The Emporor Has No Clothes: New Zealand’s vulnerability in the face of the global financial crisis argues that New Zealand’s recent prosperity is based on credit-fuelled rising property values driving consumer spending, and export growth in the agriculture and tourism sectors.

Their key point is that New Zealand is very vulnerable to impacts through the credit channel on business activity and investment. The policy response required entails focus on maintaining the availability and stability of credit, rather than compensating for sluggish demand.

There is also a significant (but not large) risk that there will be an abrupt withdrawl of credit from overseas lenders, however this risk is mitigated by the relatively strong position of local banks compared to their overseas counterparts.

The institute also published a presentation outlining suggested remidies for this situation entitled Heavy Mountain Weather: Funding risks for New Zealand and proposed solutions, which concludes:

• New Zealand is being impacted through the growth channel (especially commodity prices, tourism and other export markets). But it is the credit channel where the greatest risks remain.
• New Zealand is different to the rest of the world. We have some advantages (a stronger banking system) but different vulnerabilities (dependence on offshore funding). New Zealand faces tighter fiscal constraints that limit options that involve increased government spending.
• New Zealand’s response must include an ability to support strategic New Zealand businesses, should they face funding difficulties that threaten their viability or makes them vulnerable to foreign take-overs.
• The response should leverage the Government balance sheet and create a conduit for Government strategic investment in companies, should this be required. The response should also include leveraging private sector investment through a government underwriting function and measures to attract overseas funds to invest in high return projects.
• A range of options should be considered; including the creation of a New Zealand growth fund that would leverage SOE assets, invest in other companies and run on a clear commercial basis with transparent governance.
• The rest of the response should contribute to a long term game plan for the country: to position New Zealand ahead of other countries in seizing opportunities as the world emerges from the global recession.
• The long term game plan should also correct the policy mistakes that have left a legacy of very high indebtedness to the rest of the world and increased New Zealand‘s vulnerability in the present crisis.

Both papers are well worth a read.

You can also listen to or download the author Benedikte Jensen discussing the papers in a segment from this morning’s Morning Report programme on National Radio.

Last year Rob gave a presentation to the Angel Association conference in which he said that the current financial turmoil would result in conditions that would be “worse than anyone alive today has seen”, and was later quoted in the Business Day as saying “We’ve had about 60 financial crises in the western world since 1700 but nothing of this scale or contagion ever”.  Rob has never been seen cavorting with Chicken Little before, and so I caught up with him on Christmas Eve to explore what was behind his thinking.

Key points:

• Previous crises have affected small numbers of markets or investor groups, but the current crisis is global and systemic
• We currently have previously unknown levels of leverage; eg in the 1930’s crisis private sector debt hit at 275% of GDP, but recently reached 380%.
• A depression of the scope of the 1930’s is unlikely, due to the speed and scale of recent government intervention.  We’re unlikely to see a 20% drop in output or 20% unemployment. Nevertheless, the global recession is likely to last 2-1/2 to four years.
• Perceptions of uncertainties have increased, rather than the uncertainties themselves — the uncertainties have always been there, we’re just recognising them now.

Rob also offered specific advice for angel investors:

• Focus on having adequate financial flexibility, eg strong balance sheet ratios and access to funding.
• Be ready to seize opportunities as they arise. Opportunities in crises are unprecedented, and in recessions we are more likely to see game-changing moves.
• Recessions cause huge changes in industry leadership; structural changes in patterns of demand lead to new market opportunities.

And his bottom line: These are unusual times that call for unusual measures.

Rob’s reading list:

• Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Z. Aliber
• Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages by Carlota Perez

Listen to or download the podcast:

The US Angel Capital Association’s Angel Group Confidence Report shows that US angels are planning on reducing activity by about 10% in 2009.  That’s not too bad,  considering the backdrop of economic chaos.

Interesting factoids:

• 72% of angels expect a liquidity timeline of at least five years post-investment
• In 2008, groups closed on average 4.82 deals worth USD 1.3M, or about USD 270K per deal
• Roughly 50% expect deal quality to increase next year, with another 35% expecting it to stay the same

Syndication is common and becoming pervasive in the US, with 72% of groups co-investing with other angel groups in 2008, and 90% planning on doing so in 2009.

Some of the comments are also instructive:

• “The ability to syndicate deals to fill out the round will become a competitive advantage, making angel groups a significantly more attractive source of funding than lone wolf angels (who therefore might decide to join groups).”
• “Any portfolio company currently trying to raise money is having a hard time. We will need to have follow on money to protect our investments, yet members may decide to risk their initial investment rather than liquidate public market stock at current valuations. Portfolio companies must tighten their belts immediately.”
• “Valuations are down; opportunities can be found in a variety of sectors (e.g., software, therapeutics, diagnostics) with seasoned mgt teams that have weathered similar recessionary periods. “Grey hair” around the Board tables will be more valuable than ever.”

As we know, angels tend to be optimists…

So moving from the microcosm of US angel investment to the Entire Economy of New Zealand (guess which is bigger), pour yourself a long drink before sitting down to read the The New Zealand Institute’s essay, “The end of the golden weather: The financial crisis, global recession, and what this means for New Zealand”.

The author, Benedikte Jensen, does an excellent job of of summarising recent global economic events from a New Zealand perspective, and teasing out some of the implications.

It is not a happy story.  She says,

Overall, it is likely that this recession will be protracted and the recovery will be weak and subdued – an L shaped recession – both for the world, but also for New Zealand… The challenge for policy makers is to ensure that the problem is properly recognised (i.e. not seeing this as simply a business cycle) and that an appropriate set of policy responses is put in place to ensure that there is an appropriate pathway back to sustained growth.”

The specific risks for NZ are identified as:

• The end of the commodity boom creating vulnerabilities due to NZ’s reliance on commodity exporting
• NZ’s high external indebtedness makes us vulnerable to sudden shifts in the sentiment and risk profile of overseas investors
• Difficulties in attracting foreign investment due to our insignificance and investors’ risk aversion
• The resulting likely retrenchment of local investment nobbling our ability to grow when we need it most

Jensen also notes that “the US is looking increasingly like Japan in the 1990s and an alternative engine of growth for the global economy is not apparent”.

Ouch.

This paper is the first in a six-part series.  Paper 2, due out in January will address the implications of the global crisis for New Zealand.  Further papers will be released during the next few months, concluding with paper 6, “New Zealand’s place in the world”.  We look forward with some trepedation to reading the whole series.