Brian Fallow

The Economics Editor of the NZ Herald

Standoff risk to NZ economic revival

If President Barack Obama does not avoid a default the market reaction will be extremely violent, says AMP. Photo / AP
If President Barack Obama does not avoid a default the market reaction will be extremely violent, says AMP. Photo / AP

Brinkmanship in the US threatens the business and consumer confidence on which its economic recovery depends, says AMP chief economist Bevan Graham.

Briefing journalists yesterday on AMP Capital's latest quarterly performance, its executives said they shared the financial markets' confidence a deal would be done and default avoided.

But if a default did occur the market reaction would be extremely violent, said AMP's head of investment strategy, Keith Poore.

"Equities would tank, big time. Main Street as well as Wall Street would protest, politicians would come under extreme pressure so default would be short-lived, but it would have an impact on the economy, for sure."

But Poore pointed to the credit default swaps market which was pricing the chances of a US default over the next five years at between 3 and 4 per cent - not high by the standards of the past four years and lower than in 2011.

It was a classical prisoner's dilemma from game theory, he said.

"The optimum for each side is to hold out and have the other side cave in. But if they both hold out you get the worst possible outcome, which could be catastrophic."

AMP's head of fixed income, Grant Hassell, said US treasuries were the primary collateral used for backing a lot of transactions in the financial market. "If people won't accept US treasuries you start to degrade the ability of [financial] institutions to deal with one another," he said.

"And that is exactly the Lehman's scenario," Graham said, referring to the freezing of financial markets after Lehman Brothers' collapse in 2008.

While AMP's view was that a deal would be reached, the question would be for how long, he said.

Recurrent episodes which indicated US political leaders could do fiscal policy only on the edge of an abyss undermined the confidence of businesses to invest and to hire, and of consumers to spend.

"And then the recovery which is finally starting to happen in America takes a backward step."

Hassell raised the issue of the implications for US monetary policy, as the Fed looks to taper off its purchases of US Government debt which have been running at a rate of US$1 trillion a year.

"You have got the Fed sitting there going, 'Who is going to be the marginal buyer of US Government bonds when we stop buying?' The politicians are making it even harder to find that buyer."

Poore said the initial impact of a US default on the kiwi dollar would be to send it lower because it was a "risk off" event, but in the medium term that could be reversed as the likes of China and Japan looked to diversify out of US securities.

- NZ Herald

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