Some say central banks have done too little too late, some say they've acted too aggressively. As food prices rise 11.3 percent today, what decision-makers do mostly agree on is that there's a new outcrop of inflation looming. NZ and the world face a hard landing in which millions may lose their livelihoods, Jonathan Milne reports.
You want to see inflation? Try the Swiss ski resort of Davos this week. Usually, the beef tenderloin Chateaubriand at the Steigenberger Grandhotel Belvédère's Bistro Voilà would set you back 64 Swiss francs (NZ$108).
The extravagant steak (cooked between two other pieces of meat that are then discarded) is served first with a sweet potato waffle, mini-vegetables, béarnaise sauce, and then with Pommery mustard risotto, pepperoni tempura and grape must jus.
But this week, political leaders and corporate chief executives have gathered there for the World Economic Forum. Hot off the digital press, they have copies of the forum's 2023 Global Risks Report that identifies the cost-of-living crisis as the biggest short-term risk to the thousands of companies, communities and countries they represent.
European Commission president Ursula von der Leyen told them: "We see rising inflation making the cost of living and the cost of doing business more expensive."
READ MORE: * What 2023 has in store for the New Zealand economy – Mike Jones, BNZ * Eric Crampton: No painless escape route from inflation * Post-Covid inflation adds a new twist to the famous Phillips Curve
And as if to snidely illustrate her point, the alpine resort town's prices have been hiked to even headier heights. "Food is more expensive than usual at the hotel because of the investments we've made, building pavilions and additional offices. We have a huge cost that we have to make up for," says the Grandhotel Belvédère's manager Hans-Rudolf Ruetti.
The hotel has hired 150 more staff and set up x-ray machines. Events start at 6am with breakfast meetings, followed by lunches and more meetings, then dinners and nightcaps that can go until 3am or 4am the next morning.
Standard room tariffs at the Belvédère typically range from NZ$510 to $1,045 a night, but Ruetti says that's been increased about 50 percent for the World Economic Forum.
"My reason for declining the Davos invitation was not because I thought they were engaged in diabolical scheming, but because it sounded boring AF lol." – Elon Musk, Twitter
"Just imagine, you have the most important people in the entire world — from politicians to business people and entertainers — you have them all here," he writes, at Business Insider.
"Do they change the world by meeting here? Maybe they don't. But it's important for them to talk to one another. Even if it's not monumental, I believe it's important for people to talk to each other in this more relaxed atmosphere."
Once, the conspicuous consumption of Davos would have attracted fiery protests, yet somehow after two years of Covid-enforced absences, Davos now seems less relevant – to politicians and protesters alike. “The format seems slightly dated now," one Davos veteran tells Politico. "The private jets and oligarch parties are no longer in step with modern biz life."
Amazon chief executive Andy Jassy is meant to be attending, but will no doubt be keeping his head down, days after announcing he is laying off 18,000 employees worldwide because of the "uncertain economy". Amazon, one of the world's five biggest companies, has suffered the impact of soaring inflation encouraging businesses and consumers to cut back spending.
And Tesla enfant terrible Elon Musk tweets: "My reason for declining the Davos invitation was not because I thought they were engaged in diabolical scheming, but because it sounded boring AF lol."
Previously, the likes of Bill Clinton, Angela Merkel, Bono, Michael Dell and Bill Gates have based themselves at the Belvédère for the World Economic Forum. US President Donald Trump had his own luxurious floor at the InterContinental built for this event.
Now, the list of forum attendees is less impressive. Superpower presidents Joe Biden, Xi Jinping and Vladimir Putin aren't there; the new British and Brazilian leaders couldn't be bothered; France's Emmanuel Macron hasn't even made it across the border – though maybe that's because French train drivers have all gone on strike.
"The health and economic after-effects of the pandemic have quickly spiralled into compounding crises. Carbon emissions have climbed, as the post-pandemic global economy fired back up. Food and energy have become weaponised by the war in Ukraine, sending inflation soaring to levels not seen in decades, globalising a cost-of-living crisis and fuelling social unrest." – Saadia Zahidi, World Economic Forum
New Zealand Prime Minister Jacinda Ardern and Finance Minister Grant Robertson both attended Davos in 2019; this year they've just sent trade minister Damien O'Connor.
Some would credibly argue that conversations like those held at Davos, between economic decision makers in government and business, are needed more now than ever. “The global economy is moving through strong headwinds, which will buffet New Zealand this year,” O’Connor says.
The war in Ukraine has had a huge influence on energy and food security, which are often at the heart of social cohesion, O'Connor adds in an NZ Herald interview. "Hopefully, Europe gets through winter in a way that enables their people to be safe and secure but if not, there will be flow-on implications – that flow into global trade."
Certainly, this week's World Economic Forum poses a question that should be foremost in all decision-makers minds: how can we rein in global inflation without plunging the world into a sustained recession, at the cost of millions of livelihoods?
O'Connor hopes to meet with Kristalina Georgieva, the managing director of the International Monetary Fund. At the Time100 dinner that kicked off the forum this week, she urged leaders not to let the "global polycrisis" distract from the urgent need for greater cooperation.
The forum's Global Risks Report calls on leaders to act collectively and decisively, balancing short- and long-term views. In addition to urgent and coordinated climate action, the report recommends joint efforts between countries as well as public-private cooperation to strengthen financial stability, technology governance, economic development and investment in research, science, education and health.
The global pandemic and war in Europe have brought energy, inflation, food and security crises back to the fore, it says. These create follow-on risks that will dominate the next two years: the risk of recession; growing debt distress; a continued cost of living crisis; polarised societies enabled by disinformation and misinformation; a hiatus on rapid climate action; and zero-sum geo-economic warfare.
"These economic travails will, of course, fall hardest on the most vulnerable countries, providing even more fertile ground for populist demagogues to sow the seeds of resentment and discontent. " – Prof Joseph E Stiglitz, Nobel laureate
Those that are already the most vulnerable are suffering, it says. In the face of multiple crises, the numbers of those who qualify as vulnerable are rapidly expanding, in rich and poor countries alike.
For New Zealand, the report says the biggest risks are the cost-of-living crisis, followed by rapid or sustained inflation, natural disasters, a housing bubble burst, and debt crises.
Georgieva warns that solving the cost-of-living crisis will be impossible without first addressing the global fragmentation. “If we continue to erode the integrated global economy, it will cost the world 7 percent of GDP,” warned Georgieva. “If you guys don’t like inflation today, if we destroy the integrated global economy – oh, brother.”
Services inflation
At the one extreme of the crisis, food and energy costs have been weaponised by the war in Ukraine, widening inequality and fuelling social unrest, the Global Risks Report says. It's providing even more fertile ground for populist demagogues to sow the seeds of resentment and discontent, says Nobel laureate Joseph E Stiglitz.
At the other extreme ... $150 steak Chateaubriand.
Somewhere in-between is my sons' haircuts.
Returning from a summer beach break, I take myself and my sons into the barber's in Onehunga this week, to trim our unruly mops.
The $80 I pay for our three cuts certainly isn't exorbitant by Auckland standards, but it's more than what I'm used to.
The need for hairdressers to increase prices is understandable; they're paying more for rent, power, supplies and wages – either to themselves or staff. Indeed, Stats NZ says the average cost of a woman's shampoo, cut and blow wave has topped $80 for the first time. The price of a haircut went up an average 6.7 percent in the year to September 2022 – and that rate is likely to increase in next week's consumers price index update.
The reason this is worth remarking on is that services inflation is the new cost of living battleground. At a time when supply chain pressure is finally easing, taking some heat out of price rises for tradable goods, New Zealand is about to be hit by more intensive services inflation.
Here in New Zealand, Stats NZ published the December food price index today, soaring to a near record 11.3 percent, the highest since 1990. Since December, when Stats closed its data collection, the price of 2L of supermarket brand milk has actually dropped a few cents from a high of $3.91 last month, to $3.88 today – though the shortage of eggs will keep grocery prices rising through January.
Headline inflation will see an artificial jump when the petrol excise subsidy ends in March, effectively returning it to where it would have been without a year of reduced tariffs. That will affect inflation perceptions and perhaps inflation expectations, says NZ Initiative economist Dr Eric Crampton, but the Reserve Bank will sensibly look through that 0.5 percentage point effect in setting interest rates.
"Goods price inflation is likely to fall ... with the cost of shipping falling rapidly. But services inflation is going up fast in New Zealand, and that’s the sticky, domestically-generated inflation that doesn’t go away easily." – Finn Robinson, ANZ
Internationally, the price of timber has fallen by roughly two-thirds over the past year, and now isn’t far off the five-year average before the Ukraine crisis. Brent crude oil has fallen by roughly a third since last summer, and DRAM chip prices continue to plummet and are now hovering around a five-year low.
In the US, used car prices fell sharply in the second half of last year, though they remain quite high compared to two years ago. As for shipping costs, the Baltic Dry Index is around a third of the level from a year ago, and if the trend seen in recent months continues, it will soon be down to the exceptionally low levels seen during the Covid crisis.
The slowing headline inflation reported last week by the US Bureau of Labor Statistics, as well as official year-end statistics from China and Korea, has sparked buoyant headlines and worldwide optimism that the word of the cost-of-living crisis has passed.
That optimism is entirely misplaced.
"Goods inflation was a key driver of inflation early on, with supply chains jammed up by Covid disruption, and consumer demand for goods being juiced by a potent combination of fiscal stimulus, and being unable to spend on services like holidays," says ANZ Bank economist Finn Robinson.
"Goods price inflation is likely to fall rapidly over 2023 (and already is falling fast in the US) with global supply chain pressures easing, and the cost of shipping falling rapidly. But services inflation is going up fast in New Zealand, and that’s the sticky, domestically-generated inflation that doesn’t go away easily."
Robinson is a veteran of a four-year tour of duty in the Reserve Bank economics division. He says: "The biggest inflation challenge facing central banks, including the Reserve Bank, is the ongoing surge in services inflation."
That surge is also much more influenced by the record levels of private sector wage growth that we are seeing in New Zealand, he says.
And with the return of international tourism putting even more pressure on an already stretched labour market, encouraging wage growth, it will be challenging for the Reserve Bank to return annual CPI inflation all the way to the midpoint of its 1-3 percent target range, within an acceptable timeframe.
“Like slowing an oil tanker from full speed, domestic inflation will take longer to tame.” – Mary Jo Vergara
Kiwibank economists agree: Goods inflation is cooling, but tight labour market conditions are keeping services inflation elevated – and it's not just New Zealand. The latest inflation data out of the US last week shows core goods inflation slowing in the 12 months to December, but core services inflation accelerating to 7 percent. With a tight market and faster wage growth, services inflation will be a challenge to cool.
New Zealand doesn't publish its December quarter CPI until January 25, and its September quarter data now looks desperately dated.
Even then, though, those few who delved deep enough into the spreadsheets noticed that the price of goods had increased 1.7 percent over three months (down from 2.4 percent in the previous quarter); the price of services had increased 2.7 percent over three months (up from 0.5 percent).
Rising rents make up a 10th of consumer price rises
For the time being, today's today's statistics provide some insight into the extent to which services inflation is picking up where goods inflation has left off. As well as the food price index, the rent price index came out today.
It confirms that increasingly, the impact of rising prices and interest rates is being passed down to those least able to afford it. In the US this week, new research from the New York Fed shows it's low-income families who are now being hit hardest by inflation, because they’re unable to substitute less expensive goods for pricey items and have fewer cash reserves.
Similarly in New Zealand, landlords are passing on their increased mortgage servicing costs to tenants; families without much disposable income must spend what little they have on increasingly expensive basic foodstuffs; manual and shift workers will bear the brunt of the removal of the fuel excise subsidy and bus and train fares returning to full prices.
Is there any way to avoid the impact?
The Reserve Bank says it will use higher interest rates to engineer a recession because that’s what it takes to slow spending and inflation. “There will be a likely rise in unemployment," Governor Adrian Orr told MPs before Christmas.
It’s an unappealing stance, but many mainstream economists agree. Kiwibank economist Mary Jo Vergara says: “A slowdown is coming. And it must, in order for the battle against inflation to be won.”
Kiwibank’s economists are most concerned about the strength of domestic inflation. “Like slowing an oil tanker from full speed, domestic inflation will take longer to tame,” Vergara tells Newsroom.
“For one, wage inflation – a major component of domestic inflation – has yet to peak. And inflation expectations remain stubbornly high. We also have to account for the expected end to the discounted fuel excise tax and half price public transport.”
There is a big difficulty in steering an economy, like steering that oil tanker. Over-correcting.
“The inflation scare will turn out to be a fizzer. The refix of mortgages this year will be the deciding factor. It will be crushing.” – Shamubeel Eaqub, Sense.Partners
It takes 12 to 18 months for the OCR changes to flow through. Home-owners are gradually forced to refix their mortgages at higher rates. Households respond to higher mortgage servicing costs and rents by cutting their discretionary spending on goods and services. When demand drops, it's harder to raise prices. Businesses respond to reduced revenues by cutting their payroll. Wage growth slows; unemployment rises; demand slows still further.
It all takes a while. And in the meantime, the Reserve Bank is hiking the official cash rate, again and again. Nine times since October 2021, and it's not done yet – it's signalled a willingness to continue increase the OCR to 5.5 percent and beyond, if necessary.
The fear is that instead of a gentle downturn, the Reserve Bank (and other central banks) swerve the economy violently into a deep and sustained suppression. Some economists believe that’s already happening.
Is rampant inflation the ailment that causes the pain and misery – or is it the cure of high interest rates?
Shamubeel Eaqub, from Sense Partners, believes the Reserve Bank has erred massively.
“They are dinosaurs who don’t understand the economy,” he tells Newsroom. “They have based their entire hiking strategy on the expectation of a wage price spiral. And completely missing the credit boost and allocation of it to mortgages as key problems of their policy response.”
“The inflation scare will turn out to be a fizzer. The refix of mortgages this year will be the deciding factor. It will be crushing.”
Some economists argue we don't need to go to the extremes of manufacturing a recession and unemployment, to slow inflation.
“Inflation is not a new problem for the poorest in New Zealand. It will continue to be an issue for all Kiwis unless we change how we approach it." – Craig Renney, CTU
They are led by Professor Stiglitz, the Nobel laureate economist, who is a former chief economist of the World Bank and chaired President Clinton's Council of Economic Advisers.
"Central banks’ unwavering determination to increase interest rates is truly remarkable," he writes now. "In the name of taming inflation, they have deliberately set themselves on a path to cause a recession – or to worsen it if it comes anyway. Moreover, they openly acknowledge the pain their policies will cause, even if they don’t emphasise that it is the poor and marginalised, not their friends on Wall Street, who will bear the brunt of it."
New Zealand Council of Trade Unions economist Craig Renney says the traditional main tool for controlling inflation – increasing the interest rate – is taking money out of working people’s pockets disproportionately and increasing unemployment. "That makes New Zealand’s already dire wealth gap worse, and hobbles our long-term economic growth."
He argues for an Inflation and Incomes Act to develop a more equitable economy, while managing the country's transition to a longer-term low-inflation environment. “Inflation is not a new problem for the poorest in New Zealand," he says. "It will continue to be an issue for all Kiwis unless we change how we approach it.”
'Toxic mix'
Back in Davos, it's cocktail hour – but with a difference. Instead of a traditional Schümli Pflümli, a champagne-based Kir Royal (22 francs at Grandhotel Belvédère's Carigiet Bar) or the eyebrow-singeing Flämmli, there's a volatile new mix this year.
"The interplay between climate change impacts, biodiversity loss, food security and natural resource consumption is a dangerous cocktail," says John Scott, the head of sustainability risk at Zurich Insurance Group.
Saadia Zahidi, the managing director of the World Economic Forum, adds her own twist. "In this already toxic mix of known and rising global risks, a new shock event, from a new military conflict to a new virus, could become unmanageable," she says. "Climate and human development therefore must be at the core of concerns of global leaders to boost resilience against future shocks."
