An air of unreality surrounds the economic and fiscal update the Government released today.
It forecasts brisk economic growth averaging 3 per cent over the next five years, generating ever plumper surpluses.
It sets up an election-year debate about how to divide up those surpluses between tax cuts/income support, increased spending on public services, debt reduction and resuming contributions to the Cullen fund.
But by definition, the cheerful forecasts for economic growth do not allow for New Zealand being sideswiped by an economic shock from the rest of the world – the kind of shock that turns a lot of two-income households into one-income households and pops a property bubble.
The chances of getting through the next five years without such a shock are very low indeed.
There’s Donald Trump, for one thing.
Everything we know about his temperament and character indicates he is a disaster waiting to happen – the only question is when and in what arena. His election is akin to putting a child behind the wheel of a supercar and handing him the keys.
For example, hard on the heels of trampling over the One China policy, this week he has fired off intemperate tweets over the renminbi’s depreciation against the US dollar – oblivious to the complexities of China’s exchange rate policy and ignoring the effect his own election has had in driving US interest rates and the US dollar higher.
It does not augur well for relations between the two largest economies, nor therefore for the rest of us.
Then there is Europe.
Last weekend’s Italian referendum adds political instability to that country’s bitter cocktail of feeble economic growth, high unemployment and sky high public debt.
It increases the chances that a toxic build-up of bad debt in the Italian banking system will go from being a chronic to an acute problem, shaking the single currency’s already rickety foundations.
If it is the harbinger of Euro Crisis II, The Sequel, it would only add to Europe’s other challenges: Brexit, populism, refugees and Russian irredentist adventurism.
China, meanwhile, is sitting on a credit bubble. The ratio of private sector debt to gross domestic product (fast-growing though its GDP is) has doubled over the past eight years.
“The rapid increase in Chinese debt, continued pressure on the renminbi from capital outflows, and high house price inflation in major city centres indicate large vulnerabilities in the Chinese economy,” the Reserve Bank says in its recent financial stability report.
“A disorderly unwinding of China’s imbalances could particularly affect New Zealand banks’ access to offshore funding markets, given that China is the second largest market for New Zealand exports.”
Against this international background, fragile at best, we need to look at our own finances from the standpoint of resilience.
Our Reserve Bank has only 1.75 percentage points now available for conventional monetary policy.
New Zealand households are net borrowers from the banks to the tune of $75 billion, and “other residents” (ie businesses) another $25b. The banks fund this by being net borrowers from non-residents (foreign savers) to the tune of $92b.
Access to that inflow of savings at tolerable interest rates, and the ability to lay off the risk that when it has to be repaid the exchange rate will have moved against us, are clearly vital.
Offshore funding markets could be disrupted by a number of factors, including credit rating downgrades, a disorderly unwinding of vulnerabilities in China or Europe, and geopolitical risks.
Statistics NZ reported this week that 99,000 owner-occupier households spend 40 per cent or more of their pre-tax income on housing. Another 127,000 households that rent spend 40 per cent or more of their income on housing.The Reserve Bank tells us that about a third of new mortgage lending is at debt-to-income ratios of more than six times.
Looking forward there are two possibilities. One is that the economy is not walloped by an almighty international shock.
In that scenario, banks are increasingly reliant on offshore funding, their funding costs are rising and mortgage rates inevitably follow.
The more likely scenario is that there will be a shock that sees unemployment rise, incomes fall, foreclosures and forced sales jump, and a hit to household wealth generally that deepens the recession.