit of consolidation while ODs are cleared but the coin will start flowing through from the provinces next year. You guys can speculate all you want about the value of your houses blah,blah,blah but the seeds of the recovery are in place where it really counts...down on the farm!

by ITYS | 12th Oct 10, 7:32am 1286821967

Dear Roger,

please wake up and smell the real story about interest rates in New Zealand. It is primarily driven by reservce Bank liquidity requirements which has seen deposits being lost as an income stream to the trading banks and has now become a funding tool - similar to the days of getting in large cheap tranches of foreign capital to leverage and on lend and create a property bubble in NZ which holds no sound economic basis apart from greed and sub prime.

Oh, and if you think the farmers are going to be spending it large think of this. $7/kgms. Avg debt $23/kgms - $1.80/kgms in interest only servicing - $3.50/kgms FWE (plus if an adverse weather effect takes off 5%-10% off all expectations - leaves $1.70 for risk/capex/deferred maintenance/drawings oh, and some people may need to DELEVERAGE. You may have heard of it.

cheers, ITYS

by Andrewj | 12th Oct 10, 8:19am 1286824791

Sheep Shagger, you are the most optimistic farmer I have ever known, are you for real?

I just spend a pile of money on cattle, its so wet and short of feed Im hoping to make a few bucks before Christmas, its rained here which has taken some pressure of me. Most agents are talking of an average year,all of my friends will be paying interest only this year. I think its ugly out there, my bank manager agrees as does my works agent,trucking company and all my farming friends.

by cam | 12th Oct 10, 8:21am 1286824862

"There is a statistic that points to 80% of the dairy industry debt being in the hands of 20% of dairy farmers."

I would be interested to know where that statistic comes from.

Can you enlighten us please?

by Colin Riden | 12th Oct 10, 10:00am 1286830832

The data originates from the RBNZ. They published in their Financial stability Reports for 2008 data from analysis of IR10 tax returns for YE 2006.

Some analysis from that the time is here:
http://www.agprodecon.org/node/90

"The RBNZ has in its last two Financial Stability Reports provided information that together allows a better estimate of dairy farm debt than has previously been possible. The May 2008 report established a pattern for the distribution of debt for sheep-beef and dairy properties from analysis of data from IR10 tax returns for the year ending March 2006. The RBNZ information illustrates a concentration of debt with 20% of farms - particularly the new, higher gearing for dairy than sheep and beef, and debt being 28% higher than reflected in the banks Standard Statistical Returns (SSR)."

by Nicholas Arrand | 12th Oct 10, 10:13am 1286831583

So that data, Colin, is 4 years old. Should we think that the debt has broadened out since then?

by Colin Riden | 12th Oct 10, 12:43pm 1286840619

It would be great if the RBNZ got updated data and added revenue so that we gained a better idea of distribution of debt per unit of production.

My expectation is that the concentration of debt is probably getting worse. Those farmers with little debt will have done well and have likely reduced leverage. Those who had excessive debt are likely to now have even more - and possibly to sources other than banks.

by Colin Riden | 12th Oct 10, 12:43pm 1286840628

It would be great if the RBNZ got updated data and added revenue so that we gained a better idea of distribution of debt per unit of production.

by Matt in Auck | 12th Oct 10, 8:24am 1286825091

Kate

Much of the Auckland region is either rural land or ocean.

As Demographia have correctly documented, the density of the urban area of the Auckland region is actually fairly high - a lot higher than most comparable cities in Australia / North America.

As an architect with substantial experience in higher density housing, I can tell you that the economics of higher density housing are shot. We did a development analysis for a site in Glen Innes recently, accounting for all costs 2 bedroom, 80 square metre apartments would have to sell to the market for circa $420K to make even a moderate profit. When you can still buy detached 3 bedroom houses on full sections for that price in Glen Innes then there is no way such development is going to happen. No go for investors too - at best a brand new 2 beddie apartment in Glen Innes could get are in the order of early to mid $400 per week - so around a 5% gross yield.

Of course not only do the market elements not stack up, but of course there are other factors such as the difficulty in developers obtaining funding, especially for higher density developments, and the community / political opposition that is inherently tied to such development.

I am not advocating sprawl. There are plenty of international examples where peri-urban development has been done sensitively, with a range of housing types and densities, a strong environmental focus, mixed use and quality design

I AM really worried that the new Council will continue to pursue a Smart Growth agenda that has severely failed Auckland over the past 10 years. It doesn't take a genius to see that they have failed - how many apartments do you see around places like Glen Innes, Mt Albert. Ellerslie, Mangere etc.?????

by Kate | 12th Oct 10, 8:40am 1286826016

Peri-urban to my mind means development between urban and countryside in the E. Howard tradition. Yet what has happened in Auckland I believe is that the urban has just grown and grown such that the real uninterrupted rural/countryside more or less begins in Waikato to the south and beyond Rodney in the north. And scattered between there are pockets of lifestyle. Isn't this urban geography part of the reason the new Supercity covers such a vast area?... the city just goes on and on?

I'm only guessing, as I'm not that familiar with the region's planning, but I would assume much of the development pressure is to turn the lifestyle areas into "peri-urban" - which to my mind they already are - just not a densely developed as some landholders might like?

by PhilBest | 12th Oct 10, 10:58am 1286834319

Blogger Ross Elliott in Australia, who is one of the specialists in this topic, has been saying for years that monocentric, high density urban planning is a guaranteed route to economic disaster. It is a congestion increaser, not a congestion reducer. It is a cost increaser, not a cost reducer. Not to mention that it kick starts speculative bubbles in land values. All the "investment" in bubble values could have paid for billions of dollars of infrastructure or productive investments - but it is payment, and debt assumed, for nothing - for "air", perhaps.

The monocentric urban model is actually the main PROBLEM, not the main solution, in the very factors the urban planners claim to be their highest priorities. They are ideology driven in that they like the idea of herding human beings into "mass" living and "mass" transit, and will ignore any evidence in favour of multi-nodal development and growth and inter-connectedness and mobility. These things are the death knell for mass transit, even though private vehicles will operate far more efficiently under that urban model. The planners simply refuse to run with private vehicles and roads and efficient, flexible urban form, even though this would bring large gains in efficiency of resource use and emissions immediately. Instead, they hold out for a utopian long term conclusion where they hope MOST people will have abandoned their cars and their houses with sections.

This reminds me of how David Horowitz described advocates of Communism; in bad faith, they always compare free market reality NOT with communist reality, but with communist theoretical utopia. Our urban planners are acting in the same bad faith, comparing the potential free market efficiencies of flexible zoning NOT with the reality (congestion, wastage, inefficiency, pointless cost burdens) of their misdirected policies, but with their imagined future utopia. Meanwhile, we have undoubtedly incurred a lot more wastage and pollution for having followed their policies, than if we had allowed urban growth to proceed with greater flexibility, and built more roads. By the way, buses use roads too. This is why planners do not like them as much as trains.

by Andrewj | 12th Oct 10, 8:56am 1286826985

Dairy debt stats

http://www.agprodecon.org/node/91

by Kunst | 12th Oct 10, 10:50am 1286833825

Great link Andrew - the only issue missing - influence of climate changes on dairy farming. - but I didn't register, so I may missed that part.

by Sheep Shagger | 12th Oct 10, 11:21am 1286835679

Andrewj

That link is from June 09 when fonterra were forcasting $5.20 as you well know it ended up at $6.60 and forward projections at $7 -$7.10. A very selective use of statistics and accompanying commentary. Stop looking in the rear view mirror.

Kunst

You are great at making sweeping doomsday statements and offering nice slogans as remedies but always fall short of offering realistic alternatives as CO alluded too yesterday.

by Colin Riden | 12th Oct 10, 12:30pm 1286839843

You are also being a bit selective in your use of statistics. The final payout for the season ending July 2009 was from memory $5.21 before the retention of 1 cent. Those figures would not have been final till the second half of 2009.

by Kunst | 12th Oct 10, 12:39pm 1286840345

SS – in today’s world small economies are only successful long term with a comprehensive and sustainable strategy involving all industries. RemoteNZ currently makes (B)millions of revenue with agriculture and tourism, but only as long as the reputation of 100% pure green and clean can be maintained. One industry has the potential to harm their own, but others enormously not to mention taxpayer’s pockets.

….and SS if you like it or not yes - it is already happening.

by Andrewj | 12th Oct 10, 11:43am 1286836992

I was just answering the question above. If you are dairying it may pay to read an interesting article on dairy product volitility by cornell Uni. IF they are right then we are at the top of the curve again and milk prices will be well back next season. Im impartial on the matter ,an interested observor.