By Bernard Hickey
Just imagine being approached by someone in the street or online with an investment proposal that went something like this:
How about you borrow almost NZ$30 billion to invest in something that produces a commodity that swings in price by more than 50% over a two year cycle? How about you invest in producing that commodity on the idea that demand for that commodity has moved structurally higher, but pretty much ignores what other suppliers of that commodity might do?
Would you consider that a risky proposition that deserved a very healthy dose of scepticism? Would this sound like an even bigger and more dangerous version of 'Think Big', which relied on huge debt funded investments that assumed a high price ad infinitum for a single commodity and did not consider the supply response of other producers? You would probably be more than a little sceptical.
Yet that was the proposition that New Zealand Inc essentially agreed to invest in over the last decade. This is the story of the dairy boom that has now bust, leaving dairy farmers holding debts of over NZ$40 billion and producing a commodity that is currently losing them more than NZ$1.6 billion a year. Those debts are worth more than three times the income produced by that land and up from just NZ$11.3 billion as recently as 2003.
The Reserve Bank has forecast that if this week's payout cut to NZ$3.90/kg is extended into next season and then recovers only slowly after that then 44% of those loans would be non-performing. That doesn't necessarily mean the banks would kick 44% of farmers off their land -- they are more likely to roll over most of that debt to avoid mass mortgagee sales -- but it does mean the banks face profit drops of as much as 18% and land prices could fall 40%.
No other business leader in any other industry would borrow three times income to build a business that produced something they couldn't control the price of, which could fall 54% in two years, and the production of that commodity depends at least partly on the weather. Robert Muldoon was ridiculed and condemned for borrowing and betting big on a continued high price of oil when he invested in petro-chemical plants at Motonui, Waitara and Kapuni, and indirectly on the Clyde Dam and Tiwai Point expansion.
This sort of investment decision makes no sense. Unless, of course, you weren't actually borrowing the money purely to produce cashflow from the sale of that commodity. It makes perfect sense if you are borrowing money to push up the value of land, the gains from which are tax free.
Most farmers would vehemently deny they are farming for tax-free capital gains, and most do indeed hold their land for multiple decades and often for multiple generations. But it is simply not credible to say that land value is irrelevant in their decision making. It's certainly relevant in the decision making of the banks who lent them the NZ$40 billion and no other business in the country could borrow that much to invest in any asset other than land.
Rod Drury and Stephen Tindall, for example, would never even have dreamt of asking banks for billions to grow their businesses. The bankers wouldn't have even let them through the door with a proposal to borrow against the value of a bunch of shop leases, stock, computer code and sales agreements.
Finance Minister Bill English put it best this week when he said it was time for farmers to be more like proper business investors.
"This is an industry where they've had a focus on growing equity and growing land values for quite a long time now. It's going to be a significant adjustment to getting back to the core business of effective farming for cash flow," English said. "They are going to see land values drop. That is pretty much certain," he said.
However, the Government can't ignore its role as a cheerleader for the collective investment decision that farmers made over the last decade. It has actively encouraged the massive conversions and intensification of land use of recent years through (albeit small) loans for irrigation schemes and by making the dairy expansion a centrepiece of its central 'Business Growth Agenda' goal of doubling the value of primary industry exports by 2025.
And then there's the pesky matter of tax free capital gains. Not even Labour has suggested farmers should pay tax on capital gains. That would be one way to change the perverse business investment decisions that led New Zealand Inc down the path to Think Big Redux.
A version of this article was also published in the Herald on Sunday. It is here with permission.
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