• History’s Judgment

    As he finds himself sailing into increasingly choppy waters, it is perhaps not surprising that the Prime Minister’s thoughts might turn to the judgment that history might make of his term in office. There have been several occasions recently when John Key has speculated on that matter; and, amongst other predictions, he has confidently forecast that he will be remembered as having left the economy in a stronger condition than when he took over.

    It is hard to conjure up much by way of statistical evidence to support that assertion. Indeed, the contrary seems more likely – that history will regard the Key government as having been responsible for a further and possibly decisive relapse in a long-term comparative economic decline that might even threaten New Zealand’s viability as an independent, self-governing state.

    Could such pessimism be justified? Surely, it may be argued, in a world that is likely to provide an ever-expanding market for premium food and other primary products, New Zealand’s expertise in this area will guarantee a rosy future?

    That should certainly be the case; our advantages as a primary producer, coupled with our political stability, our freedom from corruption and our access to expanding markets should mean increasing prosperity. But optimism on this account has to be tempered by our government’s insistence on pursuing policies that we know from hard experience will hold us back rather than take us forward.

    Despite the advantage of conditions, like a stable banking sector and buoyant export markets, that are more favourable than most other countries have enjoyed, we have spent the last four years or more bumping along the bottom of recession. Even more worryingly, as a recovery of sorts gets under way, it is driven by factors that make it inevitable that we will compound the very problems that have dogged us for decades.

    Far from resolving our economic problems, we are about to intensify them. The long-awaited “recovery” is a function of increased domestic consumption and a building asset inflation. We are heading straight back into the same old familiar vicious circle, and each time we do a circuit, yet more escape routes are closed off.

    The Auckland housing bubble and the consequent diversion of savings and bank-created credit into property rather than the productive sector means that our manufacturing and other productive industries are denied the investment they need to compete in international markets.

    The inflationary stimulus produced by rising Auckland house prices will mean higher interest rates – rates that are already offering a premium to “hot money” speculators – and that in turn will mean that the dollar remains over-valued.

    High interest rates and an over-valued dollar will further handicap our manufacturers and exporters and will knock the top off the returns we are able to make even on the products we can still sell overseas – ask the dairy farmers.

    The over-valued dollar will also trigger an orgy of imported consumer goods, worsening our balance of trade, necessitating more borrowing and therefore a higher premium to overseas lenders to induce them to lend to us, and the constant temptation (to which the current government willingly succumbs) to sell off more of our dwindling assets into foreign ownership so that we can balance the books.

    The costs of increased borrowing and repatriated profits made by foreign-owned businesses have to be paid across the foreign exchanges, thereby worsening our indebtedness as a country and weakening our ability to control our own destiny. The damage to our productive sector means that, far from developing new products, our productive base has become dangerously narrow – and as the assets of, and income streams from, even that narrow base pass into foreign hands, we will look in vain for the national wealth to re-invest in our future.

    Indeed, John Key sees overseas ownership (often given a positive gloss by being termed “investment”) as not just a painful necessity but as the most promising path to future prosperity. The short time horizon of a foreign exchange dealer does not apparently equip him to ask what will happen when the profits and assets of our shrinking productive base are in foreign hands, and foreign owners (think Rio Tinto) have extracted what profits they can from our mineral resources.

    To paint this picture is not to speculate in pessimism; it is merely an extrapolation of trends that are already long-established. Those who resist such a scenario should ask themselves which part of it is not already familiar. If these trends are allowed to continue for much longer, our national future is grim. We would have lost any possibility of deciding our own future. The only question worth debating then would be whether we become an economic satellite or colony of China directly or whether we are first absorbed into a greater Australia on the way.

    But none of this – either the inheritance left us by our forefathers or the mortgaging of our future – seems to matter to New Zealanders today. History’s verdict on today’s economic policy is likely to be harsh. But that will not be our concern; history, after all, is written by winners.

    Bryan Gould

    17 April 2013

    This article was published in the NZ Herald on 19 April.

  • Lies, Damned Lies and Statistics

    The debate about the current state of the New Zealand economy is less useful than it should be because of two increasingly dominant aspects of the way in which we address these issues.

    First, is the perennial proclivity of our media to consult – almost exclusively – bank economists, as though they are able, from their positions as paid mouthpieces for the banking interest, to tell us all we need to know about the wider economy.

    Second, is the growing practice of asserting – when the statistics fail to tell a story that suits our policymakers – that the statistics should not be believed.

    We have seen both of these elements at work in the current discussion about employment. We are solemnly assured that the fall in the number of people both in work and seeking work cannot be taken seriously because it is an article of faith that the economy is actually doing rather well.

    We have seen the syndrome at work, too, in the continuing discussion about the overvalued dollar and its malign impact on jobs, investment, output, productivity and the trade balance.

    There are good reasons to believe that the dollar, we are told, is not really overvalued. This is an oft-told story. One of the most pernicious of such assertions is the fatuous “Big Mac index” published by The Economist; this populist version of a purchasing power parity index purports to measure the degree of under or over-valuation by comparing the local-currency cost of buying a Big Mac in various countries.

    But the price paid for a hamburger in the domestic economy tells us very little about price competitiveness in the internationally traded goods sector. Successful exporters almost always have – as a consequence of, among other factors, the economies of scale available in manufacturing for export – a quite different cost and price structure from that of domestic production for local consumption.

    When Japan, for example, was growing fast in the 1960s and 1970s, and exploiting worldwide markets for manufactured goods like cars and television sets, the inflation rate in their export industries was low by world standards, so that they could go on exploiting a price advantage, even while their domestic inflation rate across the whole economy was actually higher than average.

    We are also told that there is no need to worry because our dollar is not overvalued against the currencies of all our trading partners. It is certainly true that the trade-weighted index has some deficiencies, and that against the Aussie dollar (which is also overvalued in world terms), our current parity is quite advantageous – thank heavens, because otherwise we would now be “drowning not waving.”

    But, as Steven Joyce says, our exchange rate establishes values against all currencies; and what matters – in terms of whether it is overvalued or not – is the impact it has on our overall balance of trade. A correctly aligned exchange rate should allow us to balance our trade, by “clearing the market” in conditions where we are also achieving a sustainable rate of growth and the full utilisation of our resources, including labour.

    It is no comfort, in other words, to be told that we are not handicapped by overvaluation in respect of one or two of our trading partners when the corollary is that the total trading picture is one of considerable disadvantage.

    Nor is it much comfort to be told that the major impact of overvaluation is on our ability to compete against imports, rather than on our ability to export. The international market for manufactured goods embraces both exports and that part of our domestic market that is open to imports. So weak is our export effort (as a consequence, at least in part, of overvaluation) that it is the competition from imports in the domestic market that matters much more to us. The manifest and growing vulnerability of domestic producers to that competition is just as much a consequence of overvaluation, and even more damaging to our prospects, than is our disappointing export performance.

    We should also beware of historical comparisons designed to show that the dollar is, in some respects at any rate, no higher in value than in earlier times, particularly when those earlier times are themselves very recent and when our history of consistent overvaluation extends back for decades.

    Rather than juggle with the indices in an attempt to distract attention from the hard reality of overvaluation, it would be much more helpful to look at the characteristics typically exhibited by uncompetitive economies – in other words, those with overvalued currencies.

    Such economies have slow rates of growth, high unemployment, low rates of investment and productivity growth, persistent trade deficits, a perennial need to borrow overseas, a propensity to sell off assets – including national assets – into foreign ownership, high levels of import penetration, a weak export sector, and low rates of return on investment and therefore of profitability.

    Sound familiar? Forget arcane debates about small fragments of the picture; if we want to judge whether or not our currency is overvalued, these are the consequences that provide the conclusive evidence.

    Bryan Gould

    10 February 2013

  • Getting the Dollar Down

    That dwindling band who continue to deny that our economy is being hurt by an overvalued currency will usually – in the face of the indisputable evidence – take refuge as a last resort in the assertion that “there is nothing much we can do anyway – we just have to live with it.”

    Nothing is further from the truth. We have an overvalued dollar – which continues to destroy jobs, weaken our industry, worsen our balance of trade, and increase our indebtedness – because that is what our policymakers choose.

    The usual assertion that there is nothing that can be done usually focuses on – and then dismisses – the possibility of intervening in the foreign exchange markets, as though this is the only option. But intervention is the least effective measure that could be taken; it is quite true the Reserve Bank, and its (comparatively) puny resources, would be quite unable to offset the huge flows of hot money that determine the value of our dollar. Intervention is merely a straw man that can be conveniently knocked down so as to distract attention from more effective options.

    That is not to say that the occasional selling of New Zealand dollars (as the Reserve Bank has done recently) would not be helpful in inducing a little doubt in the minds of speculators who are usually confident of a guaranteed interest rate premium and probably a capital gain as well, while the Governor’s unequivocal description of the dollar as “overvalued” was also a useful signal; but there are much more effective measures that can and should be taken.

    The first and most obvious step is to change the policies that inevitably force up the dollar’s value. We persist in paying an interest rate premium to overseas lenders to persuade them to lend us money; and the more we do that, we more we push up the dollar and weaken our economy, and – as a consequence – the more we have to borrow and therefore to offer high interest rates to persuade them to go on lending to us.

    We insist on creating this vicious circle, despite all the obvious downsides, because we assert that controlling inflation – not sustainable growth, not competitiveness, and not full employment – is the only goal of policy, and that raising interest rates is the only way of doing it. If we identified wider goals of policy, and stopped using interest rates and the exchange rate for literally counter-productive purposes (when we should be focusing directly on the actual causes of inflation, such as unrestrained bank lending for non-productive purposes), we could avoid repeatedly shooting ourselves in the foot.

    Other countries are rapidly learning these lessons; even the Governor-in-waiting of the Bank of England has signalled that he is ready to abandon inflation as the sole focus of policy. Sadly, so committed are our leaders to an increasingly discredited orthodoxy that they will not even contemplate any change. And our government has compounded this stubbornness by opposing policies that would help recovery from recession – and bring the exchange rate down at the same time.

    By identifying the reduction in its own deficit as the principal goal of policy, the government has signalled that its priority is the financial rather than the real economy in which most people live and work. This concern for the short-term value of financial assets ensures that foreign lenders will go on buying dollars, secure in the knowledge that nothing will be done to jeopardise “confidence” amongst financial institutions and that the dollar will go on rising.

    Other countries, by contrast, now know better. They know that the only way to escape recession is to get the economy moving again by improving competitiveness. They have increasingly turned to quantitative easing (or printing money) – as in the US and the US – or, even more interestingly and much more effectively, to fiscal stimulus – as in the case of Shinzo Abe’s new Japanese government. The effect of these measures is not only to encourage growth and recovery, and – interestingly – to get government deficits down, but also to devalue the currency; in the case of Japan, that goal is quite overt.

    These measures show that not only that these countries understand the importance of improving competitiveness by bringing down the value of their currencies but at the same time how easy it is to do so – just check out what has happened and is happening to the US dollar, the pound and the yen.

    We remain stubbornly in that dwindling group of countries whose priority is maintaining the value of the currency and who are willing to sacrifice everything, including recovery from recession, to that end. While others reduce the value of their currencies, we say we know better and continue to push up the value of our dollar.

    We have an overvalued dollar, in other words, because we choose to. When bankers, stockbrokers and other holders of financial assets assure us, in other words, that we “just have to live with it”, they are just putting their own sectional interest ahead of the rest of the economy.

    Bryan Gould

    2 February 2013

    This article was published in the NZ Herald on 6 February.