• Bankers Know Little and Care Less

    We were assured last week by the Deputy-Governor of the Reserve Bank, Grant Spencer, that New Zealand exporters had “adapted to” the overvalued dollar which, as interest rates climb, will go on rising.

    So that’s all right then.  Sadly, though, complacent and ill-informed statements like this do nothing to alter the grim reality; the current exchange rate – to say nothing of hikes in the dollar’s value yet to come – is doing, has done and will do great damage to our economy.

    Exporters – or at least some of them, if they are lucky – have “adapted to” this circumstance by merely surviving.  They have done so either by maintaining their prices in NZ dollar terms, at the risk of foregoing market share because their prices are thereby less competitive, or they have reduced prices in NZ dollar terms, thereby cutting profits and reducing the ability to stay in the market.  In either case, this is not the path to successful exporting.

    Exporting successfully is an expensive business.  Unless margins are good enough to make possible all the spending needed to cover all the additional costs, such as freight and commissions, to develop the overseas market through promotion and after-sales service, and to provide the re-investment needed for product development so as to keep pace with foreign competition, it is not worth the effort.   No wonder so many of our potential exporters either don’t try or give up quickly.

    Even our most successful exporters pay a price for the dollar’s overvaluation – just ask our dairy farmers.  Export profits are by definition lower than they would be if the dollar was at a more competitive level; even our best firms are therefore less able in the long run to keep pace with foreign competitors who don’t have to face the same currency head wind – and that’s to say nothing of those who are struggling at the margin.

    And it is not only exporters who suffer.  Everyone who looks for customers in the traded goods sector, whether at home or overseas, is at a price disadvantage by comparison with goods made by foreign competitors.  New Zealand producers who have never thought of exporting will still be on the back foot because imported goods will be able to undercut them on price in their own home market.

    Nor is it the case that the deleterious effects of overvaluation are limited to the traded goods sector.  The problems and reduced performance of that sector mean that the whole economy suffers; effective demand for prospective investors is reduced across the economy, profits are lower than they should be, unemployment is higher, investment is discouraged, and the trade balance is weakened and thereby acts as a constraint on growth.

    In that more stagnant economy, productivity growth and innovation are held back, and we become more and more dependent on the increasingly narrow sector able to keep its head above water in international terms.  In order to maintain the living standards we insist we are entitled to, we find ourselves not only using our overvalued dollars to buy imported consumer goods at the expense of domestic production but we then try to cover the cost by selling off our assets to foreign buyers and borrowing more from foreign pedlars of short-term “hot money” who demand an interest rate premium as their reward.

    At the same time, we prepare to enjoy the consumer and import boom that accompanies the huge volume of bank-created credit that is fuelling the rise in house prices in Auckland in particular; as first-time buyers are shut out by those rising prices, those who already own their houses respond to the growing value of their equity by feeling better off and therefore spending more.

    As a result of that unsustainable consumer frenzy, the Reserve Bank then takes fright and – focusing solely on its single remit of controlling inflation – finds another reason for raising interest rates.  And it is of course the prospect and reality of high interest rates that provokes the overvaluation of our dollar in the first place.

    Every step in this vicious circle is foreseeable, yet the Reserve Bank contents itself by advising the productive sector to “adapt” – the equivalent of a doctor telling a patient suffering a wasting illness caused by drinking polluted water that he should go on drinking but “adapt to” the consequences.

    The tragedy is that the longer we fail to face the reality of our situation, the faster becomes the trip round the vicious circle and the deeper becomes the downside.  Each time we touch the bottom of the orbit, the less chance we have of hauling ourselves back up.

    What we need now is some new thinking – not another circuit of a policy proven to fail.  The Bank of England, no less, showed last week a willingness to face facts when it published a paper by three of its economists acknowledging for the first time that virtually all the money in our economy is created by bank lending – and that raises the interesting question of what that lending should be for.

    Our own Reserve Bank, however, evidently remains stuck in a rut of its own creating.

    Bryan Gould

    31 March 2014




  • 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