In This Edition: Serfs In Our Own Land
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Sludge Report #136
Serfs In Our Own Land
New Zealanders might be forgiven for thinking they are subject to a central banking conspiracy of sorts.
First - at the March Monetary Policy Statement - and then in an unusual in-between MPS move on April 17th - the New Zealand Reserve Bank has decided to go it alone among the central banks of the world and start raising rates from already extremely high levels.
These moves come at a time when the Swiss are continuing to cut rates from levels already less than a third of ours, when the US is still only pondering raising rates from their lowest levels in 40 years, and when the NZ economy has only just started growing again after a period of more than five years in the doldrums.
Then, on April 26th, a little more than a week after sticking the knife into NZ homeowners for a second time in a month the Reserve Bank Governor, a man in whom the country had come to expect the highest standards of political neutrality, suddenly resigns and announces his intention to stand as a candidate in the General Election for the National Party.
Now, three weeks later we, the NZ public, are being treated again with yet another rate hike, this time taking the Official Cash Rate to 5.5%.
An outside observer might conclude that a double play is underway here.
The former governor has switched teams to try to shore up political support for the continued independence of the Reserve Bank, while the bank itself is continuing along its merry road of screwing every last cent it can for international capital owners out of the long suffering NZ worker and homeowner.
Extreme views, perhaps, but consider the following.
The official explanation for today’s additional rate hike is that the bank is “cautiously withdrawing monetary stimulus” that it generously provided the NZ economy last year when the 911 balloon went up. It is doing so, as always, for our own good, to prevent inflation.
Meanwhile, in the text, it is asserted repeatedly that the international outlook is more rosy than previously thought.
Please forgive Sludge if he now pauses to take a snapshot of a pink pig hovering past the Reserve Bank’s briefing room window.
Firstly, according to the theory we are constantly told, raising interest rates is a blunt instrument that takes 18 months to have an effect on inflation.
If this is true then how can it be necessary to raise rates three times in as many months. Clearly the rises we have already had will take some time to have their impact. Is the bank not yet again jumping the gun?
Secondly on the question of the alleged “stimulus” being provided to the NZ economy in the form of low interest rates. Last MPS Sludge made a point of asking then Governor Don Brash what level of interest rates would be considered neutral.
He confessed that he had no idea what the answer was. And yet the mantra remains in the official literature today, as if simply by repetition it will somehow become true. Unfortunately this logical thesis is all to prevalent in orthodox economic thinking in general.
Today Sludge learned somewhat obliquely that neutral levels of rates are the long term average. A level we are presently 1% below approximately. While this is an interesting theory it ignores the fact that households are now more than twice as indebted, both in real terms and in comparison to their incomes as they were a decade ago.
Secondly we have the ongoing question of the state of the international economy, which the bank concludes is more hale and hearty than previously thought.
While this may be the “consensus” view of a bunch of bank economists, Sludge might cynically observe that it does not encourage bank deposits for bank economists to be overly pessimistic.
Perhaps then, instead of relying on the traditional supposition from the bond salesmen, we might instead look at some facts:
Last week the US stock market hit its lowest levels since
the immediate aftermath of 911, yet on average it is still
trading at a price to earnings ratio that is twice the
2. Oil prices have spiked in recent days and are now back close to the $30 USD level;
3. The US Government has just revealed that it is expecting to report a $515 Billion, (half a trillion dollars) deficit for fiscal year 2001;
4. The traditional safe haven of fearful money in the run-up to recessionary conditions, gold, has experienced a sustained rally since 911 and is this week selling around the $310 USD an ounce mark, up from $265 USD an ounce prior to 911;
5. Commodity prices – particularly significant for the NZ economy – are falling;
6. The US Government has just passed a $190 billion USD farm subsidy package which is likely to place further downward pressure on commodity prices for farm produce for the next five years at least;
7. The Swiss central bank has in recent months cut its equivalent of the federal funds rate twice down to 1.25%;
8. And finally, while it may have escaped the attention of local gnomes on the Terrace here in Wellington, international commentary in recent weeks has been pointing increasingly towards the idea that the post 911 recovery is not nearly as robust as it had been thought to be earlier in the year.
None of the above points to a buoyant international economic outlook. In fact it points to the exact reverse.
At this point the Gnome cheerleaders will doubtless reply, but what about inflation? Inflation remains close to the top of the 0-3% band, ipso facto a tightening is required now, is this not the raison d’être of the Reserve Bank Act?
To a point yes. But not necessarily so as the bank itself points out in its own report today.
Given that monetary policy tends to influence demand only 18 months out, the accepted wisdom is that near term inflationary aberrations can be at times tolerated.
For example, when inflation went through the top of the band in late 2000, largely on the back of a hike in oil prices, this was considered an external shock to the system which it was unnecessary for the Reserve Bank to respond to through any excessive tightening.
Secondly, as pointed out earlier, we have already had a tightening – two in fact - and shouldn’t we wait a little to see what they do first.
Thirdly there is the anticipated impact of rising oil prices, an impact which – while directly inflationary in some respects - also directly dampens overall economic activity in an almost identical fashion to the raising of interest rates.
Fourthly several factors, external of the central bank’s influence, are expected to combine in coming months to place downward pressure on inflation. Namely, commodity prices are falling, the exchange rate is rising and high levels of migration ought to be expected to maintain plenty of capacity in the labour market.
Finally there is the uncertainty surrounding the global economic outlook, weaker global economic conditions will mean lower import prices and therefore lower inflation.
Regardless of who is right about the proximity of the inflationary threats, today’s announcement of yet another tightening will be a bitter pill for New Zealand house and business owners.
And in the wake of the recent defection of the Governor to a life in politics, the reputation of the bank cannot help but be harmed.
Many New Zealanders will need to be forgiven for concluding that the New Zealand economy is fast becoming the equivalent of a provincial outpost for both its banks, and the offshore owners of the vast bulk of its capital resources.
When things are going well we are expected to work our guts out to provide profits to prop up an ailing center. And when things are not going so well out here on the edge, ditto.
Either way the rules that apply to Australians, Great Britons and Americans no longer appear to apply to us. We have become serfs in our own land, and the tragedy of it all is that we have done it too ourselves.