Fantasy economy exposed

23:18, Nov 14 2010
ECONOMIC RECOVERY: The slump may be officially dead, but it can still bite.

It's been called a fragile recovery, a glacial recovery, and even a joyless, jobless recovery. But since September last year there has been no doubt among most economists and politicians that we are, in fact, emerging from recession.

Officially, we have been in recovery since June 2009, with GDP expanding about 2 per cent in the past five quarters.

So why does the economy feel so bad – for households struggling to repay debt and live within their means and for businesses struggling with low, or non-existent, consumer demand? When will the economy return to "normal"?

Welcome to the new reality, say economists Dominick Stephens, a senior economist at Westpac, and John Ballingall, deputy chief executive of the NZ Institute of Economic Research (NZIER). This may be about as good as it gets.

"There is no reason to expect consumer spending to go back to the growth we experienced in the last decade," says Mr Stephens.

"That was based on a doubling of house prices which allowed massive ramping up of debt, therefore more consumer spending. It is extremely far-fetched to think this will happen again. The reality that the last decade was the exception, rather than the rule, is beginning to hit home."


Mr Stephens sees the past 10 years as a "fantasy-land". "People are asking `when will this be over'? It is over. That was a strange period where we spent more than we earned. We're in the new reality now."

In the short to medium term, the best we can hope for is that house prices stop falling and, "with the changing tone of the economy", consumer spending begins to grow modestly.

Mr Ballingall, too, sees no rapid growth ahead. "It will be a long, hard slog from the bottom of the recession," he says.

"We are in recovery but from a low starting point. The next 12 months will be tough. We wish it weren't, but that's just how we see it."

NZIER has seen no recent data to contradict the grim view taken by its economists in last month's Quarterly Survey of Business Opinion. This described a simultaneous slowdown across all economic sectors and regions midway through this year, alongside plunging business confidence. Seasonally adjusted, a net 9 per cent of firms are pessimistic compared with a net 26 per cent of optimists in the June survey.

"The economy contracted in the September 2010 quarter," NZIER said. "Business profitability is deteriorating; this may weigh on investment and hiring, which are drivers of medium term growth."

The problems are self-perpetuating. Unemployment depresses consumer spending which, in turn, discourages hiring and capital investment, which depresses consumer spending.

Last month NZIER estimated each New Zealander was now spending $45 a week less than during the past decade – or about $10 billion a year. Retailers and the residential property market have been the key losers. Latest figures from Barfoot & Thompson and Quotable Value show Auckland house-sale volumes are 35 per cent down for the year while prices across New Zealand are down 5.5 per cent from their peak in late 2007. Retail sales, like GDP growth, have averaged less than 0.5 per cent per quarter.

In its July business opinion survey – and long before Reserve Bank governor Alan Bollard's significant change of view (downwards) on the strength of our economic recovery – NZIER's principal economist Shamubeel Eaqub warned that small businesses were leading the decline in confidence. "That's a big warning sign," he said. "They tend to be the canaries in the coalmine. There are signs the recovery may be stalling."

This was evident even before the Reserve Bank started raising interest rates in June. "A year into the recovery, you would expect the economy to be going really strongly by now."

Mr Eaqub says the weakness in house sales in the past nine months is a good indication of the overall level of demand in the economy. Business lending has contracted by 7.5 per cent year on year in recent months and firms are not hiring or investing.

Any recovery in the export sector is "very narrow", he says. About half the activity involves three commodities (dairy, forestry and oil) to two destinations (Australia and China).

Mr Ballingall says he feels like the Christmas Grinch. "The worst is over but getting back to best will take some time yet. And quite possibly it will be a different best.

"We're not sure when the economy will be operating at full potential again because there have been such fundamental shifts in the way consumers and businesses operate."

Nevertheless, most economists  and banking economists, in particular  were happy to talk up the recovery until Dr Bollard signalled a significant change in his view in his monetary policy statement on September 16.

Weaker retail (down 0.4 per cent on July's figures) and housing sales (down 3.9 per cent in August), and a major debt repayment binge by households and businesses, were the major drivers behind the bank's decision to hold the official cash rate at 3 per cent, rather than pushing up interest rates as about half the market had expected.

The most recent surveys show business confidence on the rise. The BNZ's latest monthly survey indicates a net 28 per cent of respondents expect the economy to improve in the next year compared with 18 per cent last month.

But, as chief economist Tony Alexander notes, it's a different story when businesses are asked about their hiring intentions and conditions in their own sector.

"Comments made by respondents about how they see their sector of business right at the moment remain firmly on the downbeat side," he says.

"There are some comments suggesting improvement but they remain sparse and a key theme remains tight cash flows and customers in no hurry to make purchases.

"Overall, economic conditions are clearly still challenging. Improvements appear tentative and we think most businesses and households will have to wait until potentially well into 2011 before they generally feel the better economy in their dealings."

Typical of the paralysis is a comment in last month's BNZ confidence survey from a respondent in a construction-related sector: "Although we can afford to buy new equipment, I do not have the confidence to do so."

Cameron Bagrie, the ANZ's chief economist, was among the first to note more than 12 months ago a significant disconnect in confidence surveys between businesses' optimistic expectations for the economy in general, and their gloomier view of the outlook for their own firms.

Driving this has been an epic shift in consumer attitudes towards debt and discretionary spending since the beginning of 2009.

For example, in 2007 households withdrew $7b worth of equity, largely from house mortgages, but by the end of 2009 they had returned $5b.

The challenge is how to cut debt while maintaining demand in the economy.

As Mr Bagrie puts it: "The critical ingredients for a broad and robust recovery, in the form of hiring and investment, are still lacking despite [October's] small improvement [in business confidence]."

And what about consumers? Does consumer confidence also matter?

"For sure," says Nick Tuffley, chief economist at ASB Bank.

"Consumers account for about two-thirds of spending in the economy so you don't need a big change in the pace of consumer spending to have an effect on the wider economy."

Could closed wallets jeopardise the recovery? A sustained contraction in spending "could be an issue", Mr Tuffley says, but that's not the case right now.

"We're seeing growth but it's muted and [in future] the mixture of growth will be different, with households under-performing compared with the export sector.

"New Zealand was growing in excess of 3 per cent a year for 15 years before the recession.

"A chunk of it was household spending and the housing market was very strong.

"We are now moving into a world where households are more careful about debt.

"That tail-wind from households is no longer there.

"It's not a feel-good recovery, it's more like a feel-less-bad recovery."

The Good News: Unemployment fell from 6.9 per cent to 6.4 per cent in the September quarter.
Commodity prices rose by a record 31 per cent in October, compared with a year ago, and are 3.5 per cent higher than September.
Business confidence rose to 28 per cent, up from 18 per cent in September, according to the BNZ – the strongest figure since May.
Wages and salaries grew 0.6 per cent in the September quarter, compared with 0.4 per cent in June.
House prices are only 5.5 per cent lower than their peak in late 2007.