Sludge Report #30 – Things Fall Apart
IN TODAY’S EDITION: Sludge Gets Serious About The Disintegrating World Economy
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Sludge Report #28
Sludge Gets Serious About The Disintegrating World Economy
It is perhaps appropriate that the world economy appears to be disintegrating at the same time that the world’s attention is focussed firmly on the physical competitions underway in Sydney. Metaphors concerning violin playing come to mind.
The unfortunate truth – for those still with only half an eye on the financial markets – is that the NZ dollar problems are far from confined to NZ. The entire economic fabric of the planet is now facing a crisis very similar to that during the 1997-1998 “Asian Economic Crisis”. Only this time it is happening faster.
Then, Asian currencies – accompanied by the NZ and Australian Dollar - went through the floor. The consequence was widespread economic chaos throughout the Eastern Hemisphere. Thousands of job losses. Loan write-offs. Poverty and pain for the people of Asia and a mini-recession in NZ.
This time it is the Euro that has caught the flu. And it is taking almost all other currencies in the world down with it.
More importantly however, this time the underlying symptoms are worse. Last time the causes were arguably bad lending decisions and speculation on the currency markets. This time the bogey-man is the hoary one of old - inflation.
Commodity prices are spiking across the board. This means raw materials – all of them, not just oil – are getting more expensive.
While this is good news in the short term for some NZ exporters, it is bad news for the consumer – both here and everywhere else in the world. And this means it is also bad news for Western economy (G8) economic growth – and thus will ultimately be bad news for NZ exporters.
In the long run European consumers who can’t afford petrol for their cars are unlikely to start buying larger quantities of NZ meat, wool, wine, butter mussels and venison.
The word inflation may no longer scare children (as they haven't seen any for a decade), but it remains the bogeyman it has always been. Inflation is bad, ugly.
Initially inflation in commodity prices (and a falling currency) means falls in margins for importers, transport companies, retailers, manufacturers, employers. Lower profits mean slower job growth.
For Kiwi mums and dads, it means reduced buying power. That is, if you want to balance your household accounts, you will have to buy less petrol, less (or cheaper) food, go out less, buy fewer cars, TVs, computers, house extensions, go to the movies less.
This in turn leads to further pressure on manufacturers, employers and retailers, and ultimately banks.
Take for example an affluent middle class family sitting on a $250,000 mortgage in a $350,000 house. The checkbook stops balancing at the end of the month. Suddenly the idea of selling the house and moving into cheaper rental house starts looking attractive. Only problem - there are no buyers in the market (Note: The NZ property market volume of sales fell to 12 year lows in July).
Meanwhile back in the productive sector, businesses who are finding it increasingly difficult to sell their products (and remember 75% of the NZ economy is domestic) are hit by reduced profits, falling asset values, liquidations, mortgagee sales. The cycle is self reinforcing.
In the mainstream media, and on political podiums throughout the world, this is not however how things are being portrayed.
The ridiculously strong US Dollar is lauded as if it is merely a sign that the “economic miracle” of the US Economy is continuing from strength to strength. Here in NZ Helen Clark and Michael Cullen are confidently expecting growth to bounce back in the September Quarter.
The NZ Public, like the European truck-drivers, are beginning to feel terrorised by continuing petrol price prices. Retail sales have only stopped falling because NZ households are being forced to pay millions of dollars more for their petrol, and petrol is a retail item. The June quarter is now expected by most forecasts to show a contraction of up to 1%. September, in Sludge's view, is likely to be worse. Petrol prices have through the quarter continued to rise and rise.
Credit card borrowing statistics out yesterday from the Reserve Bank show fairly conclusively what is really happening in the NZ economy. Kiwi mums and dads are extending credit card balances to pay their mortgages – (and most probably, other credit cards too). This can be seen because the extra spending is not reflected in retail sales, which remain flat. Meanwhile anecdotal reports from Auckland bank managers indicate many small businesses are extending house mortgages to keep their small businesses afloat.
In the long run of course these tactics will not work. Unless you want to lose your house, and/or your shirt, painful choices have to be made, to cut costs, lay off staff, turn off the heater, catch the bus, eat spam.
Unfortunately even in the booming export and tourism sector the bite will come once the impact of a reduction in European growth, and European consumer spending, starts to impact on export returns.
The second significant symptom of concern is the global political situation.
The recent petrol protests in Europe, S11 in Australia and upcoming demonstrations in Prague against the S26 are part of another simultaneous global paradigm shift now well underway.
In the UK Tony Blair’s government is now running second to the conservative party in polls. Here, the NZ Labour Party is not doing much better. The “petrol effect” is serving to add further pressure to a political environment which has been fragmenting for the last two years.
The left in NZ, Australia and the UK are in the process of splitting apart completely now. Ken Livingstone, Anti-capitalists, Greens, Social Crediters and hard left socialists are all heading off into completely new territory, way to the left of what has over the past decade been the dominant political faction of the left, the so-called “center left”.
Unfortunately this new hard-left has little in common with the center left and its support of free-trade and deregulation.
In the latest NBR-UMR Insight Poll the Greens and the Alliance showed a surge of support. Why?
Because the public are beginning to ask questions about the solutions offered by the dominant parties, National and Labour.
On the bottom-line what is going on politically now is a shock impact from petrol price rises, voters are feeling anxious, powerless and disenchanted – with all politics. Change , even radical change (such as cutting off the petrol supply in the UK directly) is receiving public support!
This is not to say the European petrol protestors are socialists. Far from it. Some of them may be, but most of them are simply angry. And looking for solutions, to what they see as a failing system. These are small business people, truck owners and farmers, traditional conservatives. And it is when conservatives start turning feral that you know there is a paradigm shift underway.
And here is the nub: According to economic theory held sacrosanct by both Labour and National here in NZ, the Federal Reserve in the US, the Bank of England, the Reserve banks of NZ and Australia, the IMF, etc. etc: The appropriate response to inflationary pressures – such as those being experienced in NZ and elsewhere – is to raise interest rates. Raising interest rates in theory is supposed to tame inflation. It does this by discouraging people from expanding money supply by borrowing and spending.
Only problem is in the current circumstances any fool, including the Reserve Bank fortunately, can tell that it is impossible to prevent inflation that is driven from abroad through increases in the cost of imports such as oil and through weak currencies, simply by raising interest rates.
Our paying more to borrow money is not going to make OPEC sell us cheaper oil, or China sell us cheaper clothes.
In fact it is patently obvious that raising interest rates in these circumstances would be completely counterproductive. They would reduce the already stretched buying power of consumers and exacerbate the situation.
The reverse of interest rate rises are what are now needed.
The NZ economy has now reached a point where what it needs is stimulus, and lots of it, on the domestic front. Interest rates need to start falling, and soon. And arguably the government also needs to increase spending or perhaps even cut taxes.
Unless pressure is taken off the NZ consumer’s wallet, and fast, a deflationary spiral now looms larger than at any stage over the past two decades.
It is interesting to note that this response is already happening from the markets – although not fast enough.
While inflationary pressures are exploding (and interest rate expectations are rising), mortgage interest rates in NZ have been falling for the past three or four months. Perhaps in this area at least the market is anticipating what is needed, even if the Reserve Bank and Government can’t yet see the wood for the trees.
While falling NZ interest rates would inevitably put even more pressure on the dollar this is unlikely to matter much over coming months as the real world events that are causing NZ’s pain are – as ever – located firmly on the other side of the world.
In the long run they will most probably have to follow in NZ's footsteps and lower their own rates too.
OPEC in saying it is “dismayed” at the high levels of taxation on oil levied in Europe was effectively declaring the beginning of an economic war against the West. It was saying, indirectly, that it will no longer allow the Western economic alliance to dictate economic realities to it.
OPEC – which incidentally is made up primarily of nations in which usury is considered a sin - was telling the world, and the G8 in particular, that it is time for change. Just as the blockading strikers and S11 and s26 protestors are.
At this stage no one is particularly clear on what changes it is that they want made. All that can be said for certain is that the centre is under considerable pressure, and that staying on the present path is no longer an economically or politically viable option.