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NZ Herald business editor at large

Liam Dann: It's a mad, mad world

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From Britain, to the US to Australia, voters are punishing politicians. Why the anger and what does it mean for markets? asks Liam Dann
Why the anger and what does it mean for markets? Illustration / Rod Emmerson
Why the anger and what does it mean for markets? Illustration / Rod Emmerson

Even after the shock result, financial markets could have shrugged off the Brexit vote, says Greg Peacock, chief investment officer for investment fund NZAM.

But despite what the stock exchange numbers might suggest, they haven't. Instead, there is growing unease about what happens next as a new wave of political volatility spreads across the Western world.

"So the financial market impact lasted two days," says Peacock. "If you look at it on a standalone basis, the UK is 4 or 5 per cent of global GDP; if it slows down or even goes into recession there is a bit of 'so what' about that."

But the significance of Brexit and the fears it is creating "are really what it implies about future events". The UK is in turmoil, Australia is in turmoil. Who is next? Donald Trump and the US elections are looming large. Then there is Italy, where Prime Minister Matteo Renzi has offered angry voters the chance to chuck him out with a referendum on political reform in October. And what about New Zealand - could we follow the trend?

"What we are seeing is a push back against, some would say, the whole post-World War II movement - globalisation and free trade," Peacock says.

"The global financial system just feels extended here. You've got negative bond yields. High multiples on equities. It's become kind of self-fulfilling in the sense that whenever there is a crisis the reaction is to cut rates and pump QE."

The beneficiaries of those polices have been people with assets.

"Bonds, equities and property. They've done better than anyone could possibly have imagined but there is a very large proportion of people in those economies who simply feel like they have been passed by," says Peacock.

Mark Lister, head of research at Craigs Investment Partners, says "the Brexit was a wake-up call for politicians and investors and I think we'll see plenty more of it.

"It's simply a reflection of the fact so many people feel like they are missing out on their share of the boom."

We're used to hearing this kind of thing from left-wing commentators and politicians. But neither Peacock nor Lister has a political axe to grind. Their analysis is matter-of-fact and born of concerns for investors.

Watch: The Economy Hub: The rise of 'up-yours' voters:

Video

"The low interest rate thing hasn't really fired up economies or seen any wage growth come through," Lister says. "All we've done is make house prices and share prices go up. The wealthy end of town feel wealthier, the bottom end and the middle end haven't really benefited at all and people are just getting sick of it and are feeling very disenfranchised."

Auckland University professor of macroeconomics Prasanna Gai has worked for the Bank of England, Bank of Canada and advised our Reserve Bank. Nearly 10 years on from the global financial crisis we are still suffering the fallout, he says. And there are echoes of the 1930s.

We have allowed central banks to "shoulder all the burden" and politicians' failure to confront the big structural issues may be coming back to bite them.

"You've got a confluence of three factors," he says. "Firstly, productivity growth everywhere is unusually low. That's a consequence of a misallocation of resources in the boom which preceded the global financial crisis."

Then there is debt.

"Global debt levels are at historically high levels ... because debt has served as a substitute for income growth pretty much everywhere." Then you have the central banks with very little room left to move and "a substantial rise in economic uncertainty as well as policy uncertainty."

[Brexit] is simply a reflection of the fact so many people feel like they are missing out on their share of the boom.
Mark Lister, Craigs Investment Partners

What we are seeing is "protectionist discontent", he says.

In other words, people are looking for political leaders who promise to put their local interests first even if that might not be in their greater long-term interests.

"It is no accident," Gai says. "If you think back to history and the Great Depression, financial crises and protectionism go hand and hand. All these events, whether it's Brexit or Australia or the US, kind of have a very similar theme.

"The central banks prevented a catastrophe [after the GFC] and everyone banked on an eventual recovery. But politicians have underestimated the consequences and the duration of a financial cycle gone wrong ... and they have not self-corrected along the way.

"There is a strong case for other policy measures to take a leading role. So structural policy, fiscal policy - for example, tax reforms that get the bias away from the accumulation of debt - incentives that spur productivity and dynamism. Structural reforms that target these issues will help."

"Remain" supporters rally in response to Britain's Brexit vote. Photo / AP
"Remain" supporters rally in response to Britain's Brexit vote. Photo / AP

There is a sense, then, that it has all just taken too long. Ironically, just as the US Federal Reserve was starting to hike rates, the public has lost patience and rebelled - potentially creating a new crisis.

"There is a risk that such a dynamic can become self-fulfilling, and be difficult to shake," says Prai.

There is a "scarring effect" on households and business and they are all holding off on investment decisions.

"During the GFC you had a lot of economic uncertainty, this is now being exacerbated by policy uncertainty because we don't know what the governments are going to do ... or even who's going to be the Prime Minister or what their policies are going to be."

From a market point of view that's problematic, Lister says.

"It's hard enough trying to pick economic outcomes, but to try and pick political outcomes, that's even more difficult again." For markets it means more ups and downs and more sharp reactions - both positive and negative - for an extended period, he says.

Trump may be a warmonger but even if he went back to war in the Middle East, it's not going to create another recession.
Mike Taylor, Pie Funds

"It is really hard to see what the circuit breaker would be."

Mike Taylor, chief executive of fund manager Pie Funds, takes a more optimistic view of the turmoil.

These events can create a lot of noise but don't spell doom for markets, he argues.

Economic uncertainty has a much larger effect on markets than political uncertainty.

"We saw that at the start of the year when fears of a US recession pushed global markets down 15 to 20 per cent. The Brexit effect has been mild by comparison."

It is important not to overplay the connections between events, he argues.

For example, there is a banking crisis looming in Italy, he says.

"Investors have to be careful not to say: the Italian banks are in trouble because of Brexit, because that's not true."

Republican presidential candidate Donald Trump speaks during a campaign rally. Photo / AP
Republican presidential candidate Donald Trump speaks during a campaign rally. Photo / AP

Taylor argues there are three things that really hit markets: "getting caught in a bubble like 1987 or the dot.com crash of 2001, financial market collapse like we saw in 2008 and lastly, when we see a fast rise in interest rates that can choke an economy and cause a recession."

Even someone like Trump in the US could present less of a market risk than some people fear, he says.

"Think back to 2003 when Bush went to war," Taylor says. "People are concerned that Trump may be a warmonger but even if he went back to war in the Middle East, it's not going to create another recession."

Still, economic concerns lurk. We have already seen global trade declining for about 18 months, Peacock says.

There is a risk of political uncertainty extending and exacerbating that trend.
"So you look round the world and say which economies are vulnerable to global trade," Peacock says, "China is top of the list."

Australia's Malcolm Turnbull. Photo / AP
Australia's Malcolm Turnbull. Photo / AP

That is ominous for New Zealand, which is increasingly reliant on China. It's a connection that has in many ways buffered us from the worst of the post-GFC economic mess.

So far in New Zealand, political revolt hasn't been big a factor, Peacock says. "But if you saw NZ First rising in the polls it wouldn't be a great surprise."

Taylor agrees there may still be unintended consequences from Brexit. And he agrees the post-GFC environment has been very tough for those who didn't already have assets.

"Just take Auckland: if you had no exposure to Auckland property you've had no growth in your wealth effectively. Whereas, if you were fortunate enough to own a property or properties, you're probably a millionaire. So there has been more inequality."

So could New Zealand be next?

Jennifer Curtin, University of Auckland associate professor in politics and international relations, points out that we have already seen one example of revolt with the Northland by-election - where voters handed the Government a resounding defeat.

Unsurprisingly, New Zealand First leader Winston Peters was beneficiary of the voter dissatisfaction.

When it comes to populist nationalistic leaders, he is our guy.

Italy's Prime Minister Matteo Renzi. Photo / AP
Italy's Prime Minister Matteo Renzi. Photo / AP

"Peters is the perfect kind of centrist, protest party independent style candidate," Curtin says. "He has the power of rhetoric and the charisma to draw people to him from both the Left and the Right."

Political reactions are linked to public perceptions of what is happening in the economy whether those perceptions are right or wrong, she says.

"The people who are the recipients of austerity are often the same people that are feeling disaffected. So it's not just working class voters in blue collar sectors who may have lost their jobs offshore, it's also young people 18-25; we see rural voters feeling disaffected.
We have seen a series of economic change that have affected people's lives materially."

What we saw with Brexit is that when you give people the chance to vote in a referendum "which is a yes/no, am I happy or am I not, this is a great opportunity."

Turmoil makes NZ dollar a safe haven

Political upheaval is stoking turmoil in currency markets as a wave of populist antiglobalisation sentiment sweeps the world.

Britain's surprise decision to leave the European Union sparked some of most volatile trading ever seen in the British pound.

And though most sharemarket indices - including London's FTSE 100 - have more than recovered losses sustained following the referendum, that hasn't been the case for Britain's currency.

It remains about 12 per cent below pre-referendum levels against the US dollar and hit a 31-year low against the greenback on Wednesday after the Bank of England warned that risks surrounding Brexit were beginning to "crystallise".

So far, the New Zealand dollar has largely benefited from post-Brexit currency movements.

With such a volatile political outlook in many parts of the world, this country is increasingly becoming a beacon of stability in the eyes of international investors.

"In the current world we're wearing one of the cleanest of all the dirty shirts," says ANZ chief economist Cameron Bagrie.

The New Zealand dollar has largely benefited from post-Brexit currency movements. Photo / iStock
The New Zealand dollar has largely benefited from post-Brexit currency movements. Photo / iStock

"There's a new thing people are looking at and it's political sensibility and stability and compared to an awful lot of places around the globe, we've got that."

And though this country's official cash rate is at a record low of 2.25 per cent, even that is attractive when many central banks are running near-zero interest rates.

On Tuesday the kiwi climbed to a 13-month high of 77.15 against the trade-weighted index, a basket of exchange rates against currencies including the US dollar, British pound, Japanese yen and euro.

Yesterday afternoon the kiwi was buying 55.15p, up from 48.5p before the referendum.

The New Zealand dollar also gained ground on its Australian counterpart this week amid uncertainty about the outcome of Australia's election.

It rose as high as 96.33Ac on Monday, but had fallen to 95Ac yesterday.

Though the kiwi usually gets sold off during times of heightened risk aversion, Bagrie says it has recently attained a "safe haven" status.

"The normal transmission mechanism isn't working," Bagrie says.

But he says the kiwi could come under pressure if "populist-driven unease" spreads to emerging economies, which include many of New Zealand's export markets.

That has already happened, in a way, with the election last month of Philippines President Rodrigo Duterte, a tough talker who swept to power on a hardline anti-crime and corruption platform.

"If [political turmoil] really starts to up the ante in terms of the risk profile of emerging market economies it will be a clear sell signal for the New Zealand dollar," Bagrie says. "The offer of those higher interest rates just won't matter."

- with Christopher Adams.

- NZ Herald

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NZ Herald business editor at large

Liam Dann is business editor at large at the New Zealand Herald. He has been a journalist for 20 years, covering business for the last 14 of them. He has also worked in the banking sector in London and travelled extensively. His passion is for Markets and Economics, because they are the engine of the New Zealand economy. He hosts The Economy Hub video show every Thursday.

Read more by Liam Dann

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