Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: Next year an economic cracker

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The domestic economy received a big injection from surging wool prices in 1951.
The domestic economy received a big injection from surging wool prices in 1951.

Next year should be a cracker as far as the New Zealand economy is concerned.

There are strong indications that it will be a once-in-a-generation year, as were 1951 and 1974 when the New Zealand economy grew by 15.6 per cent and 7.2 per cent respectively.

Economic growth is unlikely to be quite as strong as 1951 or 1974 but we now have some similar characteristics, particularly a soft commodities boom and a huge increase in the country's terms of trade index, which made these standout years.

The domestic economy received a huge boost from surging wool prices in 1951, wool and meat in 1974 and buoyant dairy demand at present.

The downside to 1951 and 1974 were rising prices and a strong New Zealand currency, two characteristics that could dominate the domestic economy in the year ahead.

In 1950, the United States Government started buying large quantities of wool to outfit troops during the Korean War. This resulted in a 46 per cent increase in wool prices in 1950 and a 129 per cent rise the following year.

New Zealand's terms of trade index, which measures the amount of imported goods an economy can purchase per unit of export goods, skyrocketed from 1091 in 1949 to 1406 two years later.

The domestic economy took off in 1951 with real GDP soaring 15.6 per cent, its best year since the 15.3 per cent growth rate achieved in post-Depression 1937. The downside was an increase in the inflation rate to 10.4 per cent in 1951.

The wool boom had a huge effect on agriculture as farmers invested heavily throughout the 1950s to expand into areas previously considered unproductive. National sheep numbers rose from 34.8 million in 1951 to 70.3 million in 1982 as chemicals and fertilisers were used to clear unproductive land and encourage grass growth.

The first signs of the 1970s commodities boom appeared in 1972 when the terms of trade index rose from 966 to 1070 before finally peaking at 1300 in 1974.

Meat prices climbed 50 per cent over this three-year period and wool prices 162 per cent.

The economy grew by 4.4 per cent in 1973 and 7.2 per cent in 1974 as the country experienced strong migration inflows, minimal unemployment, buoyant retail sales and a surging housing market.

Residential house prices soared more than 50 per cent in the two years ended December 1974.

The economy was clearly overheated as inflation rose from 6.1 per cent in 1972 to 7.3 per cent the following year and 10.2 per cent in 1974.

Another feature of the 1970s commodities boom was the strong New Zealand dollar which appreciated by 13.5 per cent on a trade weighted index basis between 1972 and 1974 and from US$1.1952 to US$1.4004 over the same period.

The good times came to an abrupt end in 1975 when the terms of trade index plunged from 1300 to 897 after the Organisation of the Petroleum Exporting Countries (Opec) raised oil prices nearly four-fold. This had a devastating effect on energy importers, particularly New Zealand.

New Zealand's economic performance has been disappointing since the mid-1970s, particularly compared with Australia. There have been occasional bursts of heightened economic activity, mainly driven by increases in consumer debt caused by rising house prices, but there has been limited investment in the country's productive sector.

The economy has been characterised by large net migration outflows as New Zealanders have been attracted by high-paying jobs across the Tasman.

But the economic momentum has swung dramatically over the past twelve months and transtasman migration flows could reverse as Australians are attracted by greater job opportunities in New Zealand, particularly in relation to the Christchurch rebuild.

There are several reasons New Zealand's economic outlook is more comparable to the early 1950s and early 1970s than the past 40 years. These include:

Terms of trade: The country's terms of trade index rose 7.5 per cent, to 1356, in September, the highest level since December 1973. Australia's terms of trade have fallen 18 per cent this year.

Dairy: GlobalDairyTrade auction prices have appreciated 52 per cent over the past twelve months and dairy exports surged 49.1 per cent in the three months ended October 31 compared with the same three months in the previous year. Recent surveys show that farmers have significant investment intentions, an important feature of New Zealand's strong economic performance in the 1950s.

China: It is now New Zealand's largest export market and is expected to continue to grow by more than 7 per cent a year.

Christchurch rebuild: The inner-city rebuild programme should gather momentum when construction begins on the justice and emergency services precinct from March next year, to be followed by the health precinct in the June or September quarter. These projects, which are mainly funded by the Crown and city, should encourage private sector investment in the inner city.

Migration: The country has had strong net migration inflows in recent months and had total net migration of 17,490 for the 12 months ended October.

This figure is expected to increase steadily over the next few months, and Statistics New Zealand figures show more than 90 per cent of new arrivals settle in Auckland.

Housing: The strong migration inflow should continue to boost the housing market and housing construction, particularly in Auckland.

Government finances: The Crown's financial deficit is falling and the Key Administration may announce tax cuts in May's budget. However, large expenditures on the Christchurch rebuild may restrict this option.

Confidence: Business, consumer and farming confidence are all at, or near, all-time highs.

Companies: Most domestic companies have strong balance sheets and plenty of capacity to expand and invest. Rod Drury and Xero have lifted the ambitions of New Zealand companies and we now have a large number of young entrepreneurs with aggressive global aspirations.

KiwiSaver: Last but not least is KiwiSaver, which is giving us a pool of private permanent funds that can be partially invested in the domestic productive sector. KiwiSaver ought to have the same positive effect on the domestic economy as Australia's compulsory superannuation has had on its economy.

In view of these factors the outlook for the New Zealand economy is exciting, the best it has been since the early 1970s.

The present export- and investment-led upturn could be maintained for several years - as long as dairy prices don't collapse, the Chinese economy doesn't go into an unexpected downturn and there isn't an external shock like that of the mid-1970s.

However, it is inevitable that inflation will increase - as it did in 1951 and 1974 - and the New Zealand dollar could go higher and higher.

Reserve Bank Governor Graeme Wheeler faces a huge challenge to ensure that he keeps a lid on inflation while at the same time ensuring that any rise in interest rates doesn't push up the NZ dollar.

The Australian Reserve Bank didn't achieve this objective during that country's mining investment boom and this is one of the main reasons our economic outlook is now much more positive than that of our transtasman neighbour.

Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

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