It is a surreal time to be a student of the New Zealand economy. Our economy resembles a rickety two cylinder engine powered by dairying and the Christchurch rebuild. Our political leaders suggest that the high value of the New Zealand dollar is a vote of confidence by international financiers in the strength of our economy. They also imply that record low interest rates are a sign of economic good fortune. Meanwhile, businesses continue to fold and unemployment appears to be mounting.
In 2008 our economy narrowly dodged a bullet. During the global financial crisis, the Government moved swiftly to ensure confidence in our financial system by providing a guarantee to banks and other lenders. This cost taxpayers dearly with the collapse of institutions such as South Canterbury Finance. But the guarantee prevented a general meltdown that would have occurred if depositors had realised just how fragile any financial system is to a systemic loss of confidence.
The bankers received a massive shock and reined in their lending practices. The housing market slumped yet did not collapse as occurred in some countries.
Such an outcome would have been very ugly for our economy. There are several likely reasons why a sharp housing correction did not occur here at that time. Most New Zealanders struggle to accept that housing markets are susceptible to corrections. They refused to sell so sales volumes plummeted for several years.
We also didn't experience the large surge in unemployment that occurred in England, Spain, Ireland and the United States. The industries that contracted rapidly there were construction and finance which were major employers. These countries also had a large overhang of unsold newly constructed dwellings from the boom period.The other factors propping up our economy were the booming Australian and Chinese economies.
So the attitude that prevails here is that we were the exception. Our housing boom of 2003-2007 was driven by fundamentals rather than excess credit and speculation. This view continues to deny how vulnerable our small economy is to external shocks. These could easily expose that we have been living beyond our means as a nation for many years under the delusion that housing inflation represents real gains in national wealth.
Trigger points could include a sudden plunge in our exchange rate or an adverse event affecting the dairy industry. There is little doubt that the New Zealand dollar is overvalued against many currencies. It is propped up by our staunch anti-inflationary policy and the perception of currency dealers that we are a relatively safe bet due to the predictability of these policies.
This is not the same as a vote of confidence in the validity of these policies. If the New Zealand dollar plunges suddenly then our cost of living will surge. This would rudely expose that we have been living beyond our means for many years. The Reserve Bank is closely monitoring the rampant housing market in Auckland and Christchurch which are being driven by renewed demand interacting with supply constraints. The commercial banks are resuming their old aggressive lending practices. The Reserve Bank appears confident that this is not leading to a renewed credit binge. What it is doing is luring more young Kiwis into mortgage servitude to purchase very average dwellings.
While this may be rational and affordable with record low interest rates, it makes an increasing segment of our population very vulnerable to any sharp correction as occurred in 2007/8. The banks are aware that in such a circumstance they are unlikely to pay the full price for unsound lending practices. We are continuing to dig ourselves into the deep hole that we were lucky to escape from several years ago.
By Peter Lyons
Peter Lyons teaches economics at St Peter's College in Epsom and has authored several economics texts.