Both Australia and New Zealand face the worrying prospect of the impact of lower commodity prices. For Australia it is iron ore whilst across the Tasman it is the dairy industry. So how will each economy be affected by this?
The whole milk price has fallen from:
US$4999/tonne on 18th February 2014 to US$2270/tonne on the 16th December – a 54.6% decrease.
This downturn in prices will have a significant impact on the rural economy of NZ. The lower prices will not only reduce dairy farmers’ incomes, but there will be a knock on effect in other parts of the local economies as farmers and contractors will be less inclined to spend or invest in anything but necessities.
Short-term credit facilities will be able to help farmers with their costs but permanent lower returns would cause a rethink regarding production capacity and economies of scale.
Aussie Iron Ore
For Australian the iron ore prices have fallen from US$136 a tonne December 2013 to US$68 a tonne December 2014. This will have a major effect on their economy for the following reasons:
Iron ore represents 25.5% of exports from Australia
Iron ore producers are significant tax payers to the Australian Government. The drop in prices = AUS$18 billion loss of revenue
Lower prices mean less investment in capital – this sector has been a major part of the Aussie economy over the last few years
Who will take the biggest hit?
It is expected that Aussie will take the biggest hit mainly because of the tax revenue lost through lower iron ore prices. In NZ dairy farmers are not big tax payers and the NZ government are not expecting a big fall in tax revenue. Furthermore overall economic activity is largely unaffected as milk production is likely to continue in the short-term. However the falling unemployment rate in NZ and a rising level in its Trans Tasman neighbours suggests NZ is in a much better state to weather the storm. Other indicators below favour NZ. These include GDP growth and consumer confidence as well as having the ammunition of being able to cut interest rates further, a situation that Australia might find difficult.
Source: NZ Herald December 20, 2014
Back on deck after a good two week break. One issue that has been prevalent has been the drop in oil prices. The benchmark Brent crude oil price has fallen from US$115.65 on 19th June 2014 to US$56.42 today (4th January 2015) – that is a 51.2% drop. Why have prices dropped so much in such a short period of time?
The main reason for this is the increase in fracking where energy companies go deep into the ground and blast the shale rock with a mixture of water and chemicals which releases oil and gas to the surface. This technique has been particularly prevalent in US where production has increased from 5 million b/d in 2008 to nearly 9 million today. Ultimately the price has dropped because supply has outstripped demand. Of world production OPEC produces 30.3 million b/d and the rest of the world 61.8 million b/d. With this over supply you would expect OPEC countries to agree to reduce the volume of oil they pump everyday. However, according to Brian Gaynor in the NZ Herald, they are unwilling to reduce production for various reasons:
1. Most member countries are heavily dependent on oil export revenue
2. They have to meet interest costs on large government deficits
3. They believe that lower oil prices in the short term will discourage further investment in fracking and ultimately lead to higher long-term price for conventional oil.
Oil prices and world growth
The link between oil prices and the economic conditions of the global economy are well documented.
Low oil prices = booms periods in the global economy from 1948-1973 and 1993-2007
High oil prices = recessions – 1974-75, 1981-82, 1990-91, 2008-09
Low prices do stimulate growth – it means more spending power for consumers and it cuts cost for business. However the lower price will affect countries like Russia, Venezuela and Iran as they can only balance their books if the oil price is at US$100 a barrel or more. The US would be particularly affected by this lower oil price as much of the investment in fracking has been financed by high yielding but risky junk bonds. As the credit risk becomes greater with lower oil prices this could lead to sales by investors which would lead to illiquidity. According to The Observer newspaper “fracking could become the new sub-prime”.
Many thanks to Henry Chueh (a former student) who alerted me to this article from the interest.co.nz site.
In 1950 the American Dream was owning a house and the maximum amount of consumer goods.
In 2050 the American Dream may be owning nothing, but having access to everything.
The Sharing Economy is the tool enabling this shift from ownership to access. At a high level the sharing economy involves – utilising inefficient assets so the resources of those who have, can be accessed by those who want.
What happens when the importance of access to things trumps the value of owning those same things? The end of ownership. From computer hardware, to houses, trucks, cars, and more, the notion of ownership is changing as software enables the matching of people and organizations that have things and those that need them.
It reminded me of a leader article in The Economist (see picture below) last year on the sharing economy, which is a little like online shopping, that started in America 15 years ago.
At first, people were worried about security. But having made a successful purchase from, say, Amazon, they felt safe buying elsewhere. Similarly, using Airbnb or a car-hire service for the first time encourages people to try other offerings. Next, consider eBay. Having started out as a peer-to-peer marketplace, it is now dominated by professional “power sellers” (many of whom started out as ordinary eBay users). The same may happen with the sharing economy, which also provides new opportunities for enterprise. Some people have bought cars solely to rent them out, for example.
With oil prices heading to below $60 per barrel and inflation on the rise the Russian economy is bracing itself for some difficult times ahead. Oil is imperative to Russian growth rates and The Economist reported that in 2007, when oil was $72 a barrel, the economy managed to grow at 8.5%. Additionally between 2010 – 2013, when oil prices were high, the country’s net outflow of capital was $232bn – 20 times what it was between 2004 and 2008. See graph from The Economist.
But as oil prices drop so does the currency which mean imports become more expensive – the bigger the drop the more expensive they are. Russia imports a lot of goods – the value in 2000 was $45bn compared to in 2013 $341bn. This lower value of the Rouble fuels inflation and it is expected to reach 9% by the end of the year. To maintain peoples spending power the government will need to intervene in the economy and run bigger deficits.
But there is another problem a weaker Rouble makes debt servicing more expensive so in the long-term more money needs to be found. When there was a high oil price instead of increasing their reserves, money was spent on salaries and pensions and especially the armed forces where spending increased by 30% since 2008. One wonders why they spent so much on the Sochi Winter Olympics. However drastic steps are being taken to reduce the decline of the Rouble with priests blessing the servers at the Central Bank with holy water.
Interesting report from the OECD that was published yesterday. There are a couple of good graphs that can be used for teaching inequality: The increase in inequality from 1985 – 2011; and the impact that inequality has on growth.
The Gini coefficient increased in 16 out of the 21 OECD countries for which long time series are available, rising by more than 5 points in Finland, Israel, New Zealand, Sweden and the United States and falling slightly only in Greece and Turkey (Figure 1).
The OECD estimate that increasing inequality by 3 Gini points (that is 0.03) points would drag down economic growth by 0.35 percentage point per year for 25 years: a cumulated loss in GDP at the end of the period of 8.5 per cent. Figure 2 below shows the that the increasing levels of inequality are estimated to have reduced growth levels in the majority of countries. Those of note are:
New Zealand -15%
The graph also shows that greater equality prior to the crisis helped increase GDP per capita in Spain, France and Ireland.
Key Findings from OECD Report
* The gap between rich and poor is now at its highest level in 30 years in most OECD countries.
* This long-term trend increase in income inequality has curbed economic growth significantly.
* While the overall increase in income inequality is also driven by the very rich 1% pulling away, what matters most for growth are families with lower incomes slipping behind.
* This negative effect of inequality on growth is determined not just by the poorest income decile but actually by the bottom 40% of income earners.
* This is because inter alia people from disadvantaged social backgrounds underinvest in their education.
* Tackling inequality through tax and transfer policies does not harm growth, provided these policies are well designed and implemented.
* In particular, redistribution efforts should focus on families with children and youth, as this is where key decisions on human capital investment are made and should promote skills development and learning across people’s lives.
You can view the full document at:
A hat tip once again to colleague David Parr for this piece on buckwheat prices. As Russia comes to term with falling oil prices, a depreciating rouble, high inflation and sanctions over the Ukrainian crisis there is one other indicator that is worth a mention – buckwheat prices.
Buckwheat is seen as part of the Russian staple diet and can be eaten with any meal in Russia – porridge, served with liver, stuffed inside a roast piglet. It was when rumours started that buckwheat supplies were running low that shoppers rushed out to supermarkets to fill their trolleys. A drought in Russia reduced the buckwheat harvest from 700,000 tonnes to under 600,000 tonnes but this could hardly cause the rapid increase in prices. However media reports were enough to act as a catalyst for panic buying amongst consumers -it took only four days for the town of Penza to be stripped of buckwheat stocks which normally last for two months. In Moscow buckwheat rose from around 30 rubbles to 50 rubbles. Furthermore with the introduction of Western sanctions people are starting to stock pile buckwheat as they are unsure of what will eventuate. It is estimated that over a third of the population have stocked up on buckwheat over the last month.
It seems that buckwheat is a sacred food for Russians and it tends to be in very short supply when there is any sign of crisis in the economy. But it is not just buckwheat which has increased in price. There has been a 30-40% increase in basic foods such as eggs, fish chicken, and sausages as Russia enforces retaliatory embargo banning Western food imports.
From the National Australian Bank – non-mining GDP growth is already running at around or slightly above trend at around 2.75%. This improvement accords with the message of sectoral business conditions in the NAB survey. In 2011, interest rate markets ignored the strength in mining and correctly priced off the weakness in the non-mining economy. Non-mining GDP growth is already running at around or slightly above trend at around 2.75%. This improvement accords with the message of sectoral business conditions in the NAB survey. In 2011, interest rate markets ignored the strength in mining and correctly priced off the weakness in the non-mining economy. While it’s much too early to make the reverse conclusion, especially given the pick up signalled is only very mild, it’s certainly a scenario worth monitoring as it would be a major surprise for Australian rate markets.