Dollars & Sense: Low interest rates for years to come

This week I have attended a conference put on by the Economist magazine in Sydney, looking at the Asian finance scene. But much discussion was undertaken on the situation in Europe.

One strong point needs to be made right here: not a single person expressed confidence that Europe is close to solving its debt problems. All spoke in terms of the difficulties getting worse, that they will last for many years, that there is a risk to Chinese growth from Europe’s woes, and that a weak China would slow Australia’s growth. The same goes for us.

The nature of the European debt crisis essentially comes down to this. Investors in the north channelled money to the south for many years feeling secure within the Eurozone and a belief that the superior yields offered by southern European borrowers were of little risk because inclusion in the Eurozone would bring convergence of the member economies in terms of output per person, incomes, living standards etc.

Instead what happened is that the divergence in productivity between northern and southern countries has increased, and southern banks lent money into a property construction boom which has now turned into collapse.

The northern investors want their money back. This is starving southern European banks and therefore southern European economies of cash. Growth has disappeared and the ability of southern governments to offset the credit crunch, construction crunch, and confidence collapse through stimulatory policies is near non-existent.

They do not have their own currencies which can depreciate and boost exports. They have no interest rate control and official interest rates are already very low anyway. Their government finances are shot through either bad 2000’s practices then GFC-induced fresh deterioration, or simply the latter (Spain).

Their economies are in major need of reform but citizens are tired of pain and voting for weirdoes promising relief.

Therefore, the investors want even more of their money out. Southern European banks are on the verge of collapsing and bringing down their northern neighbours.

There is no over-arching European body which supervises European banks, there is no mutual bailout fund, and there is no deposit guarantee scheme.

The June 28-29 summit made good noises about the first item, but progress will take a long time and is barely relevant to the current situation.

So investors still want their money out of those countries and out of the bonds of those countries’ governments. No circuit-breaker to assuage investors appears likely.

The speaker on video link from Brussels spoke of cures no one back in the conference room in Sydney expressed confidence in.

The relevance to New Zealand farmers is this. One, Europe’s economy is in recession and likely to go deeper. This will directly lower commodity prices.

Two, China’s exports to Europe are falling, Chinese growth is slowing, and this will depress our export prices.

Three, the world’s capital markets are not functioning properly and that means suppressed growth over a period of years, which will depress commodity prices.

These things mean low interest rates will be with us for years, not just another 6-12 months.

Our government will need to kick the timing of a return to fiscal surplus out by a year at least. Investors including pension funds and insurers will be searching for yields better than simple government securities and bank deposits.

That means funds going into residential property, and for more on that you can see the results of my monthly survey of residential real estate agents at http://tonyalexander.co.nz/topics/surveys/bnz-reinz-survey/

If it is China you are interested in then read all about it in my Growing With China publication at http://tonyalexander.co.nz/topics/china/  

For your guide, the next issue, due out on July 23, will include discussion of the offshore investment activities of China’s SOEs.