Friday, September 30, 2011

Down We Go

What does it mean to have your credit rating downgraded? Why did the Fitch ratings agency do so now for New Zealand in particular?

Credit ratings are based on your ability to repay credit (money) that is extended to you for whatever purpose you deem fit. The word 'credit' comes from the Latin word Creditum, meaning to loan or entrust or 'I believe'. So when you take out a loan, a counterparty will entrust their money to you and receive interest on that loan. The interest charged depends on the risk the counterparty thinks you have of not repaying. The higher the risk, the higher the interest rate. The counterparty may also ask for assets as collateral to ensure that if you don't pay, they get those assets.

How does this latest fall in ratings from AA+ to AA affect New Zealand? Simply put, people don't trust us as much as they used to to pay back debt. Interest rates are headed higher.

As I mentioned last week, these are the figures Fitch is concerned about:

As at June 30, 2011:

International Assets = $113 billion
International Liabilities = $253 billion

Net International liabilities = $140 billion (or 70% GDP)

This net external debt of 70% to GDP is too large Moreover, New Zealand continues on a path to increase this debt through deficit spending. Fitch "noted that New Zealand had one of the highest levels of household indebtedness among developed countries at 150 per cent of disposable revenue, which hasn't declined significantly since 2008."

We are in the poo.

Reason? Our debt is too high to manage in this current world economic climate. The path to growth needed to pay back such an horrendously high debt level has vanished.

We hear our politicians say we 'are in good shape' and that we will return to growth within two years, or whatever. But, strangely enough, when those time frames play out, the growth forecasts get pushed out to another future time frame. They are playing games with the truth, they are not saying where this is really headed. They want to walk the fine line between all out anger from their constituents (translated to lack of votes for them) to maintaining calm and confidence in the system.

New Zealand's economy is totally reliant on our large trading partners to maintain growth. Their books aren't in any better shape than ours. Australia is in trouble as the China real estate and growth bubbles start to deflate. Trading in isolation from them will not produce the wealth we need to repay this debt. This is what Fitch sees, the unwinding of trust and confidence in our ability to repay that which was entrusted to us.

When, and not if, interest rates rise, more people will be in financial stress. Add this to jobs disappearing as growth departs, New Zealand is set up for a torrid time in the next medium term.

As Gerald Celente says, when the money stops flowing to the people on the street, the blood starts flowing in the street. Let's hope it never comes to that.

Gold in New Zealand dollars: $2095.88 per oz
Previous all time high: $2284.16 per oz (19 Aug, 2011)

Silver in New Zealand dollars: $39.72 per oz
Previous all time high: $59.19
per oz (30 Apr, 2011)
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