By Bernard Hickey
In 1896 a US politician called Williams Jennings Bryan gave a speech that became known as the 'Cross of Gold' speech. In the speech, which helped win him the Democractic nomination for President, he decried America's fixation with staying on the gold standard.
Back then, financial crises were common and triggered massive economic disruption.
Wages were slashed, unemployment jumped and poverty inceased whenever there was a market slump. Many, including Bryan, blamed the hard connection between the money supply and the amount of physical gold in America.
The economy appeared hamstrung by the supply of gold.
Whenever economic output grew faster than physical gold supplies the economy juddered to a halt, or worse.
Bryan's speech to the Democratic National Convention in Chicago in July 1896 was electrifying. He challenged the orthodoxy about how money worked, how economies should be run and why 'sound money' doesn't necessarily make everyone better off in the long run.
Many compare the Euro-zone to the gold standard in that it is forcing those Southern European economies to crunch their workforces and wages lower to restore competitiveness, rather than let their currencies devalue and let inflation help them out.
Greece, Portugal, Spain and Italy are being crucified on the European project's own 'cross of gold' of the Eurozone standard. Unemployment is at depression levels and it seems the only way their economies can adjust is to slash wages.
But what about here in New Zealand?
We don't have a gold standard, but increasingly we have our own 'cross of gold' in our now strictly enforced inflation targeting regime.
New Reserve Bank Governor Graeme Wheeler is an inflation-fighting hawk who is determined to lock inflation down to around 2%, effectively pushing it below the upper end of the 2-3% range where it has sat for the last decade or so under previous Governor Alan Bollard.
This week Wheeler made few comments about the damaging effects on employment and the current account deficit of a high New Zealand dollar.
His entire focus was keeping inflation down, as his Policy Targets Agreement with Finance Minister Bill English specifies, and as the Reserve Bank Act of 1989 directs.
Markets interpreted his lack of concern about the currency and high unemployment as a hawkish signal that he is unprepared to cut rates to boost the economy.
Wheeler's hands-off approach to using other tools such as Loan to Value Ratio targets also suggests that he will use the blunt instrument of a higher Official Cash Rate to puncture any housing bubble.
As a consequence, the New Zealand dollar spiked up to 74.4 on the Trade Weighted Index, its highest level since August 2011 and just 1% below its post-float high. This is despite a spike up in our unemployment rate to 7.3% and a sharp slowdown in our economy in the second half of 2012.
New Zealand's obsession with strict inflation targeting and its hands-off approach to the New Zealand dollar is our own 'Cross of Gold' that is crucifying the economy.
Exporters, workers and ultimately the economy are paying for this adherence to the theory that low inflation cures all ills.
We've had low inflation for two decades, as did the rest of the developed world. But all it did was encourage a deregulation of the financial system, spark an explosion of debt and unleash floods of hot money around the planet.
It's time to shed this obsession with the magical powers of low inflation and look at other ways to run monetary policy.
As Bryan said: "You shall not press down upon the brow of labor this crown of thorns; you shall not crucify mankind upon a cross of gold."
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This piece first appeared in the Herald on Sunday. It is used here with permission.
50 Comments
Bernard, have a look at this graph
http://www.tradingeconomics.com/new-zealand/money-and-quasi-money-growt…
The power of deflation. Wheeler is helpless, he's dropping interest rates so we can afford to pay the interest on our present debt, and even borrow a little more, but all its doing is stoping a natural correction and by pushing the correction down the road its going to be much worse as he's hampering new investment.
Think how NZ would look with %8.5 interest rates. That would destroy the dollar though.
Where is all the new money going?
AndrewJ
Thank you once again.
What we have is all Smoke-and-Mirrors. Worse than Ponzi could have dreamed up.
Every generation the world needs a realistic saviour of the WW2 Churchill type.
My vote will go to AndrewJ. Prime Minister as well as Minister of Finance. Just like Muldoon. But with real feeling for the "average Kiwi" this time.
And once you have tamed NZ - the world is your oyster - just like Muldoon - World Bank and IMF are awaiting your common-sense approach.
I am serious!
Whats the pay like? I mean once I line up at the trough Im going to want a few perks.
everyone else is doing it.
http://en.wikipedia.org/wiki/Crony_capitalism
The Chinese are learning fast, hot line to Putin for advice helped.
By Don Kirk in Crony Capitalism Insidious Socialism, Ethics, Socialism's "intellectual suicide"
Yesterday’s New York Times has an article on the 70 year old Wen Jiabao, prime minister of the People’s Republic of China and leader of the Communist Party, retiring with a personal fortune estimated at 2.7 billion dollars. His mother was a school teacher her entire life, his father tended pigs during the Cultural Revolution, and Mr. Wen has been a government functionary his entire life, growing up as a boy “in extreme poverty.”
Clearly Mr. Wen never accumulated his family fortune as a risk-taking capitalist. Just as clearly, the morality of communism is government-sanctioned theft. Whether capitalist or communist, as Acton noted long ago, “Power corrupts, and absolute power corrupts absolutely.”
So you want me to approach the problem like Stalin did or pol Pot? I guess in the end it doesn't matter as long as we get the job done. :-)
How many people work for the government or rely on the government for their income, is it over %50 yet? because that could be a problem. However with determination we can do anything, once the State feels the steel of the Proletariat it will crumble.
Not at all Andrew. I think you are trying to duck your responsibility to start a move to form a political party.
I don't care what sort of party you form as long as you don't start from a belief that you are, or already have, 'the answer'.
Note that a willingness to learn from your party membership will immediately distinguish you from all the other political parties.
Andrew, the 'five star' is your political party model of choice:
http://hat4uk.wordpress.com/2012/12/09/eu-accident-monti-resigns-enter-…
Berlusconi will not be alone in running on a ‘get out’ ticket: Beppe Grillo heads the Five Star Movement, an anti-EU, anti-corruption and Eurosceptic party. Signor Grillo is a comedian, actor, fecund blogger, and all-round Italian activist. But he is no joke: his Party won last week’s Sicilian local elections, and a Slog source in Italy described other politicians as being “terrified of what he might achieve in a General Election”.
I read that article in NYT. I guess it's the reason people feel the need for a smaller government in the end. A trust thing. Right, Left , who cares?
Of course at the moment we need more involvment by intelligent govenment, but instead it's a depressing sight....esp Labour.
Cheers
AJ - trading economics is one of my favourite sites. You are correct Wheeler is helpless he is stuffed either way or as someone else said on this site he has been snookered.
It's the taxation system that is causing all the problems. Different rules for foreign investors from local investors.
Deregulation was meant to free up the NZ economy for NZ'ers few people anticipated it would be open slather for anyone from any country. Free trade agreements were about access to markets with our products and other countries free to do the same. It was never promoted as having the ability to sell the underlying assets that produced the products as the taxation variables between countries was already known.
The problems won't go away unless Government is significantly reduced in size, Government must up-hold the Bill of Rights and property should be included.
Foreigners who invest here should have to contribute to the taxation system.
All this compliance BS has to be binned. A level playing field across NZ in regards to taxation.
http://www.professorfekete.com/articles%5CAEFWhatChineseUnemployment.pdf
To see the Friedmanite bunk in the true
light of science we need only recall that devaluation always makes the terms of
trade of any country deteriorate. The euphoria of exporting more will last only
as long as the stockpiles of imported ingredients used by the exporting industry
last. Ever after, the country will have to pay more for the imported ingredients.
It will also get less value for units of its exports a double whammy that is
certain to make trade imbalance deteriorate
The worst aspect of our misery is that in putting Keynesians and Friedmanites in
charge of our economy and monetary system we have condemned ourselves to
eternal slavery. Previously, elected or unelected officials could be recalled and
given a dishonorable discharge in case of failure. Not any more, not in the realm
of economic and monetary policy-making. The worse mistakes monetary
officials make, the more power they are entitled to grab. You could never make
these guys admit that they have been wrong. They know that the power they
now have, the power to print money, is unlimited power. They will never give it
up. Après nous le deluge.
AJ - The worlds population is nothing more than a giant dairy and sheep farm, perhaps I should throw in vineyards as well. You either get milked or fleeced one way or another and those in power get inebriated with the power.
Apres nous le deluge - hmmmmm......After us the deluge - I care not what happens when I'm dead and gone.....Madame de Pompadour...1954? Simply put - it will be someone else's problem.
I don't know where to begin commenting on this piece.
#1..."low inflation sparks flood of debt and hot money" this is an oxymoron. You can't have both. We have had a LOT of inflation since the US went off the Gold exchange standard in 1971, 471.2% (http://www.usinflationcalculator.com). They went off gold not because there was not enough gold, this is a misconception, but because they wanted to fight a war in Vietman and not pay for it (through taxes)
#2 World GDP growth from 0-1998 is a compounded annual rate of 2.21%* (*Appendix B.The World Economy: A Millennial Perspective by Angus Maddison (OECD, 2001), p.28), this is about the natural growth rate of gold accumulation through mining. Precisely why gold is so good as a stabilizer. Too little gold is a falsehood, just a pretext to spend what you don't have or won't tax for. Governments perennial problem.
#3 What is the problem of money supply growth of a maximum of 3%. This means the economy doubles every 23.45yrs. In around 50 yrs an economy 4 times larger. 3% is a lot of growth compounding exponentially. Talk of 5% or more is simply silly. Remember 471.2% inflation since 1971. #4 The exchange rate of the NZD has nothing to do with our central bank. It is the result of competitive devaluations going on worldwide especially in the US. Gold would prevent this. The USD is supposed to be the reserve currency, by definition the currency of standard value. There is no talk of value in your piece. How do you save, plan or invest in this climate of no standard of measure for money. It's a mess of political doing, wanting to spend and not pay, to blame a metal of a standard value is disingenous at best. CheersIn the absence of any counter argument from the Reserve Bank or Treasury or the government, I have to agree with you Bernard.
Their case just may be helped if they researched and explained the likely outcomes of an inflation only target using only the OCR; compared to say a current account target, or an exchange rate target, or an unemployment target (or a combination of two of them). The outcome they could predict could be on short term and long term employment; inflation, GDP growth, fiscal and current accounts, fiscal debt and national net debt. They could have a view on which industries would benefit most from the two policies. (The current policies clearly help property trading and banking; and, to be fair, property improvements but seem to kneecap manufacturing and anything that is export or import competitive.)
They may perceive there are commercially sensitive reasons why they are silent on these alternatives (like the effect on foreign creditors); but surely these policies are so important that in a democracy we are entitled to know why we are following a path long abandoned by pretty much every other developed nation.
I sense from Wheeler, rightly or wrongly, that he is somewhat frustrated by the fact that he has to actually answer to politicians and the media, and he gives relatively cursory answers as a result. If I'm correct in this, well sorry Boyo, but its a critical part of the job. At the very least go out of your way to explain yourself.
Otherwise we can only conclude that the policies you are following are rubbish.
Stephen L - "be careful what you wish for"
Stephen,
Interesting, if not always an easy read. I presume your intended message is that the rest of the world has issues as well; albeit unique certainly to regions, and generally even to countries- and that message is accepted. Separately reading the comments in say the Telegraph show there are many Brits unhappy with the BOE, even if I think they generally have done a good job since the GFC. Similarly there are many critics of Bernanke. Europe has so clearly made a hash of what it's doing that there is little debate, unless you are German.
In the details though, it seems to me that the US and UK have each supported asset prices, and so household wealth, through very low interest rates. This has reduced the net debt effect for highly mortgaged households as well.Similarly our RB has supported house prices with relatively low interest rates, and a very open door to foreign money.
Each of the US and UK though has also managed down their currencies, so also supporting other industries, in particular manufacturing (or in our case tourism and other import substituting) industries. So an American or Brit at least has two or three plausible ways to grow their wealth. All of our signals point to housing, and away from employing anyone to do anything useful.
There may be plausible reasons why the single minded policy we are following is better than say the UK or US (each of where unemployment seemed to peak a year ago, and even though their GFC starting problems at least in terms of potential to get worse were greater than ours), but in the absence of any explanation from those putting the policies in place, it's very hard to be confident.
it seems to me that the US and UK have each supported asset prices, and so household wealth, through very low interest rates.
But at what cost? - net liabilities, especially those of a federal nature have and are still exploding. Read more courtesy of ZH
Again, interesting, thanks.
I may differ from you, and ZH, in thinking that Federal, or BOE, debts based on printed money are not really debts at all. So to that extent I wonder if ZH overstates their debt. I do realise that by devaluing their currencies through printing, they are arguably reducing their wealth in terms of other countries, but they are supporting their current accounts.
Simplistically it seems to me an easy measure of a country's relative increase in wealth or indebtedness, is its GDP growth less any current account deficit. (Not perfect at all as wealth is usually a multiple of income, but a useful enough proxy). The US and UK are bringing their current account deficits down. Ours of course is ballooning out from an already very high level.
The problem we have is if we agree to relax on the inflation targetting we are essentially creating credit at interest, and I have no doubt it's possible. Unless we buy that debt domestically the interest is owed offshore, compounding our problems. If we buy the debt domestically then to keep the credit cost down the reserve bank would need to monetize government debt at an artificially low rate, one that individuals would reject.
The US can do this because of the USD reserve standard. They can export dollars and so inflation. Countries must hold them.
A question I have is how do we do that here when we owe offshore and the creditor is not stupid, he will smell a rat and demand higher rates.
Otherwise I agree on the idea of targetting jobs and economy not just inflation.
I would not like to see a gold standard by the way just a modernized gold exchange standard perhaps along with a basket of currencies? There needs to be a brake on spending without taxation. There also needs to be a mechanism to allow a proper savings program for one to provide for retirement. Not this gamble and hope madness we have at the moment.
That is why I ask about value with regard to money. Modern money is simply debt, to be defaulted on.
Cheers
Perhaps some of the current problems could be solved by importing a bunch of robots instead of migrant humans
http://globaleconomicanalysis.blogspot.com.au/2012/12/mine-sniffing-dol…
If by "our economy" you mean the growth lobby economy then I can understand your comment
Robots also do not require the landlord's friend - the accomodation supplement.
Instead of having to hire in cheap migrant workers to work on farms, replace them with robots
Instead of getting in migrant workers to work as hairdressers, replace them with robots. No healthcare or pension costs. But still collect the GST on the service.
Instead of sending manufacturing off to low-cost labour countries, keep it in NZ and run the factories 24/7 - the robots don't care what time of the day or night it is.. There might be some benefit to the growth lobby from that outcome through robot maintenance.
Maybe set up some kitset house manufacturing through the use of robots. And use other robots in the assembly on site. Probably a little ways off for this one but it might bring down the cost of replacement housing.
@ Gibber - Maybe set up some kitset house manufacturing through the use of robots. And use other robots in the assembly on site.
Remember this interview with Sir James Goldsmith
http://www.youtube.com/watch?v=4PQrz8F0dBI
part II
http://www.youtube.com/watch?v=SZTzPmn-87w&NR=1&feature=endscreen
part III
http://www.youtube.com/watch?v=yonUgZ2Y6Qs
Good youtube video's although no surprises there.
Many believe the problem is that there is no equalization process for trade. The US can have perpetual deficits without limit since the removal of the gold exchange standard. Therefore US business is forced offshore. With equalization Asia would be forced to also import to balance trade out. Gold imposes a discipline missing today.
We are probably naive to think the 1%'ers care about the world economy as it relates to the population in general. It's about extraction of wealth, of which they have been wildly successful.
So what do we do. Not participate in the money go round by hoarding? Millions are doing this and it's a real problem esp in India.
Cheers
being a total layman here, but isn't manipulating the OCR the only tool Wheeler has? And isn't targetting inflation the only part of the econonmy he's allowed to target - written into law, and isn't the inflation band target of 2-3% also written into law?
This talk and criticism of Wheeler being snookered, not using a LVR or other tools is all just pissing in the wind. It's the government that has to enable the RBNZ to change their emphasis and allow them to use other tools.
Why beat up on Wheeler, he's been handed a old dog and told to teach it new tricks.
Bernard, could you please explain something for me: how is cutting wage rates by going "sorry buddy times are tough we're going to have to give you a pay cut" worse than doing pretty much the exact same thing via inflation of the money supply/currency devaluation? I'll explain why I believe the first approach is not only more just, but produces superior economic outcomes.
Austrian business cycle theory posits that credit-induced bubbles result in "misallocation" of capital towards the interest-rate-sensitive early stages of production (construction, mining etc). A key insight is that it also causes artificially high wage rates in these sectors (just look what Aussie miners are getting paid).
Inflation of the money supply can still happen under a gold standard but gold tends to act like a bungee cord, snapping prices back to their previous, non-inflated level via a quick bout of deflation. What's the antidote to deflation? There are two options: cut wages and prices to reflect the new, smaller money supply; or print like crazy/cut interest rates to prevent the money supply from shrinking. I'll call this the "Hickey put".
From a purely moral/ethical perspective the first option is preferable in all aspects. It is transparent and honest (people know they are getting their wages cut), while printing money is subterfuge and trickery. Printing money also transfers wealth from the poor and middle class to the asset-rich 1% that have benefited the most from the bubble. Deflation does the opposite: asset prices tend to fall further than wages so inequality is reduced. The 'Occupy' crowd should be out there advocating this solution!
Economically, cutting wages and prices is a far better response to deflation than trying to re-inflate. Perhaps the best example of this is the 1920-21 "depression that wasn't", when the US economy entered a recession more severe than the early stages of the Great Depression. Wages fell 20% in one year but the Consumer Price Index fell 15.8% so purchasing power wasn't greatly reduced, and the economy quickly bounced back.
Compare this to the policy response at the beginning of the Great Depression, which was to try and keep wages high so consumers could "buy back the product". This resulted in unemployment rates of more than 20%. So keeping wages high when the money supply is shrinking is clearly a no-no.
But here's where the gold standard, or lack thereof, comes in. Gold limits the ability of central bankers to inflate and governments to "stimulate", which has of course been the response to the current crisis. Unfortunately this doesn't address the root cause of the crisis: the misallocation of capital I outlined earlier. In fact, it can prolong and even re-inflate bubbles (cough Auckland house prices cough cough).
And worst of all, instead of prices adjusting down with wages, wages have been stagnant to falling for many people while costs have gone up and bankers and asset owners have got richer and richer.
"Inflation targeting" has been a disaster for the economy and for asset-poor salary and wage earners, not because there hasn't been "too little inflation" but because inflation's inherent transfer from poor to rich has been perpetuated by the lack of an "anchor" (gold). It has also been cleverly masked by the supposed "inflation fighters" who are required by law to expand the money supply enough for the price level to increase. Comparing this regime to the rigours of a gold standard is either misdirection or a sign of misinformation.
Yes you can't protest low interest rates by holding gold. Only to release it when rates are stable. Although gold hoarding is growing worldwide.
If debts are defaulted on, and they will be, the other side of the balance sheet are the creditors, the recievers of the interest stream. Many are global pension plans.
Hold on to your hats....
Cheers
It must be very frustrating for Bernard to have so many people pull sentences out of his article and criticise them while at the same time ignoring his central point.
Bernard is not saying we should go back the gold standard, he is not saying we should stop inflation targeting nor is his focus the history of why America abandoned the gold standard.
His central argument is that Wheeler should not sit idly by as things deteriorate and focus solely on the OCR. He should be looking at other options and tools to control house price inflation without hurting our export sector by pushing up the NZD. His apparent lack of concern and unwillingness to act has just sparked another round of speculation into the NZD
Yes , some have gotten side-tracked onto the old Gold Standard debate ....
... Bernie's theme was whether Wheeler should actually earn his keep , or just follow the narrow vision " steady as she goes " path of his predecessors Bollard & Brash .
.... where's those bad eggs , Amanda , I've developed a sudden urge to throw some ....
Do you think those investors buying the New Zealand dollar based on carry or momentum, money fleeing China or money fleeing QE have any idea or care what the fair value of our currency is?
A currency can stray at levels that cause severe trade imbalances for decades. Do you believe nothing should be done to keep jobs in NZ, keep the export industry healthy and prevent excessive debt build up due to trade imbalances? If so you have different economic beliefs to the rest of the world who are busy defending all these things...
The idea a currency can "stray" as you put it implies some point of "belonging". You don't describe how you think such a belonging point is discovered. As the system stands we float the rate and it is "found" by the market mechanism of supply and demand. What is discovered in that process is the true belonging point and the currency has not strayed by definition.
Also, any desire to manipulate the currency (beyond the market) doesn't address any of the root causes of a high demand for NZ dollars.
The fair value (about which a currency strays) is simply the level needed to balance the books, where no surplus or deficit is being run up.
I'm not advocating direct currency manipulation, but the alternative tools Bernard is refering to such as a minimum LTR would exactly address the root cause you are refering to and allow a lower OCR.
It's a nice idea, this fair value one you moot, however I think I'm probably correct in suggesting very few countries run such a system.
Holistically I see few problems with a deficit created by demand for dollars used to invest in productive assets that give a return greater than the cost of running that deficit. China has done that with huge amounts of direct foreign investment since 1992 and with spectacular success. I am not a fan of the way they did it and think their will be large consequences for their exchange manipulations.
When that demand for dollars is channeled into zero return investments like housing it creates a structural problem that slowly erodes the real standard of living. So if NZ'rs choose not to save and use foreign borrowings to drive up local house prices there are consequences for the exchange rate. Which, as I am sure you are aware, has flow on consequences.
It's not all the reserve banks fault and their remit under government is pretty clear and limited.
The USD is the reserve standard of the globe and as such is exported to be held as reserves.
The US must run a dollar deficit, it's required for the system to work as there is no longer any gold stabilizer to equalize trade.
China holds enormous quantities of dollars many looking for an "investment".
Those reserves can be used to buy Kiwi assets at any price thereby driving up the NZD. Where is any sense of economic logic or normalcy in this?
Do we say to our free trade partner we don't want this "investment"? Or that you aren't allowed?
Of course not, but the problem is not a lack of tools at the reserve bank, but a lack of any standard unit of measure as far as money goes.
You simply cannot ignore the role gold played. It is not just for goldbugs. Central banks are now buyers and I suspect with 20/20 hindsight would not have removed the link to the dollar so easily.
Many would argue that what we have is a fiasco....
Cheers
I think we should always remember even if there are investors demanding dollars there has to be a seller.
It's also interesting to wonder what the long term return on those enormous chinese reserves will be. They can't sell them without losing enormous amounts of value from them.
The time frames may be very long but I do not believe the deficit can run "without limit".
I do not know what that limit will be or even what will trigger the collapse. In the long run the deficit will have an effect. If one looks at middle class wages in the US and the income gap between rich and middle class an argument can be made there are already structural and increasing consequences.
The other thing is it takes two to tango and China has been quite complicit in buying vast quantities of US dollars to fund the debt.
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