Signs to watch for in the global economy

In December 2008, three months after US bank Lehmans imploded triggering the global financial crisis, the price of gold hit the then record high of US$1200.

At the time, analysts predicted it had reached the top of its cycle, an opinion given substance by gold’s rapid drop in value to around US$1100 in the months following.

Back then, the other “flight-to-safety” asset was the US dollar. Panicked investors piled into the greenback, pushing the New Zealand-US cross rate to US49c in March 2009. It was not until June, when fears of a meltdown abated, that the kiwi pushed above US60c again.

Today global financial markets are again jittery because of uncertainty around the ability of some European countries to meet debt repayment schedules and the US, which is closing in on its US$14.3 trillion debt limit despite a last minute deal to lift the bar.

The price of gold is again reflecting market nervousness: an ounce is now more than US$1600; less than a year ago, it was US$1150.

But the NZ-US exchange rate tells a different story, one that reveals the unique nature of the present dangerous period: the kiwi has reached a post-float high of more than US88c.

As Roland Randall, Singapore-based senior strategist for TD Securities, notes, the US dollar is no longer the safe haven it once was.

The greenback is low because of the the historically high deficit level in the United States and its sluggish economic recovery.

Analysts predict the kiwi dollar will remain above US80c for the next six months.

There is much international uncertainty, exacerbated by the “fast-moving” nature of events, comments BNZ chief economist, Tony Alexander.

But  in the event of continued turmoil in financial markets due to concerns about the US deficit and nervousness over debt levels in the Eurozone , the following sequence of events, says Alexander, might go like this:

“World markets would seize up again, leading to banks having to recapitalise [by] using government money and deficits would get worse.

“They would have to rein in spending, so there would be weakening activity,” Alexander says.
 
If the Chinese find their export orders are collapsing as consumers go back into their shells in the US and Europe – you’d basically get some version of a repeat of the post-Lehmans situation.”

Randall believes the impact on New Zealand from such a scenario could be severe: “It’s not the direct trade links that are so important; it’s about confidence in the financial markets.

“The risk to New Zealand is its exposure to offshore borrowing and the impact of the Euro contagion on financial markets,” Randall continues. “The tap could be turned off as a result of these global issues and then the banking system in New Zealand would be in crisis.”

David Tripe, head of Massey University’s banking studies, says the Australian-owned banks are in much better shape than they were in 2008. Reserve Bank capital requirements, including shifting a greater proportion of bank funding from short-term to long-term, provides greater comfort.

“But they still do have significant dependence on non-resident funding,” Tripe warns.

However, it’s not all doom and gloom. Standing New Zealand in good stead is an improved overall debt position. Tripe: “[Treasury] figures, as at 31 March, suggest that the net foreign position is less than 80% of GDP – it’s hardly good but it’s not as bad as it was.” By comparison, the US debt is 98.6 percent of GDP.

How international financial institutions treat New Zealand as a debtor, Tripe says, in the advent of a second crisis is debateable.