By Bernard Hickey
As the proud father of a 12 year old girl I have not been able to avoid the phenomenon of 'Frozen' and that bloody song -- Let it go.
It is the worst/best kind of ear worm and try as I might, I can't stop myself humming the chorus when thinking about matters financial and economic.
"Let it go, let it go, Can't hold it back anymore, Let it go, let it go Turn my back and slam the door. And here I stand. And here I'll stay. Let it go, let it go.The cold never bothered me anyway ... "
Have I successfully forced you to hum it?
Good. I'm sharing the joy this fine day.
I've found myself humming it a lot lately when watching central banks trying to grapple with some deep and dark economic forces, and generally struggling.
That includes our own Reserve Bank of New Zealand.
In the last month the European Central Bank has announced plans to print up to 1.1 trillion euros to buy bonds in an effort to pump money into the economy and avoid deflation.
The Bank of Japan ramped up its four year old money printing programme for the fourth time last October in a desperate attempt to reverse decades of deflation.
The People's Bank of China is about to embark on fresh monetary easing after nearly three years of falling producer prices and the US Federal Reserve has only just finished it's third round of money printing, even though its inflation rate is falling too.
The Swiss and Danish central banks have cut their deposit rates to negative 0.75% and 0.5% respectively. That means they are charging other banks to look after their money.
Reserve Bank Governor Graeme Wheeler pointed out this week that central banks will buy more bonds this year than in any year since 2011.
All this quantitative easing is driving down long term interest rates to their lowest levels since the 1400s. All this easy money overseas has a real world effect here.
That cheap money is flowing through to us in the form of falling fixed mortgage rates and keeping our currency relatively high as European and Japanese investors hunt for higher interest rates here.
These central banks are desperately trying to pump up their economies by using unconventional policies to solve what they think is a conventional problem. Thanks to the pioneering work of the Reserve Bank here, most central banks now target inflation at around 2%, although it is not usually their sole target.
When they see inflation falling towards deflation, they stimulate the economy.
Understandably, these central banks worry that falling prices are the result of too much slack in the economy with weak incomes and demand because of falling employment. That is clearly the case in Europe and arguably has been in Japan too.
But what if the falling prices are because of the 'good' type of deflation caused by a supply shock?
That's where the general level of prices falls because of a new type of technology or the discovery of a new source of commodity makes it more efficient or cheaper to make things and sell things.
This is a controversial view, but one that is gaining traction because of what some are describing as an epic shift in the way consumers and businesses are using technology.
The idea is that the combination of very cheap and powerful mobile phones, the app economy and the globalisation of services could deliver the same 'supply shock' boost to production (and reduction in prices) as the advent of the steam engine produced in the late 1700s.
This would cause structural deflation like that seen through much of the 1800s.
If the deflationary forces are caused by a supply shock then it would mean all the central bank money printing would be a wasted and potentially dangerous effort that simply pumped up asset prices into bubbles that could burst with devastating effects.
Why, therefore, try to flog the dead horse by pouring yet more fuel into the asset bubbles in housing, stock and bond markets.
Why not just 'let it go'? New Zealand is definitely facing at least one supply shock-driven deflationary force.
The extra oil supply from America's fracking revolution is cited as one reason for the halving of the oil price at the end of last year.
New Zealand has also seen a labour supply shock from a record 50,000 net migrants in 2014, which is helping to repress wages and prices.
New Zealand faces deflation because of supply shocks, rather than a lack of demand that could be solved with lower interest rates.
Governor Wheeler is rightly cautious about not responding to these supply shocks by 'flogging the dead horse' and pouring fuel on the Auckland property fire with yet more rate cuts.
The trouble for him is that central banks are responding to what may be a steam engine-style supply shock with yet more money printing that is leaking out the sides of their economies and dribbling down into the Auckland housing market. That dribble from near record money printing is more than enough to pump up Auckland's housing market.
New Zealand can do little to stem the flows, but at some point policy makers will have to work out what is really causing all this deflation, and whether all this money printing is working only to fire up asset prices, rather than demand.
They may have to start humming the tune to and ... let it go, let it go, turn their backs and slam the door!
Got the earworm back? Good.
33 Comments
The main difference between the steam engine shock, and this shock is the GDP growth rate. More people were moving into better paying jobs at the same time as they were able to afford goods previously only affordable by Kings. Credit was expanding rapidly, and there was an abundance of callatoral. Nowdays good collatoral is hard to come by, growth rates are anemic, and the benefits from apps are marginal (at least for me) compared to the benefits of affordable clothing they had back then.
The 'steam oil shock' should be called 'the coal shock' as it is really about harnessing the huge pool of untapped energy (i.e. fossil fuel - coal) which started doing an unprecedented amount of work for society. It was being able to utilize this huge energy pool that enabled us to 'grow' and for economic improvement to occur - the 'steam engine' was not the primary driver, the large energy surplus was.
As some of us have been trying to point out to you Bernard, the conditions are extremely different this time. We don't have huge energy reserves waiting to be tapped to stimulate more 'growth', now we're literally scrapping the bottom of the barrel in terms of real net energy return. I know economists don't care about EROEI but the physical laws of thermodynamics get the final say in the matter.
Bernard Hickey in his prime.
http://www.interest.co.nz/opinion/56214/opinion-bernard-hickey-asks-if-…
This is the trouble with watching a pot boil, or a slow motion train wreck, you can lose sight of the forest for the trees.
Yes compare BH then, to this now:
''The idea is that the combination of very cheap and powerful mobile phones, the app economy and the globalisation of services could deliver the same 'supply shock' boost to production (and reduction in prices) as the advent of the steam engine produced in the late 1700s.''
Seriously? Mobile phone apps?
I have found I have a massive boost to production now that I can watch Live cricket on my phone whenever I want. I can also check my emails on the go which lets me know which overseas vendor has a great deal on viagra this week ( A few of the boys here might be interested).
Technology will save us. After all guys we didn't leave the stone age because we ran out of stones. On a side note it was funny listening to our energy man Simon Bridges this morning on the national radio trying to explain why it was great that he was minister of energy and the environment. In one breath he was saying how bad and serious climate change is and in the next was trying to justify selling x amount of drilling permits.
I'd add the laws of diminishing returns and the power law. We live in a finite planet after all, and yes we can produce oil from sea water if we really want to, so no use stresssing about running out of oil. As you say the issue is, what is the return like, and I'd say the return is reflected by falling and going negative interest rates.
Exactly! As it stands, a barrel of tight oil provides significantly less net energy than a conventional barrel of oil (after the energy accounting has been done).
Seeing as conventional oil is in decline, even if we keep producing the same total amount by increasing unconventional oil production, the real net energy return for society is constantly declining. Watch as we struggle to maintain our infrastructure and institutions in the future.
Well oil is the classic example, the price has declined not because of any efficiency decreasing production costs, which is the industrial revolution deflation, but in fact the opposite. A less efficient form of production has come online, which has still been profitable. It's very strange to have falling prices in an enviroment where production costs are rising, it can't last.
"The Saudis are obviously expecting that these low prices will turn off U.S. fracking, and I’m sure they are right. Almost no new drilling programs will be initiated at current prices except by the financially desperate and the irrationally impatient, and in three years over 80% of all production from current wells will be gone!
Thus, in a few months (six to nine?) I believe oil supply is likely to drop to a new equilibrium, probably in the $30 to $50 per barrel range. For the following few years, U.S. fracking costs will determine the global oil balance. At each level, as prices rise more, fracking production will gear up. U.S. fracking is unique in oil industry history in the speed with which it can turn on and off. In five to eight years, depending on global GDP growth and how quickly prices recover, U.S. fracking production will start to peak out and the full cost of an incremental barrel of traditional oil will become, once again, the main input into price.
This is believed to be about $80 today and rising. In five to eight years it is likely to be $100 to $150 in my opinion. U.S. fracking reserves that are available up to $120 a barrel are probably only equal to about one year of current global demand. This is absolutely not another Saudi Arabia."
He gets it.
Please explain, Steven.
It would seem to be that there is abundant supply almost everywhere you look. Labour, energy, hard commodities, retail space, food, electronic goods, clothing, everything except Auckland property pretty much.
Lack of aggregate demand I hear you say. Our savings rate at a pitiful 2% of income (RBNZ 2014) can't be the cause of deflation. Consumption is not being sacrificed for savings here or abroad so lowering interest rates is pushing on the proveriable string.
It has to be supply: more factories, more workers, more mines and oil wells, more ships and shopping malls all financed by interest rates at the lowest since forever. If you want inflation, you need buyers with the ability to buy. We have the absurd situation where the median annual Kiwi income (pre tax) of $30,000 - $15/hour is less than the calculated living wage of $18.50/hour.
So more than half our (and most of the western worlds) population are not getting a living wage. There's your problem right there and anyone suggesting that the non unionised Joe dogs body is going to be a winner from inflation is a fool or a liar.
Dont put words in my mouth please.
"seem" is what it isnt. If you only take the short term view yes. Oil, since 2005 after we hit peak conventioanl crude oil oil has been expensive, ie $80+. Oil as energy is in a temp over-supply, due to over-producing of shale. These players are over the next 3 years going to go bankrupt. In the meantime they are laying off workers, workers with no jobs have no money and hence cant buy. To continue that theme I dont doubt there is deflation, what I say is it isnt good deflation if ppl have invested and now dont make the expect returns or even make losses. Where you get a better good for the same money, yes OK, this isnt the case overall.
Im not sure we disgree here btw.
Inflation in small amounts is a good thing, it shows a growing economy, ergo that is good for jobs and wages.
lack of variety. NZ has many of the same items in its stores - this speaks of lack of supply.
Falling quality of goods. Especially when tied into the above is a strong signal. People can't choose the better product if it's not in supply.
Savings? why do you want savings? banks only need them because government tells them they need a certain ratio. For most consumers its better off in some investment portfolio of their own. As for businesses, savings are no use whatsoever, as borrowed money can be created by the scratch of a pen, entirely for free if needed, if they didn't have to pay "savers" and its better margin for them to sell on interest bearing credit anyway.
The non-unionised Jo is usually better off these days that the one paying for the union fees - many of the hard won union consessions have been wittled away by low profits and staff levels in the chase of "competive advantage" (c.f. "variety").
In fact if the inflation is coming from naturally (not legislatively) increased wages, I'd definately say Jo Dogsbody is much better off, as such raises are indicative of better business revenues.
But it can't be supply. Commodities are tanking because of oversupply. Loans for expansion are only a pens' scratch away - although interest in NZ is too high (too good return to invest, rather than consumer, and it depresses Velocity of Money, and WORST of all the worth of investment return vs the worth of labour return is heavily in favour of investment. ie all investors (who by definition have extra money, get rich faster than it is possible to create new extra money - resulting in "the new consumer who invests, it is those who spend that sacrifice [future earnings] - the direct opposite of the quadratic curve which our financial and economic philosophies are built on !!! The more people save and invest, the worse off we will be ! You can see this in action where QE and Keynesism create more of the problem that they were suppose to fundamentally address ...they're supposed to pushing the pointer to the right of the curve....where we're already on the down side through use of supply-side economics. Supply does not create demand...just check any waste disposal area for proof.
but we can't address the undersupply of funds until the labour vs investment issues is addressed, or it will just create more leveraged investments (and no employment orientated business revenue)
There must be a way of loosening monetary policy (in synch with global factors) for the general economy while ring fencing Auckland housing.
Are interest rates really the main factor driving the Auckland prices? It seems all other developed countries such as U.k, US, Canada, Germany etc all have interest rates of 2% or less and that is not the main issue with main city house Inflation.
NZ would benefit from more Govt spending on hospitals, schools, universities, research centres & infrastructure etc which would in effect be a loosening of monetary policy getting it into the hands of workers and regions, while tightening up foreign purchasing of NZ property.
The problem with our tight monetary policy currently is that it is like a mini austerity package - unsuitable in the middle of a global recession.
Thanks BH what a great article. I just finished reading Harry Dent's demographic cliff. He makes a somewhat plausible argument that the worlds deflation is demographically induced. It seems to me that the battle between natural deflation (whatever it's causes), and central bank induced monetary inflation is now destructively tearing countries/societies/class divides/generational divides in half. This must lead to social instability in the future. Bryan Bruce and Nigel Latter have already made documentaries about growing inequality in NZ (both docos released just before elections).
I think the picture is pretty bleak in NZ. The private debt to GDP ratio in NZ is almost 160% from RBNZ figures. Take away business debt the household debt to GDP ratio is almost 100%. Compared to other countries those numbers are really high, and according to Steve Keen's models if debt levels continue trending upward it will lead to a debt induced breakdown of the economy.
Growing asset prices must come at the expense of increased domestic debt levels, or increased foreign ownership. I think it's pretty obvious what's going on there. All that being said, I'm still going to look at a few open homes today.
Disintermediation of Middle class jobs/businesses stalls spending and uncertainty over interest rates also is paralysing the economy
So nothing is as it seems, there is good deflation/inflation and bad deflation/inflation, there is good GDP and bad GDP.
Maybe a reason why the economic equations don't seem to perform is debt.
Could we suggest that what the Australian banks have brought to NZ in the last 30 years is:
- Australian policy toward property and property construction/development, based on immigration to their wide brown land.... This means any mug with a mobile phone can take the title "developer".. Prior to this NZ immigartion was based on the immigrant coming to work (often with skills), not bringing loot. [with the avaliability of credit, why do we need people to bring more money rather than skills]?
- They stopped funky lending such as DFC, NZI & BNZF. Hence the freaky lending went to debenture companies and SCF..
- They have introduced the concept of more, trustee security margin has been left behind, they lend more, no need for 2rd/3rd funders as the bank took everything, lending more...
- A residential property has become a near currency (ATM like with redraw facility) and giving (based on comparative sales value data, last man in increases the cedit line for all).
- They took control of the process, from application to drawdown (real estate agent, loan broker, valuer, lawyer), funding all and paying directly most... - why say anything as the money talks..
RBNZ does not need print extra currency to protect the banks, as we depositors do that now (with Plan B being the RBA, the ASX and then Oz Govt. looking after the parents).
Maybe Supplyside good? Our problem is that Govt. has also borrowed too much (not unlike Reagan but not hard assets) , otherwise are we not running version of voodoo economics - with some problems in implementation.
Could we suggest there is no public need of or policy reason for the Auckland housing bubble in that it is entirely self made/rule of human hand by folk in Auckland (in that they are not taking to supplyside). Why not take a page (paper not servant) from the Hong Kong play book. http://www.globalpropertyguide.com/Asia/hong-kong/Buying-Guide
- check out the special stamp duty, depending on holding period...
as for tunes maybe more this
https://www.youtube.com/watch?v=KQCShKW-nfA
replace preacher for central bankers and you're away.....
Henry Tull
Hong Kong Playbook
John Key is on the record as saying he will monitor the Australian response to calls for greater controls over non-residents and non-citizens investing in both rural and residential property
well now
As of today, Monday 9 February 2015, as a result of the frenzied turmoil surrounding the continued prime ministership of Tony Abbott he has now declared there will be a property register of all property transactions by people who are not australian citizens
There you go John Key, it's been decided, so, wot'cher waitin for
Mobile phone apps? Hardly, but the entire software industry is just getting started and its impacts will be tremendous. Example: McKinsey is forecasting that software will eventually replace managers which makes sense, as most managers just do repetitive stuff like looking at some numbers and hardly show human qualities. In the UK alone, it is estimated that 40% of all jobs will vanish within 20 years.
Add to this the globalization of e.g. wages. Depressed wage growth in the "West" is in the big picture simply a result of a convergence of Asian and Western salaries.
But never mind all this. Money printing can be a short-term emergency measure, but not a policy that is now running for the best part of a decade. Eventually this will undermine the trust in the paper money system itself with unforeseeable consequences.
Anyways, good luck to us all :-) ... I think we will pay a high price for our shortsighted greed in the not too distant future. Btw, funny thing the US seems to provoke WWIII over a place as unimportant as Ukraine. Are we so broke and stuffed that they need a war to push the reset button?
Btw, if there really is a war in Europe, then imagine how house prices in NZ would go up! Just joking ...
"First of all, the extreme violence of the slump is to be noticed. In the three leading industrial countries of the world—the United States, Great Britain, and Germany—10,000,000 workers stand idle. There is scarcely an important industry anywhere earning enough profit to make it expand—which is the test of progress. At the same time, in the countries of primary production the output of mining and of agriculture is selling, in the case of almost every important commodity, at a price which, for many or for the majority of producers, does not cover its cost"
Good deflation? rinse and repeat the same mistakes it seems, however today we have a new twist,
"He begins to doubt the future. Is he now awakening from a pleasant dream to face the darkness of facts? Or dropping off into a nightmare which will pass away? He need not be doubtful. The other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of nature and men's devices are just as fertile and productive as they were."
"nature" except today the resources are now approaching, at or past peak.
The difference between real interest rates and nominal interest rates has to be taken into account when having any discussion on deflation/inflation......if someone is investing they should look at the real interest rate not the nominal rate.
You won't get negative nominal interest rates so it can't fall below zero. So take zero as the lowest point for nominal rates.....then look at deflation e.g. -2% and the answer will be the real interest rate as follows.
So do a little equation along the lines of..... 0 - (-2) = +2........now just think about the effects of deflation at say 5%.
The real interest rate represents the true cost to the borrower and the true return to the lender.
One of the indirect effects of money printing (qualitative easing) is that it generates enormous returns to the US treasury equivalent to nearly 30% of the us corporate tax take, a good little earner.
http://www.federalreserve.gov/newsevents/press/other/20150109a.htm
https://research.stlouisfed.org/fred2/graph/?graph_id=205930
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