Roger J Kerr suggests four actions that could address our current inflation problem. He also is sanguine about how the US debt ceiling problem resolution. And he is highly critical of how the RBA is foreseeing its developing issues

Summary of key points:-

• Solutions required, not just identifying the problem with inflation
• US debt ceiling breach to play out like all the previous occasions
• The Reserve Bank of Australia cock-it-up again!  

Solutions required, not just identifying the problem with inflation

There has been considerable media space and air-time devoted to New Zealand’s 7.20% annual inflation rate over recent weeks. The “cost of living crisis” and “the economic damage of high inflation” have dominated the headlines. Unfortunately, most of the analysis, explanations and commentary from various economists centres on what makes up the price increases i.e. explaining the problem rather than offering solutions to the problem. It is very superficial analysis and falls well short of identifying the root causes of prices increases to consumers, and what needs to change to reduce those prices and ensure they do not happen again.

The Reserve Bank of New Zealand is charged with the responsibility of controlling inflation within the 1.00% to 3.00% band, however they seem very reluctant to address and highlight the fundamental causes of consistent price increases and instruct the Government of the day to do something about it. Instead, the RBNZ merely take reactionary monetary policy action after the fact, shoving up interest rates to clobber demand in the economy in the hope that it will lead to decreases (or no increases) by price setters. The interest rate intervention is off course very blunt, not targeted and takes a long time to be effective due to the majority of home mortgage borrowers fixing their interest rates for one to three years.

There is no easy fix to the inflation problem when the situation is allowed to occur in the economy of the more permanent “wage-push” inflation. Inflation becomes imbedded into an economy when the demand/supply equation in the labour market becomes totally lop-sided. In the post pandemic era, the demand for labour across all sectors of the economy has become so intense that the price of that labour (wages) is continually ratchetted up and the additional cost recovered with price increases for products and services. The nasty wage/price spiral cycle has to be broken with immediate and overt policy prescriptions. Thankfully, the new Prime Minister appears more open to change in this respect than the last one.

Big and bold decisions are now required by our leaders to bring inflation down to protect the spending power and preserve the value of savings of our citizens. Below are four suggested solutions to reverse our inflation problem:-

1. Immigration recruitment campaign – New Zealand has been far too slow and too bureaucratic to attract skilled and semi-skilled immigrant workers into the country to re-balance the labour market supply/demand equation. Whilst enhanced training opportunities for locals is vital, the need is now, not in three years’ time. The New Zealand economy has been built on the knowledge and skills of immigrants, so it is nothing new and a massive recruitment campaign is desperately needed right now. Over 18 months ago this column was consistently highlighting that worker shortages would be a major constraint on our economy and export growth in particular. It is now all evident to see.
    
2. Reduce the regulatory/legislative “cost overburden” – A detailed analysis of the sources of domestic/non-tradable inflation over the last 10 years (which has always run at 3.00% to 4.00% pa and is now considerably above that) would reveal that regulatory/legislative impositions have caused cost increase that have to be recouped somewhere. i.e. households end up paying for it. The most extreme example is local government rates which have increased, on average, 7.00% every year for 10 years. Councils have massively increased staffing levels to handle regulatory/legislative requirements imposed on them by central government. The additional staff costs are recovered through rates increases. Someone needs to step in to stop this out of control, price-setting lunacy occurring in the public sector. The Government needs to take control of its own backyard by introducing a “Inflation Responsibility Bill” (just the same as Ruth Richardson’s Fiscal Responsibility Bill in the 1990’s) so that the inflationary impact of every piece of legislation/regulation is identified and controlled.
    
3. Higher NZ Dollar exchange rate – NZD/USD exchange rate volatility over the last two years has not helped to reduce tradable inflation to offset the persistent high non-tradable inflation. We import nearly everything that consumers require (building materials, household appliances/furniture, fuel, clothing, electronics etc), therefore a higher NZD currency value against the USD will reduce import costs and therefore end-prices. The RBNZ should know the level of forward FX hedging in both the import and export sectors, therefore be able to calculate the economic impact of a higher NZD/USD exchange rate to bring inflation back down. The majority of exporters are currently highly hedged one to three years forward; therefore export sector profitability/investment has a buffer against a higher NZ dollar value. RBNZ Governor, Adrian Orr has the opportunity on 22 February to “jawbone” the NZ dollar higher as a strategy to reduce inflation without damaging the economy.
    
4. Increase competition in building and supermarket industries – Successive governments have just really fluffed around the edges in respect to monopolistic and duopolistic price-setting behaviour in these two industries. Cutting out the several “middlemen” before product gets to the end consumer would be a start. Proactively inviting in a big global chain supermarket player would also help.

Naturally, there will be expected as well as unexpected consequences on the economy from such immediate inflation-busting measures. However, the Government and the Reserve Bank need to explain to the public that the greater good is best served through reducing the current debilitating inflation rate.

US debt ceiling breach to play out like all the previous occasions

The risk of debt ceiling breaches comes up every year at this time when the US Federal Government is running budget deficits (which has been the case  for some time now). What is the risk of the US Government defaulting on its debt by not having the cash to pay the interest coupon or repay a maturing treasury bond? When the debt ceiling limit is reached the Federal Government needs to find the cash from somewhere else to meet their debt obligations, as they cannot issue any new debt. Typically, special funds and cash reserves are temporarily raided, and some government services are shut down. Politicians in Congress use the opportunity to leverage their positions and policies and it always comes down to the wire to a compromise to avoid a debt default. The can is always kicked down the road and President Biden’s Treasury Secretary Janet Yellen, is already suggesting a lifting of the debt ceiling as the answer. As every borrower well knows, that is never a sustainable answer!

If the US politicians pontificate on this for too long, the financial and investment markets exert immediate pressure to find a solution and that in turn forces the political compromises. Whilst nobody believes the debt default risk will every materialise, market volatility can intensify. No matter which way you look at it, it is not positive for the US dollar value and therefore the potential for a debt crisis just adds to the stack of USD negatives in currency markets at this time.

The Reserve Bank of Australia cock-it-up again!  

Last week’s Australian inflation result for the December quarter (annual inflation rate higher than forecast at 7.80%) once again has the pressure on the RBA to undertake yet another U-turn on monetary policy. In early 2022, the RBA did not see the need to increase interest rates until 2024 to combat rising inflation. They abruptly reversed that stance in May 2022 and lifted interest rates. Over the last few months of 2022 the RBA pontificated that they could slow down on interest rate increases and wait and see what the data brings. The markets had been pricing a 0.25% OCR increase at the 7 February RBA meeting, however many commentators are now pressing for a larger hike as there are no signs that their inflation increase has peaked. The foreign exchange markets have already responded to an expected widening interest rate gap between the US and Australia and pushed up the AUD/USD rate to 0.7100. A 0.50% OCR increase on 7 February from the RBA is unlikely but cannot be ruled out entirely. The AUD would spiral higher if 0.50% was delivered.

Whatever the RBA decision, the AUD looks set for further gains to 0.7500/0.7500 against the USD, dragging the Kiwi dollar up with it. Iron ore and copper prices are on the rise again with Fortescue Mining recently reporting their largest volumes of iron ore exports ever (97 million tonnes over the July to December 2022 period, 17% up on 2018 levels). Speculative currency market positioning still has many punters “short-sold” the AUD. They will be hastily buying it back to close-down their positions before their losses get too big.

Mining companies in Australia have not invested or re-invested in new mining capacity over the last four years due to Covid and the uncertain Chinese trade relationship. Matters are much clearer today, so a massive capital investment catch-up is on the cards. As many mines or extraction infrastructure are foreign owned (Chinese, Japanese, US and European), we are very likely to see large foreign capital inflows into Australia occurring over coming years. The AUD has been pushed higher due to such capital flows in the past and currently at 0.7100 it still has to be considered relatively undervalued compared to economic performance, economic health and hard commodity prices.

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.