The inflation monster is baaaaaaack

This week New Zealand’s inflation hit a 31-year high after decades when the spectre of relentlessly rising consumer prices seemed to have been conquered forever. What happened can only partly be blamed on domestic issues – a 32 percent rise in the price of fuel, for instance, simply had to be accepted. Although that last issue is, at least in part, an ‘own goal’ given that the neo-liberal ‘reformers’ of the late 1980s abandoned plans to make the country 50-percent self sufficient in petrol, handed much of the infrastructure over to private enterprise at bargain basement prices, and – just this year – that same private enterprise has closed the only refinery in the country. But I digress.

Why has the old twentieth century monster, inflation, suddenly exploded into life? Surely it had been beaten, thrashed to within an inch of its life a generation ago by draconian economic policies that stripped money from the economy and thus, simultaneously, also punished everyday people for existing. The New Zealand generation of the late 1980s and early 1990s went through a lot of pain as a result. But inflation was beaten, meaning the rich weren’t having their wealth eroded. Was it all for nothing?

We can look at proximate causes for today’s blow-out – and economists certainly do. But to me the underlying problem is historical and structural: the 1980s neo-liberal version of capitalism with its hands-off ‘financial markets’ and lack of ability to reign in poor behaviours by key players clearly doesn’t work longer-term. Much of the immediate issue, I think, can be put down to the failure by governments, worldwide, to properly respond to the General Financial Crisis (GFC) over a decade ago. This made it crystal clear that the free-market liberalisations of the early 1980s simply weren’t sustainable. All they did was open the door for behaviours that sent money flooding from the poor to the rich, turned money itself into a tradable commodity – and created fragile constructions of imagined value in the process, which didn’t take much to bring down.

You’d think the world would have learned from the Dutch tulip bubble of the early seventeenth century, where those hoping to profit from the mania ended up trading not actual tulip bulbs, but certificates promising ownership shares in a tulip bulb that they hadn’t seen. These slips of paper, themselves, began gaining value and – well, yah. We know where that went, suddenly, in February 1637.

Photo I took of a tulip in the Keukenhof, 2004 using Fuji ASA200 film.

The GFC of 2007-2010 wasn’t too different. Look at it this way. Money was lent to people who manifestly couldn’t pay it back, and spent by them on disposable commodities. These debts were then treated as a commodity: packaged up and ‘securitised’ for sale to others. This meant they were assigned a value by a credit rating agency as to how likely the debts were to be recovered, giving these securitised ‘products’ a credibility that, in fact, they didn’t have. You get the picture: ‘products’ consisting of consolidated third-party debts were being traded themselves. These trades were well disconnected from the origins of the debts; and as you’d expect, the whole thing fell over like a house of cards.

The world was actually staring down the barrel of a second Great Depression at the time – one that some of the economists I knew feared might last a generation. So what happened? Were the structural issues looked at and fixed? Of course not. The neo-liberal financial system was too heavily embedded into political funding. The attitudes that went with it, in any case, were so normalised that nothing could simply be shut down. Instead governments bought their way out of the looming depression with ‘stimulus packages’ and what was called ‘monetary easing’, ie: printing money. Even New Zealand ended up doing it in the end.

As it happens, printing money is the easy way to stoke inflation, because inflation occurs when the amount of money floating around exceeds the supply of goods. And it can get crazy bad, as in Weimar Germany in the early 1920s where the Weimar government printed money to buy foreign currency with which to pay war reparations, and ended up destroying their economy (technically, these reparations meant that the Allies, who’d been printing money themselves to pay for the war, exported their inflation to Germany). But governments of the 2010s, worldwide, somehow knew better. They were more sophisticated. CPI inflation had been smashed forever. Of course consumer prices aren’t the only prices to worry about, and what actually happened was that this flood of money instead blew up fixed asset prices, as in houses. But CPI inflation had been fixed.

And now? Well, booyah!

The sudden return of CPI inflation is a global phenomenon, but part of the cause in New Zealand is also proximate, following the policy misjudgements of 2020 when the Covid lockdowns were treated as a supply shock and money was poured into economies, in NZ and elsewhere, both by printing it and by slashing the cost of hiring money (interest rates). It was exactly the reverse of what was needed, and here all it did was further blow out house prices, which aren’t part of the CPI. When coupled with the world’s lightest regulatory regimen over the finance sector – the conceptual equivalent of balancing an egg on its head and waiting to see what happens – the result was a flood of cheap money and a huge potential problem should anything go wrong.  

Now the world’s entered a genuine supply shock: but instead of flooding the local economy with money – the usual cure for such shocks – the Reserve Bank’s going to have to throttle it back to keep inflation down. It’ll do that by hiking the wholesale price of renting money (the Official Cash Rate). Last time this happened was in the early 1990s when the Reserve Bank’s attack on structural CPI inflation, coupled with Finance minister Ruth Richardson’s openly punitive fiscal policies, prompted the worst depression in NZ since the 1930s – and this at a time when the rest of the world was booming.

I was working for the Reserve Bank at the time and still recall that period vividly. I had a flatmate who was a Treasury economist: rumours circulated that, after issuing the so-called ‘mother of all budgets’ in 1992, Richardson was going to turn up at the post-budget Treasury bash dressed as the Terminator. You know – everybody who was sick, disabled, or who’d lost their jobs through no fault of their own because of the apocalyptic way the economy had been churned in the previous six or seven years – well, they were now getting what was coming to them, and they deserved it for choosing not to be rich. Punish the people! Punish the people!

When I see politicians today referring the victims of current socio-economic inequities as ‘bottom dwellers’, and when the light down the economic tunnel starts looking more like an oncoming train, I am a bit worried we’re about to go down that track again. This time for a generation. Ouch.

When will Mickey Savage come back to save us?

Copyright © Matthew Wright 2022

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