When Will All the Spending Stop?

Two weeks ago in this column, we mentioned that it was the banks who were leading the way in the property market with a mortgage war.  Last week Alan Bollard, Governor of the Reserve Bank came out with a very similar argument.  As his was very much a prepared speech, he had probably been forming his opinions for some time.

While the trading banks have to report to the Reserve Bank on a regular basis, the Reserve Bank is unfortunately almost powerless to be able to take any real action.   They cannot stop the banks having their mortgage price war, offering finance deals to borrowers whose only asset is their ability to earn.  There are now only two New Zealand owned trading banks and both are minnows in comparison to the Australian owned trading banks that dominate the market.  The good news is that if the Australian owned banks get into trouble they will not be able to ask the New Zealand government to bail them out like they did twice for the BNZ in the early 1990’s.

We need to remember that New Zealand has one of the world’s most open economies.   Over the economic cycle, we rely on important contributions from the export sector and inbound tourism.  At the moment, despite reasonable terms of trade the impact of net exports is weak, while the domestic sector has continued to grow extremely strongly, driving imports strength.   The positive trade balance we have enjoyed over the last decade and a half has now reversed. 

The trade balance has now fallen to a deficit of 2 per cent of GDP.  This trade deficit has been a principal (but not the only) reason for the severe fall off in the current account balance (the balance of flows carried in the country and abroad.) Our current account deficit has now reached 8 per cent, the worst figure since 1986 and very marked by OECD standards.   What this points to is that the New Zealand dollar must fall.  The decline in the New Zealand dollar exchange rate will either be gradual, as domestic spending pressures ease off, or it will be more abrupt as global investors reassess New Zealand as an investment destination.  This past week, we have seen a large overseas financial institution advise its clients to sell the NZ dollar.

Over the past few years, the household sector, which represents a large part of the economy, has been running down its savings in spectacular fashion.  We are now living in a spend now phase, so much so that we are now dissaving at about 12 per cent, which is very low by OECD standards.   Such spending has been made easier by banks and other financial institutions lending freely on homes, encouraging people to put other debt on to their mortgage, and increasing mortgage levels to allow home-owners to consume part of the equity in their homes.  This may be part of a longer term change in behaviour by baby boomers to consume more of their wealth during their lifetime. 

We have real concerns about all this spending, particularly when it is largely on non productive items.  If the spending is coming from non borrowed money, it would be more prudent for some of it to be wisely invested to provide for the inevitable “rainy day”.