Sludge Report #197 - Short The Dollar!
MEMO: To international bankers
FROM: C.D. Sludge
Please short the dollar!
It'll be good for both you and us. And you know you want to.
Greexit, Eurogeddon…. watch out…. flight to quality and all that. Follow your instincts.
Sure NZ dollar govt. securities and Fonterra paper is good - but is it really that good?
The NZ Debt Management Office has been so surprised at the unprecedentedly low interest rates that it can borrow at that
it has already entirely pre-funded the 2013 fiscal deficit - all $8 billion of it!
Which means that if interest rates start to rise a bit as a result of the $NZD looking a bit less shiny, the Government
isn't really going to take much of a hit as they can wait till a lower dollar does some magic and gives us the recovery
that we need (and which will quite possibly be derailed by a high dollar if you don't short it.)
A Foreign Bankers Guide Understanding the NZ Budget
Today our Government has published a budget which superficially looks relatively good. A return to surpluses by 2015 and
no sign of any need for quantitative easing down here in Godzone. Hell we haven't even really had much austerity here.
Bunch of birds.
However I would encourage all bankers to dig a bit deeper in their analysis.
NZ's Finance Minister Bill English has proved to be something of a magician in his ability to make silk purses from sows
ears over his three budgets to date and this is no exception.
Officially on the basis of today's budget you can expect NZ to be back in surplus by June 2015, this notwithstanding the
fact that we ran a $16 billion OBEGAL fiscal deficit in the last financial year and have expanded net crown debt by 700%
over the past four years.
Admittedly this deficit is due in part to the Earthquake in Canterbury in Sept 2010 and February 2011, the same
earthquake which is now being cast as our economic saviour (but which may not prove to be as predictable as Treasury
And what is an OBEGAL I expect you want to know?
Historically it's something our previous Finance Minister Michael Cullen invented to stop NZ's finances looking too
flash in the early noughties. He was keen to stop his cabinet colleagues from spending up too much.
The OBEGAL is deficit forecast to get a lot better this year and next. Down to $8 billion (loss) next year and roughly
the same the year after.
So if you are going to trade on this budget I would encourage you to examine the fine print. There are a fair few
gotchas in the NZ budget that you (and your ratings agencies) ought to be aware of when coming to their risk and return
Some Gotchas For Kiwi Short Sellers To Focus On
E.G. On page 22 of the economic and fiscal update it says: "Compensation to employees is forecast to grow 3.9% in the year ending March 2013 increasing to 5.2% the following
year, underpinned by the firming labour market and the Canterbury rebuild."
Dig a bit deeper into the appendices and you find that this breaks down into employment growth of 1.6% or thereabouts
and hourly pay inflation of 3.8% and 3.9% over the next two years.
I expect this will be news to many NZ employers - several of whom have been engaged in attacks on unionised workforces
in recent months. It also seems highly implausible that this is the scale of wage settlements that theGovt. is intending
to provide to its public sector employees.
And given the contribution of personal income tax to overall tax revenues - sensitivity to this forecast assumption
being wrong will impact directly on the bottom line in the fiscal deficit numbers.
While it is true that NZ wage growth has been relatively high in the past 12 months, Treasury's assumption seems to be
based almost entirely on the Christchurch reconstruction boom taking place as expected in 2013-14 - and being as fast as
And it is anticipating that the Christchurch boom will flow through to the rest of the country in wage settlements.
For the benefit of foreign bankers it is worth pointing out that Christchurch is in the south of New Zealand. It is cold
and has an accommodation shortage and workers are likely to have to live in caravans. How this will translate to broad
wage inflation in New Zealand is a mystery.
The Christchurch Earthquake Boom
And speaking of the earthquake boom on page 12 of the fiscal update we learn:
"… the number of dwelling consents and rebuilds is small… uncertainty surrounds the pace of new building work… Treasury
forecasts assume a large increase in residential investment from the middle of 2012…. pace of activity is forecast to
continue to rise reaching a peak growth rate of over 40% in the year ending March 2014."
We also learn on page 10 that more than two thirds of all the growth in GDP in the year of the turnaround (which will
now by 2014) is due to come from residential and business investment (the vast bulk of which is in Christchurch and
What people/bankers outside NZ need to understand is that there are some very considerable capacity constraints which
may make these hedged assumptions brave if not also heroic. We are not in Kansas with 10s of thousands of mobile
tradespeople within a 500km radius.
NZ is a small country. We already have a problem with not having enough trades-people to build and maintain the housing
stock that we have. And we have a housing shortage (crisis according to some reports).
So exactly how the workforce in Christchurch is going to double in 18 months is something that has not been explained
(or even planned for as far as I can tell). Immigration is probably the answer but as a country NZ are often a bit
precious about this and the political debate around this hasn't even begun. Asked the question in the budget Q the Finance Minister said he expected that many of the workforce would come from people returning to NZ.
We have had three years of marked decline in residential investment. Much of the workforce in the sector has now left
the country (with their families) and are now enjoying %40 higher incomes in Australia - how will these people be lured
back? Most of them never lived in Christchurch in the first place and would have no desire to go there unless paid
frontier mining like incentives to do so.
Meanwhile the political situation in Christchurch is not exactly rosy either. An astonishing 87% of the people in
Christchurch think that the government hasn't done enough for the city in terms of its recovery. A popular revolt is
possibly on the cards in the city which could delay or impact on the ability to make decisions around investment in the
rebuild of Christchurch.
So yes Christchurch will be rebuilt - and when it is it will help the NZ economy. However whether this will happen when
the Govt. forecasts it will happen is a question which deserves some scrutiny.
And if it doesn't happen when it does and as fast as expected then it blows the fiscal projections out of the water.
This will come in the form of poorer than expected tax takes, deteriorating fiscal projections and downwards pressure on
So why not short it now?
Then there is the centrepiece of our Government's economic policy - the controversial, divisive and (according to some
leading economists e.g. BERL) irrational - plan to sell stakes in our state owned electricity generators. This is held
up as the "market" friendly side of NZ economic policy but is it really?
Leaving aside the question of whether the sales plan will be de-railed by legal action or the government's wafer think
majority - one of the key questions raised by this policy is one of economic credibility.
According to the charts on pages 42 and 43 (decoded with the help of a treasury analyst) we find that over the four year
period of sales up to 2016 the Government forecasts it will.
- Raise $6 billion in sales proceeds (presumably incurring fees of something in excess of $200 million on the way)
selling the assets at $1.5 billion each year.
- This will result in foregone dividends of the period of $460 million and foregone profits of $900 million = $1.3
- On the other side they forecast NZ will save $575 million in tax revenue.
- Which equals a $725 million loss in value.
Scoop put this to the Finance Minister in the Q session in the lockup and his response was to say that selling the stakes in NZ's electricity generation-retailers
would lessen the risk that the Crown might otherwise face in its ownership of electricity assets in a market which is
showing a flatish demand curve.
In reality the NZ electricity market is continuing to see price increases of 10% per annum, generation capacity is being
built at pace.
Once fully sold down the forecast foregone dividends and profits are an annual $540 million = indicating an assumed
price multiple on sale of around 12x = which is not the typical profile of a business sector which is considered to be
Which begs the question is it rational to consider renewable energy assets to be risky assets for the Govt. to hold?
Debt Market Management - And The Likely Path Of The NZ Dollar
So where is the NZ Dollar headed? And why should you short it?
If you want the fiscal forecasts in this budget to prove accurate - and certainty is supposedly of high value to markets
- then another 10% fall in the New Zealand dollar would be just dandy for what we like to call NZ Inc.
As it stands the dollar has been trading in a range between 82 US Cents and 77 US Cents for a lengthy period. This is
pretty painful for NZ exporters, the tourism sector and indeed the entire country.
By contrast a lower dollar will:
- Take heat out of the housing market;
- Increase the profitability of NZ's export businesses (which is where the real jobs are as opposed to the banking
sector which profits from an expanding current account deficit);
- Enhance NZ growth prospects and the likelihood that NZ bond yields will continue to improve for their holders;
All of which is obviously self-interested.
But on top of this (and this is where the smart money might like to take heed) it is likely headed in that direction
While NZ is considered a relatively safe bet in the finance markets at the moment - especially when compared with Europe
- we are a small isolated economy in a big world. When things deteriorate globally our dollar falls (though this has
changed a bit in the past three years) and deservedly so.
And while the NZ government would like you to believe that it has all the answers and is managing the economic settings
of NZ with deft agility the reality is that this is not the case.
Instead we are betting on a rainbow. A post earthquake construction boom which has been delayed over and over again by
seismic activity and which is subject to a large range of complex risks around when and how big it will be.
So please short the dollar.
NZ's exporters will be delighted - and with this year's deficit already funded I doubt that even the NZ Government would
be that unhappy with a downgrade in the next 12 months.
Anti©opyright Sludge 2012