Tony Alexander - Shrinkage

Tony Alexander - Shrinkage

The request from the Prime Minister to businesses that they think about how to operate with safe distances between employees and how to keep a register of everyone on a premises, is reinforcing a view that Level 4 will probably end on April 23 and Level 3 will be instated.

As we start to think about the post-lockdown economy, we’ll each be taking a stab at what the recovery will look like. However, while the ending of the lockdown will lead to an immediate boost in economic activity, that does not mean our economy will be tracking upward in terms of “we’re growing now so everything is good”. In fact, after the initial surge economic activity could plateau or even shrink a bit further depending upon how much restructuring businesses undertake in the next three months.

How long might our economy shrink for? Treasury last week looked at recessions in New Zealand since the early-1970s and how long it took for upturns to start and for economic activity to reach its previous level. Their attention and commentary were on that latter development, but here I’ll concentrate on how long on average our economy shrunk after the shrinkage started.

They cover six recessions starting from 1976 with shrinkage periods respectively of this many quarters







The average is 4 quarters, or one year exactly. In the absence of anything else to go on you might assume our shrinkage this time also lasts four quarters starting from the March quarter. Hence a year-end turning of activity upward. That sounds bad.

But this shock is very different from downturns in the past and there are numerous factors which will shorten the shrinkage period.

  • Absence of high debt growth leading into the recession.
  • Absence of both high interest rates leading into the recession and still highish rates through it.
  • Absence of a primary sector hit from a high exchange rate.
  • Absence of a commodity price collapse.
  • Absence of soaring oil prices.
  • The fact that job losses are occurring up front rather than in a traditional manner which lags the actual decline in economic output.
  • Related to this, the sudden ending of our inbound tourism sector. Having hit zero, no further shrinkage occurs.
  • The technical effect of most of our economy being shut for four weeks.
  • Businesses, seeing the Covid-19 crisis as the last straw, undertake the three-year weeding out period I’ve been predicting entirely this year. There’s a reason NZ productivity growth rates these past three years have been so low at 0.4%, 0.1%, then 0.3%. The need for change has been building up.
  • Factors which might lengthen the shrinkage period include these.

  • Substantial economic shrinkage offshore.
  • The six-month mortgage deferral and Business Finance Guarantee Scheme merely delaying failure for some home owners and businesses.
  • Based on the various scenarios released by Treasury on Tuesday, because the June quarter shrinkage of our economy will be so great (maybe 24% under their first scenario which looks the most probable), recovery will start from the September quarter.

    But that will be a technical recovery based substantially on the economy actually being able to operate. But for any individual business the level of uncertainty regarding when customers will feel comfortable enough to start buying again is very hard to predict.

    This then gets right to the heart of what businesses need to do in order to get through this weak period. You probably cannot predict when your customer flow will regrow strongly on a sustainable basis. So, don’t build your adjustment plans around that occurring at any particular time. Focus on becoming sustainable through a period of uncertain weakness, and building flexibility to respond quickly when your particular sustained upturn comes along.

    Recovery Speed

    What about the speed of recovery, as distinct from the length of time our economy shrinks? You’re going to get tired very quickly about the debate over whether we are going to have a V-shaped or U-shaped recovery, or a W maybe which has happened before. So, I’ll discuss some of the relevant factors here then maybe not approach the topic in this format again for a while.

    The first point to note is that if you click on the Treasury link above and look at their graph showing six recessions, you’ll see three had strong recoveries and three were drawn out. There is no tendency one way or the other.

    So, if you’ve got any sense, you’ll stop reading this section and just do what I wrote last week which was not to try and pick the upturn timing for your business at all. Just forget it, put structures in place to handle lower average activity than before, then adjust to your particular surge when it comes along. Plan to play catch-up rather than thinking some miracle has occurred and you’ve just been delivered an ability to forecast big changes in your customer flow which none of us had three months ago.

    But if you’re still reading, here are some factors which suggest the recovery back to our economy being as big as it was three months ago will be a slow one.

    1. Debt levels in the household, business, and government sectors will blow out as a result of this shock. All parties will want to reduce their debt ratios once recovery begins. Too much focus may be going on pressuring the government not to adopt “austerity” policies when recovery commences. But restraint by the other two sectors should not be ignored.

    2. This recession was not caused by a sharp hike in interest rates aimed at fighting inflation. Therefore, big interest rate falls have not occurred. So, there will be no firm lift in purchasing and investing driven by borrowers considering interest rates to be so extremely low that they can’t afford not to take advantage of them.

    3. This recession has not been caused by a sharp hike in the NZ dollar associated with soaring interest rates used to fight inflation. Therefore, there will be none of the traditional soaring rural incomes while the cities languish in woe profile. And there will be no rush of inbound tourists taking advantage of the weak NZ dollar.

    4. This recession was not caused by a collapse in our export commodity prices (the traditional cause of recessions in the 1800s and 1900s), therefore there is little chance of a broad economic surge associated with prices recovering back to at least normal levels.

    5. I’m putting this factor in here because it seems PC to do so, though realistically, I doubt it will have much strength unfortunately. Seeing improvement in our natural world as a result of sharply decreased travelling and work pollution we might decide to change our consumerist ways and focus a lot more on protecting the environment. At the margin some will think and act this way. But for most, any thoughts of doing so may disappear faster than a New Year’s resolution.

    6. Until a vaccine is developed and applied, we will remain wary of having to go back into lockdown. That concern will naturally limit the speed with which consumers return their spending back toward more normal levels. People will want to build up extra savings. Those concerns will also make businesses wary of taking on new employees – full-time staff in particular. Contracted employees may be taken on, but with clauses along the lines of no pay should a lockdown occur again. Businesses will also be wary of undertaking new capital expenditure because of lockdown risk.

    7. Banks will write some big losses as a result of this shock. They will need and want to rebuild their capital bases and because the size of those bases is influenced by the risk profile of lending banks undertake, they will even more strongly veer away from riskier lending than was going to be the case in response to the seven year path to raising Tier One capital ratios. A new structural tightening of bank lending will retard business growth, especially in a country where the capital markets are not traditionally used by most businesses as a source of growth funding. That may have to change.

    Arguing for a fast recovery, some people may say we’re going to see a wholesale relocation back to New Zealand of manufacturing activities which have gone offshore over the past three decades. They will focus on supply chain worries and how those worries necessitate keeping component manufacturing local. This may happen with regard to medical equipment and supplies in the United States. But the chances of this happening in any general way here are minimal.

    Manufacturing shifted offshore because we consumers are price-conscious and invariably purchase whichever product seems the best bargain, paying only scant attention at the best of time to something Kiwi-made.

    Just because something seems to logically fit a posited narrative does not mean it makes any real-world sense.

    Bank Loan Pricing

    For the moment banks are absolutely flat out servicing the biggest influx of demands from existing clients that they have ever seen. All their resources are being devoted to handling these requests. But eventually this highly intense customer-servicing period will pass. Covid-19 ...

    When that happens banks will turn their attention to a whole range of things. Margins have been compressed because funding costs depend upon more than the swap rates and bank bill yields which you and I can see, and those other costs have gone up. Banks will want to rebuild their margins and when they get the staff resources to do it, they’re going to raise credit margins imposed on business borrowers. These things are far less visible than margins on home loans.

    So, if my bank were currently prepared to stand by a set of fixed interest rate margins, they might have given me before lockdown, or even just yesterday, I’d personally be inclined to lock those rates in before they have time to reprice them. The Reserve Bank’s OCR is only one influencer of customer borrowing rates.

    And, for your guide, a disconnect has opened up between wholesale funding costs and term deposit rates. With people scared of the world around them currently money will be flowing into bank accounts. At some stage banks will react to these flows by cutting those term deposit rates as one means of starting to get margins back under control. Our banks do not have funding problems. This is not the GFC. So, the need to aggressively compete for deposits is not all that strong.

    Banks will also at some stage start turning to making estimates of their losses as the recession progresses and customers who might have bought some time with the Business Finance Guarantee Scheme take a deeper look at their business after six months and decide to call it. In a recession, business closures and failures don’t all happen at once. They can come in waves related to earlier excess optimism about what the future will look like. And given that our futures had become far less predictable even before Covid-19 came along, you’d be wrong to think you can have anything approaching clarity in your revenue and cost projections being made now for the next year or two.

    Plenty of businesses making projections now, reckoning they will get through, will get it wrong. Bankers know that and they will at some stage get sufficient resources in hand to start taking deeper dives into business loan sustainability. And they’ll start getting on the ‘phones calling you as compared with the other way around at the moment.

    Seriously, if you think your business is unsustainable, you are better to close down sooner rather than later, painful as that may be. We might have joked about the “fail fast” approach of the modern technology start-up world. But it applies in a different way to all sectors now.

    Closing down is however not the only option and businesses should first make full use of the resources available to assist with restructuring, cash flow forecasting etc. In the words of one banker who responded in last week’s survey.

    “It is critical at this time that businesses complete quality financial forecasts both for internal use and to support borrowing requests. Funding to assist with professional support around critical cashflow and scenario planning, reducing impacts from critical events, and managing people through uncertain times, can be applied for via the NZTE / RBP network:-

    Emailed Queries

    Bank Pain

    An emailer this week suggested that the banks should take more pain by writing off some portion of the debt of struggling mortgage clients. Banks sometimes do this for some customers who have perfectly viable businesses but can’t handle the last lump of debt. But this won’t happen on a generalised basis for a number of reasons. Banks are already going to record big losses from the deep recession putting business clients under. Margins have already tightened as noted above.

    A big positive for our economy this time around is the robustness of our banking sector. It would make no sense to double up on the virus shock by adding in a GFC-type shock involving concern over the viability of bank balance sheets.

    Helicopter Money

    Another person asked whether “helicopter money” might be the answer. This refers to an idea proposed for Japan many years back of simply flying helicopters over cities and dropping out money which people would spend and therefore boost the economy. It did not happen then and it won’t happen now. Why?

    First, there is already a large package of fiscal and monetary support measures in place with more to come of more conventional bent. Maybe up to another $20bn going by comments from the Finance Minister on Tuesday. Second, throwing money at people will achieve nothing if people don’t want to spend it. Most people will not be in a weak cash flow position because of this recession. If unemployment rises from 110,000 to 260,000 that will leave about 2.5mn people in work. Then there are the over 700,000 superannuitants. Plus, around 300,000 people already on other benefits.


    What about a UBI = Universal Basic Income? The same argument as just above applies. Most people will not have their incomes much affected by this recession. Think of all those public servants for instance. They do not need untargeted, experimental welfare which would necessitate very large increases in tax rates. Anticipating such high taxes people would likely cut their spending rather than increase it.

    Commercial Rents

    I got asked about commercial rents. The balance of power in this relationship is shifting from the landlord to the tenant. A lot of commercial space is going to open up over the coming year. If you are a tenant with a lease coming up for renewal in the coming year or 18 months and your landlord won’t discount the rent now, maybe you could offer to extend the lease (when you know you’re going to survive), but only if they cut the rent effective immediately.

    The owners will be concerned that the valuation of their building gets calculated on the basis of rental income. So, they probably won’t want a permanent cut in rent. That means they will be more open to extra rent discounting over the remainder of this year then reversion to normal rent in exchange for you extending your lease now, than permanently lowering the rent.

    As an aside, some smaller investors will now know why people like myself stifled our reaction when they would say they are sick and tired of residential tenants and are now going to only invest in commercial properties because they are “easy”.

    More Public Holidays?

    The last thing our business sector needs now is more days when they are paying people for no output. If there is a desire to stimulate the domestic travel industry then there are better ways than forcing businesses to pay for more long weekends.

    State Advance Corporation?

    One emailer wondered if the government couldn’t borrow bulk funds at a 30-year fixed rate and lend it out. He appeared to be motivated by a desire to shift business away from Aussie-owned banks more than trying to reduce people’s mortgage interest rates. The objections and problems are many.

  • The last thing we need is a greater role for the state in our lives as a result of this crisis. It’s bad enough that public servants are coasting through on unchanged salaries with high job security.
  • Hardly any Kiwi ever fixes their mortgage rate longer than three years. Only a tiny number would want to fix for 30 years.
  • The level of interest rates is not the problem for mortgagors. Rates are at record lows. The issue is keeping one’s job and being able to service a mortgage at all and the answer to minimising that issue lies in the labour market, not encouraging more uptake of mortgage debt which would encourage a new structural lift in average house prices once this is over.
  • The bulk (not all) of the unemployment burden will fall on young people and those at the low end of the socioeconomic spectrum. These people tend not to have mortgages.
  • The six-month mortgage deferral scheme will provide substantial debt-servicing assistance during the worst period of rising unemployment and uncertainty.
  • The government will be blowing its debt level out with fiscal assistance. Doing so at the same time to become a mortgage provider would be unwise from a credit rating and business point of view.

    The Downturn

    If you’re interested in the housing market the most important thing you can do is keep your focus on the long-term and not get overly caught up in the highly volatile short-term bursts of ecstasy and agony which propel bad decisions. During short-term shocks, the psychology of fear overwhelms the long-term fundamentals.

    When the housing market experiences a shock downturn it burns off

  • those who bought very late in the cycle with high debt,
  • those who might have bought years earlier but kept borrowing against rising equity,
  • those who need the cash to support their business,
  • those who unfortunately lose their income so can no longer meet mortgage payments,
  • those who can’t handle a decline in rental income, and,
  • those who are reef fish – panicking in one direction then the other because that is what others seem to be doing. In that latter group you could include those people who switched their KiwiSaver funds from aggressive to conservative after the markets had sold off aggressively 3-4 weeks ago.
  • When these things happen the well capitalised investors with a long-term focus, who run their portfolios as businesses and not self-managed retirement funds, make their best purchases. The best of them will already have well-established links with real estate agents and even bankers, so those people at the coalface of selling can effect a quick sale if needed.

    When things boom, these professional people step back from the market. The yields get too low, and the quality of people becoming property “investors” becomes not so good. Owner-occupying buyers become highly frustrated at the high prices being paid by investors whether they be short or long-term focussed, and concerns soar about affordability. Eventually something comes along to trigger a correction in the market. But history tells us we can never forecast when a correction will occur, what will trigger it, how big it will be, how long it will last, and how quickly recovery will occur on the other side.

    Generally, the corrections are not really that large in terms of immediate price changes. It’s more that prices fall a bit then go nowhere for a few years.

    We have a position in the housing market now where the well-capitalised investors are already letting their interest be known to real estate agents etc. But they are in no hurry to transact. One reason for that is the six-month mortgage deferral which delays the pain which some people will feel as a result of this deep recession. Only when the deferral period ends and they face not just their normal repayment amount but potentially something slightly higher because of the extra debt, will they then find they have to sell.

    In addition, a recession does not burn off all businesses at the same time. People will logically try to hold onto their business for as long as possible and only when all is lost will they close it down and have to sell their house. Contributing to this lag will be the lack of banking staff resources to undertake deep enough dives into business finances to see that they can’t make it. This cycle an extra burden will fall upon accountants to inform their clients about their true prospects, rather than waiting for a call from the bank.

    As a reminder – last week I took a stab at how much real estate turnover will fall once the initial clear out is done following ending of the lockdown period. I’ve guessed declines of 40% from a year earlier for each month from June onward. Bottoming out late in the year. I’ll update that when we get actual real-world insight into what is happening.

    This reinforces my view that the likely enhancement of New Zealand’s reputation through all this will see a quick return to recent high net migration inflows with potential for even higher numbers in coming years. The immediate big area of uncertainty is about how many Kiwis will come back from overseas during the time when our borders are closed to foreigners.

    Here are some of the long-term things to ponder, and if they seem familiar that’s because I’ve been listing them and many others in one form or another since 2008.

    Let’s start with a couple of new ones.

    Money printing drives up asset prices

    We’ve not had money printing in New Zealand before. Now we have $30bn worth planned, perhaps rising to $50bn over the coming year. This will boost share prices and property prices compared with what they would otherwise be based upon the intense negative economic and employment shock underway.


    Our economy grew firmly at an average pace of 3.5% per annum from 2014-2018, assisted by an unsustainable boom in inbound tourism, a residential construction surge, and 5% addition to our population from strong net inward migration flows. For the coming year the net migration flow will probably still be positive, but not the 45,000 of the past year. But what about when the borders open up in 2021 when the planet gets vaccinated?

    A real estate agent I spoke with this week noted that whereas people offshore usually make up about 15% of hits on their property listings website, that proportion has jumped to 45%. That might be because local property hunting is down. But it probably to a great extent reflects Kiwis offshore looking at what their money will buy them back in New Zealand.

    Will more of us Kiwis want to desert these forlorn shores to seek our fortunes elsewhere? We didn’t post-GFC as we eyed ongoing woe and austerity policies out there, this shock offshore is bigger than that, so the economic forces dragging us away will be less. People looking in will see (hopefully) a country which because it is a set of islands, well managed with societal cohesion we are even surprising ourselves with, became almost uniquely virus free. Our enhanced reputation (if this happens) is the sort of thing which attracts long-term migrants – one imagines Americans particularly given the leadership issues and lack of policy response coordination over there.

    This factor won’t apply over the coming year. But over the long-term Covid-19 may boost our migration-driven population growth and thus lift housing demand once the washout from current events subsides.

    Low Borrowing Costs

    Not a single one of us at any time predicted that mortgage rates would be where they are now. They are at record lows and set to stay low for many years. Low debt servicing costs heavily mitigate the pressure to sell a house or not buy one generated by employment uncertainty. As light at the end of that jobs uncertainty tunnel starts appearing, the low mortgage rates will give the housing market a fillip upward which will be sustained.

    Housing Shortage

    We went into this crisis with shortages of housing and those shortages are set to worsen as construction falls away potentially strongly over the coming two years. Why? A pullback in buyers willing to commit both for a finished property and one expected to be built. Presales of properties will decline sharply. Also, bank financing of property developments will dry up, potentially for a number of years. However, should the government initiate a huge house building programme this would reduce the construction decline. Then again, they tried this once and failed badly, revealing they do not have the managerial abilities to manage such a venture.

    Further Reading

    In this publication of March 30, I list as many negatives and positives for the housing market as I can fit on four pages. Covid-19 ...

    Interest Rates – Will They Rise or Fall?

    They fell as our economy was hit by the GFC. They rose a tad over 2010 when our economy was picking up, but then fall again after the Christchurch earthquake in 2011. Then they went up over 2014-15 as our economy accelerated quite well and inflation looked like heading up. But it didn’t and so interest rates got cut to record lows.

    Then they got cut again last year when the Reserve Bank got spooked by high levels of business pessimism. And then they got cut again last month as we got an appreciation for the deep economic contraction which fighting China’s Covid-19 virus would entail.

    The Reserve Bank has said it will keep the current official cash rate of 0.25% at this level for the next 11 months. Chances are high that it will still be at this level 2-3 year from now as credit demand for coming years will be restrained by businesses and households working to reduce their current debt burden blowouts. Funding of high deficits being run by the government will exert some upward pressure on medium to long-term rates. But the Reserve Bank is explicitly looking to prevent that by purchasing exactly those term securities.

    In the near future it’s unlikely we will see any changes in wholesale interest rates big enough to start getting excited about scope for changes in mortgage interest rates. Same for businesses, but with a risk of some increases starting to creep in as banks factor in higher funding costs behind the scenes and reducing risk tolerance.

    For the record, the 90-day bank bill yield started this week at 0.45% and ended at 0.44%. Wow. The three-year swap rate however fell from 0.57% to 0.48%, pressured downward by some rate declines offshore and additional quantitative easing policy from the Reserve Bank.

    NZ Dollar

    The NZ dollar tends to go up if the world feels relaxed and people buy riskier assets like shares. It also goes up if our commodity prices move upward. A rising Aussie dollar can also drag us along a bit at times.

    This week our currency went up for a while by 1.5 US cents to trade just over 61.5 cents, pulled up by rising world sharemarkets. But we’ve ended today virtually unchanged from last week near 60 cents exactly as markets have weakened overnight on the back of some poor US profit results and data showing the deep economic impact (in the short-term) of fighting the virus.

    The NZD looks fairly directionless at the moment. The fundamentals of eventual economic recovery suggest it will go up as the year advances. But exporters are likely to be presented with some good bursts of weakness which will deliver hedging opportunities along the way.

    Against the Aussie dollar we have drifted even further away from parity, proving yet again how tough a barrier that is for the NZD to settle above. We sit currently near 94.5 cents from 96.5 cents a week ago and almost parity one month ago. The slight NZD decline to its lowest level against the AUD since late-November reflects the AUD gaining on the back of some good demand for mineral exports coming out of China, higher gold prices, and a better boost than the NZD from new stimulus measures in the United States. Plus, some investors appear pleased for now with Australia achieving the same proportionate control of Covid-19 as New Zealand but without the intensity of our lockdown.

    For your guide, the following website has been set up for you and I to go to in order to find things during lockdown. Maybe worth a look and even registering your business.

    And this one has been set up for businesses willing to offer special deals for healthcare workers as a thank you for their service during these challenging times.


    There have been no new minimum interest rates introduced this week so the calculations below are unchanged.

    When fixing a mortgage rate term most people take whichever rate is the lowest. So, each week I shall calculate what rates would have to be in the future to make this option better than some alternatives. Note, there are far, far more alternatives than calculated here. And always remember, it is worth paying a premium for rate certainty over a longer period of time. It’s also worth using a broker to get the best deal. Broker use is far higher in Australia than New Zealand but we will probably catch up.

    Current minimum fixed rates across the main banks. *

    1 year 3.05%

    2 years 3.35%

    3 years 3.65%

    4 years 3.79%

    5 years 3.89%

    I can fix 1 year at 3.05%.

    Is this better than fixing 2 years? Yes, if in 1 year the 1-year rate is below 3.65%.

    Is this better than fixing 3 years? Yes, if in 1 year the 2-year rate is below 3.95%.

    Is this better than fixing 4 years? Yes, if in 1 year the 3-year rate is below 4.04%

    Is this better than fixing 5 years? Yes, if in 1 year the 4-year rate is below 4.10%.

    Is it likely that in one year’s time the one-year fixed rate will be above 3.65%? No. So if two years was as far out as I was looking, I would personally opt to fix one year currently. In a year’s time what are the chances that the two-year rate is above 3.95%. Again, not strong. So, I again would fix one year then look to fix two years one year from now if a three-year exposure was my preference. We Kiwis tend to fix at whatever the lowest rate is, and the balance of probabilities suggests doing just that currently will yield the lowest debt cost for the next few years. However, I personally am a conservative borrower. If someone were to offer me a three-year fixed rate at 3.3%, I’d probably take it.

    *Minimum 20% deposit, owner occupiers, 6 largest lenders.

    Compounding is minor so is ignored.


    I do not believe so. Bank non-swap rate funding costs have risen in this new uncertain global credit risk environment. In a visual sense that would mean the most recent data points in the red lines in the four graphs below are actually a lot lower than shown. The extent to which margins are above average for the 1-3-year terms is a lot less than implied here. That, taken in conjunction with banks pulling back from attracting new business, and past instances of margins staying well above average for extended periods, says to me further rate cuts from current levels are not very likely.

    You can form your own opinion as to whether banks might be about to raise or lower their fixed rates by looking at the following graphs. They compare published fixed rates with the most frequently changing component of the total cost of funds – the swap rate. Note that there are other funding costs which will not be captured here, but they change infrequently. But be warned. There is no real forecasting insight delivered by a thing (equity, exchange rate etc.) moving further from some concept of fair value or average. If a thing is 10% above trend, it might simply be on its way to being 40% above trend. For good bank rate comparisons access