Sunday, February 10, 2019

Time to rethink the Reserve Bank

Slowly and with questionable competence the Labour Party is incoherently patching together a policy platform aimed at restoring the employment of New Zealanders to the central mission of the New Zealand government. It is, I confess, the reason I voted for the party at the last election in November 2016.

After nine years of National in power it was obvious to me, and I think to many other swing voters, that the policy of unfettered immigration National had inherited from Labour and accelerated, was eroding wages, inflating property prices and essentially turning New Zealand into a land of exploiters.

But the problem for Labour, it seems to me, is that the measures of government, and in particular inflation and Gross Domestic Product, have been so captured by international capitalism that making change in New Zealand will instantly bring us into conflict with the way international markets work.

In New Zealand inflation is the only target of the Reserve Bank. It's target is to keep inflation in a range between one and three percent. If inflation goes above three percent in theory it should begin contracting the money supply by increasing the interbank lending rate. If inflation is below one percent it should loosen money supply by reducing that rate. So the cost of borrowing money very much depends on the definition of inflation.

The main measure of inflation is the consumers price index. This measures the cost of goods and services in New Zealand by monitoring prices over a "basket" of goodies each weighted by their bearing on their proportion of annual trade each year. Interestingly these traded commodities do not directly include capital items such as houses.

While Statistics New Zealand is to be commended for this research, ultimately, in my opinion the effort is largely misguided. This is because the focus on traded commodities in the market has little bearing on the demand for, or supply of, money in the New Zealand economy.

The commodity market is largely driven by six things:
1) The cost of energy - notably petrol and diesel
2) The cost of production (technology)
3) International prices for commodities
4) The effect of local weather (e.g a bad harvest).
5) The cost of wages and salaries
6) Land costs

These divide into two main categories: ephemeral passing price changes, and deeper structural price changes. Energy costs have by far the highest bearing on daily prices at the margin but these, like weather effects, are ephemeral, changing with global geopolitics, and the Reserve Bank, typically, "sees through" (ignores) them. Technology generally reduces costs, although changes in technology can mean that redundant technologies in the CPI basket (like film development) rise before they are excluded. Because New Zealand has no subsidies and minimal tariffs international commodity prices are always going to be reflected in local prices fairly quickly.

However none of these costs really change the overall demand for money as such. All the really change is the way the money there is already in the economy is allocated. For example if petrol costs go up, demand for coffee or chocolate biscuits goes down.

But wages and salaries are much more complicated. Every week a huge amount of money is paid out by employers and by the end of the week, for many, it has been spent on all the needs people have. Wages and salaries are basically the demand for money to sustain a certain lifestyle. That is, the ability to buy food, shelter, clothes, energy, durable goods and information.

Wages in New Zealand averaged just under $20 per hour in 2003 when our population was four million, and now averages $32 per hour as it approaches five million. With a labour force participation rate of 65% (2004) to 69% (2018) and an average of 1,761 hours per year it is trivial to calculate that the demand for money from wage and salary earners has increased from around $84 billion per year to about $192 billion a year over the past twenty years.

Not surprisingly these totals are a very large percentage of the so called gross domestic product of New Zealand. That is the total amount of money traded each year in the economy. Why? People gotta eat, and stay warm and dry and they spend most of their money each week on basically doing that. If one looks at the economy largely in terms of wage and salary inflation then, one can only agree with the Reserve Bank that there is very little change and so-called "inflation" has been negligible. While what we buy has changed (goodbye Sky, hello Netflix) gaining 80c per hour per year has hardly been a spectacular improvement.

But my contention is that this definition of inflation (which is internationally accepted) is because international capital is deliberately blind to capital inflation and excludes it from such statistics.

If house prices increase ten percent compound in Auckland for twenty years (as they did) that is not "inflation".  Inflation isn't when you need twice as much money to buy the things you (collectively) already own every seven years. No, that isn't inflation at all! Inflation is when wages and salaries go up. Over the past twenty years New Zealand's market value of housing stock has climbed five fold to around $1.1 trillion [ https://www.rbnz.govt.nz/statistics/key-graphs/key-graph-house-price-values]. The same house that had a market value of $120K in 2000 is now valued at $600k. The total requirement for New Zealand dollars to effect land transactions has climbed from two and half times the total amount of amount of wages and salaries traded each year to around six times the total amount of wages and salaries traded.  At the same time the total amount of debt held by New Zealand households has increased from $56 billion to $258 billion all of which generates vast profits for the mostly Australian banks that dominate our mortgage lending market.

A large part of why this has happened has been the deliberate disconnection between the wages and salary market and the land market. When only those participating in the wages and salary market are able to fund the land market there is a natural connection between the two. But when this link is severed ( or"liberalised" like that's a good thing) anyone in the world with a spare million dollars discovers they can make ten per cent per annum real from the Auckland housing market and there is no capital gains tax then not surprisingly they start buying.

The entry of a significant number of well heeled buyers means that prices begin to be pushed at the margin and before you know it you have a self fulfilling prophecy. Before long local buyers are joining the stampede and you have a bubble. And the problem with land is they stopped making more of it. For this reason it is considered by the international banking system to be the best collateral for lending there is. That means you can borrow more against land price inflation than you can wages and salary inflation. In theory, so long as you have increasing equity in your collateral and can service the interest out of wages and salaries it doesn't matter. But, of course, you can only service interest so long as interest rates remain low and interest rates can only remain low so long as wages and salary growth remains low.

But that means today the Reserve Bank is painted into a corner. If wage and salary "inflation" goes up so must interest rates and then the whole country discovers it can't afford to service its huge mortgages leading to defaults, price falls and negative equity the whole inflated system would collapse. In short thanks to the willful blindness of capitalism New Zealand is locked into a highly leveraged economy with a gun against its head. Either we play ball or all hell breaks loose.

How do we play ball? We need to keep wages and salary "inflation" low. How do we that? We hinder collective bargaining or enforcement of employment rights and import people in very large numbers. Our population reached three million in the early seventies. It reached four million in the early 2000s, and will hit five million this year. Our immigration rules are now so slack that foreign call girls can call themselves "Skilled Migrants" (though what skills they have over any local I don't know) and the average salary of employed Skilled Migrants is less than the average for New Zealanders as a whole.

We have so called "students" from India and China who don't study much except personal experiences of near slave labour; and an "investor" only has to have enough money to buy a house in Auckland, rather than actually invest in New Zealand businesses.

What this means is that farms and urban properties are now huge capital reserves which can be banked, or borrowed against. It creates a class of capital owners and a class of serfs. It means that achieving a return on capital especially on low margin commodities becomes increasingly difficult putting pressure both on farmers and retailers alike. That in turn means demand for cheaper and cheaper labour until you end up with quasi legal migrants crammed into low cost housing trying to scrape a living from wages only a fraction of the so called "minimum" wage.

In other words most of the ills of New Zealand's society basically come from opening our housing market to global capital and adopting a capital centric rather than a human centric view of the world. It means higher housing costs, more exploitation of foreigners and locals, fewer opportunities for our young people, more stress and mental health problems and less egalitarianism. In short it means shittier lives for more people.

All of this might make sense. If New Zealand was developing the way Germany grew after the war, or Japan redeveloped or Singapore grew between the seventies and the present, by leveraging its capital into greater and greater investment and trading revenue it could be a generational sacrifice for long term wellbeing. But we aren't. We aren't borrowing on the house to make money. We are borrowing on the house to buy shiny imported things from foreigners. This is a recipe for disaster not development.

So what do we have to do?

First we have to recognise that global capitalism is not our friend and earning the praise of bankers is not winning. Global capitalism is run for the benefit of global capitalists not our people. This means re-establishing a more sensible relationship between wages and salaries in the domestic economy and land values. How do we do that? Given that it is a loaded gun pointed at our economy the answer is "with great care."

First we have to do what the government is doing. Quietly disconnect the money hose by restricting access to our land market to those who participate in the wage and salary market. Lots of other countries have already done this and there are plenty of proven ways to do this. Second we have to restrict access to the wage and salary market. This means reforming the immigration system completely - something the government has barely even scratched the surface of. It doesn't mean no immigration, it means a much more considered and sensible immigration system. One that isn't there to be gamed by former immigration Ministers turned consultants.

Third, it means big changes to local government funding, planning laws, incentives and management. This is already being looked at by the Productivity Commission, but it is very early days. Personally
I think we should centralise rates under IRD the way the Republic of Ireland did back in 1974 to achieve better compliance and efficiency. It won't stop local government stupidity (as Ireland demonstrates) but it should work better.

One Shibboleth of local government in dire need of reform is the Resource Management Act 1992. Originally conceived as a means to maintain sustainable development of wide open spaces it has made decisive and low cost development of urban areas and provincial towns unnecessarily expensive. Throughout local government there is a surfeit of planning documents and legal obligations, a dearth of skilled officers and very little common sense. Where other nations have waged war on "Red Tape" New Zealand has turned it into a form of civic decoration. Without a more responsive and better incentivised local government system construction of housing and infrastructure will remain unnecessarily expensive.

Fourth, we need to look closely at the way our building consent system works. While New Zealand wins plaudits from international agencies on its lack of graft there are very murky corners of building and construction industry where New Zealand standards seem to be largely written to benefit local incumbents. Yes, it is true that New Zealand's combinations of seismic risk, high winds and high UV-B radiation make for unusual specifications it still appears that there are potential building solutions available in other nations which are not easily deployed in this country. Reducing these barriers would go a long way towards reducing the costs of increasing the housing stock at the margin.

Fifth, and most important, the connection between immigration and politics must be severed completely. This includes land purchases, political donations by realtors, and political donations by non citizens. There is too much scope for 'changing settings" in such a way as to expand the market and open the money hose spigot again.

Will a capital gains tax help? In my view it will help a little but it is no magic bullet. Other nations have capital gains taxes and they only smooth out bubbles, they have never prevented one. It can combat land banking when land is left effectively unused to simply collect capital gains. Personally I think a stamp duty (a sales tax on land sales) is a much simpler way to cure speculation.

Will all of this make us poorer?

In terms of straight capital definitely yes. In terms of human capital it depends on what else we do. What the New Zealand land stampede has done has put New Zealand on investors radar. Instead of simply closing the door and ignoring that interest we could revive the Development Finance Corporation concept which was started by Robert Muldoon in the 1970s. The DFC was a New Zealand owned merchant bank, much as Kiwibank is a New Zealand owned retail bank. A victim of the Rogergnomes and global capital it was actually a useful investor in New Zealand human capital, seed funding, and mezzanine funding a number of prominent businesses and certainly a lot more effective, efficient, transparent and prudent than giving Minister Shane Jones (Matua no less) a billion dollars a year to play Santa Claus (or is that Tony Sopprano) with.

Some may accuse me of wishing to return New Zealand to the 1960s. Certainly New Zealand in the 60s was a far more egalitarian, wealthy and happy place than it is now. But it was also stiflingly restricted, small minded, and dull. The revolution of the 1980s was culturally important for its renunciation of the overbearing paternalist state and that was not a bad thing.

But in a world where unfettered tax avoiding global capitalism is threatening to turn people into serfs pending their complete replacement with automation I believe it is time for the State to once again reassert the importance of the collective best interests of its citizens and tax payers. If this doesn't happen I fear a future of corporate feudalism which I suspect will make 1984 look rather tame.It is time for citizens to recognise that the financial institutions they have grown accustomed to are not necessarily acting in their best interest and need to be reevaluated, even if this may attract the derogation of those who would prefer to continue to exploit us.

To that end I think we need to look very closely at the way our monetary policy is managed. If it is only managed for the benefit of capital it is inevitable that we will become the kind of capitalist society like the US, like Russia, like the Philippines, I don't remember voting on becoming. 

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