The risk associated with a country, (eg New Zealand) is sufficiently lower than a bank or non-bank financial institutions. The current account deficit in December was 7.9% of GDP – so our debt was 7.9% of our income, that sounds sustainable to me. I do agree that it would be good if it was lower – hopefully tax cuts will help with that.

“exchange rate $0.80:$1 down to $.40:$1 when the Northern Rock of the South Pacific stops borrowing yet more money”

If the exchange rate suddenly tumbled, it would be cheaper for people to invest in NZ. As the rate of return is the same this will attract investment and drive the dollar up. $0.40US is unrealistic, especially with the US dollar so weak.

Also if we ‘stopped borrowing money’ then the supply of NZ dollars would fall, driving up the exchange rate – not driving it down!

“The government has taken money out of the hands of taxpayers. As their gross incomes have risen the only way people have been able to spend some of that hard earned increase in gross income has been to borrow more to spend”

Yes, its called Ricardian equivalence – that is why I expect a fair chunk of tax cuts to be saved or used for debt-servicing. Economists do realise this is going on, but the money is being saved by government (ergo surpluses) so its not too big a deal.

“The point being that it becomes unsustainable at some point. Northern Rock looked sustainable not so long ago.”

Again, why are you comparing a bank to a country. If our banking system was fragile and/or our government was running big deficits to go along with the current account deficit we should be concerned – however it is not like that so the analogy is misleading.

“Old school stagflation is a very real risk for New Zealand.”

As i’ve said we have had a drought and a spike in fuel prices, these are called aggregate supply shocks. Stagflation occurs following aggregate supply shocks – however stagflation for a year or two is not a huge deal if it is only mild (slow growth, above target inflation). If you are thinking of double digit inflation and a recession (what people tend to think of when hearing the word stagflation) then you are a bit over pessimestic.

8.3% of income in 1 year is manageable. When it has persisted over many years there is an imbalance which must come back to equilibrium.

What do you think would happen if Chinese manufacturers were no longer able to rely on China buying US Treasury bills to allow US consumers to purchase Chinese goods.

What is going to happen when Japanese lenders realise they face a 50% loss in capital(exchange rate $0.80:$1 down to $.40:$1 when the Northern Rock of the South Pacific stops borrowing yet more money. For NZ borrowers 8% on a $200,000 mortgage is affordable on an income of $80,000. 12% on a $400,000 mortgage is still not affordable on an income that has only gone up 25% to $100,000.

Some Japanese lenders WILL realise the merry go round has stopped and will try to get out first. Facing a prospective 50% capital loss within 12 months makes an interest rate of 10% not quite so attractive.

The government has taken money out of the hands of taxpayers. As their gross incomes have risen the only way people have been able to spend some of that hard earned increase in gross income has been to borrow more to spend. Once that genie has been let out of the lamp it is very difficult to get it back in. Every other consumer is borrowing to spend so why not do it themselves. as an economist you dont like to deal with human behaviour but it is a very real impact on what has happened in the western world in general and new zealand in particular.

The point being that it becomes unsustainable at some point. Northern Rock looked sustainable not so long ago.

Old school stagflation is a very real risk for New Zealand.

If it was unsustainable no-one would lend to us. I agree that we will have to pay back our debt at some point. However, what is our current account deficit, 8.3% of GDP, so 8.3% of our income – thats handleable, its not yelling out for a sudden correction.

“12 years ago mortage rates were up at 12.5% but house prices were much lower”

Twelve years ago the houses that were on the market were smaller, the price of land was much lower (as the opportunity cost was lower) and our population was smaller. Ergo its a completely different situation.

“The governments sound fiscal position has been caused by overtaxation which has suppressed growth”

That does not change the fact that it is sound – the argument that growth has been ‘suppressed’ is separate to the argument that we are on the verge of an economic collapse.

“If New Zealand does get by without a recession it will only be at the cost of an extended period of stagflation”

Stagflation is for a year or so is likely, it is likely all across the world – especially as the price of imported manufactured goods increases. I’m confused here, didn’t we have a small period of stagflation in 2006 – isn’t stagflation just a couple of quarters of low growth (below 1% annualised) and inflation outside the target band.

This type of stagflation is NOTHING compared to the old school type – I think we should probably define it to mean something a bit stronger.

Your post says that the dip will be shallow. 12 years ago mortage rates were up at 12.5% but house prices were much lower.

The governments sound fiscal position has been caused by overtaxation which has suppressed growth. High interest rates will continue to do the same.

If New Zealand does get by without a recession it will only be at the cost of an extended period of stagflation. Which is preferable? A short sharp correction or steadily falling further behind the rest of the world?

When credit dries up, and it will, the price of houses will be unsustainable.

Either that or stagflation as wage pressure based on the need to afford somewhere to live forces a correction.

UK & Australia are different. Australia has boomed off the back of commodity prices & exports to China. UK has boomed off financial services and Billionaires wealth transfers whether Russian or oil based. The US economy has boomed but housing affordability there is on a much more balanced level. The fact that lending practices are dodgy has not resulted in the same overpricing of housing so prices do not have so far to fall.

New Zealand has had the benefit of dairy prices, which is small in comparison. Otherwise it has used the virtual wealth created by the property boom to add large numbers of bureaucrats, break productivity growth, spend up large on welfare and do a number of other value reducing activities.

Equilibrium will come, and it will be painful for New Zealand. The 87 crash and the housing boom have similar attributes

Yes, they are, and have been for the past eight months (especially over the last four). However, this situation won’t last forever – it just depends on when the risk from the subprime mortgages gets washed out of the system.

“New Zealand is utterly reliant on the Japanese carry trade.”

To fund our current account deficit, indeed. However, as a small and robust economy I’m confident we will find it easier to secure credit than a large country. I agree that ultimately we will need a correction in our current account, hopefully this can be a gradual improvement instead of a sudden sharp correction. I think tax cuts will help.

“When, not if, some of them determine that the return is not worth the risk there will be an enormously destablising correction”

As long as the US remains weak our dollar is a reasonably strong bet to remain strong. WIth the high yields we provide to investors I don’t think the carry trade will dry up for that reason. We have to be more concerned about whether the global supply of credit remains elevated. I am confident that the large central banks will do everything in their power to prevent a complete stalling of the credit market – as a result we may face higher inflation and interest rates than we do now, but not economic collapse.

“I am reminded of 87 pre crash”

If my memory serves me correctly, the 87 crash was most potent in NZ, as speculation had been over the top here. Comparatively, NZ does not have the same level of subprime loans and negative gearing, so the impact on housing is likely to be weaker here. As a result, I do not expect NZ to slow as much as the US or UK

When, not if, some of them determine that the return is not worth the risk there will be an enormously destablising correction. Credit will disappear and the currency will finally tank. It might be for the long term good of the country but it will not be a pretty sight.

I am reminded of 87 pre crash, except it is mortgage backed private spending on the basis of unsustainable house price inflation that has been fuelling the boom.