Hang on everybody, things could get rough

21:14, Jun 25 2012
Tony Alexander
BNZ chief economist Tony Alexander

The Greeks have narrowly given a majority to the New Democracy Party, which could form a coalition with the socialist Pasok Party and become government, writes Tony Alexander.

Given that the main party supports continuation of the austerity measures needed to be implemented in order to keep receiving bailout money from the IMF and European partners the markets in some regards have greeted the election outcome positively. But not in all respects.

For instance in Spain, 10-year government bond yields have risen yet again amid still deepening concern about the state of Spain's banking sector. Sharemarkets have also been noticeably lukewarm in their responses as details are awaited of the nature of a coalition, what the approach truly will be to austerity, whether economic reforms aimed at boosting competitiveness will continue, and whether Greece can truly remain in the euro. It is highly possible that things will settle down for now.

It is also highly possible that they will get worse. In other words, no-one knows what will happen in the very near future.

It is actually worse than that because as things stand, should a new shock hit the global financial system and economy the ability of governments to respond will be radically constrained by the absence of space to cut taxes and raise spending because investors have strongly signalled they are tired of financing overspending by politicians.

Then it gets worse. Central banks already have interest rates at very low levels so capacity to cut them further is very limited. Rates are at the levels they reached in the depths of the crisis during 2009 in the UK, Europe, Japan, New Zealand and the United States. Then it gets worse again.


Central banks have tried repeatedly to boost their economies by printing money.

But that has merely resulted in liquid banks but not increased willingness to borrow from private sector businesses or willingness to lend by banks – apart from in New Zealand's housing and agricultural sectors it seems.

And sorry folks, but it gets worse again. There was a very good article in Monday's Wall Street Journal that looks at the way governments have failed to grasp what they were supposed to be doing in the past four years since the crisis fully got rolling. All governments can do with alterations in fiscal and monetary policy is buy time for the private sector to get affairs in order and for structural reforms aimed at boosting competitiveness to be put in place and hopefully start bearing fruit.

But few countries have embarked upon deregulatory drives aimed at raising productivity. We haven't, neither has Australia. That is a key problem in Greece although in Spain and Italy measures have been taken. In France, however, things are going decidedly in the wrong direction with changes to be made that will make it harder for businesses to make employees redundant, therefore reducing the incentive to hire people – especially inexperienced young people – in the first place.

In the next few weeks we could easily see the current round of Europe's debt crisis settle down. But their underlying fundamentals are poor and it is virtually guaranteed that further turmoil will follow. This is something we pointed out a couple of years ago and in some regards exactly what we pointed out early in 2009.

Back then we noted that the most important lesson of the Great Depression was to pay whatever price was necessary in order to prevent it happening again. That meant raising government deficits in particular to provide short term economic insulation. But the price would then be paid over the next two decades as government debts were brought back under control.

British Prime Minister David Cameron recently said that he does not think Europe has reached the half-way point in its debt crisis. Actually they may not be even one-quarter of the way.

We should all be running our personal and business finances in expectation of an unsteady economic environment for the coming decade with the low predictability of interest rates, exchange rates and customer demand.

Thankfully we do at least have some good insulation in New Zealand with the Christchurch rebuild and from our growing links into rising Asian economies.

The Southland Times