The problem with economic forecasts

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OPINION: To say that a lot of uncertainty remains about the global economic environment over the next few years would be an understatement.

It may be better to say forecasting economies in this climate is a matter of best guesses based on economic models not designed to accommodate the biggest financial shock since the 1930s.

 For instance, while economic theory and experience tell us that low interest rates will tend to discourage saving and encourage business investing neither is happening.

Around the world households are boosting their savings levels having just experienced a massive loss in their wealth.

Businesses are refraining from investing either because they already have empty buildings and spare machinery, or they have little confidence in an upturn, or their banks won't lend them money.

This latter factor is a big problem in the United Kingdom and United States in particular.

Bank capital bases have been so badly reduced they can ill afford to take on more risk to those diminished bases by lending more money.

Every loan can go wrong therefore if few loans are written risks are minimised.

This is why the Bank of England is continuing to boost its money printing activities to try and ensure some of the money sloshing around will be lent out, and in the US the Federal Reserve appears in no hurry to start unwinding its earlier money printing measures.

Here in New Zealand there is no evidence that low interest rates are boosting borrowing demand. In the urban business sector total debt fell close to $1.5b during the September quarter.

Over each of the past three years business debt has grown $2.5b over this three month period. In the household sector debt is growing only around 0.2 percent a month or around 2.5 percent annualised.

Growth two years ago was over 13 percent. Non-housing household debt is in fact falling and has so far decreased 7 percent since the end of last year.

In the farming sector things are different however. Farm debt grew 12.2 percent in the year to September and although this rate of growth is down from 22.2 percent a year earlier it remains both high and massively inconsistent with what is happening in the business and household sectors.

In fact the farm debt growth is also inconsistent with farm sector activity measures.

The value of consents issued for the construction of farm buildings was down 55 percent in the September quarter from a year ago and 29 percent for the year all up.

The number of farms sold in the three months to November was down 47 percent from a year ago with sales for the year down a huge 60 percent.

 Farm sale prices on average have declined 33 percent in the past year. Tractor registrations were down 20 percent in the three months to October from a year ago and 9 percent for the entire year.

And if we take retail spending outside Canterbury in the South Island as a farm spending proxy, then we find sales in seasonally adjusted were unchanged in the September quarter whereas they grew 0.5 percent nationwide.

So, if farmers aren't spending, but farm debt continues to soar one has to be very concerned about what is happening to farm balance sheets.

One might do best to have no expectation that the increased Fonterra payout will lead to higher spending, and in fact one should probably exclude farming completely from joining in this economic recovery.

This helps explain the strong Reserve Bank reluctance to raise interest rates - imagine the debt servicing problems for farmers now largely on floating interest rates, especially as the currency will soon likely exceed US 80 cents.

And yet at the same time as cash flow and balance sheet pressures in the farming sector are possibly the worst they have been since the mid-1980s, farming's long term prospects look the best in generations.

NZ is concluding free trade deals left right and centre and prospects have just soared for some sort of a deal with the US. Looking back 20 years from now, when one might consider it to have been the best time to make a canny farm purchase?

Tony Alexander is chief economist at BNZ