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From rock star economy to rock bottom

From rock star economy to rock bottom

News and views from New Zealand – Dennis Dorney

Economic with the truth

My lack of formal qualifications in economics has never bothered me because I subscribe to Winston Churchill’s belief that if 12 economists were given an economics problem to resolve, they would produce 13 different answers. A profession that clearly doesn’t know its own views has no right to criticise mine. One of the many ‘truths’ that I was expected to believe was that of ‘natural advantage’, which was explained to me like this:

” A doctor is also a keen gardener but lacks the necessary spare time, so he employs a gardener. It may be that the doctor is a better gardener than the man he has employed but as he can earn more money as a doctor it pays him to employ a gardener and concentrate on his own more lucrative talent. His natural advantage lies in being a doctor; his employee’s lies in being a gardener.”

So what is wrong with that? Firstly what happens if the local economy falls on hard times and money becomes scarce. The doctor having, involuntarily, more free time can now work in his garden.

And what happens to the gardener? Secondly, we don’t know that the gardener, given the chance of a better education, would not have been a better doctor that his employer. The industrial revolution reveals numerous instances of major technological innovations devised by men with no formal education. ‘Natural advantage’ might not be ‘natural’ at all.

Milk solids and hard cheese

New Zealand’s ‘natural advantage’ currently lies in dairy produce, and has always depended on farming and horticulture, so our ‘advantage’ is essentially lots of open space and a high enough rainfall to keep grass happy. Not a unique or very inspiring advantage. So a nation which, was once well enough educated to produce Ernest Rutherford, father of nuclear physics, has chosen to be the gardener rather than the doctor (or the farmer rather than the scientist.) And we’re about to pay for it .

Most NZ dairy farmers own shares in Fonterra, a dairy co-operative, which sells its produce on the global market . Most of the produce is milk solids (dried milk powder), which has minimal value- added component and the main sales customer is China, which – as I have mentioned in a previous article – is buying up NZ farms and building dairy plants here to capture the value-added market, without any evident concern from the NZ government .

About 96% of NZ’s dairy produce is exported, so in the event of a downturn in the market, little could be absorbed in NZ itself. Dairy products contribute about 5% to NZ’s GDP and, importantly, about 25% to its overseas trade. But NZ is still a very small player in the entire global dairy market, so is very exposed to fluctuations in overseas demand.

Undeterred by the obvious risks, our government has a policy of doubling NZ’s dairy industry capacity as quickly as possible.

Stupidity is not a ‘natural advantage’

For a while the ‘natural advantage’ worked well. From about $4.00/kg in 2007, farm gate prices rose steadily to peak in 2014 at $8.40/kg at which level dairy farming was very profitable.

During this windfall, export prices for wool, lamb and timber have been fairly stagnant, so sheep farmers sold up their farms and bought up (or converted to) dairy farms, thereby putting more pressure on NZ’s ‘natural advantage’ to perform.

This was a bad move on many levels. Sheep farming requires less sophisticated equipment, needs less water, and can be carried out on poorer quality land. And the farmers were selling on a buyers’ market. They were then buying in a sellers market, needing to buy or acquire expensive equipment and assets (irrigation etc) and the result was that they borrowed money at levels which could only be repaid if the farm- gate prices remained steady.

The market did not hold. From its peak it has fallen unremittingly at the last 10 Global Dairy Trade auctions to $4.40. In response Fonterra has reduced its fore- cast price for the 2015-2016 season to $3.85/kg. Dairy NZ’s analysis shows that the average farmer needs $5.40/kg to meet production costs. For those who bought in at the peak, the figure is probably much higher. Thus these dairy farmers may have problems servicing their debts.

The earliest that a sustained improvement is likely to occur is the first quarter of 2016, because there is clearly a global market glut for dairy produce at present. Partly this is due to removal of EU quotas: China has stock piles; trade with Russia is virtually embargoed; at the latest TPP talks, as Australia no doubt knows, Canada, Japan and the USA are refusing to allow access to their dairy industry.

Confronted by an avoidable situation, the failure of the Government to foresee the problem is lamentable. Its strategy of pursuing our ‘natural advantage’ is now in shreds, as is its entire economic policy. Adding to its woes are a number of indicators that suggest the rock star economy (if it ever existed) is now over.

The perfect storm

Foreign investors, rattled by the slump in our main export earner, have abandoned the NZ dollar. In the last year it has fallen from about $US 0.78 to $US 0.65, the biggest sustained fall since the 2008 financial crisis.

To stimulate the economy the Reserve Bank of NZ is reducing the OCR from $3.50, reversing a series of rises last year. Predictions of a rate of 2.5% by Christmas are common, complicating matters by making mortgages more attractive at a time when house prices are rising ever faster.

This is playing havoc with business sentiment. In the dairy industry confidence is “astoundingly negative” while in the broader business community confidence, which had been rising, is now the lowest for two years. In the gathering storm there is just one small glimmer of hope for the farmers — a fall in the $NZ dollar and a drop in interest rates on loans, which may yet be their salvation.

Dennis Dorney is a member of ERA living in New Zealand, and is a regular contributor.

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