New Zealand Economy

Jesse Colombo has written an article in Forbes magazine warning that the New Zealand economy is in a bubble that will end in disaster. This grated a bit because the popular view among economists is that New Zealand is a rock star economy that is leading the pack. Politicians quickly jumped in to label Jesse Colombo as a doomster, who does not understand what is happening here.  However, he picked the subprime collapse, so he must be given some credibility.

I have some sympathy with Jesse Colombo’s view. The New Zealand economy is currently strong. The unemployment rate is 6%. The Treasury is forecasting real growth of 2.5% for the next couple of years.

Two things have helped the NZ Economy.

1. The Christchurch earthquake brought billions of insurance dollars into the country. Thousands of houses have to be rebuilt over the next two years. Many more need to be repaired. A huge number of commercial buildings are being rebuilt with insurance money. This is a huge boost to the economy.

2. International prices for dairy products are at record levels. This has really helped the New Zealand economy.

Despite this good news, there are two big worries about the economy.

1. As Jesse Colombo has pointed out, house prices are grossly overvalued. They have doubled in the last ten years. In Auckland , which is our the largest city, young people are paying more than half a million dollars for a do-up or an old dunger just to get into the market. Banks have been supporting the boom by providing mortgages for 95 percent and sometimes 100 percent of the purchase price. (The central bank last year introduced limits on loan to value ratios in attempt to cool the market). The central bank has kept interest rates very low for the last few years, but they are now beginning to rise. Household debt is very high, so many people are vulnerable to a decline in house prices or a big increase in interest rates.

2. The New Zealand economy is very dependent on the dairy industry. When I was growing up on a farm, the sheep industry was larger than the dairy industry. Over the last twenty years, a huge number of farms have converted to dairying. This has required an enormous capital investment, but returns have been very good, and farm prices have sky rocketed. Most of our milk products are exported to China. So we really have all our eggs in one basket. Last year, a faulty test that recorded botulism in milk powder stopped exports to China for a few days, until the error was corrected. Some categories of milk powder still do not have access to the Chinese market.

The New Zealand is very vulnerable to a biosecurity crisis that effects our exports to China. It would also be severely hurt by a collapse in residential real estate. So like most rock stars, New Zealand could easily fall off the edge.

Permanent Downward Shift

The New Zealand Treasury recently issues the following picture.

Their spokesperson said that the impact of the global financial crisis on the NZ economy was not purely cyclical. After most downturns, the economy usually recovers quickly and returns to the growth path that it was on before the crisis. Their analysis suggests that this will not happen with this crisis, so the lost output will not be restored.

The Treasury is worried that the government will not receive the same level of tax revenue as before. I am more worried about the loss of output. I dug into the numbers to identify the sector where the output has been permanently lost. What I found is interesting. The services sector is doing fine. Agriculture has struggled, but is still doing okay. The construction industry declined rapidly at the end of the housing boom, but will eventually recover when growth population increases the demand for housing. The retail sector has been flat. Nothing striking in any of these!

The big change has taken place in the manufacturing sector. The middle column of the table below, shows the change in sales adjusted for price change in the manufacturing sector between 2007 and 2010. The right-hand column expresses this change as a percentage. The column on the left shows the original size of the industry.

Source: Statistics NZ

The only industry to grow is paper and paper products (so much for the paperless office). Most other industries have lost at least a hundred million dollars of sales. The larger industries have lost more than two hundred million dollars of sale. Looking at the entire manufacturing sector sales of nearly two billion dollars have disappeared from a sector worth eleven billion. This is the equivalent of our entire forestry-related industries disappearing overnight (Wood and Paper Products). Fill jobs in Manufacturing declined by 17 percent over the same period.

Some of the activity may return when the construction sector recovers, but I presume that most of this activity is gone forever, possibly to China.

This is the Permanent Downward Shift in Output. Putting it more bluntly, the manufacturing sector has been gutted in the last few years.

One reason is lack of demand from trading partners. The other reason is the Reserve Bank's policy of keeping interest rates high to kill the housing boom. The high interest rates caused problems for real businesses. They also attracted speculators, which strengthened the New Zealand exchange rate, which put pressure on exporters. This was a double whammy for manufacturers.

Big Dipper

The government statistical agency has just released economic growth statistics for the September 2010 quarter. The Christmas news is that GDP has declined by 0.2 percent.

The New Zealand economy peaked in the Dec 2007 quarter. The recession began in Mar 2008 quarter, a quarter earlier than in most other countries, because a serious drought affected our agriculture industries. The economy bottomed out in the March 2009 quarter after five quarters of recession, with GDP 3.5 percent below the peak. The banks in New Zealand had not got caught up with the subprime junk that contaminated the Northern Hemisphere, so the decline was not as big as in many other countries. The recession in the United States was almost twice as deep.

Since the bottom of the recession, the economy has been recovering slowly, but now it has stumbled, with only half of what was lost being recovered. Our GDP is still 1.7 percent below what it was at the peak. The construction industry has not recovered and the retail sector is still struggling. The good news is that the NZ dollar has weakened over the last few months as speculators have withdrawn, and prices for dairy and meat products, which are a huge chunk of our exports, are at record highs. Unemployment is below 7 percent, so there is no reason why the 0.2 percent decline is a signal that things will get dramatically worse.

Some commentators are talking about a double dip depression. That is a bit misleading, because there is no indication that we are going into a massive decline. A better description would be a big dip.

Household Deleveraging

American households have shut up shop and stopped spending. After a couple of decades of borrow and spend, they need to get their balance sheets in order. This creates a problem for business that produce consumption goods. This falling demand is a serious issue for the businesses produce consumer goods, but fortunately many of them in a China.

In a free economy, this falling demand would not be a problem. When households stop spending, interest rates usually fall. If households are saving more, banks can offer lower interest rates and still get the funding they need. If households stop borrowing, banks have to lower interest rates to attract borrowers. Increasing supply and falling demand both push interest rates down.

When interest rates fall, numerous investments projects, which previously could not make a reasonable return, suddenly become viable. The result is increasing demand for investment goods. Some businesses will respond to that demand by shifting resources from the production of consumer goods to the production of investment goods. This adjustment may take a couple of quarters, but by shifting the mix of production away from consumption to investment, the slack in the economy is quickly taken up. More important, the resulting build up of capital goods tends to make the economy even more productive in the future.

In a free economy, if demand for consumption falls, production shifts to investment goods. When household start consuming again, the extra capital makes the economy more productive, so the demand for extra goods is easily met. There is no need to have a demand driven recession.

Unfortunately, America is not a free economy and interest rates are fixed by the Fed. Although households are saving more, the Fed has left interest rates unchanged, so the signal that declining interest rates should give to businesses has not gone through. Worse still, the Fed held interest too low during much of the decade. This sent the wrong signal to businesses, and may investment projects were undertaken that would not have been viable, if interest rates had been at an appropriate level.

Artificially low interest rates cause households to borrow too much and business to produce too many investment goods. Households are reducing demand for consumer goods to get out of debt. Businesses should be able to switch to producing investment goods, but there is already a glut of capital goods, due to past overproduction in response to artificially low interest rates.

The leaves the productive sector in a bind. Demand for investment goods and demand for consumer goods, which should balance each other, are both declining. This leaves the government to fill the gap by increasing its purchases of investment goods.

Unfortunately, the government does not have any money, so it has to borrow to spend. This works in the short term, if a nation is willing to mortgage its future, but in the long-term, this increase in government debt adds to huge debt hanging over the country.

This debt and demand imbalance will prevent the economy from launching into economic growth, but it will not cause it to fall off the cliff, for quite a while. A double dip does not seem very likely, but nor is it likely to be a vee. The American economy could trundle along at a bit above mediocrity for quite some time.

American Economic Situation

Many economists are suggesting that the American economy will experience a double dip depression. Quite a few Christian prophets have jumped on the same bandwagon, but I am not sure if this is wise. The American economy seems to be in a much better state than these pundits are suggesting.

The banking system seems to have come through the crisis quite well. Goldman Sachs and friends are getting a lot of stick, but they did America a favour by flogging off a large share of American subprime debt to European banks, without buying back any of the sovereign debt from Greece and Spain that the European banks are now choking on. Having written off their subprime debt, or better still flogged it off to the Fed, the larger banks are now reasonably sound.

Federal debt is a very serious long-term problem, but as long as the Fed is willing to engage in quantitative easing (printing money) the chickens will not come home to roost. In normal circumstance, printing money would cause the value of the dollar to collapse, but given that most countries are engaging in similar policies, there is no currency to devalue against. This pumping could trundle on for a several decades before the day of reckoning comes.

The households who poured their savings into houses they could not afford have lost their house and their savings, but the strength of the economy does not depend on them. There is a huge surplus of housing in many parts of the country, so the house building industry is not going to take off any time soon, but house building is not the heart of the economy.

The heart of the American economy is its ability to innovate and that is still very strong. As long as America can continue to develop new products like the iPhone and the iPad, which are wanted by people all over the world, it should not be written off. An economy that can produce robots that can saw through pipes a mile under the sea is not gong to go under any time soon.

Unemployment will continue to be a problem. However, provided the American people continue to be willing to send their young people to fight and die in futile foreign wars, surplus labour will not be a serious problem.

The stock market has run well ahead of the recovery and is due for a correction, but there is no fundamental reason for stock prices to collapse.

I am not expecting a double dip. Nor do I expect a rapid recovery. I expect that the American economy will trundle on at current levels. I will explain why in my next post.

Preparation is Urgent

We have allowed evil into our economy and society, and when it turns against us, we will be powerless against it.

• Evil is lurking and will strike when the time is right and opportunity comes.

• The economy will nearly go “belly up”. Order might be restored, at the last minute. Many will be seriously hurt, whether they bail out or jump.

• The crisis will bring a serious fuel shortage. Some fuel will be available, but supplies will be stop-start.

• The crisis will cause food shortages. Some people will have plenty, others will have none. Some hard working people will face long delays without food. They will become angry and may get violent.

• Most Christians are totally unprepared for the next crisis. Many are travelling on in isolation, totally unaware that a huge disaster is going to cut into their path. Most will survive, but they will be distressed and shaken.

• Christian pride and complacency will be exposed.

• Christians must learn to live more simply. The smaller option will often be the best.

• Some Christians will be betrayed. People that they have risked their lives to help will turn against them and take advantage of their generosity.

• There will be no quick fixes for this crisis. We will be stuck in the mess for quite a while. The disaster might last longer than the good times that went before.

• When we get through the crisis, we will have progressed much further towards the kingdom than most people expected.

Preparation is urgent. There is no time for mucking around, trying to get things perfect. Getting prepared is more important than getting things exactly right.

Christians should be Alert

Christians should be preparing for this next crisis, but most have been lulled into a false sense of security by the mild impact effects of the current crisis. People are heaving a sigh of relief, as the economic signs and statistics indicate the crisis has ended and recovery is underway. Most Christians are thinking:

If this is the worst depression
since the 1930s,
its not too bad
I can cope.
Things are tight,
but I am alright.

This widespread sense of relief is based on a misunderstanding of what has happened. Most Christians came through the financial crisis unscathed, but not because they were prepared to cope. God turned back the crisis, because were not prepared.

A greater danger now lurks, but casual chatter has created a dangerous complacency amongst Christians. In face of danger, we plunge on, because things look rosy on the surface.

Most Christians could not cope with a real economic crisis. The independence and individualism that characterise modern western Christianity will not “cut it”. Christians should be establishing connections with other Christians who will support them when times get tough. Some should be moving closer together to create zones of security in a chaotic world.

Devil of a Depression

The financial crisis was not that bad in New Zealand.

• The banking system is strong
• GDP declined by less than 3 percent.
• Most people still have their jobs.
• Property prices fell be 10 percent, but have recovered quickly.
• People are still walking their dogs (not eating them).

God was going to work the crisis for good by using it to shake the nation, but his people were not ready, so he turned back the evil. The crisis was not as severe as expected, because God held back the economic tide to protect careless people from unnecessary suffering. The entire world benefited from this mercy,

but…

It will not happen again
In recent years, a power shift has taken place in New Zealand. We have unwittingly handed control over many aspects of our culture, our society and our economy to the forces of evil. Our nation has progressed so far down the wrong road that the forces of evil now have a much freer hand. God’s ability to turn back evil is now severely limited. By choosing to cast off restraint, we have left evil unrestrained.

So far the consequences have not been that serious, but the evil one is now flexing his muscles ready to show what he can do. He has been watching the world financial crisis and thinking, “I can do better than that”. His is planning a strike against our export industries that will devastate the New Zealand economy and plunge us into a serious disaster. This crisis will not be constrained by the hand of God, but will be the devil’s depression.

The current financial crisis will be followed by a worse depression worked by the devil’s fury for the purposes of evil. A crisis made over by God could have brought revival and blessing, if we had been prepared, but the devil’s depression will bring collapse and destruction that is deeper and darker than anything that this generation has seen.

Satan is not as powerful as we like to think. He is having difficulty getting together the capability to cause a disaster, but he will eventually succeed.

Uncertain Economy

At the moment, I am not certain how things will go. There are two possibilities.

1. The actions of the political and monetary authorities might be effective. Sometimes the wrong solutions are effective for a while, even if it stores up problems for the future. The capital injections of central banks may be enough to unclog the banking system. Collapsing gasoline prices and declining mortgage interest rates might make households feel confident enough to take out their wallets and start spending again. The world economy might respond by changing up a gear and moving slowly back into growth mode.
2. Government policies might fail. Unemployment could surge upward meaning that more and more households are unable to make their mortgage payments. An increasing number of mortgagee sales could cause house prices to collapse even further. More toxic bank debt might be exposed causing the banking system to implode. A big wind down in consumer spending could bring business activity crashing to a halt. These effects could join together in a vicious circle of decline.

The political and financial authorities hope that the first option will prevail, but they cannot be certain.

One outcome is certain. The credit crash will lead to an immense increase in state power. Huge losses in personal and economic freedom will be welcomed throughout the world by people who want to be rescued from troubles.

Two Pivotal Changes

The economic crisis in America is bringing about two critical changes.

1. The days of easy credit are gone forever. Two decades of low interest rates and easy borrowing have dramatically changed our lifestyles. Tight credit will change our lifestyles back to what we can afford.
2. America is grouching to being the Beast. It was once the home of market capitalism and the bastion of independence. Faith in the state has been growing rapidly over the last few decades. The state has just made a huge series of interventions in the economy and most Americans are cheering. They will never be able to resist the lure of the state again.

The Economic Situation (12) - Overall Assessment

Globalisation and the development of Asia have strengthened the world economy immensely over the last couple of decades. This strong economic activity should continue into the future, but five major risks which are very difficult to assess.

1. The first risk is the credit crunch. Will the pain be limited to the financial sector, or will it spill out into the rest of the economy. Higher interests rates are inevitable, but their impact on economic activity is much more difficult to assess. The flawed financial system will eventually collapse, but not for a while yet.
2. A related risk is the lever pullers who run the financial system. They have considerable ability to get things wrong trying to put things right. The credit crunch is the result of a foolish response to the dotcom crash.
3. The third risk is the price of oil. The long term direction of oil prices is very difficult to assess. A serious escalation of prices would do serious economic harm.
4. War in the Middle East could cause tremendous damage.
5. Most depressions are caused when unexpected events are exacerbated by political leaders. The capabilities of our political leaders have not improved recently. They still have the ability to stuff things up. Unexpected events are inevitable. Mistakes by political leaders are even more inevitable.

The last of these five risks is the most serious. The kingdom of man has been riding high for several decades, but its days are numbered, because the Kingdom of God is coming. God will sooner or later shake the kingdom of man, so that it falls away. The clever political and economic leaders will assist him by making this situation worse. They will totally undermine their credibility.

The world economy looks quite strong, but we should never take prosperity for granted. God may have something different in mind. He usually shakes the kingdom of man when it is not expected.

This full series is at Economic Situation.

The Economic Situation (10) - Balancing Oil

An economic model that can accurately assess and weight all these factors together to determine the future price of oil does not exist. We simply do not know how severe some of these effects will be. However, we can be sure that all these factors will come together in the oil market to decide the price. I am happy to leave this question to the market to decide.

I do not have any revelation about the direction that prices will go. In the short term, I expect that ail prices will continue to go down as the weakness in the American economy bites and as consumers respond to high gasoline prices.

On a more cautionary note, I have been amazed out how easily we have coped with oil prices above $100 a barrel. We have grumbled a lot and carried on doing most things that depend on oil. Air travel had not declined dramatically. I once thought that prices at that level would cripple the world economy, but the events of the last few months have proved that this is not the case. The credit crunch has had greater impact than high oil prices. I am sure that OPEC have noticed this too. They do not have the ability to control oil prices, but given that they have had some extremely good years, they will be able to bring significant cuts in production to prevent oil prices from falling to far. Therefore, I suspect that we are unlikely to see prices go much below $100 per barrel. That is not a problem as the world economy will be able to cope.

Wise observers will be aware that market prices sometimes overshoot. We have probably just seen oil prices overshoot on the way up. They may also overshoot on the way down.

In the longer term, the pressures on oil prices are mostly upwards. How fast and how far they will go up will depend on how quickly new supplies can be pumped and how quickly the world can reduce dependence on oil. No one knows the answer to that except God.

The Economic Situation (9) - Bad News about Oil

1. Although Americans have cut back on their gasoline consumption, it is not clear that this can be sustained. The American suburban lifestyle cannot function without cheap gasoline. Americans may not be able to change their lifestyles sufficiently to bring about a permanent drop in dependence on oil. If gasoline prices drop a little, they will probably hit the hammer again.
2. The weakening of the American economy is reducing demand for oil. The problem is that this could be temporary. When the economy returns to full health, most of this demand for oil will be restored, putting upward pressure on prices. If the recession is short, the demand for oil will recover quickly.
3. Oil production has slowed over the past few years. I am not sure if we are anywhere near peak oil, but there is no doubt that the easy oil has already been pumped.
4. A serious problem is that no one knows the size of Saudi Arabian oil reserves. When the Americans were kicked out of Aramco in 1979, the Saudis had proven oil reserves of 50 billion barrels. Since then the Saudis have increased their reserves to 260 billion, despite not find a single new oil field. In the past ten years, they have pumped at least 50 billion barrels of oil, but their reserves are never adjusted down. The problem is that the Saudis do not allow any outsider to monitor their production or authenticate their reserves. Their reserves may be much smaller than they claim. When the truth emerges, the world might be oil shocked.
5. Nigeria has become an important oil producer, but the political situation in the oil producing areas is increasingly unstable. Oil workers have been kidnapped and oil pipelines have been destroyed.
6. Iran is an important oil and gas producer. Any military action against Iran would disrupt Iranian oil production. Iran might retaliate by closing the Straits of Hormuz through which half of OPEC oil must pass. This would blow out the price of oil.
   
   The problem is that Prime Minister Ehud Olmert of Israel, President George W Bush of the United States and President Mahmoud Ahmadinejad of Iran are all weak political leaders with declining domestic political support. They are all shoring up their weak political positions by pointing to foreign enemies. Despite the current posturing by the leaders of Israel, the United States and Iran, I expect wiser heads to prevail. I do not believe military action against Iran is likely in the next decade, but every time that war is threatened the price of oil will go up.
7. The United States has already pumped all the easy oil. Even if the law is changed to off-shore drilling, the new oil will be more expensive to extract.
8. The North Sea fields operated by Norway and the UK are being depleted quickly.
9. Russia has immense reserves of oil in Siberia, but they may not have the technical capability to extract and deliver this oil to market.
10. Central Asia has large reserves of oil and gas, but transport is difficult.
11. The big unknown is Asia. Will the Chinese economy turn down? This is the key question, but no one knows the answer. The developed world will certainly import fewer goods from Asia. However the new Chinese middle class are starting to spend and consume in a serious way. The growing demand from Asia may compensate for the declining demand from the west.
12. In the long term, demand for oil from China and India will be huge, if they continue to develop at current rates.

The Economic Situation (8) - Good News about Oil

1. The best cure for high prices is high prices. People respond to high prices by reducing consumption. Producers respond to high prices by increasing production. This is already happening. Consumption in the west is declining
2. The United States is no longer as dependent on oil as it was during the first Oil Shock in 1973. Part of the reason is that much of the oil intensive manufacturing has moved to China.
3. High prices encourage oil exploration. However, increasing production is not easy in the short term. A new oil field can take several years to bring into production. If the fuel is in a remote hostile environment, it may take even longer to bring into production.
4. Rising oil prices make processes that extract oil from sand and shale economic. This will increase production.
5. If oil prices remain high, new energy technologies will emerge to reduce dependency on oil.
6. Despite OPEC’s efforts, the market for oil is relatively free. If prices remain high, consumption will reduce and production will increase, which will bring prices down.

The Economic Situation (7) - Unknown Oil

The big fly in the ointment is the price of oil. It has doubled in the last few years. Opinions differ as to what will happen next. Some say that the fundamentals mean that the price will drop to $US20 a barrel. Others say that it will increase to $400.

The truth is that no one knows. It is impossible to look at the fundamentals of any good and decide what the price should be. The Soviet Union proved this to be true. They tried to look at the fundamentals and decide what the price of good should be, but they always got it wrong. They set the price of bread to low, so there were always shortages and people had to queue. Other prices were set too high, producing a glut of goods that nobody wanted. The truth is that no person or organisation has sufficient knowledge to determine what the price of any good should be. The benefit of markets is that prices go up and down to ensure that supply matches demand.

I smile when people say that based on fundamentals, they know what the price of oil should be. These fundamentalists do not understand markets.

There are several factors that make the price of oil particularly hard to forecast. Some are positive and others are negative. I will look at them tomorrow.

The Economic Situation (6) - Strong Economy

The impact of the credit crunch will mostly be limited to the three sectors mentioned in previous posts. The rest of the American economy is incredibly strong. The strength of these sectors should more than compensate for the decline in the construction industry and the finance sector.

The big unknown is this. Will the credit crunch spill over into the rest of the economy? The situation might get serious, if the credit crunch feeds into other sectors of the economy through high interest rates and tight loans for investors.

The American money system is seriously flawed and will eventually collapse when God has had enough of American shenanigans, but in the in the medium term I expect it to keep lurching on from minor crisis to minor crisis. As the politicians and bankers prop it up to cure one crisis, they will sow the seeds that create the next problem.

The Economic Situation (5) - Retailing

We will see a shift in consumption patterns, rather than a big decline in consumer spending. Retailers that sell food and basic necessities will continue to do well. Their share of retail turnover may actually increase as prices of necessities go up.

Some parts of the retail sector will face pain. Retailers who are selling discretionary goods financed by higher purchase or credit card will find their customer base had disappeared.

Those who work in the retail sector may find they are getting less hours and their incomes might fall.

The consumption boom has lead to an overinvestment in shopping malls and retail outlets. Some of these investments will decline in value as the retail sector is rationalised as a greater share of household budgets are allocated to food and fuel.

Imports of consumers goods will decline, which will be good for the American deficit.

The auto industry will suffer. Cheap money has allowed the big auto companies to sell cars on tick. Those days are finished. Vehicles will be much harder to sell without cheap credit. Motor vehicle dealers that specialise in fuel guzzling vehicles will have to move to different segment of the market to survive.

The Economic Situation (4) - Housing Crash

The collapse in house prices has already begun. The situation is worst in the UK and the United States, but a slump in house prices is spreading round the world.

The construction industry will be quiet for the next few years. An enormous number of unwanted houses have been built. Selling this backlog of houses will take several years. Many people in the construction industry will need to find different work.

Most homeowners will not be seriously affected by the decline in house prices. Provided they remain in work and are able to pay the interest on their mortgage, they will be able to sit out the crash and wait for house prices to increase in a few years time. This might not happen soon. In previous cycles, at least five years went by before houses prices returned to the peak of the previous boom.

Those who will suffer are people with high levels of debt who have to sell their houses. This should be relatively rare, but some people who get sick or lose their jobs might be unable to maintain their mortgage payments and be forced to sell. Some will find that the price they get for their house is less than what they owe their bank. This will be very painful, because they will still owe their bank money without owning a house.

Lawyers usually do not suffer. They will earn less from conveyancing, but they will make plenty from foreclosures and sorting out the credit tangle.

Freddie Mac, Fannie Mae, Ginnie Mae and Britney Spears may all go belly up. This will be painful for shareholders in these companies, but homeowners will still have to pay their mortgages. It will leave American taxpayers in the strange position of guaranteeing their own mortgages.

The Economic Situation (3) - Credit Crunch

The credit blow out is finished. The world is moving into a decade of tight money.

The major effect will be higher interest rates. Money will be difficult to borrow. Many people and businesses will find their loan applications turned down, as banks tighten lending criteria.

The credit crunch will affect several sectors of the economy.

The financial sector is already under tremendous pressure. The sub-prime crisis is just the beginning. Losses will increase and more banks and finance companies will collapse.

When banks have to write off bad loans, their capital is reduced. This means that most of the pain will be felt by the shareholders of the banks. However, they have creamed it over the past decade, so their pain should not be too great.

Depositors are only affected by bad loans, if the bank has to close. This should be rare.

Somes jobs in the finance sector will disappear. Financial consultants have been on the pig’s back over the past decade, so it hard to feel sorry for them.

People who sell bankers their Louis Vuitton bags may face a town turn in business, but the pain will mostly be confined to the finance sector.

Nevertheless everyone will feel some pain, as many superannuation funds have invested in this sector.

The decline of the finance sector will only get really serious, if tight credit conditions begin to affect the rest of the economy. High interest may stifle business growth.

The Economic Situation (2) - Credit Blow Out

During the last decade there has been a tremendous expansion in credit all round the world. This started when the US Federal Reserve cut interest rates when the Dotcom bubble crashed in 2001. Since then a huge surplus of money has been slushing around the world distorting markets everywhere.

The growth in money was exacerbated by a whole lot of new banking tricks developed by banks in the United States and copied all round the world. These included securitisation of mortgages and moving debt into off-balance sheet subsidiaries. Cheap money was available to everyone everywhere, including many who could not afford to pay the money back.

This flood of easy money had several effects:

1. Cheap money created the housing boom. All round the world house prices rocketed upward as banks provided huge mortgages to anyone who asked and some who didn't.
2. Easy credit fuelled a consumption boom. Consumers used their credit card to purchase more and more consumer goods, particularly electronics. This boom was exacerbated by a wealth effect, as rising house prices made homeowners feel like they were better off. Cheap imports from China also kicked the consumption boom along.
3. Cheap money enabled people to buy cars than they could afford.
4. Low interest rates make many marginal business investments viable, causing capital investment to become distorted.