Playing a fiscal guessing game

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

Because 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 tells us low interest rates 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, because the have little confidence in an upturn, or because banks won't lend them money.

This latter factor is a big problem in Britain and the United States in particular. Bank capital bases have been so badly reduced they can ill afford to take on more risk by lending more money.

Every loan can go wrong so if few loans are written, risks are minimised. That is why the Bank of England is continuing to boost its money printing activities; to try to 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 $1.5 billion 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, annual debt is growing only around 2.5 per cent.

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

In the farming sector things are different. Farm debt grew 12.2 per cent in the year to September and although this rate of growth is down from 22.2 per cent a year earlier, it remains both high and massively inconsistent with what is happening elsewhere. 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 per cent in the September quarter from a year ago and 29 per cent for the year all up.

The number of farms sold in the three months to November was down 47 per cent from a year ago with sales for the year down a huge 60 per cent. Farm sale prices on average have declined 33 per cent in the past year. Tractor registrations were down 20 per cent in the three months to October from a year ago.

If we take retail spending outside Canterbury as a farm spending proxy, then we find seasonally adjusted sales were unchanged in the September quarter whereas they grew 0.5 per cent nationwide.

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.

It may be better to have no expectation that the increased Fonterra payout will lead to higher spending.

In fact, we 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 cashflow 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.

New Zealand 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 may it have been the best time to make a canny farm purchase?

» Tony Alexander is the chief economist for the Bank of New Zealand.

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