Don’t Throw Your Hats In The Air Just Yet.
A hike in interest rates next month is a done deal – and it will be the first of many. The virtual certainty of higher rates – presaged by Graeme Wheeler’s speech last week – is presented in the media as bad news for home buyers, and that it certainly is; but its real significance goes much wider than that.
What it really tells us is that, despite all the self-congratulation about the long-delayed recovery from recession, our long-term problems are not only unresolved but are likely to get worse.
The truth is that we cannot be allowed to grow at anything like the rate that out most important competitors in Asia take for granted; and the reason for that is that our past failures have ensured that we are a fundamentally uncompetitive economy. Because we are uncompetitive, we dare not grow at a reasonable rate for fear of renewed inflation and worsening our perennial balance of trade difficulties.
Any increase in purchasing power would go, not on investment in increased domestic production from New Zealand industry, but on the import and consumption of goods we are no longer able to produce ourselves. And even more predictably, any increase in the money supply will end up unerringly in an inflated housing market, creating the illusion that people are better off than they really are and encouraging them to spend their unrealised and supposed equity on yet more imported consumer goods.
Those problems would mean in turn an increased need to borrow and to sell off our dwindling assets, so that higher interest payments and repatriated profits would impose further burdens on our balance of payments. No wonder the Governor of the Reserve Bank has taken fright.
The whole point of the rise in interest rates is to choke off the economic growth that we might otherwise aspire to. The monetarist doctrine that has dictated our economic strategy for three decades stipulates that a rate of growth that would fully utilise our resources and accordingly mop up the pool of unemployed must by definition be inflationary – so much for faith in the ability of an efficient and competitive market economy to generate increased production.
The Governor’s intervention will at least be welcomed by some employers who fear the effect of full employment on wage rates. Applying the brakes at this early stage is a certain recipe for exercising a downward pressure on wages and, in due course, for a further transfer of wealth from wage-earners to asset-holders. Little wonder that it is applauded by a minority.
The tragedy is that higher interest rates at this stage of the cycle will actually make our problems worse. The higher rates we will have to pay to mainly overseas and short-term lenders will not only increase the burden on our balance of payments but the inflow of foreign funds will push up the exchange rate of our already overvalued dollar. Our own domestic producers will find that they are even more handicapped in the battle for markets at home and overseas – even less able to withstand price competition from rivals whose governments pursue very different strategies designed to maintain their competitive advantage.
Indeed, some of our trading partners make no secret of their preference for following a quite different course. Singapore, for example, uses indices of competitiveness, not the inflation rate, as the primary determinant of macroeconomic policy. China has for years maintained their currency, the renminbi, at an undervalued level, tying it to the US dollar to ensure that they lose none of that advantage.
The government of Shinzo Abe in Japan has gone even further and has engineered a 35% depreciation of the Japanese yen so as to set the economy back on a sustainable growth course. They have achieved this by doing the exact reverse of the higher interest rates that are now in prospect for us; instead of tighter monetary conditions, they have significantly relaxed monetary policy but have ensured that the extra money available is carefully directed into productive investment rather than consumption.
Western economists are entirely ignorant of the great post-war Japanese economist, Osamu Shimomura, and of the successful investment credit creation strategy that he pioneered and that is again being applied by Shinzo Abe. Locked into our tight little certainties, we cannot conceive that the rest of the world has anything to teach us.
It is a safe bet that Graeme Wheeler, who is no fool, understands these issues perfectly and recognises the futility of the strategy he is pursuing, but is at a loss to know what to do about it. He will know that our current and much-touted “recovery” depends on the stimulus provided by Christchurch reconstruction (why did we have to wait for an earthquake to make that kind of investment?), high – and probably temporarily so – dairy prices, and our old friend, an unsustainable and damaging housing boom.
These factors will either be short-lived or positively harmful to any long-term recovery. When they have been exhausted or have done their worst, we will be left with even fewer options, and an even grimmer outlook, than we have at present. It’s too early to throw hats in the air just yet.
Bryan Gould
2 February 2014
The Same Tired Old Excuses
As job losses reach crisis proportions, and many point the finger at an overvalued exchange rate, we have to put up with the same old tired and ill-informed assertions to the effect that overvaluation is not the culprit.
Those who say this usually make two assertions; first, the exchange rate is irrelevant and secondly, there’s nothing we can do about it anyway. Neither assertion is remotely accurate.
As to the first, the usual line is that factors other than price matter in international markets; yet only a moment’s thought will produce the commonsense conclusion that it would be very surprising if we could charge whatever we like. If we ask more for our products than the market says they are worth, we will have trouble selling them, or at least selling them at a profit. To argue otherwise is to deny simple reality.
The one sure way of ensuring that we have to charge more than we should is to allow the exchange rate to rise too high. The exchange rate, after all, converts all our domestic costs of production – for labour, energy, raw materials and so on – into the prices we charge in international markets, and that includes our own, where we compete with imports. As the rate rises, it ensures that those prices are artificially inflated, and are no longer competitive. Even on those sales we do make, it cuts the profit margin – just ask the dairy farmers; the whole economy suffers as the cream is blown off the top of our dairy exports by the overvalued dollar.
That is why, in a nutshell, we can’t pay our way in the world, and have to borrow excessively to cover the gap between what we can sell and what we want to buy. That is why we dare not grow our economy fast enough to bring down unemployment; it’s because we know that if we do, we’ll run into balance of payments constraints and will have to borrow even more.
We’ve been doing this for so long that we think it is natural and unavoidable. That’s why ministers in successive governments over three decades have believed that solemn lectures about improving productivity, and promising that new research – always “soon” – will generate new “sunrise” industries, will do the trick. As any manufacturer will tell you, if the profit on your exports is decimated by the exchange rate, you have no money to re-invest in improving productivity, funding new research and technology, or taking any of the other steps needed to close the gap on better-resourced international rivals.
The second argument is the fallback position always adopted by those who have run out of other arguments. All this may be true, they say, but there is nothing to be done about it. The dollar’s value is established by the market and reflects the fortunes of other currencies, like the US dollar. If that means a high New Zealand dollar, we just have to live with it.
But this is nonsense. There is no such thing as a clean float. The view that the markets take of the Kiwi dollar is strongly influenced by what they know to be government policy, especially if that policy has a direct bearing on the dollar’s value and has been maintained for decades so that there is little prospect of it changing.
What determines the value of the dollar, so that it is higher than it should be in terms of balancing our trade, is quite simple; it is the fact that we have for many years offered investors – especially overseas investors, the legendary Japanese housewife or Belgian dentist – an interest rate premium for buying New Zealand dollars. That premium has been so high for so long that short-term investors find it worthwhile to borrow money they don’t have at low interest rates in their own countries so that they can buy New Zealand securities at a high rate of return; and because so many do this, the demand for and therefore the price of the New Zealand dollar rises, and the investors make a capital gain into the bargain.
The only people who lose from this are the people and businesses of New Zealand. Why does our government go on allowing this to happen? Because we insist on using high interest rates as our main, indeed only, counter-inflation tool; and since those high rates destroy our competiveness by pushing up the value of the dollar, we are then forced to borrow even more at even higher rates.
Quite apart from other factors – like commodity prices and the terms of trade – that influence the value of the dollar, the main element of over-valuation is, in other words, a direct consequence of government policy. We could change that tomorrow if we wished. We need to understand that high interest rates and the overvalued dollar are not only damaging our economy but are not even appropriate as counter-inflationary tools. If we addressed the real reasons for inflation – excessive bank lending and credit creation for non-productive purposes – we could stop the insane process of deliberately pricing ourselves out of world markets.
Bryan Gould
12 September 2012
This article was published in the NZ Herald on 14 September.
Is The Mad Butcher Mad?
The love-in between the Mad Butcher and the Prime Minister, dutifully reported in every detail by complaisant media, is perhaps best described as reciprocal back-scratching – a term that is at least more polite than alternative anatomical allusions that might come to mind.
But while Sir Peter Leitch might have every reason, in view of favours received, to respond with a typically high-octane endorsement of the Prime Minister, the rest of us might be a little cautious. We might take the view that John Key and his government should be judged by other and more demanding criteria.
Like, for example, their success or otherwise in managing the economy. We all know, don’t we, that while the rest of the world is struggling, New Zealand is doing pretty well? At least, that is what we are constantly told.
And it is certainly true that we have good reason to suppose that the deep and intractable problems that afflict others have passed us by. Our main export markets happen to be, after all, two of the most buoyant economies in the world. Our commodity prices have reached record levels. The government’s debt, though constantly offered as the reason for public spending cuts, is – thanks largely to the prudence of the previous government – amongst the lowest in the developed world. Our often-maligned Australian-owned banks are a bastion of stability in a world facing renewed financial meltdown.
By contrast, other (and major) parts of the world economy are facing really tough times. The Americans are paralysed by political conflict. The eurozone is engaged in a losing battle with debt – a contagion that seems to be spreading like wildfire. And the British are determined to inflict on themselves a home-grown version of austerity that ensures that there is to be no early recovery from recession.
So, we surely have every reason to expect that our good fortune will be recognised by the credit-rating agencies and that we will show up as one of the bright spots in the OECD.
So, why have we suffered a credit downgrade? And why do Standard and Poor’s and Fitch seem not to have taken much notice of the government’s feel-good message? They are more concerned with our high external debt, which they say is on track to get worse, not better.
And if we really are bucking the trend, that should surely show up in the most recent quarterly GDP tables? Yet sadly, the OECD’s second-quarter GDP figures also tell a rather different story. New Zealand recorded a 0.1% growth rate in that quarter – a figure that means that we are out of recession by just about the smallest statistical margin possible.
But wait, as the TV ads say, there’s more. The figures show that while there are a few OECD members who have done worse than us (and one or two have actually gone backwards), the majority have done significantly better than us.
The paralysed Americans? They scored double our rate at 0.2%, as did the British, and the eurozone as a whole. European members of the OECD did better still at an average 0.4%. The debt-ridden Italians managed 0.3% and the equally debt-ridden Irish a whopping 1.6%. Our neighbours across the Tasman, on whom we are supposed to be gaining, did 12 times better at 1.2%.
We are told that we must expect tougher conditions to come. The Prime Minister, using a metaphor that typically places him in a sporting context, assures us that we can expect him to “roll with the punches”; but it is difficult to do that when you are flat on the canvas.
The story we are told is not, in other words, borne out by the facts. And those facts are most brutally apparent to all those who suffer directly from our failure to make the most of our relative good fortune, but who don’t make it into the media that often.
Foremost among them are those who go to make up our obstinately high unemployment total – a statistic that not only means a constant drag on our economy and a diminution in our national wealth, but that also represents tens of thousands of wrecked individual lives.
And sadly, the fastest growing element in the shameful jobless total is young people. Their rising numbers mean that young people now constitute a higher proportion of our unemployed – at 45% – than in any other OECD member country.
That statistic, coupled with the equally shameful and rising level of child poverty, shows that our failures are not just for here and now; we are building a divided and broken society for a generation and more to come.
Too many of our younger generation are condemned to a poor start, denied through public service cuts the early childhood education that would give them a chance, suffering poor health through the illnesses and diseases of poverty, unable to afford or qualify for skill training, vainly looking for paid employment in an economy that has already thrown thousands on the scrapheap, taking tragic refuge in drugs, prostitution and crime.
A constant diet of feel-good stories is all very well; but those who care about our country will want to dig deeper and make their judgments accordingly.
Bryan Gould
28 September 2011
This article was published in the NZ Herald on 3 October.
Re-opening the Debate
Something important has happened in New Zealand politics. After two and a half decades in which economic policy has been a no-go area for political discussion, we have at last seen the beginnings of a debate about what is potentially the central issue of our politics.
“There is no alternative” was very much Mrs Thatcher’s mantra, but it held equal sway in New Zealand. Indeed, it has been even more significant here, because the aggressive free-market orthodoxy first introduced by a Labour government was then reinforced by their National successors. As a consequence, the major parties chose not to engage each other over the basic principles of economic policy, and the whole question of how our economy should be run was consigned to the sidelines.
The reluctance to discuss economic policy was nevertheless surprising, given the constantly expressed concern and disappointment at our poor economic performance. As the gap between New Zealand and Australia widened, and our productivity figures remained stubbornly unimpressive, the finger was pointed at every conceivable explanation – bar the obvious one. It is only now that the realisation seems at last to have dawned that our comparative economic decline might – just might – have something to do with the economic policy settings we have faithfully followed for twenty five years.
For most of that period, we have slavishly adhered to the view that government’s involvement in the economy should be limited to regulating monetary conditions and that even that limited function should be delegated to unelected bankers charged with the equally limited goal of controlling inflation. Beyond that, the rest of the economy could safely be left, it was thought, to look after itself.
It turned out that things were not so simple. The apparently simple and technical question of controlling inflation through interest rates and exchange rates proved to have important and unfortunate consequences for the real economy. The productive sectors of our economy were constantly handicapped by high interest rates and an overvalued dollar, and by secondary consequences like the relative attractiveness of investing in property as opposed to productive capacity and of bingeing on cheap imports as opposed to saving. There was, in other words, a price to pay for using instruments like the exchange rate for purposes they were not meant for.
Government over this period, of course, was let off the hook, disclaiming any responsibility for managing the economy as a whole. It was content to dabble in micro-economics, and in balancing its own books, but showed no interest in issues of competitiveness or demand management. Macro-economics simply did not exist.
So, what has changed? The Labour opposition has been thinking. They seem to have grasped that there is no upside in either electoral or practical terms in simply agreeing with the government, and that the evidence before our eyes demands that New Zealand should strike out in a new direction.
So, the two-party consensus on economic policy is at an end. It is proposed that the purpose and techniques of government’s involvement in economic policy should change. Macro-economic policy is back.
What are the chances of the debate taking off? They are better than one might imagine. The current government continues to stick to orthodoxy, but they are led by a pragmatist. Sooner or later, and hopefully sooner, John Key is going to realise that he and his government will get nowhere near the goals they have set themselves if they continue to slog along the same road that has led nowhere for so long. That would mean just watching the Australian tail lights disappearing into the distance.
There is also reason to hope that the official mind might be less rigid than it has seemed for so long. The regime at the Reserve Bank under Alan Bollard is clearly less doctrinaire than it was under Don Brash. Even the Treasury cannot be entirely immune from common sense.
To get the debate under way is not of course to win the argument. But whatever the outcome, our public life will be stronger for re-opening a real discussion about the role of government in achieving economic success. And not for the first time, we might even lead a world-wide trend.
The voters may or may not reward Labour for its courage in challenging an orthodoxy that has prevailed for so long. But we all owe Labour a debt of gratitude for starting a debate that is long overdue.
Bryan Gould
25 October 2010
This article was published in the NZ Herald on 27 October.
An Ideological Straitjacket
With inflation falling, a full percentage point cut in interest rates at the end of the month now looks like a done deal. But while a relaxation of monetary policy is both welcome and overdue, it does not remotely measure up to what is now required if we are to ward off what could be the most serious recession in most people’s lifetimes.
That isn’t to say that home owners should not see some small reduction in their mortgage interest payments. Businesses – at least those still willing to borrow – should get marginally better deals from those lenders still willing and able to lend. And lower rates should mean that overseas speculators are less likely to push up the value of our dollar by chasing the interest rate premium we have insisted on offering them over recent years.
Even so, the impact of the Reserve Bank governor’s expected decision will be pretty marginal. Any slight easing in the cost and availability of credit at home will be offset by the higher cost and greater difficulty our banks will encounter in borrowing overseas. And even if credit is a little cheaper and easier, that may not be of much use if fears of a recession mean that people are no longer willing to borrow and spend. Relying on monetary policy in these circumstances is a bit like pushing on a piece of string.
When Treasury advised the government a week or two ago that the economic situation had worsened over the three weeks of the Christmas break, they revealed themselves as the only observers who failed to see – from some months back – that a further and rapid deterioration was inevitable. The suspicion must be that they are still fighting the last war, still fondly hoping that the measures that were too late to deal with last year’s home-grown recession – already well entrenched long before the global meltdown – will now serve to deal with the world crisis. Following along in the wake of events, relying on tax cuts planned last year and a belated cut in interest rates, will simply not cut the mustard now that the world economy is in free fall.
It is of course true that we have not so far had to grapple with the financial crisis that has engulfed much of the world’s banking system. Our (largely Australian) banks have so far avoided those problems, though they may find the going gets tougher over coming months. But what we haven’t seemed to have grasped is that the shattering loss of confidence in the world’s banks is now spilling over in to the real world economy – the one where people actually live and work and spend and try to make a living.
As recession gathers pace overseas, we have yet to feel the full impact of export markets that are going backwards, of commodity prices that are falling, of import prices that are rising, of credit from overseas sources (on which – as proportionately the world’s second most indebted nation – we are dangerously dependent) becoming more difficult and expensive to arrange.
Nor have we understood the impact on our domestic economy of falling house prices, rising unemployment, tighter government spending levels and more bankruptcies, closures and bad debts. As people feel less wealthy – as the perceived value of their assets falls, and doubts grow over their future income levels and job security – they become less likely to spend and invest, compounding the recessionary impact of the meltdown overseas.
This is not to say that there is an easy consensus about what does need to be done. But what is clear is that most overseas governments, with varying degrees of reluctance, have accepted that simply cutting the cost of credit when people may not wish or be able to borrow is not the answer. What is now needed, as Keynes recognised 75 years ago, is a fiscal stimulus that will raise the actual level of spending in the economy. That means government investment in infrastructure and services that will benefit the economy, and possibly putting money into the pockets of people – like the poor and the retired – who will spend it, even if this means temporarily rising government deficits.
While others have accepted that difficult times require special measures, we seem locked into an ideological straitjacket which is obsessed with monetary policy and seems more frightened of a burgeoning government deficit than of national bankruptcy. Yet there is no reason why we should be less courageous than others in making our response to recession. The one bright spot in our economic situation, after all, is that the government’s finances are, by comparison with other countries, reasonably healthy. We must hope that our new government will have the courage to recognise this, to understand what they must now do, and to do it before it is too late.
Bryan Gould
21 January 2009
This article was published in the Sunday Star-Times on 25 January.