By Bernard Hickey
This week the long-simmering symptoms of the Dutch Disease burst into a bright red rash of losses right across the Australian and New Zealand economies.
The Economist coined the phrase 'The Dutch Disease' in the mid 1970s after Holland discovered natural gas in the North Sea. A surge of gas revenues pushed up the Dutch Guilder and slammed its manufacturing sector as the rise in its currency made its goods uncompetitive.
Now the Australia and New Zealand economies are experiencing the same phenomenon at the same time, thanks to huge demand from China for two different products.
Australia's iron ore boom through the past five years drove the Australian dollar up by a third. New Zealand's free trade agreement with China in 2008 unleashed massive demand for milk powder, which also helped push up the New Zealand dollar by around a third.
This week a collection of events on both sides of the Tasman crystallised just how much the Dutch Disease has changed our economies, and often in surprising ways.
For example, the Dutch Disease is likely to end decades of V8 rivalry between the Holden and Ford tribes.
This week Holden announced it was ending manufacturing in Australia because the high Australian dollar and high wages meant it made much more economic sense to build Commodores in China than in Australia, unless there were massive new Government subsidies. Ford announced in May it was leaving Australia, which means Toyota is the last remaining car maker across the ditch.
Most believe it will soon pull out too because the car makers share common parts suppliers that can't survive with just one customer.
That means the loss of about 200,000 Australian jobs.
The softness in Australia's jobs market is rebounding across here too as net inward migration climbs.
Fewer Kiwis are leaving for jobs in Australia as the mining booms slows and the manufacturing sector is crunched by the high currency. Plenty of Kiwi-born Australians are coming home too.
That is helping to fuel the 15% house price inflation seen in Auckland over the past year.
The second strange effect of the Dutch Disease was revealed this week by Fonterra when it forecast a halving of its profit and a 22 cent per share cut in its annual dividend. It also froze its forecast milk payout at NZ$8.30/kg, all of which seemed counter-intuitive given Chinese demand for milk powder has exploded.
It's all about the widening gap between milk powder prices and more processed products such as butter and cheese.
Fonterra normally sets the milk price it pays to farmers based on the international milk powder prices. But the power prices have run far ahead of cheese and butter prices, which means Fonterra is having to 'over-pay' for the 30% of milk it then processes into the lower priced cheese and butter.
This has slashed NZ$800 million from Fonterra's profit and forced it to cap the milk price when it could, in theory, have raised it to NZ$9/kg.
The final surprise result of the Dutch Disease was revealed this week by the Reserve Bank.
It included a scenario in its Monetary Policy Statement that would see New Zealand's terms of trade, which measures the 'power' of our exports to buy a certain amount of imports, stay at its current 40 year highs for the next couple of years.
The milk powder boom is the major driver for this.
The Reserve Bank estimated it would have to hike interest rates even more than it's currently planning to keep inflation under control. This scenario would see mortgage rates rise to 8.5% within a couple of years, rather than the 8% currently indicated by the bank.
So what?
So what can or should be done about New Zealand's version of the Dutch Disease? Some countries have successfully managed to avoid the worst of the impact of their Dutch Disease. Norway is the best example.
It too faced a surge of demand for its currency when it found oil in the same North Sea as the Dutch found gas.
The Norwegian Government chose to skim off some of those US dollar revenues from oil in the form of royalties and reinvest them directly in bonds and stocks offshore, thus avoiding having to convert them into Krone and pushing up the currency.
Norway's Sovereign Wealth Fund is now worth NZ$1 trillion.
It worked to avoid a big appreciation and its manufacturing and other labour-intensive industries are still growing. Norway's Government was able to control at least some of those oil revenues because it owned the main oil company Statoil and can collect royalties from others.
New Zealand would struggle to do the same for New Zealand's 'white oil' in the form of milk powder. Fonterra is owned by farmers rather than the state and no one has yet worked out how to impose a 'royalty' on milk collections in the same way royalties are collected on oil.
The Green Party might have a few ideas, in particular the idea of some form of polluter pays principle or resource rental from water use. A Government would have to apply some sort of special tax on dairying.
The last time a government tried something like that (the fart tax) there were tractors driving up the steps of Parliament faster than someone could say 'sovereign wealth fund.'
One way would be to encourage Fonterra to invest much more of its profits offshore.
That would prove even less popular with farmers.
The years ahead will be dominated by this issue.
How will the proceeds of New Zealand's 'white oil' boom be distributed in a way that keeps plenty of people employed on good wages?
How much will trickle down to workers?
How much will trickle out in the form of dividends to foreign-owned bank shareholders?
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This is an extended version of an article that appears in the Herald on Sunday. It is used here with permission.
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