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Sludge Report #91 – NZ's Flat (Shrinking) Economy

In This Edition: NZ's Flat (Or Is It Shrinking?) Economy

NOTE: Authors of this report will be anonymous and wide ranging, and occasionally finely balanced. Indeed you are invited to contribute: The format is as a reporters notebook. It will be published as and when material is available. C.D. Sludge can be contacted at The Sludge Report is available as a free email service..Click HERE - to subscribe...

Sludge Report #91

NZ's Flat (Or Is It Shrinking?) Economy

Reading the headlines in the papers lately, C.D. Sludge has been rather surprised to read, over and over again, reports appearing to indicate that the NZ economy is AOK, hunky-dory, in short, a box of birds.

Reports have included commentary on record export returns, a record trade surplus, falling unemployment, rising job adverts and surveyed employment intentions, and an allegedly recovering house market.

On the basis of this data the economic brains trust of NZ's major trading banks have concluded variously:
- that the NZ economy is growing;
- that the dollar will appreciate in coming months;
- and that there is no need for any further Reserve Bank interest rate cuts.

In fact as GDP figures out today show, the NZ economy is not AOK, it is just treading water. Meanwhile the dollar is falling, and as any business person and householder in the country will tell you, there is an urgent need to cut interest rates.

In the latest set of GDP statistics for the March 2001 quarter - the first three months of 2001 - the NZ economy did not grow at all.

According to Statistics NZ, on a yearly basis the economy grew at 2.5%, which does not soundt so bad. However when you look more closely at this, you find it is calculated on a basis other than looking at how much bigger the economy is now than it was a year ago. On that basis the economy has grown just 0.7% in the last 12 months.

(C.D. Sludge took this issue up with Statistics NZ boffins and the following is their explanation.

“The way that you have illustrated (ie adding the last 4 quarterly % changes) will give you an approximation of the movement for March 2001 quarter compared to the March 2000 quarter. We also publish this movement (ie percentage change from same quarter previous year = 0.7%) in our release. You might want to call this a point-to-point comparison. For the annual movement we want to compare all four quarters this March year (2001) compared to all four quarters in the previous March year (2000). The annual movement has the advantage over a point-to-point comparison in that gives a more stable growth rate series, especially where there is variability at the end points. The method we use for calculating an annual percentage change is the same used by other statistical agencies around the world, and is also used by many of the analysts in New Zealand.”)

Now in normal circumstances a flat economy would probably not be that bad. It might indicate, as Finance Minister Michael Cullen tries to interpret it in his press release today (See... GDP Result Disappointing But Historic - Cullen), that the NZ economy has just been biding its time before surging ahead. And certainly the mainstream economists are still trying to put a positive spin on the figures out today.

However when we have a flat economy accompanied by high inflation and an export and tourism boom, then Sludge immediately wonders, what the hell is going on!?

And after looking behind the glam, it is discovered that the truth about NZ’s “flat” economy is that it is not “flat” at all. It is shrinking.

Consider the following:
- On a ballpark basis NZ’s tradeable sector (the export and tourism sectors of the economy) is roughly 30% of the total NZ economy, with the non-tradeable, domestic market, economy making up the rest.
- Again, on the basis of ballpark analysis , recent reports indicate the export sector has been expanding lately at around 25% to 30%.
- Calculating 25% of 30% gets 7.5% - that is the booming tradeable sector ought to be contributing (conservatively) somewhere in excess of 5% growth to the NZ economy as a whole.
- But in fact as figures out today confirm, the economy has not grown, rather they show it is flat, which means the domestic sector is shrinking, quite fast.
- Again on a ballpark basis, a negative 4% contribution (5% of export growth – the 1% of actual growth experienced) to annual GDP growth from 70% of the economy indicates a contraction of approximately 6% in the non-tradeable sector.

And that is what most people would call a domestic recession.

And when you think about it, this is not nearly as surprising as it seems.

Over the past year NZ households have experienced declines in overall wealth (mainly from a decline in the value of their housing), record inflation levels in food, and steadily increasing energy prices.

Those who are still sceptical about this analysis should have a look at the Reserve Bank’s money supply aggregates. While the Reserve Bank is want to argue that these do not mean a great deal usually, even they acknowledge that if a trend is evident over all the indices that it is significant.

For the statistics themselves see…, the following is a summary:
- On a year on year basis total resident M3 money supply, M3R, is growing on an annualised basis at 5%. This compares to an average over the last decade of closer to 11%.
- Private Sector Credit, PSC, is growing at 5% too, again roughly half historical averages.
- Resident Private Sector Credit, PSCR - arguably a more reliable method of looking at the domestic economy - is now growing at just 3.7% annually, down from 8% in May 2000 and 9.4% in May 1999, 9% in May 1998 (during the Asian Economic Crisis) and, 11% in May 1997 (the last time any real growth in the NZ economy was experienced).
- Meanwhile household claims – the amount borrowed by households - are up 5.8% over the past year. Again well below historical averages.

Which brings Sludge to the question of NZ’s spectacularly high interest rates.

Regardless of how much more growth may or may not have occurred since April the 1st, how can the Reserve Bank justify NZ having the highest interest rates in the world at the same time that its economy is flat? Additionally, how can it justify routinely miss-forecasting NZ’s growth rate?

At 5.75% NZ’s interest rates are currently two full percentage points higher than those in the USA.

They are higher than Europe’s and Australia’s too and fully 5.75% higher than Japan’s. In the circumstances you would expect to be seeing the NZ Dollar appreciating. In fact it is falling.

According to the theory of modern monetary policy management, the objective of the pricing of money (what the Reserve Bank does when it sets interest rates) is to restrict the expansion of credit so as to prevent inflation getting away on the economy. Usually it is considered that what should be focussed on in this process is the medium term, or 18 months hence.

Often the analogy of a an accelerator and brake is used to describe this process.

The Reserve Bank seeks to prevent money being priced so low as to flood the engine, that is, provide it with too much money, and thereby cause wastage in the form of inflation.

So how does one measure whether the price of money is too low?

An obvious way to do this would be to look at the monetary aggregates and the levels of overnight settlements between banks, which tell you – in terms of the engine analogy – exactly how much petrol is going through the carburettor.

On this basis you would look at current stagnant levels of credit expansion and conclude that money has been priced too high for at least the last 18 months.

However - for reasons that completely escape Sludge – the Reserve Bank is resolutely opposed to even talking about monetary aggregates.

In recent times the overnight settlement monitoring system previously used to prevent sudden pushes on the accelerator by banks has been scrapped. In the last couple of months weekly reporting of monetary aggregates has also been scrapped. Meanwhile Reserve Bank economists look at you as if you are mildly demented if you try to draw their attention to the clear evidence that interest rates are too high shown within their own data.

Go figure!

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