By David Hargreaves
There was a time, feels like just yesterday, when the business of cooking up a recipe for economic growth was deliciously uncomplicated.
Take one large Canterbury rebuild, roll it in money, add a dusting of very expensive milk powder (possibly golden in colour), heat rapidly with strong inbound migration and an expanding workforce, bring to the boil, then allow to simmer with low inflation and interest rates, garnish with rapid house price appreciation (well, yes, in A particular city) and voila, one tasty economy, coming right up. Cooking with gas, as they say.
But even the finest cuisine has a ‘best before’ date that seems to sneak up on you before you know what’s happened, and so is the case with our economy.
Our national dish, our economy du jour, which was so mouth-watering in 2014 is, less than a year later, going off at a rate of knots and starting to develop a bit of a whiff.
But is it going to end up mouldy, or simply just rather lukewarm and lacking in flavour?
Well, this is where we swap the cooking utensils for a crystal ball. Unfortunately, the crystal ball I’ve got in front of me is full of mist. Please feel free to try your own crystal ball gazing and share the results with us all at the bottom of this. Well, I won’t be able to stop you really, will I?!
Anyway I will try to make some sense of it all: In fairly simplistic terms, we are likely to look back at the past couple of years as a period in which various disparate factors came together in a virtuous blend. High dairy prices, coupled with the need to rebuild Christchurch and strong migration flows (partly to help with the rebuild), with the net influx assisted by a faltering Australian economy that meant the large numbers of new immigrants were not offset by equally (and usually larger) numbers of Kiwis trying their luck across the ditch.
Just in case there was the chance of exuberant behaviour driving up prices, a rampant New Zealand dollar kept import prices down and then, heck, even that often troublesome oil stuff came to the party with massive falls in the price last year and now into this too.
If we could, however, explain the economy’s recent past as containing a series of harmonious ingredients, working together, then it has to be said the future economy seems to be attracting a combo of much more discordant factors, many of which seem likely to work against each other. The extent to which these factors do or don’t work against each other seems likely to determine whether we move into a period of ho hum growth (but growth nevertheless) or get another unwanted taste of recession. At the moment I’m not sure all the relevant factors have moved themselves sufficiently into place for us to definitively call a/ that we are heading for recession or b/ that we are not.
Let’s look at some of the factors in play:
The Christchurch rebuild, having seemingly taken an age to get started, now seems to have ridden over the top of the peak and be heading down the other side. All too quickly. The silver lining here could be that it might be possible to re-allocate a lot of the resources going into the Christchurch building effort into the much touted and talked about ramping up of Auckland residential construction activity. So, that’s one issue that could resolve itself quite well. Whether Christchurch’s local economy suffers a post rebuild hangover is a key point as is the extent to which such a regional hangover might be felt more nationally.
What, though, about the dairy sector, which was seen joyously riding a cow off into the vivid red sunset only last year? But hang on. Did somebody talk about the sun going down? Oh boy. Did it. The sheer pace at which our golden milk powder turned to, well, dust, has been beyond unnerving. The economists’ confident talk only a few months ago of a recovery of prices as we got into the new season havs been washed away by a torrent of dire global auction results.
Unless prices miraculously start to recover pretty darn quickly – and we are talking the next couple of months – it will be too late for anything other than damage control in the current season. We are already really in the situation of measuring this season in degrees of badness – bad or atrocious, depending on what happens from here.
Two difficult years
This means that by this time next year farmers will have come through two very difficult years. It is an open question how firstly they will fare and secondly what impact their poor returns will have on their spending and therefore on the wider economy. The banks will need to remain very supportive, or risk having a withdrawal of support or attempt to play hard ball come back to bite them later. But presuming there is no miraculous dairy price recovery this season, it then becomes paramount that something good happens next year. And is there any guarantee of that?
It has been interesting to see some changes of view from our economists in recent weeks. Whereas previously there has been among some at least a kind of blanket view that prices will recover because, well, prices DO recover there are now some slightly different opinions. ANZ economists this week talked of ‘structural shifts’ in the marketplace that could produce lower average dairy prices in the medium term than has been the case in the past. The point is, unless there is a marked recovery in prices over the next year then our dairy industry might be in for quite a big and not necessarily pleasant overhaul. What such upheavals would do to the broader economy again remain conjecture. But in the short term…well, not pretty, surely.
The fact that the labour market now appears to have turned again seems likely to further fuel the fire on what is an appropriate level of inbound migration. There’s always been a lot of migration here. Heck, I’m a migrant. The surge in migrants has in the recent past helped to fuel demand in the domestic economy as well as people to fill extra jobs that were being created.
In the past, signs of a downturn in our economy (such as we are now seeing) would invariably be greeted by the sound of running feet in the direction of Australia. When that’s happened in the recent past then the subsequent population and labour market gap here has been filled by migrants.
There is, however, a real reason to believe that this pattern won’t be repeated this time. The simple reason is that the Australian economy’s not showing real signs of recovery. A bolt over to the ‘lucky country’ has always been a bit of a safety valve for Kiwis. Maybe not just at the moment. So, it is speculative, but what happens if the Kiwis stay at home, the job market starts to tighten and the same numbers of migrants keep coming in? It would be a recipe for both economic and social stress.
Migration in the New Zealand context is nothing like as simple as everyone likes to think, I would suggest. How would our tertiary institutions fare financially if they could not keep bringing in large numbers of overseas students, for example?
The Government’s been reluctant to go anywhere near this issue, but it might have to in the next 12 months or so.
The inflation poser
There’s many many more things that could be talked about, but in the interests of keeping this shorter than an encyclopedia, I will finish with interest rates, inflation and the currency.
The wonders of hindsight tell us it was a mistake for the Reserve Bank to raise the interest rates, through the Official Cash Rate (up to 3.5% from 2.5%), last year. The RBNZ expected inflation to blip up this year. It hasn’t so far. The oil price and a stubbornly high Kiwi dollar provided two reasons. But clearly the RBNZ is seeing changes (that it is somewhat mystified by) in how inflation is transmitted (or isn’t) through the economy. I saw some suggestions recently and, apologies, I can’t recall from where, that the increasing use of online technologies may be blunting the old ways in which inflation was transmitted. Sounds logical to me. The very low cost base of an internet business means the traditional model of arriving at pricing no longer applies.
The dollar is now falling, helped a lot by the expectation that the US will soon put interest rates up. It will be very interesting indeed to see what happens if the expected September rise is deferred to December or even into next year.
But for now, the dollar IS falling. That should help exporters a lot. It should also start producing inflation here as the cost of imported goods will go up. But again, you wonder if the old transmission mechanisms will kick in as they once did. Internet-based businesses may be able to bear cost increases better. In any case, this is now a very consumer-driven society. Quite simply these days if people think something’s too expensive they won’t buy it. It’s entirely possible suppliers of goods will have to absorb a fair bit of the increased costs themselves, meaning that inflation won’t really kick up that much…but what will it do to the suppliers of goods taking a hit on their profit margins? Is the new reality of imported inflation that we see the middle guy squeezed out?
RBNZ and inflation
The RBNZ still sees meaningful inflation on the horizon. I’m not so sure. With one or two remarks that have been thrown around by the Government, you get the impression it’s becoming rather impatient about the length of time the RBNZ has now been presiding over inflation outside of its 1-3% targeted range. It might not remain tolerant of a central bank that it could accuse of not adhering to its Policy Targets Agreement. The RBNZ is being watched.
If I read the RBNZ’s current thinking correctly (and I have been wrong on that score very recently), I reckon the central bank’s certain to drop interest rates again (to 2.75%) next month but then look for at least a ‘pause’.
However, I think by December it will be clear that inflation genie is certainly not out of the bottle and the RBNZ will have to take the OCR back down to 2.5% And I’m now beginning to agree with those (Westpac among them) who think more reductions may be necessary next year.
But as this missive attempts to debate, there’s so many variables – more so than usual – at the moment, that it’s really hard to pick with any certainty what might happen over the next 18 months. And that’s not something you could say about back in 2013 when the course looked very clear and predictable.
Around about the time of the Global Financial Crisis, company directors – it suddenly seemed like just about all of them – came up with an expression that was half hilarious half infuriating, namely that they had “poor visibility” of future market demand for their products. In other words they didn’t have a clue what was going to happen, but didn’t want to say that.
Well, I think we are entering another time of “poor visibility”. The mist in that crystal ball’s getting thicker by the minute.