By Neville Bennett*
What will happen to New Zealand if Australia falls into the mire?
I ruminated on the problem and do not have all the answers. Yet I felt I had enough info to start a discussion.
Some of the points I want to talk about are based on the idea that Australia is already in the mire.
I think it has classic Dutch Disease with knobs on as it is subject to huge capital flows.
Its economy is slowing, and that could be hurting us: a factor in the fall in manufacturing which is a major point in NZ’s poor GDP returns filed this week. I think Australia has become too dependent on the resource boom and its economy will now fall as international demand cools.
If I am right, the Australians are in for rather grim times, and their housing market will face a huge correction as confidence falls.
I can also perceive a probability that the international banking and trading community could rapidly revise downwards their confidence in the Australian dollar. I will get a bit technical on this point (sorry!) but it will establish an argument for a quick fall in the Australian dollar. I think currency traders tend to lump Australia, Canada, South Africa and New Zealand together, so if the Aussie falls the Kiwi falls. Both have impaired fundamentals.
Low growth in Australia and New Zealand
The New Zealand results came in on Thursday at 0.3% for the quarter, which was about half what the Reserve Bank and other economists expected.
It means that NZ growth over the last year is a pathetic 1.4%.
Note also for the moment that agriculture contributed 3.5% but manufacturing fell by 2.5%.
We expect agriculture to fare well, but we ought to wonder more about manufacturing’s fall: could that be because foreign markets were slack or was it because the Kiwi is too high? The immediate point to note is that NZ growth is vulnerable to any shock: be it foreign markets, credit, exchange rates, government expenditure, capex, or interest rates.
Let’s make the point at present that foreign holders of Kiwi securities will be nervous at present about our prospects. There was some selling off in markets. I think this could be increased as foreign perceptions change. Moreover, low growth makes it harder to raise interest rates, so traders might start expecting the Kiwi to fall.
The Australian Reserve Bank (RBA) recently asserted that growth would be “close to trend’ of 2.75% p.a. I will eat my hat if this is correct. This is “talking up”.
The Aussies ought to know that they are in the forefront of destructive capital flows. I found that they took a huge hit to the economy in late 2011 when panicking European banks sold down their Australian holdings.
The recent release of data on the December quarter of 2011 showed a small increase in GDP, and a year-on-year growth rate of only 2.3%, less that the expected trend-rate of 2.75%. Australian commentators have seized upon a blip in investments as a cause of the fall. Business investment was down by 1%. I have seen no attempt to explain this fall.
There are times when I refuse to go with the flow, and I want to know why business investment fell in the December quarter. I had to cast a wide net before getting a possible inclination. I looked at the Bank of International Settlements website which showed that last year European banks pulled $US8 billion of investments out of the economy at a time when many Aussie companies were trying to refinance loans.
European banks obviously had fears of their impending crisis. Their actions would have created a blip in Australian investment. This may not be terminal as Asian and American banks are lending, but it illustrates an Australian vulnerability: Australia is capital-short and must go overseas for credit. It can anticipate acute contractions if there is capital flight.
Australia has a bad case of Dutch disease. Dutch disease is an interesting concept. It arose when Holland received high returns from North Sea oil and Gas. The markets caused the guilder to inflate madly so Holland’s export sector withered. The currency was high and imports were sucked in. Everyone said how great it was to be Dutch but the Dutch people got little out of it.
True there was increased employment opportunities in the export sector (that always happens in cases of Dutch Disease) but employment in manufacturing fell more sharply.
The cost of living shot up, assets inflated and the Netherlands became a less favoured place to live. Brazil also has DD at present and UK firms are pulling out as it is too expensive to place staff there.
Australia gets little benefit from its minerals as much ownership is foreign. Companies like Rio Tinto have comparatively few Australian shareholders.
In Australia contraction has set in, consistent with Dutch disease. GDP was down because the terms of trade are moving against Australia. Commentators have missed this point. They say things are good because exports were up in the December quarter by 2.2% and imports down by 0.4%. They completely missed the essential point that the terms of trade were down by 4.7% because exports were under pricing pressure, and this pressure may intensify as exports to China are sharply down.
Australia has become over-dependent on the China market.
The contractions show in a small increase in unemployment by 0.1% in February to 5.2%. Observers are inclined, like Treasurer Swan, to blame much of this on the “cautious consumer”. This is economic fiddlesticks. Consumption is above trend, especially in cafes/restaurants. Australians are using the internet for many purchases and they are travelling abroad to buy: overseas holidays, up 8% in December.
In addition to Dutch Disease, Australians have the associated illness of a housing bubble.
They had tons of cheap foreign credit and have bid up house prices. Everyone knows that there will be a correction. Standard and Poors predicts a 10% fall if China has a hard-landing. Building approvals are sharply down by about 15% year-on-year. This means that the construction industry is not pulling its weight and therefore that GDP will contract and keep growth below trend.
There are good technical reasons to short the Aussie dollar at present. Their Reserve Bank has signalled falling interest rates. Its 5-yr bonds has a 2.6% premium over US 5-years. But how convincing to traders is this differential? Australian inflation has been 1.06% higher than American in the last three years, so the net benefit of investing in Australian bonds is about 1% net of inflation.
US investors might look sideways too at Australian equities. Both have p/e's of around 14%, but Aussie stocks yield 4.8% while the US S&P’s 500 yields 1.96%. But the Aussie market depends on China and is lagging while the US is progressing well. US investors might wonder if the Aussie dollar is over-valued, and decide to short it.
I think the Aussie has got too high against the US$ and will correct.
Unfortunately, if there is capital flight from the Aussie, people in the northern Hemisphere will also look acidly at New Zealand which is linked in their eyes to the commodity currencies. The more sophisticated will note the Christchurch earthquake and slow growth in GDP of about 1% despite holding a successful rugby world cup. I suspect our slow growth is partly because the Australian economy is slowing down.
I think when the Aussie goes the Kiwi will go with it: but that is good as it will rebalance our economy towards manufacturing and exports.
* Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR.