One of the standing jokes during the 14 years during which I was Governor of the Reserve Bank was that, every time the Monetary Policy Committee met to advise me on whether to tighten, ease, or hold monetary conditions, there was an “unusual degree of uncertainty” about the future outlook for the economy, and therefore for inflation. The reality was – and is – that there is always a high degree of uncertainty about the future.
Early last year, the prices for dairy products on Fonterra’s Global Dairy Trade auction were at an unprecedented level, and Fonterra was paying $8.40 per kilogramme of milk solids to its farmer members. The mood in the dairy industry was highly optimistic; business confidence generally was high; consumer confidence was high; the Government was talking confidently about achieving a fiscal surplus in the year to June 2015; and at least one overseas commentator was talking about our “rock-star economy”. Our economy was growing at a rate in excess of 3% annually, a rate which, though certainly not sufficient to enable us to catch real income levels in Australia in the next two decades, was nevertheless better than the projected growth rate of most other developed countries.
Little more than a year later, how the mood has changed! Early in August, with the average price at the Global Dairy Trade auction having fallen for 10 successive fortnightly auctions, Fonterra reduced its projected pay-out for the 2015/16 season to $3.85 per kilogramme of milk solids – a level at which the overwhelming majority of dairy farmers will be making a loss this season. Suddenly, business confidence has started to slide; there are signs that consumers are being a bit more cautious; references to the “rock-star economy” are used by Opposition politicians to mock the Government; and it has become fashionable to criticise the Reserve Bank for tightening monetary policy last year – even though most economists predicted at least as much inflation last year as the Reserve Bank did.
What went wrong? Did we become too dependent on the Chinese market? Certainly, the Chinese market has become of enormous importance to New Zealand: currently, China is our largest export market for every agricultural commodity – including wool, dairy, seafood, lamb and forestry – except beef, where China is second only to the US market. But that is hardly surprising: China is today the second largest economy in the world, and the largest trading nation. It is the second largest trading partner for the US and the European Community, and the largest trading partner for the 11 countries of ASEAN, as well as for Australia and New Zealand. And yes, China now takes nearly a quarter of our total merchandise exports, and a third of dairy exports; but 50 years ago the UK market took over half our exports, and nearly 90% of our dairy exports.
The harsh reality is that, though China continues to grow much more quickly than all of the developed economies, it has nevertheless slowed considerably in the last year or two, and may continue to slow further. Debt levels in China are very high; the property market there is uncertain; and the share market highly volatile. Largely as a result, the prices of virtually all commodities have fallen sharply over the last year or two. The iron ore price, for example, has fallen from nearly US$200 per tonne in early 2011 to around US$50 currently. The CRB index of 19 commodity prices recently touched its lowest level for 13 years. So dairy prices are in no sense unique.
This inevitably means that the New Zealand economy is in for a period of slower growth. The Government’s books may well still end with a small surplus in the year to 30 June 2015, but the likelihood of that being repeated in the 2015/16 year looks non-existent. And that means that New Zealand’s public sector debt will continue to climb. In theory, the Government seeks to balance its books over the economic cycle – running deficits when the economy is growing below potential and running surpluses when the economy is going gang-busters. Alas, in this latest cycle, we will at best have achieved a miniscule surplus in the year just past before heading back into more years of increasing debt.
Easier monetary conditions – lower interest rates and an appreciably lower exchange rate – will help cushion the blow of weak dairy prices. There’s not much doubt that the Reserve Bank will cut the Official Cash Rate again later this year, quite possibly more than once. With luck, this will help push the New Zealand dollar a bit lower. That will cushion the blow for the export sector to some degree, though at the cost of making the rest of us a bit worse off, paying higher prices for petrol and everything else we import.
In the meantime, fingers crossed that the US economy continues to grow, that China doesn’t slow further, and that the sluggish growth in Japan and the Eurozone doesn’t go into reverse! Today more than ever, we need the rest of the world to prosper!
Copyright © 2025 Don Brash.