By Michael Every of Rabobank
Allow me to focus on just New Zealand today as the perfect illustration of the law of unintended market conse-Kiwi-nces.
The RBNZ left rates on hold at 0.25% as expected, but that’s not the real story. To tell it, let’s rewind. NZ was, not that long ago, a highly-regulated economy that focused almost exclusively on exporting its lovely agri output to the UK. Then the UK made a geopolitical pivot to join the EU and its common agricultural policy, and NZ was left adrift. The country suffered a massive economic shock; had to reinvent itself; and reinvent itself it did, with a market-friendly, Asia-focused export economy. The first law of unintended conse-Kiwi-nces is that geopolitics is swinging back in the other direction, or at least as far as the EU and UK, and a pre-1973-style export focus on China is concerned.
As part of its market reforms, and after the high and variable inflation of the 1970s, which followed on the back of both the end of Bretton Woods in 1971, the oil shock of 1973, and the UK joining the EU, there was a search for a new policy direction. Neoliberal monetarism was very much in vogue, and in 1984 the RBNZ adopted inflation targeting as the focus of monetary policy, the first to do so. As part of the broader financial reforms introduced, a series of variable reserve requirement ratios and interest rate controls, to try to limit how credit flowed, and FX controls, to prevent international flows to circumvent the former, were all removed. The NZD dropped sharply, floated freely, and we entered the policy framework we see in most major economies today.
There was an immediate spike in Kiwi inflation in the 1980s. As then usual, this was taken as a signal for the wage round – and yet under this new neoliberal framework, it fell on deaf ears. While arguably necessary at the time as part of restructuring and transition towards the macrostability inflation targeting likes to flag as its ultimate reward, this was the first clear indication that wages/labour were always going to come second to business/capital/exports in this brave new world. How else was inflation to be kept in check?
As we all now know from the global experiment with this system, this power imbalance within the economic structure --which presents itself as natural, sensible, and entirely ‘neutral’-- ultimately requires workers to borrow more and more to sustain the level of consumption they would have previously enjoyed via wage growth. We also now know that this means asset bubble after asset bubble, usually of housing; and when these burst, the system can only respond with even more liquidity, which exacerbates the problem rather than acting as any kind of counterbalance for the underlying root cause. So the second law of unintended conse-Kiwi-nces is that socio-economic AND macro stability are ultimately undermined if you focus on inflation and ignore the political economy. Which is part of the reason why geopolitics is shifting so uncomfortably for NZ.
Yes, some central banks have a dual inflation and employment remit: the RBNZ had one added too. Yet in the US this was historically ignored in favour of inflation; and now that the zeitgeist has shifted, that dual mandate in both the US and NZ is being used as an excuse to let inflation --which actually means asset prices!-- run hot. So where is this mythical balance? That there isn’t just underlines that without addressing the taboo issue of labour vs. capital, which involves undoing much of the labour market deregulation of the past, central banks still can’t resolve the real problem: and so (geo)politics shifts even faster.
So here we today, and the Kiwi government has just told the RBNZ that from now on it must also “consider housing” in its interest rate and financial policy decisions, aiming at keeping them “sustainable”. The RBNZ of course considers risks to housing in terms of financial stability, but not whether the prices are sustainable (or affordable to voters) or not. Naturally, the RBNZ welcomes this decision. But what will it mean? With housing prices soaring again in NZ, as everywhere, and homelessness a political issue for the government, this logically must point to one of three policy outcomes:
- First, nothing happens. As with full employment promises, it’s just neoliberal window dressing. That would get politically difficult at some point, one would imagine;
- Second, rates have to rise despite other parts of the economy still suffering, underlining how inefficient the central rates tool is when trying to target activity across a variety of different sectors in a globalized economy. This suggestion has helped see NZD soar, now up 4% in just a week! That means potentially higher mortgage payments AND a far less competitive currency for those farmers already having to consider what exporting alternatives might need to be available in a worst-case Australia-style scenario. Fortunately, high commodity prices, which the US central bank is more than partly responsible for, are providing some kind of cushion to Kiwi farmers for now in a law of unintended(?) conseq-US-nces; or
- Third, major macroprudential measures to allow for ultra-low rates but to stop liquidity flowing to housing. This has been tried to some degree before, but current house prices tell you if it’s worked or not (hint: they are no more affordable/”sustainable” vs. wages).
I would remind regular readers that this last point is not too far removed from the idea floated just days ago – that if you want ultra-easy monetary policy for a long time without bubbles, one is going to have to use de facto credit rationing. Is the RBNZ a market thought leader here again too, but in reverse? Probably not, because then you also have to deal with capital flows to stop foreigners buying Kiwi houses, which takes us all the way back to the pre-1984 Kiwi economy again.
Indeed, the final law of unintended conse-Kiwi-nces is that neoliberalism saw a shift from an economy too geopolitically fixed on one large power, in need of macroeconomic adjustment, and with an overvalued exchange rate, to an economy too geopolitically fixed on one large power, in need of macroeconomic adjustment, and with an overvalued exchange rate. Yes, it’s far richer today: but due to asset prices, not wages. Or, putting it differently, the only logical way to deal with the underlying problem seems to be bringing back elements of the pre-neoliberal regulatory policies that were dumped 40 years ago.
In the meantime, let the NZD and the neoliberal easy money rip: and ‘good as gold,’ as they say in NZ.