Amid the economic turmoil a long-term challenge

The chiefs of the British, Australian and New Zealand Treasuries meet here next week. They will have much to discuss. The world economy is not as rosy as a year ago.

For this country, in debt up to the eyeballs to foreigners, that is a worry. For households, also in debt up to their eyeballs buying overpriced houses or using houses they already own to raise cash to splurge, the squeeze is already on.

Debt makes you vulnerable.

If you are heavily mortgaged and lose your job, you may well lose your house. If your budget is tight and interest rates climb, you face grim spending choices, especially as petrol and food prices tighten the pincer.

In the United States city of Cleveland whole blocks have been abandoned as ultra-low-interest starter loans have been replaced with interest rates at or above the market rates which people can’t pay. Cleveland is suing 21 big banks and financial institutions which it says plunged the city into financial crisis as revenue fell when home-owners lost their houses as a result of their shonky dealings.

New York state is investigating whether to prosecute major United States banks for withholding from investors vital information about shonky loans.

Some of those major banks, including John Key’s old employer, Merrill Lynch, have been taking huge capital injections from Asian and Middle East government funds to plug balance sheet holes. The United States Senate is inquiring.

In Australia a mortgage lender and a property company have been laid low and the major banks are starting to own up to having invested in shonky American lenders.

Those banks are also our banks. They are now raising interest rates because they can raise less funding.

Worldwide, no one knows how much is at stake. Latest guesses range up to $US550 billion.

Large as that sounds, it is manageable and central banks have done a fair job. But now there is a real prospect of recession in the United States. Job growth halved and house prices dropped 7 per cent in 2007. Retail sales growth has slowed.

The United States economy is one-fifth of the world economy. Its slowdown will hit us first directly and then indirectly through its general impact on the world economy, on which we depend critically for finance (including mortgages) and our cash flow from exports and tourism.

So our continued pursuit of happiness in the shopping malls depends on foreigners continuing to do well. That in turn depends on the huge imbalances in the world economy straightening out smoothly.

The prime imbalance is Americans’ household and government indebtedness to Asia. James Fallows calculates in this month’s Atlantic Monthly that, as a result of China parking the proceeds of its huge trade surpluses in United States, “every person in the (rich) United States has over the past 10 years or so borrowed about $US4000 from someone in the (poor) People’s Republic of China”.

This imbalance, Fallows adds, “can’t go on indefinitely and therefore won’t. But the way it ends — suddenly versus gradually, for predictable reasons versus a panic — will make an enormous difference to the United States and Chinese economies, to say nothing of bystanders in Europe and elsewhere.” “Elsewhere” includes us.

In addition, we have huge imbalances of our own, exhibited in our overpriced houses, massive household and country debt and large trade and balance of payments deficits — that latter deficit so big that, if we grew bananas instead of kiwifruit, lenders would long since have foreclosed on us. Moreover, the deficits are despite healthy prices for some commodities and the Tui oilfield’s mini-bonanza. We should be in surplus on trade.

As with the world, our imbalances will be fixed — either gradually over some years (Michael Cullen’s prudent fiscal buffer could help) or suddenly and shockingly.

Let’s go with the optimistic version of the next few years: that the world economy motors on moderately, driven by Asia, the United States doesn’t go into shock and the imbalances begin gradually to correct. We might unwind our imbalances relatively benignly.

But we would still be stuck around No 20 or lower in income and wealth per head. We show no sign of advancing towards the fabled “high-wage” economy. (To get those higher wages we emigrate to mineral-rich Australia.)

Growing food and carting Chinese tourists round ripoff joints in clapped-out buses is not the route to a high-wage economy. The bigger the share of our economy in commodity food and commodity tourism, the lower our relative average real wage.

And even that is at risk from losing our clean-green brand and from other countries growing top food. Fonterra and PGG-Wrightson have been investing in South America.

So the coming rebalancing, uncomfortable as it will be, is the easy bit. Our real challenge is to use the window of opportunity the food-and-tourism cash flow furnishes to build up a higher-wage set of activities.

We have maybe 10 years, if that, before that window closes.