Grant Robertson:
We will get through this
It all looks vaguely familiar. An unexpected overseas shock hammers global equity markets before making landfall here. It all feels a bit 2008, the year of the global financial crisis.
But economists warn that this is different. In fact, BNZ economist Stephen Topliss cautions that applying global financial crisis-era thinking to this crisis could lead economic policymakers down the wrong path. The medicine has to match the disease.
‘‘The problem is we all search for previous events and try and say what happened last time will happen this time, but that’s not very helpful in this case because there’s nothing like it.’’
The last time the world faced a disease like this was in 1918, when the Spanish Flu killed millions. But even this isn’t a useful comparison. On the upside, medicine has moved on, potentially softening the blow; on the downside, the world’s economies are far more integrated, increasing the risk of economic contagion.
Another problem is that we’re not yet entirely sure what we’re looking at, or where Covid-19 will show up in New Zealand’s economic data.
An economy is many different things, what you’re talking about depends on what you look at.
Gross Domestic Product or GDP is the most well-known measure. It looks at the value of goods and services produced in a country, making it the best snapshot of what kind of effect something is happening on the economy. Two quarters of negative growth, for example, will equal a technical recession.
But it doesn’t measure everything.
If children were sent home from school but nearly all of them were then looked after by their retired grandparents it would cause massive disruption to everyday life, but it wouldn’t show up much in the GDP statistics because their grandparents wouldn’t be working.
There wouldn’t be much economic loss to be measured (maybe grandparents would take fewer trips to the shops) despite the fact that the world would look very different because there would be no children in school.
No one is suggesting a scenario like this – and if your children are sick with Covid-19 they should probably stay away from their grandparents – but it’s a useful illustration of the merits of looking at several different indicators at once.
Another measure is labour. We measure the number of people who have jobs and what they’re paid, we also look at the number of people who are looking for a job, or looking for more hours, and the number of people who have given up on the labour force.
And there are other measures that give a good indication of whether things like GDP will go up or down. ANZ has a ‘truckometer’ which looks at the number of trucks and cars on the roads. In a country like New Zealand, where a lot of freight is moved by road, the volume of traffic tracks quite closely with GDP.
We measure credit card transactions, the number of people arriving in the country, Customs even keeps track of the amount of goods we export and the prices we get for it. We even measure feelings — ANZ and the NZ Institute of Economic Research survey business confidence, measuring how firms feel about the economy as a whole, and their own situation.
All of these numbers interact in some way. The big numbers ripple through the rest of the economy. A downturn in exports will hit GDP, which will likely hit employment, which will come back and hit GDP.
Covid-19 will show up in all these indicators and the extent to which it shows up in different parts of the economy will give policymakers a sense of what response is required: is it hurting imports as much as exports? Is panic stopping people from going to the shops, leading to a slump in domestic demand?
A challenge for policymakers is that these indicators take a long time to put together. We won’t know whether New Zealand has entered a technical recession until September 17, when the second quarter of GDP statistics are released, other data is also prone to trickling out.
Banks and Statistics NZ are trying to fill the information deficit, releasing preliminary data early.
It’s painting a depressing picture. Statistics NZ exports data showed that the value of exports to China is down $142 million on where it was last year. Considering most businesses were expecting exports to China to grow, rather than fall, this represents a fairly dramatic shock to the economic system.
Meanwhile ANZ’s provisional release of its survey of business sentiment shows businesses feeling more pessimistic about the economy than they have since the GFC. They’re worried, and that means they’re likely to retrench, spending and hiring less, which itself hurts the economy.
‘‘The problem is, the data is always published with a long lag,’’ Topliss said.
‘‘We won’t see a lot of this so we are heavily reliant on anecdotal data and talking to people.’’
He’s keen to look at how people are responding to the crisis and gauge what their response says about the wider economic data.
He’s asking questions like, ‘‘why are people buying toilet paper? If people were really scared, wouldn’t they buy food?’’
Topliss said the biggest thing economists were seeing was the public’s response.
‘‘We’ve had other illnesses (and) we’ve never seen a reaction quite as dramatic,’’ he said.
While the crisis is clearly both an economic and a health shock, Topliss cautions comparisons with the GFC.
‘‘The GFC was a financial crisis. It was banks struggling to get liquidity and as a consequence of that a massive contraction in the supply of credit globally.
‘‘It was all nestled inside the banking sector. Once the banking sector was fixed, the world was fixed.’’
The problem with Covid-19 is that the crisis extends beyond banking and beyond isolated sectors of the economy – it’s about the health of everyone. That makes it far more difficult to solve.
Topliss said conventional economic stimulus responses might not cut the mustard. These generally revolve around getting people and businesses to spend, either by making borrowing cheaper through the cutting of interest rates by the Reserve Bank, known as monetary stimulus; or by putting money in people’s pockets by rolling out benefits, tax cuts and infrastructure building, known as fiscal stimulus.
‘‘If people aren’t spending because they’re too scared to go to the supermarket, giving them more money doesn’t help.’’
So far, the response from the Reserve Bank and the Government has been cautious. The Reserve Bank has held off cutting the Official Cash Rate, or OCR, although it’s widely expected to do so at its next meeting, on March 25.
Finance Minister Grant Robertson has also been cautious. The Government has already announced its $12 billion stimulus package, and Robertson says some of these projects can be brought forward if there is spare capacity in the economy.
The Government’s wage subsidy scheme looks set to be more muted and focused on keeping people employed, rather than flooding the economy with money.
Like Topliss, ANZ economist Sharon Zollner is forecasting that New Zealand will slip into recession this year.
She’s concerned about how fast the virus is spreading.
‘‘It changes with one super spreader,’’ she said. ‘‘You see that in other countries – it’s low numbers for quite some time and then things change quite rapidly.’’
And even if New Zealand manages to contain the virus and stop a community infection here, we’ll still be slammed by the effects flowing on from other countries.
‘‘It started off as an exports logistic shock which is something we’ve never seen before, at least not in the measured history,’’ she said.
‘‘Now it’s become a much broader demand shock, but also a supply shock. If you look at what is happening in China they’ve basically hit pause on their economy.’’
‘‘The problem is we all search for previous events and try and say what happened last time will happen this time, but that’s not very helpful in this case because there’s nothing like it.’’ Stephen Topliss BNZ economist
The problem here is that Covid-19 is hitting the New Zealand economy from every angle. The most immediate effect was on exports, as orders for shipping to China, which takes 28 per cent of our total exports, began to take a battering.
But imports are being hurt too. Factories in China have been closed. This means less stock for local retailers to sell. They were cushioned for a time because many had a buffer of inventory to fall back on, but that’s now running out.
Another under-appreciated import impact is the fact that both China and New Zealand are part of deeply interconnected global supply chains. The processing of raw materials for some food products can happen in China, even if the final product is
made here. Covid-19 will expose just how integrated we are to the global economy.
Zollner is also keeping an eye on how the Covid19 shock could trigger a crisis in other parts of the economy.
She’s watching the junk bond market closely. Junk bonds are risky investments (hence the ‘junk’), but investors have ploughed into them in the last decade because they offer attractive returns, especially in a time where extraordinarily low interest rates have made it difficult to get attractive returns elsewhere.
These attractive returns have potentially seduced investors who should possibly have been more cautious about the risks inherent to junk bonds.
A particular area of concern is shale, an expensive way of extracting fossil fuels. In ordinary times, financing for shale gas would be almost impossible to get, it was simply too expensive to be an attractive investment proposition, but reasonably high oil prices combined with extraordinarily cheap borrowing had made shale exploration economical.
That all changed this week when oil prices plummeted, mainly as a result of airlines slashing flights and the fact that oil consumption always falls during a downturn. Add to this a geopolitical stoush between Russia, the United States, and Saudi Arabia that’s seen the Saudis ramp up production to undermine the Russian economy by collapsing oil prices, and you get something of a perfect storm.
With oil prices hitting $30 a barrel, risky and expensive shale production is no longer viable. Investors then look to offload their shale junk bonds, but to whom? All of a sudden investors have an asset they can’t get rid of, pushing up prices.
This could then flood into the wider bond market, as risky assets, which had once been historically cheap thanks to historically low interest rates, become suddenly more expensive, truly reflecting the level of risk.
‘‘So the fear is of contagion in the broad bond market, and the potential to ripple into the credit market at a time which risk spreads have been very narrow as all this cheap money has been sloshing round for a decade,’’ Zollner said.
This has a flow-on effect for New Zealand. Our Government and businesses have become used to cheap borrowing, but as a small, highly open economy, we’re seen as a risky bet too. As the costs of borrowing increase overseas, there’s every chance ours will climb too, hurting indebted businesses, although we haven’t seen it yet.
Like all economic shocks, whatever comes from the Covid-19 crisis will eventually end. People will go back to work and KiwiSaver balances will rise again.
But although regular shocks tend to end after policymakers find the right circuit breaker, something that halts the fall, Covid-19 is different. It’s primarily a health issue, so fixing the economy will mean getting people healthy enough to return to work.
‘‘In the very worst-case scenario this will last for 12 to 18 months,’’ Topliss believes.
In that time, scientists will either come up with a vaccine, allowing the world to go back to work, or the virus will have whipped around the world once, leaving people less vulnerable should it come around a second time.
‘‘I don’t think there’s anything out there that warrants any form of panic,’’ he said.
‘‘Eighty per cent of people won’t catch it, or if they do catch it, it won’t cause any problems.
‘‘Of the 20 per cent who it becomes a problem for, only a small percentage of those will end up in a real mess.
‘‘The whole world is not going to end.’’