Liam Dann: Worst of both worlds – dairy and oil prices threaten chances of soft landing

OPINION

In China, the price of things is going down. That’s a big problem for us here in New Zealand.

In fact, I think it represents the most serious threat to our chances of a
soft landing out of this pandemic economic cycle.

China’s inflation data, released last week, showed consumer prices fell 0.3 per cent in the year to July.

Even starker was the producers’ price index – which measures the levels at which manufacturers sell their goods – was off 4.4 per cent.

It is only four years since the business pages were full of explainers about why falling prices were a bad thing and how we might need to drop interest rates into negative territory to try and get them rising again.

If anyone needs reminding – and I don’t blame you if you do, it has been a mad four years – falling prices are bad because they are a symptom of a slowing economy.

As prices fall, business margins are squeezed, production falls and businesses contract. Jobs are lost and new jobs are not created. Wages fall.

Falling prices also prompt consumers to delay spending on big-ticket items on the expectation that prices will fall further. This further squeezes businesses.

If left unchecked a negative spiral takes hold that leads to recession.

In 2019, the West was battling deflation but China was booming.

It never rains but it pours.

In New Zealand now inflation is so bad that on Friday we were celebrating news that the rise in our food price index had eased back to single digits – at 9.6 per cent.

If there was ever a sweet spot – where people like me briefly stopped fretting about deflation or inflation – it was probably while we were distracted with lockdowns and worrying about daily Covid case numbers.

There used to be a saying: when China catches a cold the world sneezes. That became a bit too literal with Covid.

Of course, it’s meant to just be about the importance of the Chinese economy to the world.

Unfortunately, it remains as true as ever for New Zealand but not so much for the US.

The economic showdown between China and the US started with Donald Trump’s trade pushback and has been maintained by the Biden administration.

Just last week the US put more pressure on the Chinese economy with tough new tech investment rules.

The divergence is an ongoing headache for New Zealand policymakers.

It creates a dual-speed global economy where New Zealand is vulnerable to copping the worst of both worlds.

That’s been the trend for the past six weeks.

We’ve seen a fresh spike in commodity prices for things we import – like petrol – and a decline in the price of things we export – like dairy and meat.

Dairy prices especially remain inextricably tied to our economic fortunes.

From a record high – on the Global Dairy Trade Index – in March 2022 they have now fallen 53 per cent, largely due to depressed Chinese demand.

Farmer payouts are now below break-even and we should expect to see a slowdown in the rural economy adding to the impact of high mortgage rates in the coming months.

Of course, that might mean we can get a cheaper 1kg block of cheese at the supermarket.

Someone asked me last week why inflation here and deflation there couldn’t just all balance out.

You could make the case that a Chinese economic slowdown will be a deflationary force on the global economy and could speed up the departure of inflation from Western economies.

It might. And I hope it does. But I’m worried the situation will be more like experiencing drought and a flood at the same time.

Unfortunately, in the past few weeks, things like lower Chinese energy consumption have been more than offset by other global issues pushing up prices for oil and wheat and rice.

BNZ head of research Stephen Toplis covered both scenarios in his OCR preview this week.

If we see a second global price shock and inflation doesn’t settle then interest rates would have to rise again, and not just once, he warned.

“If the RBNZ pulls the trigger then expect a minimum of two hikes and quite possibly more,” he said.

“But the risk profile is not one-sided. Just as plausible is a New Zealand economy that goes more deeply into recession than we anticipate as lagged interest rate impacts coincide with a US recession, a further slowing in the Chinese economy, weak commodity prices and an El Nino-induced drought.”

Yikes, where did that sweet spot go?

It seems cruel to be faced with two such grim economic scenarios at once.

It makes the Reserve Bank’s job very difficult but, for now, adds to the case that they should watch and wait and be ready to move very quickly once the direction becomes more clear-cut.

We could still get a lucky break.

As long as I’ve been covering the Chinese economy – which is about 20 years – I’ve been reading Western reports warning of impending catastrophe.

But the gloomiest forecasts have never come true. It is always dangerous to bet against a country with China’s size, determination and sense of destiny.

So far Beijing has been reluctant to unleash any significant fiscal stimulus, hoping it can get by on monetary policy and stern patriotic messaging.

More stimulus won’t solve its longer-term structural problems – but it could yet deliver a short-term bump that would be a welcome relief for one small trading partner in the South Pacific.

Liam Dann is Business Editor-at-Large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.