By Brian Fallow*
People old enough to remember the oil shocks of the 1970s may be forgiven if a dismal sense of deja-vu assails them.
It would be misplaced. In one respect the current crisis is worse, because it is broader.
It is not only oil supplies that are disrupted. Liquified natural gas, urea, aluminium, and the helium essential to the manufacture of microchips are too.
But what is better this time is the monetary policy regime that was put in place to deal to the chronic, brutal inflation that followed the shocks of the 1970s. We all owe Don Brash a debt of gratitude for that achievement.
Trouble is, the credibility of that regime has suffered considerable wear and tear in recent years. Over the past six years, since Covid arrived, the consumers price index has grown at an average annual rate of 4.1 per cent. That is hardly price stability.
Fortunately wages have grown faster. Average weekly earnings have increased at a compound annual growth rate of 5.2 per cent so the rise in real wages has averaged 1.1 per cent a year.
But note the past tense. The Treasury in its half-year update in December reckoned real wage growth by that measure would be negative in the current year, and then rise -- assuming an optimistic CPI inflation rate of 2 per cent -- by just 0.5, 0.6 and 0.7 per cent a year in the out years.
Throw in some bracket creep on the tax side and higher KiwiSaver contributions, and the Treasury's outlook for wage-earners' real disposable income growth was basically zero.
And that was before the shock emanating from a feckless fool's "excursion" to the Gulf.
This is something the people who set prices in New Zealand's 600,000 or so enterprises need to bear in mind when they contemplate the hit to their margins from higher fuel costs.
The transmission from higher global oil prices to New Zealand consumer prices is not automatic. Our businesses have some agency.
They need to be mindful of who their customers are and how able and willing they are to absorb those increases. The risk is that higher selling prices are offset by lower volumes and revenues.
Then there is the fact that the Reserve Bank reckons we have a negative output gap -- a measure of spare capacity in the economy -- of 1.5 per cent of gross domestic product. How much of that spare capacity is at a competitor's disposal?
So it is a unenviable position for both households and businesses.
*Brian Fallow is a former long serving economics editor at The NZ Herald.
29 Comments
I've met this man and tried to explain about the energy underwrite of all things. Absolutely nice fellow - obviously absolutely hasn't gotten it.
Energy is the 100% underwrite of everything done. Everything. In that, no business has any agency. Profit-margin maybe; agency no.
And most of those are dependent on most of those.
97% of NZ businesses are SMEs without I would suggest the capital backing to absorb these costs, especially after recent challenges....and property values are flat.
Somebody thinking with some clarity. Couldn't express that better myself.
I'm usually fairly reluctant to pass cost increases on, especially that quickly or at a 1:1 ratio.
For the simple reason such an inflationary environment often coincides with a weaker trading environment.
It is starting to look pretty weak in the medium term.
Thanks Mr Fallow for a well written dose of facts and sanity.
Normally monetary policy is used to cool an economy. In this case the economy is stone dead cold to begin with. And I’m not convinced they have a plan b.
Was watching the news last week - it said that South Island GDP growth was 5% last year!
Not sure where they got that figure from, but if true, parts of the country/economy have actually been booming.
This is where they got that data from:
https://www.stats.govt.nz/news/southland-leads-regional-gdp-increase-in…
Ok - thanks for clarifying this David.
So Jimbo - be careful saying that there was no growth just prior to what is now unfolding - as in reality parts of New Zealand were actually seeing very strong growth recently (along with inflation outside the mandated band.....) So for example, in the South Island you have growth >5% and inflation >3% and yet no action from the central bank to cool things off a little when they had the opportunity to do so (late last year and again in Feb). So if inflation really takes off now, then I am not going to have any pity for the central bank. They could have and should have been raising rates (in my opinion) probably twice now already, but did not. Having done so, it would have been some protection/limiting factor towards what may now unfold. Instead they allowed conditions to establish themselves where if a supply shock did arrive, then it would be extremely likely that a very difficult to control surge in inflation would occur. Why? Because aggregate demand was already running much too hot before the shock even hit our shores (high growth and high/outside mandated band inflation). But they ignored all of that data in the favour of keeping rates low....for what reason I still do not understand nor understood at the time.
If you can bring yourself to believe that GDP stands for anything.
Difference between 1970's and now was low private debt to GDP.
Now we have extremely high private debt to GDP.
Higher inflation (and the resulting higher interest rates) creates an immediate suffocation of economic activity as mortgage holders (and businesses with high debt) drown in higher interest expense. They either default or demand higher wages (mortgage holders) or pass on higher prices (businesses with high debt and staff demanding higher wages to survive higher personal costs) to customers.
The less discretionary your product or service is, the more capacity you have to meet the potential buyer's willingness to pay.
If you're selling nice to haves, you're in a bind. If you have to allocate discounting and promotions to juice sales, here's a simple reality.
Your gross margin to operate is 25%. Cost of your promo or discount is 10%. Subtract 10 from 25 and divide margin by your number [25/15].
You will have 1.66. Therefore you will need to increase sales by 66% in order to have any material impact on your business.
We are going to get the perfect demonstration over the coming months of just how flawed medieval monetarism is. We have spare capacity (400,000+ people wanting work or more work! ) and the economy had only just started to recover... from a descent to a standstill. Even the allegedly booming South Island has only seen 1% job growth in the last year (the gdp increase has been driven by profits).
But, higher oil prices will flow slickly into other prices, and then wages, as sure as eggs are eggs. Margins might be compromised but they won't go negative.
If RBNZ increase the cost of debt in response, then they will just add more cost to business. And, guess what? That cost will be added through to prices too.
I know what the reckonomists will say in response - demand will fall and then prices will too. No they won't. Businesses will downsize to reflect lower demand, and the impact on prices of more 'competition' will be offset by reduced economies of scale.
I knew NZ would become the case study of how to properly screw up the exit from the covid inflationary period, but it looks like we might double up on the fuel crisis too and properly destroy our economy.
There's few countries that'll handle either that well.
And only so much makeup you can put on a shit show.
Um the economy was destroyed when we allowed our private debt to GDP to go up to 130-150% of GDP the last 20-30 years and all we did was hide from that issue by continuously dropping interest rates so we could pretend that everything was fine and dandy (when it was not..). While we did this, people called our economy a 'rockstar'. Perhaps more a shooting star that would burn itself up would be a more appropriate term. Or a rockstar with an addiction issue that would cause future career collapse - almost 99% certainly.
Not a problem as long as interest rates never had to go back up again. But to think that rates would never go up in the future would make one a fool, living in a delusional state of mind. And yet it was a common theme across society, including on this website. Even flat interest rates are an issue when private debt to GDP is so high as the system needs lower rates to continue to increase new mortgage lending and thus to 'stimulate the economy'. If rates flatten out or rise, new mortgage lending contracts and thus feels like the life is being sucked out of the economy.
So I disagree with you. Putting up interest rates is not the problem we need to address. The problem is our private debt to GDP. But you will say it is rising interest rates while you ignore the elephant in the room. We should have never allowed banks to lend so much and to shift their portfolios away from a split between business lending and residential property, to almost be exclusively residential property lending.
Our private debt to GDP is like a drunk or addict that is forced to get sober and will blame everyone around them for their pain and suffering - not admitting that they themselves created the problem through their unhealthy relationship with alcohol - just the same as NZ (and other nations around the world) with our unhealthy relationship with debt relative to our productivity. 'But getting sober is too painful and you forcing me to stop drinking is the issue!' Um no its because you can't handle your booze in a healthy way.
The issue is usually underlying mental health issues, and the substance is the escape.
So if you were trying to make an analogy with debt, the mental issue is a desire to sustain or improve living standards regardless of whether you can afford it.
Something seemed to break around the 1990's. Our private debt relative to our productivity started going crazy right up to the GFC and since then its been dangerously high (130-160% of GDP). It isn't good - but politicans and bankers celebrated as something to be looked upon as a success story.
But it isn't really - all it is is living beyond ones means - trusting that the debt will keep flowing (as interest rates went down) and if it doesn't, the system can start to contract upon itself with a nasty feedback loop - one that JFoe is describing. But my view always was that prevention was better - but that view was labelled as one of a 'doom gloom merchant' for well over a decade (as I avoided getting caught up in the euphoria of the wealth effect that seemed to be corrupting some peoples minds).
This story is reflected in real house prices.
https://fred.stlouisfed.org/series/QNZR628BIS
Something seemed to break around the 1990's
Yes, you could leverage housing, offset the mortgage against your personal income to minimise tax liability, and have an investment property paid off in 10 years if you chose not to re-leverage it after 3. It's no surprise everyone piled in as it was the greatest investment class of it's time and the snowball effect was real, and not very hard to do. Also millennials all being born leading to greater demand for bigger houses, land being freed up, still plenty more resources to use for building etc.
"So I disagree with you. Putting up interest rates is not the problem we need to address. The problem is our private debt to GDP. But you will say it is rising interest rates while you ignore the elephant in the room."
The problem is indeed (private) debt, however it must be remembered that all money is debt and an increase in interest demands an increase in money to pay that interest....you see the problem?
Who needs an increase in their ability to pay increased costs?....not the holders (issuers) of the debt, but those on the other side of the ledger....the ones you are asking to pay more for that (existing) debt.
Of course debt is also destroyed by default .....or tax.
I 100% see the problem. Hence the feedback of lower rates for 40 years (1980's - 2020) could result in the reverse feeback loop 2021 - ........(insert some year many decades from now).
We had falling interest rates for 40 years, which caused lower expenses for those holding debt (and associated wealth benefits for those holding assets backed by debt). Now what happens if the reverse of that cycle occurs, which appears to me may have started in 2021.
Debt deflation happens....we may not like asset inflation, but I suspect we would like a depression even less.
Well there have been a number of similarities to the 1920's to recent history. Including wealth inequality, asset bubbles and various manias. And we know what happened next.
The thing is though is that central banks think they learned something from the 1930's and that to avoid a depression you just issue more debt (make sure money supply keeps increasing), as we did in 2008 and 2020. But all it has done is made our fundamental issues worse, not better.
Again like giving a drunk another bottle of whiskey instead of ever sobering up. And the more bottles of whiskey you give someone, the worse the hangover is.
.' But all it has done is made our fundamental issues worse, not better."
Yep, don't disagree...but we did that and now we are where we are......I'd suggest the option of a recession and a reset has been long passed....then theres the fact that the model of growth has outrun the resources required.
Predicament
I agree with you, you're just making a different point about the mess we've got ourselves into, rather than the further mess we will get ourselves into.
Ultimately we need to deleverage. Yes. I have shared this graph many times. It's scary that we counted that private debt balance sheet expansion as a growth / productivity miracle.
It's a good one. Helps people to understand the relationship between public and private debt.
Agree - a good chart.
Wouldn't surprise me if we now see decades of falling private debt vs GDP. Ie an undoing of the past 4 decades. This will also see house prices continue to fall in inflation adjusted terms.
Mortgage debt annual growth has steadily climbed to just under 6% according to the latest data (Feb 26) and private debt as a % of GDP is picking back up too having hit a low of 137%. I was thinking pre-Trump mess that we would squeeze out another little cycle of debt fuelled growth. Now, who knows.
Yeah well I think its possible (or even probable) we look back in 10-15-20 years time and say 'wow we just lived through a very large private debt bubble'.
Then we started fighting of the remaining energy
And all those esoteric accounting measures went out the window.
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