Treasury monitoring price bubble in China; NZ in trouble if Eurocrisis goes past Spain, Secretary Whitehead says

By Alex Tarrant

The New Zealand Treasury is “certainly” keeping an eye on a possible asset price bubble in China, while there is a risk of overstating the risk of a potential Australian house price bubble, Treasury Secretary John Whitehead says.

Meanwhile he believes Spain is the Eurozone country New Zealand needs to watch the most, saying if the Euro sovereign debt crisis does not stop at Spain, there could be some trouble for New Zealand, which sources a large amount of funding from European financial markets.

Whitehead spoke to interest.co.nz on the morning of February 22 as he was leaving Christchurch airport, hours before the deadly magnitude 6.3 earthquake struck the city. The interview focussed on Whitehead’s meeting with the heads of the Australian and UK Treasuries between 16-18 February, and Treasury’s outlook on developments in Europe, Australia and China.

Prime Minister John Key also met with the Treasury heads at a Hawkes Bay retreat, where discussions touched upon high and rising house prices in parts of Australia and possible economic slowdowns in New Zealand’s two biggest export markets. See more on Key's discussions here.

Watching Europe

The three Treasury Secretaries spent a reasonable amount of time talking about global economic outlook, with a focus on the medium to long term, Whitehead said.

“We reviewed what’s going on in a number of the countries which are having problems. There’s still a lot of uncertainty around,” he said.

The UK still had a “huge challenge ahead of them,” as it faced problems arising from the Eurozone.

“The view was Ireland would pull through – that it wouldn’t be allowed not to, if you can put it that way. Whereas the outlook for Greece I think is much more worrying,” Whitehead said.

“Neither of those are essential to the world economic future obviously, and attention is turning to Portugal,” he said.

“I think the view around the table was, as it moves on to Spain, if it doesn’t stop pretty promptly there then we can expect to see quite a rough time ahead. After Spain is Italy basically.”

NZ funding lines at risk

There was always a risk Euro problems could affect New Zealand’s funding lines.

“Of course there’s huge demand going forward for sovereign funding – the US and so forth, the UK itself has got quite a long way to go before it’s in tidy order. Some of the cuts there in the public service spending are huge when you look at it – 25%, 35%, that sort of order,” Whitehead said.

“Having said that, that’s a story we’re all familiar with. Overall, folks were moderately optimistic that was going to pull through. But, there’s a one-third to two-thirds risk, if I can put it that way, that we’re in for a bit more bounce. That wasn’t the figure they put on it, that’s my figure,” he said.

China watching

Meanwhile, in talks on the macro-economic situation around the world, Whitehead said issues noticed were wage and price inflation in China, and whether the US could get unemployment under control.

“They [the US] are printing dollars in the meantime of course,” Whitehead said in reference to the US Federal Reserve’s Quantitative Easing policies.

“There’s quite a threat there on the inflation front in some ways, at the same time as you’re facing the broader problems,” he said.

Whitehead said he did not detect a high level of concern from his Australian and UK counterparts for their currencies from the US’s quantitative easing.

“The general feeling on both currencies, and on terms of trade, is the outlook for Australia and New Zealand particularly is very positive long-term,” Whitehead said.

However he thought New Zealand was still facing more volatility, not less, going forward.

“So there’ll be some real ups and some real downs,” he said.

The volatility could come from a range of scenarios.

“Demand – as China puts the tighteners on a bit to stop inflation getting out of control, and dealing with the potential for an asset price bubble there. You’re going to see that [demand from China] drop away for a while, and then as they ease up it’ll come back again,” Whitehead said.

The European sovereign situation also contained potential for shocks, he said.

“There are things like that, but the outlook, medium to long-term for both protein and minerals, we thought, was very positive. Bumpy road though.”

Watching for a Chinese price bubble

Asked how closely the New Zealand Treasury monitored a potential asset price bubble in China, due to high levels of lending at low interest rates, Whitehead answered, “We certainly watch it”.

“In a sense we’re hooked on to that Chinese-Australian train, so nowadays what happens in China will impact on Australia, and then doubly impact on us in a sense,” Whitehead said.

“So yeah, we’re watching it. There’s no doubt there’s some risk there. Having said that, our central view is whatever happens, you’ll see a bit of, maybe, a slowdown in growth, but China will continue to grow,” he said.

Chinese demand for New Zealand food exports should remain strong.

“We think there’s an inexorable rise [in Chinese demand for NZ food exports], really. You’ve just got a middle class already of 200-300 million and there’s another billion to go. And India of course as well – if things continue to go well there,” he said.

Aussie house prices

There was a brief discussion at the retreat on Australian house prices and the prospect of a house price bubble across the Tasman.

“I think the Australian view, and the more general view, is it’s a patchy picture – in some areas there’s real pressure on house prices, other areas there’s not so [much pressure] and there hasn’t been for a while,” Whitehead said.

“There’s a risk of overstating the risk, put it that way,” he said.

Meanwhile, an economic slowdown in Australia due to the recent floods in Queensland would be “one of those bumps” along the way to recovery for New Zealand.

“What happens in Australia is very important to us obviously. It will impact on us, particularly in some food prices – Queensland food production has clearly been considerably disrupted,” Whitehead said.

“We’re expecting some bumps on that. But in terms of the Australian economy more generally, they’re amazing just the way they bounce back,” he said.

Whitehead was expecting Australia to bounce back.

“The question is how quickly of course,” he said.

Convincing the people on reform

In discussions on micro-economic policy issues, Whitehead said the Secretaries pitched the question of why it was hard to convince people on the need for certain reforms, particularly looking to the longer term.

“At the same time you’re looking at 'what are the conditions which make people more open to that?'. Obviously crisis does, and that’s the situation you’re seeing in the UK at the moment,” he said.

“Pitching a story which is about long-term challenges, which in a sense is where we are [in New Zealand], is always harder because people are a lot more interested in what’s going to happen next week than what’s going to happen in five years time or ten years time.”

New Zealanders were now more open to the idea of long-term reform, given what they had seen on debt and the situation Ireland found itself in, “and countries like that which have some differences from us, but are not all that dissimilar,” Whitehead said.

“We were talking about what we needed to do differently and we’ve decided we actually have to explain things a lot better than we have,” he said.

“[Of] the variety of reasons why people aren’t as open [to long term reform] as you think they might be, one is that we haven’t explained that well. Another is people talk a lot about productivity, and in peoples’ minds that means harder work, whereas that’s not really what we’re saying.

“[Instead] we’re saying more and better investment in New Zealand and countries like us,” Whitehead said.

“The third issue the Australians particularly were aware of is that some of the reform could be seen to be biased in the past more toward producer interests than consumer interests. That might be a bit of an issue there as well that we might have to be constantly aware of,” he said.

All about the story

“It goes back to the story side. You’ve got to be able to give a narrative which explains why consumers ultimately will benefit from the changes you’re making. For example, with our tax reforms that we’ve just been through.

“Yeah there’s personal tax reductions, but why does the corporate tax reduction at the end of the day help folk – telling that kind of story much more effectively for whatever type of reform you’re dealing with,” he said.

New Zealand had to tell a story which was a bit less technical, which probably took a bit more risk.

“One of the things we talked about is, we’re all very reluctant to say where the jobs are coming from, because the truth is, we don’t know,” Whitehead said.

“There’s a degree of intellectual honesty about that.

“We can speculate and qualify accordingly, but [we should] talk about what sort of industries you might expect to see growth [in jobs],” he said.

Tradable sector at risk of Aussie-China slowdown

A slowdown in China and Australia could impact on the government’s desire for job growth to occur in the tradable sector.

“The stronger and more robust Australian and Chinese growth is, the better for us. Then it comes back to the story I was telling before – you’re going to expect some volatility, but around a trend,” Whitehead said.

“I think the first thing that really impacts on our tradable sector jobs situation is actually reducing the effective tax on the tradable sector, which is all about how many resources are going to the non-tradable sector, including government,” he said.

“What we’re trying to do on state sector reform and fiscal consolidation is critical to that story. Then it’s a matter of, as the demand comes - and it will come and go a wee bit, but the trend we think is very positive – letting the tradable sector pick that up.”

Hardest time to forecast

Before the latest earthquake, nothing had happened fundamentally for Treasury to revise its December growth forecasts.

“We had a few more figures in. Obviously late last year things were a bit quieter than we had thought they would be. Then you’ve had the Australian weather conditions and so on. But I think fundamentally the story would be broadly the same,” Whitehead said.

“You’re also seeing the odd positive sign around the World.

“It feels to me very much like one of those inflection points – things might pick up quite quickly or they might continue to bump on for a while. It’s the hardest time for forecasting in my view,” he said.

Spain the one to watch

“My best guess is, presuming we don’t have a sovereign failure in Europe, that things will either bump along for a while in the pessimistic scenario, or they’ll begin to turn up. I wouldn’t expect a dramatic drop away, short of a sovereign situation,” Whitehead said.

“Spain’s the one to watch in my view. The markets go from one country to another – they focus on one country at a time.”

“Portugal’s certainly in the picture, and they’re looking at Spain. I think Spain is the key – if it doesn’t stop at Spain I think we’re in some trouble,” he said.

Off to the World Bank.

Meanwhile, Whitehead is set to leave Treasury to take up a position at the World Bank in Washington at the end of May.

“It’s really two roles wrapped up in one. You represent the constituency, which in my case would be the East Asia-Pacific, and you sit on the board of the World Bank,” he said.

“I’m looking forward to it. I’ll miss the buzz of this place of course, because there are very few places in the world where you’re so close to the action, whatever you’re role is in New Zealand.”