Opinion: NZ's recession - a piece of cake?

By Neville Bennett The forecasted performance of the New Zealand economy is debatable. The Reserve Bank's latest Monetary Policy Statement bullishly states that there has been a modest contraction and forecasts "little growth in activity from now through until the middle of 2009. Thereafter, we forecast growth to begin to recover, but to remain below trend until 2010." Such forecasts are important. Businesspeople reading the Statement may decide that little adjustment is needed beyond being vigilant over costs and economising on overtime. The Bank claims, in effect, that there will be little growth for six months, but modest expansion will then occur. This recession is a piece of cake.

But I believe this recession will be deeper and last longer than mid-2009: a nasty shock is headed our way. The Reserve Bank's interest rates (5%) show that it is more bullish than other central banks. Prevailing rates are:  Canada 2.25%; England 2%; Japan 0.1%; European Central Bank 2.5%; Federal Reserve 0.25%; Swiss National Bank 1%,; and RB Australia 4.25%. RBNZ is, therefore, out on a limb. The historical record indicates that few New Zealand recessions are short. This one is big and global. It began  in the US in December 2007; it will be longer than the recessions beginning in November 1973 and July 1981. They were 16 months. This recession will be the greatest since August 1929. It is already palpable in closing shops and restaurants, falling house prices, builders desperate for work, and a cultural shift towards thrift. Admittedly, The Reserve Bank has to sooth fears. It has introduced retail deposit and foreign funder guarantees. It liberalised rules on collateral. Its path is very similar to the Fed, or RB Australia. The Bank has creditably played its part in maintaining capital, liquidity and confidence. Confidence is important. Governors of the Reserve Bank cannot talk the economy down when inflationary pressure is contracting. Nevertheless, there is a difference with other central banks. Our bank says "she'll be right". Near-panic reigns in G7. The British Telegraph recently reported that the BOE is working on radical plans to inject cash directly into the economy - "the nuclear option"; to be used only when interest rates approach zero. The Bank has cut rates to 2%, their lowest since 1951, and warned that "it was unlikely that a normal volume of bank-lending would be restored without further measures". The BOE may be considering direct purchase of assets, and expanding its balance sheets to pump cash into banks. It could be the first time since the 1970s that the Bank of England has targeted the volume of cash in the economy, by using its balance sheet, rather than the price of money through interest rates. The Telegraph explains that the bank would print money by buying securities through its Ways and Means account. The ECB signaled it might use "quantitive easing" (QE) for the first time ever. I imagine my monetary economics lecturers squirming when I hear the term. They were of the Austrian school, for Hayek had left an imprint in neo-classical economics at LSE. QE was a Japanese invention in its losing battle with deflation. The USA and France are undeterred although QE did not work in Japan. QE is another word for printing money. The ECB supremo Trichet admitted "We are supplying liquidity on an unlimited basis." This may be called legerdemain as the Maastricht Treaty prohibits the ECB from injecting stimulus by purchasing the government debt of the euro zone's fifteen states debt "“ a method known as "monetizing the deficit", or more crudely as "printing money". But it can achieve the same effect, the Telegraph observes, by mopping up sovereign debt, mortgage securities, or even company debt on the open market, as the Fed has already begun to do. At the moment the ECB accepts some of these assets as collateral in exchange for loans, but it has not yet hit the atomic button by buying them outright with its own freshly-minted fiat money. In September, the ECB predicted an economic rebound in 2009 but it has dramatically reversed that forecast since to a brutal contraction of a fall of 2.7% in early 2009. Sweden's Riksbank startled markets by a cut of 175 basis points to 2%, motivated by a collapse in Volvo sales and their banking sectors' over-exposure to property in Eastern Europe. The alarm evident in banking activity is mirrored by many governments adopting urgent stimulus packages. Many aim to simply boost spending: the Australians have given money to superannuants and have encouraged them to spend it. Economists may have to suppress a faint smile when reading a recent speech by the Deputy Governor of the RBA where he forthrightly explains "the paradox of thrift" (if everyone saves the economy suffers) and his exhortations to spend. He warns that if the public saves (to reduce household debt) the public sector must increase spending. One cannot keep track of every stimulus package. Perhaps the US will provide the biggest ultimately as the Democrats are anxious to help out with mortgage payments, but we must await President Obama's inauguration. The UK and Germany are vigorously active. France has given €1 bn in loans to the French car industry, and has committed itself to building 100,000 new homes to keep the construction industry active. Japan has passed an Emergency Package of Y5 trillion to encourage spending as an antidote to "a harsh storm seen only once in 100 years." Taiwan has given everyone shopping vouchers. China has competed with a US$585 bn package to boost spending on infrastructure. The global problem is deflation. Prices, demand, credit are all in decline. The IMF has changed its forecast for global economic growth in 2009 from 3.75% to 2.2%. Expect another downward revision. The G7 is in recession. If the world is in recession, how can New Zealand growth resume in mid-2009? I believe our economy will struggle with a contraction of credit, a drain of income to offshore creditors, falling export receipts, massive increases in import costs, a decline in asset prices (especially housing), a sluggish stock market, falling internal demand, and an inability of the authorities to stimulate the economy. *Neville Bennett is a long-time Senior Lecturer in History at the University of Canterbury, where he has taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.