Monday, November 24, 2008


In a few weeks or so the Reserve Bank of New Zealand will go into a huddle for a few minutes and come out gravely nodding that yes, another rate cut, probably of the order of 100 basis points is in order.

Commentators will point to global credit shortages, falling CPI etc etc. They will probably complain it isn't enough - especially given the differential between New Zealand and Europe and the US. And they will be right but Reserve Bank's wouldn't want to do anything hastily so 100 basis points is about as much as they are likely to do.

Homeowners will be happy because their floating mortgages will come down, exporters will be happy because the OCR props up the dollar and bringing it down will bring the dollar down increasing competitiveness and improving New Zealand dollar denominated revenue.

But my question is this. What difference does fiddling with the Official Cash Rate actually make to the Consumer Price Index?

The other day I downloaded a spreadsheet of the CPI changes on a quarterly basis and another on the OCR adjustments. Averaging the OCR adjustments over a quarter of tradable CPI gave me two columns: One with averaged OCR adjustments and the other with tradeable CPI. I then shifted the CPI one quarter to allow for lag and compared the two using simple linear regression. The r2 result was 0.08 which for those who don't do stats basically means there was no correlation whatsoever (you would need .75 plus to suggest a correlation). If the two columns of numbers were generated randomly you'd get pretty much the same result.

In fact the correlation between CPI and OCR is so weak it practically doesn't exist.

Over the past 18 months we have seen the price of a barrel of oil rise from US$40/bbl up to US$140/bbl and back down to US$40/bbl. That is a massive price spike and just as it did in the 70s and 80s it has generated a huge surge in prices. In theory the Reserve Bank looks through spikes like this looking for basic impacts on wages and other structural affects on demand for money. But that can be hard to do because oil prices have affected food prices and between the two of them real costs have risen astronomically.

Prior to this the Reserve Bank was increasing the OCR in order to cool down the rapid increase in house prices. But looked at in the hard light of day it has to be said that it had no affect whatsoever. The only thing that has collapsed house prices has been a massive collapse in the overly leveraged international money supply that was flooding the market.

So what does mucking around with OCR REALLY do?

When the Reserve Bank was targeting house price inflation it increased rates. The effect of that was to lead New Zealanders to borrow offshore via fixed interest rate mortgages. That increased our national indebtedness to 100% of GDP. Was that really a sensible thing to do?

The high OCR also propped up the dollar. This provided a currency guarantee for those foreigners investing in New Zealand property as a tax dodge (as we have no restrictions on foreign ownership and no capital gains tax). The increased value of the currency reduced the price of imports so we had a surge of credit card expenditure on toys which boomed out of sensible bounds and is now roughly $5 billion or over $1000 per person.

Did the OCR have any effect on housing exuberance? Frankly I doubt it. In December 2007 we learned" QV says that while house prices rose, the increase in the three month period to November this year was 11.4% compared to 12.7% the previous year". Who cares about paying 9% per annum on capital when you're getting returns like that! OCR wasn't even in the ballpark.

The ONLY thing that the OCR does is have an impact on exchange rates. We have been extremely fortunate that dairy returns and oil prices lock-stepped over the recent spike. If they hadn't we would have suffered more than we did. Managing the currency up did reduce the impact of sky-rocketing oil costs but it also meant that exporters were starting to be priced off the international market.

So we avoided some of the pain of the oil spike but we encouraged New Zealanders into foreign and credit card debt. Sounds like a policy for encouraging stupid consumerism not one for encouraging productivity.

Whats the alternative? Well here's mine. Set the OCR at 3% and leave it there.

What will that do?
1. drop the dollar ending consumerism pdq
2. encourage investment both now and into the future because 3% isn't much to beat
3. encourage internal funding of investment/mortgages rather than foreign borrowing
4. discourage borrowing from weirdly leveraged sources offshore
5. deflate current wage and price pressures

And if you want to address inflation address the real causes, e.g artificial land restrictions and government and local government charges which have been a main source of CPI over recent years. Neither of these are things the Reserve Bank Governor can do anything about.

With a fixed OCR the Reserve Bank could get back to overseeing financial institutions which - given the collapse of numerous finance companies (structures not dissimilar to 1929 era banks as it happens) - is something we arguably need a good deal more of in this country.

Radical? Perhaps. But I think worth a look.

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Monday, November 10, 2008

Red is dead, watch out for the Green machine!

The fall of the Labour Party in New Zealand is not merely the consequence of electorate boredom. Nor is it simply the consequence of bunker mentality which seems to afflict anyone in the Beehive for more than two terms. The reason the Labour Party lost is that it is intellectually bankrupt.

When Labour returned to power at the beginning of the 2000s its message of hope was simple. It would return New Zealand to the top half of the OECD for income per capita. Michael Cullen told the Chicago School mandarins in Treasury in no uncertain terms that they had a choice: my way or the highway. They knuckled under – as they had to Bill Birch before him.The problem was that after all the hoo-haa surrounding knowledge economies, and innovation the Labour Party took the easy way out. It opened the immigration floodgates – not hard after 9/11 – and fell back on the 1842 Wakefield National Enrichment Programme i.e sell the same land to newcomers for higher prices. New Zealand has been relying on this now for 160 years and when combined with an international mortgage bubble suddenly made everyone feel rich.

The Labour Party watched unemployment fall to record levels, its coffers swelling to embarrassing levels and fooled itself into believing that it was delivering on its promises. What next? It was at this point that Labour began to get religion about climate change, partly through the offices of the cunning Jeanette Fitzsimons and partly through the patronisation of the British New Labour Party who chucked Helen under the chin and told her she could be terribly important if she supported their efforts to talk up the value of carbon (which is vital to the City of London). Seeing a future swanning around being important in Europe Helen swallowed hook line and sinker and suddenly returning to the top half of the OECD seemed parochial and dull. Instead Helen decided New Zealand would lead the world on sustainability with targets even oil rich Norway would consider impressive.

Never slow to seize an opportunity the Greens went into overdrive and effectively became the intellectual leaders on both economic and social policy in Wellington. Very quietly however something was happening out in the electorate. A tear between the Labour Party’s leadership and its traditional supporters was beginning. When people who have not had much to begin with, gain something they become conservative. The Greens rank and file is however made up of both the very well-off and younger people who either can afford extra costs or simply won’t face them. Greens can go places Reds cannot. And slowly the issues started mounting up. Smacking kids, shower flow rates: Green initiatives endorsed by Labour were flowing down to the Labour base and going down like a cup of cold sick.

The more it went on the more the tear became a rend. The intellectual head of the labour movement used to commanding the attention of the masses who looked to it for protection and representation was becoming Green and biting the Red body. And newly enriched the Red body was slowly feeling bluer than ever before even if it mistrusted this new sensation. The result came to a head on Saturday 7 and Labour now finds itself without a head at all.

What will happen now?

Helen Clark’s personal failure has been to fall into the trap of ‘strong leadership’. People don’t want ‘strong’ leadership. They want inspiring leadership. The reasons leaders emphasise strength in leadership is that it does take an enormous amount of personal strength to be a leader. Compare Helen Clark the weeping Health Minister in 1986 with Helen Clark today. There isn’t a comparison. Clark has been burned, scarred and scolded into the will of iron style leader people actually can’t relate to or like. The problem with Will of Iron leaders is that they surround themselves with sichophants and burn off anyone else. Once that happens reality becomes an act of will and Government loses all sense of reality.

Labour’s problem is therefore two-fold. Most of its surviving senior people are relatively weak and they don’t have a coherent or appealing ideology. The bankruptcy in the Labour Party – like the bankruptcy in world markets is actually a lot deeper and a lot more serious than might at first appear. The role of old style unionists has diminished and the parliamentary wing looks more like the party of the gay green minority than anything that will appear to working people.
Meanwhile having carried out a brilliant campaign the Greens are strengthened and ready to become the major voice of opposition in the new Parliament. Although they will almost certainly face policy-knockbacks as the National Party blunts their sharper policies the Greens will almost certainly become the leaders of political opposition both in Parliament – and just as important on the streets.

This is a make or break time for the Greens and they have to win. For if, as promised the nation does hold a referendum on MMP at the next election and selects FPP or STV the Greens risk losing all influence in the Parliament. Their goal, therefore, must simply be to outshine the Labour Party in Parliament and out-inspire the Labour Party with young people on the street. Their ultimate goal must be to completely eclipse the Labour Party within ten years.

The Green Party needs its idealism but it also needs to get a lot stronger as a realistic alternative to Labour with corporate New Zealand. It needs to develop a more sophisticated economic view and it needs to adopt a careful balance of co-operation and antagonism with business. If the Greens are careful they will also need to step up their push into the labour movement as well and show more sympathy for the role of workers in large industrial enterprises than their purist policies have to date.

While the National Party will hold the policy pen for the next three to six years the more interesting struggle will be on the left as the Greens emerge as a force to be reckoned with regardless of electoral system we may ultimately choose.

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