The Kākā by Bernard Hickey

TLDR: There’s always a bailout. Last night the Bank of England was forced by a spiralling series of ‘doom loop’ margin calls on British pension funds to intervene with a promise to print at least another £68b to buy Government bonds in order to stabilise the market.

Ironically, that’s more than enough printed money to pay for the £45b of tax cuts for Britain’s richest that turbo-charged the turmoil in the first place. The move appears to have stabilised British and wider global financial markets for now, but flies directly in the face of the central bank’s plans to unwind its money printing and hike interest rates to control inflation. It only makes sense if the newly-appointed Conservative Government of PM Liz Truss reverses its plans for debt-funded tax cuts for the wealthiest.

The moves also undermine whatever is left of the Bank of England’s credibility and calls into question again the role of central banks in an era where their independence and powers to print money to intervene in financial markets have consistently been used to protect the wealthy from the risk of collapse and often further enhanced their wealth. This is at the expense of those without assets who rely on wages that are being eaten away by inflation and are paying rents to those same wealthy asset owners.

Another central bank intervention to protect the wealthy

The Bank of England intervened in British bond markets overnight to reverse its Quantitative Tightening and promise unlimited money printing to stop a 'doom loop' that threatened to take down £1.5t worth of defined benefit pensions schemes.

For those familiar with central bank actions since 2007, this is another intervention to stabilise financial markets that effectively sees independent officials use an arm of the state in a way that makes the richest taxpayers even richer, while ensuring that any losses are socialised to taxpayers at large. It is the definition of a captured state being weaponised to make the rich richer and the poor poorer at an enormous scale and at a rapid pace.

Here’s the Bank of England’s statement last night (bolding mine), which followed the worst collapse in British Government bond prices in modern history after new PM Liz Truss and her Chancellor of the Exchequer Kwasi Kwarteng announced tax cuts for the rich funded by government borrowing that financial markets thought was not credible:

“This repricing has become more significant in the past day – and it is particularly affecting long-dated UK government debt. Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.

“In line with its financial stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.

“To achieve this, the Bank will carry out temporary purchases of long-dated UK government bonds from 28 September. The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by HM Treasury.” Bank of England statement.

It then detailed the initial round of money printing in another statement, saying it would buy at least £5b of long-dated bonds each trading day until October 14.

The Push-Me-Pull-You central bank vs itself and its own Government

This extraordinary intervention means reversing the Bank of England previous stance of having to tighten monetary policy to control inflation of nearly 10% in the face of a reckless loosening of fiscal policy.

Just imagine a firefighter pouring foam onto a fire that the home owner is pouring petrol onto, and then the firefighter reconnects the hose to the diesel tank on the fire engine and starts pumping that diesel onto the fire. It is pure madness, particularly if Truss and Kwarteng don’t back down and give up on their plans for £45b of tax cuts that will mostly go to the already-rich. For example, Britain’s top 2,500 taxpayers will receive tax cuts averaging £18m each from the package.

The irony should not be lost on anyone that this resumption of money printing to buy Government bonds will worsen the inflation that is hurting wage-earning renters the most, and the act of inventing money to buy the bonds will see that money go from a spreadsheet cell at the Bank of England straight into the savings accounts of those wealthiest taxpayers. That will leave taxpayers at large with a Government debt that in theory has to be repaid (assuming the Bank of England doesn’t just cancel the bonds it has), just so pension fund owners don’t have to take losses and just so the richest receive a tax break, which in theory would eventually trickle down to the poorest, but which doesn’t, as decades of research from the IMF, OECD et al have proven.

It is the definition of a captured state engaging in sociopathic behaviour that socialises the losses of a financial crisis while protecting and enriching the already-rich. The Bank of England is effectively being used as a tool to transfer wealth from the poor to the rich, and to transfer risk from the wealthy to the poor.

The obvious point is that it’s not that different to what our own Reserve Bank, along with many most other developed world central banks, did in spades during the Covid Crisis. The next question being asked in US financial markets is how long before the US Federal Reserve is forced to do the same again. Treasury Secretary Janet Yellen was forced to reassure financial markets overnight that US bond markets were functional and the United States was not in the same situation. Stock markets rallied in anticipation of the bailout to come.

So how did this all go so pear-shaped so fast?

Luckily for me, I spent time working as a financial reporter for Reuters and the FT Group in the early 2000s so I hope I can understand and explain what just happened to a wider audience. Part of my job in the City of London was to cover banks, insurers, pension funds and bond markets. I was up to my neck in pension fund reports, Bank of England statements, gilt market reports and insurance sector mergers for a couple of years. Fun times.

So I’ve spent the last couple of hours delving into the bowels of how Britain’s financial markets have been operating in recent years to understand why the Bank of England felt it had to destroy its own monetary policy direction to protect the financial stability of the nation, effectively sacrificing one of its core aims (keeping inflation low) in the short term to serve it’s other core aim (keeping financial system stability) in the short term.

This is all about Britain’s defined benefit pension funds and how in recent years they started using a derivative called a ‘Liability Driven Investment’ (LDI) to protect themselves against falling interest rates. For those unfamiliar with defined benefit pensions because we don’t have many left in Aotearoa-NZ, they were an old-fashioned style of pension for long-term employees that guaranteed to pay them a certain portion of their final salary as a pension after they retired until they die. That all sounds sensible until you put together the combination of ever-aging pensioners and the long-term fall in interest rates and investment returns.

It meant that in the late 1980s and early 1990s, it dawned on large companies and Governments that these schemes were ruinous and would leave Governments and companies on the hook for massive unfunded liabilities over the long run. So many have been closed to new contributors and most pensions are now defined contribution schemes, where the saver bears the risk of a drop in market returns. These ‘DB’ schemes were very popular in the UK and have been mostly closed to new contributors because it is an extremely sweet deal for pensioners. It is one of those amazing examples of inter-generational wealth transfer. These funds currently have around £1.5t in them, which is worth about two-thirds of GDP and equal to the size of the entire UK gilts market. So when these funds move, everybody quakes in Britain’s financial markets.

On the face of it, rising interest rates should be a good thing for the valuations of the liabilities in these funds because the valuations are done by using interest rates as a discount rate to calculate a net present value of the fund. The higher the discount rate, the lower the value of the unfunded liability. But the problem is the managers of these pension funds have tried to insure themselves against having to report big upward or downward movements in the values of these unfunded liabilities, which in some cases have forced pension authorities to intervene, and in the worst cases forced companies out of business.

Surprise, surprise. It’s all about a fancy new derivative…

The way to insure yourself against big moves in interest rates is to buy a derivative, which insures you don’t lose big if interest rates fall in a big way. That means these defined benefit (DB) schemes are betting that interest rates won’t fall much, and certainly not rise much. When they do rise dramatically, as has happened this year and in an extraordinary way in the last week, these funds have to put up collateral to back their ‘bets’. The players on the other sides of these bets with LDIs are the likes of BlackRock, Legal & General, Columbia Threadneedle, Insight Investment and Schroders.

Here’s Toby Nangle, who used to head up asset allocation at Columbia Threadneedle, explaining here overnight in the FT (bolding mine):.

"When fixed rates rise, the mark-to-market of your long fixed rate swap position falls. And your excess collateral buffer is reduced. It probably needs replenishing at some point. Maybe immediately. Like right now.

“And if you simply can’t replenish it and triggers are hit, your counterparty might simply liquidate all the collateral you’ve posted and close the position. And what eligible collateral do pension schemes hold a lot of as part of their efforts to liability match? Long gilts. Lots and lots of long gilts.

“And that seems to be what has happened in recent days. Margin calls have forced pension plans into dumping long gilts, sending yields spiralling and triggering a new round of margin calls - a classic feedback loop.It looks to me as though this gilt market-hammering doom loop of margin calls and rising gilt yields triggering more margin calls is what has caused the Bank of England to depart from its “quantitative tightening” programme and engage in long-end QE today” Toby Nangle in FT

Here’s another good explanation of the chain of events below in a tweet thread from Dan Mikulskis, an actuary, and here’s explainers via Reuters, Bloomberg-$$$ and FT-$$$.

So how big could the margin calls be?

A UK regulator estimated in 2019 that the total notional value of DB schemes’ leveraged investments (LDIs) was £498.5b, which is about a fifth of UK GDP. The leverage levels inside these schemes was anything up to seven times liabilities. Others have estimated the risk at around £380b. Oy vey.

No wonder the Bank of England intervened. This sounds awfully similar to what we saw in 2008/09 when lightly-capitalised US banks created leveraged derivatives based on loans in the US mortgage bond markets and didn’t expect mortgage defaults. When the bets on these credit default swaps (CDS) on (CDOs) collateralised debt obligations went badly wrong, those institutions on the wrong side of the bets such as Lehman Bros and AIG (who have previously profited hugely from these bets) got caught in those leveraged collateral call doom loops. They didn’t have big enough buffers to survive. Lehman Bros was allowed to fail, but the ensuing carnage meant the US Federal Reserve had to bail out the global financial system within days by rescuing AIG. If you weren’t around at the time, I’d recommend watching or reading The Big Short.

Here’s a quick video clip from the movie that explains it well.

No bankers paid the price from 2008. Few will again this time.

The crushing conclusion from the The Big Short was that a captured financial system used the arms of the state to socialise the losses from reckless behaviour and made the rich even richer. But no one paid the price. Very few handed back their bonuses. Justice was never done, or seen to be done.

Yet here we go again.

There was never a reckoning from the Global Financial Crisis. Voters were never able to intervene to impose justice by jailing bankers and allowing asset owners to take massive hits to valuations. Instead, central bankers were seen as the ‘grown-ups’ and technocrats able to move fast to rescue economies while politicians squabbled. The banks themselves used shareholders’ cash to pay settlements. Only a handful of the most junior players ever saw jail time. Few of the big swinging bankers that caused the crisis ever repaid their bonuses.

Voters and elites should have intervened then to remove those powers from central banks and strip them of independence to avoid it happening again, and to remove the now massive moral hazard built into the global financial system and asset prices.

Independent central banks actually amplified their bailouts during Covid to stop financial markets slumping and bond markets freezing up. The Reserve Bank of New Zealand started doing the same thing at scale in March of 2020, removing LVR restrictions and printing $55b to lower long term interest rates. That unleashed a 45% rise in house prices, delivering hundreds of billions of dollars worth of (untaxed) house price gains to Aotearoa-NZ’s homeowners.

So what happens now?

The expectation is that Kwarteng and Truss will have to back down and that the Bank of England’s intervention gives them time to back track.

Here’s the FT-$$$ again (bolding mine)”

“A temporary intervention is unlikely to hold down gilt yields for long unless the government changes tack on its tax-cutting plans, said Mike Riddell, a bond portfolio manager at Allianz Global Investors.

But if investors get a sniff that Wednesday’s move is the start of a longer-lasting intervention in the gilt market, they may start to doubt the BoE’s commitment to acting aggressively to tame inflation, which chief economist Huw Pill signalled on Tuesday.

A more extended period of BoE bond buying would certainly help gilts, but probably spell a further decline for the pound.

“This is extraordinary,” said Riddell. “The BoE told the market yesterday that it was going to be very hawkish, now today it’s buying gilts again. What is initially seen as temporary can often become permanent. If that looks like the case, sterling could be in trouble.” FT-$$$

We’ll see. If this crisis keeps cascading into the global financial system, then we could be in for some sort of repeat of 2008/09. It’s a lot like watching a car crash in slow motion. Or even worse, a re-run of the same car crash from 14 years ago.

Sadly, the smart money is now gearing up to get in on the next bailout. That’s why the S&P 500 closed up 2% this morning and the US 10 year Government bond fell 22 basis points to 3.74%, having earlier touched 4% shortly before the Bank of England’s intervention.

Paying subscribers can see more and hear more detail and analysis below the paywall fold and in the podcast above.

Elsewhere in the news overnight

Undersea gas explosions - The European Union vowed to protect its energy infrastructure after saboteurs, suspected to be Russian, blew up the Nordstream 1 and 2 pipelines in the Baltic Sea. It ended any hope of a resumption of Russian gas supplies this winter and forced gas prices up 11% overnight; Reuters;

Bailout celebration - US and UK stocks and bonds rallied overnight after the Bank of England pledged to print £5b per day for 13 days straight to drive down long-term gilt yields. The NZ dollar bounced as well as risk appetites returned to global markets. Reuters;

‘Here’s our dollars’ - The United States held a summit for Pacific Island nations overnight in Washington, pledging ‘big dollar’ help to stymie China’s growing influence in the region Reuters;

IMF calls out British recklessness - The IMF warned Britain against its unfunded tax cuts for the rich in an unprecedented criticism of one of its biggest members, and harking back to its humiliating intervention in 1976 to bail out Britain; IMF and,

Te Pāti Māori President and Whānau Ora and Te Whānau o Waipareira CEO John Tamihere attacked the NZ Herald and NewstalkZB overnight in an Op-Ed on Waatea News responding to Matt Nippert’s report in the NZ Herald-$$$ yesterday that the Charities Commission was investigating nearly $500,000 in charitable funds being loaned to Tamihere for his political campaigns. Richard Harman reported via Politik-$$$ this morning that Tamihere told party members last night not to talk to NZME outlets again.

Some fun things

Ka kite ano

Bernard

PS: My apologies for not delivering an email yesterday. I got bogged down at a conference and ran out of steam. But back on track today. I hope this deeper dive was useful.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: This week The Kākā had its first anniversary as a paid subscription email newsletter and podcast. We marked the occasion at midday for an hour on Friday by having a special ‘hoon’ webinar for all subscribers to discuss the events of the week in geo-politics and Aotearoa-NZ.

Popular special guests Professor Robert Patman from the University of Otago, ANZ Chief Economist Sharon Zollner and Dominion Post columnist Josie Pagani joined myself and Hoon co-host Peter Bale to discuss some monumental events in geo-politics and the global economy, and what they might mean for our political economy.

We talked about:

* Vladimir Putin’s announcement of the mobilisation of 300,000 reservists and subsequent street protests in Russia, along with attempts by potential draftees to flee the country;

* Putin’s barely disguised threat to use tactical nuclear weapons to defend the ‘motherland’ of Russia, which will shortly include the areas of Ukraine annexed by Russia and where referendums to confirm that will shortly be held;

* the West’s strong and mostly united reaction rejecting the annexation and nuclear threat at the United Nations General Assembly (UNGA), where PM Jacinda Ardern gave this speech on Friday night;

* some signs of division in support for Ukraine bubbling in Europe, including in the Putin-backed Hungary and in Italy, where an election this weekend is expected to deliver a right-wing Government seen as more sympathetic to Russia;

* the US Federal Reserve’s ‘jumbo’ 75 basis point rate hike to a range of 3.0% to 3.25% and Chairman Jerome Powell’s hawkish rhetoric about the need to clamp down on inflation with interest rates over 4% for a couple of years;

* the Bank of Japan’s vow to keep printing to keep its interest rates low, and its subsequent need to intervene to stop the yen falling late on Thursday, which was the first such currency market intervention by a major central bank since 1998;

* the new Liz Truss-led UK Government’s plan to borrow to fund massive tax cuts for higher income earners and companies, which it subsequently confirmed yesterday with a plan to borrow £234b to pay for £150b of winter energy subsidies and £45b of tax cuts;

* new polling showing voters in democracies want to tax wages less and wealth more, as Josie Pagani detailed in her column yesterday;

* signs consumers in Aotearoa-NZ are not rolling over and tightening their belts under the weight of higher interest rates, which Sharon Zollner said might require our Reserve Bank to hike higher than the 4.75% peak she had previously forecast; and,

* why voters in western democracies want more of their tax money spent at local levels, and how difficult that is in Aotearoa-NZ where the central Government doesn’t share tax revenues with councils.

Five things of note this week

‘You can’t go out much, and we order you to go up’

The Government ordered councils not to allow greenfields housing developments to sprawl out into highly productive farmlands, but also wants councils to open up more land for housing. I argued these two things weren’t credibly consistent with the current approach to funding infrastructure and winning the political battles needed for housing to grow ‘up’ instead of ‘out.’

They could be if the Government also provided the financial incentives and released the debt funding shackles on itself and councils that would enable much, much more brownfields ‘densification’ of housing. Instead, the Government is simply ordering councils to allow more densification, without adequately funding the public transport or allowing for the NIMBY-fueled political backlash that is now consuming councils from the political ground up. It is magical thinking of the highest order.

This creates an awful Catch 22. Not allowing councils to build ‘out’ or helping them much to build ‘up’ is a recipe for yet more land price appreciation captured by today’s land owners. This comes at the expense of future renters locked out of the home ownership they need to build stable families and finances, and keeps them paying the world’s most expensive rents. Here’s my full article from Monday.

The densification backlash went mainstream

Earlier this month, the Christchurch City Council refused to submit an updated plan that allowed the three-storey townhouses on all sections, as ordered by the central Government after a bipartisan ‘Townhouse Nation’ deal late last year. Outgoing Mayor and former Labour minister Liane Dalziel wrote to Environment Minister David Parker to protest against the ‘one size fits all’ approach and call for a more ‘bespoke’ approach.

I asked Parker if the Government was considering legal action to force the Council to adopt the new rules, or could even appoint Commissioners. He declined comment because he said he yet to receive legal advice.

Here’s Dalziel’s argument (bolding mine):

“We are supportive of the Government’s aims to address housing shortages and enable the delivery of a wider range of housing options. However, a blanket rule change is not necessary here. We have an ample supply of places available where people can subdivide to create more housing and where no resource consent is required.” Liane Dalziel’s plea to the Labour Government.

My view: There is not ample supply of land available in Christchurch, otherwise housing would be affordable. Truly elastic land supply would allow developers to build in response to the recent surge in prices and push prices back down in response with a new housing supply surge. That has not and is not happening, as well demonstrated in this speech from Treasury Chief Economist Dominick Stephens, which is in turn based on this deep research note on housing costs by the Housing Technical Working Group, which includes Treasury, the Reserve Bank, and HUD.

‘We’re really serious this time’

The US Federal Reserve hiked its key interest rate by 75 basis points for a third consecutive time and forecast significantly higher interest rates for another couple of years to try to win back its reputation for keeping inflation low.

The very hawkish view of the world’s most important central bank is now much tougher than most investors, traders and economists think. Global stocks fell sharply.

Someone is wrong and this could get ugly because global asset prices, and that includes the most expensive residential land in the world in Aotearoa-NZ, are based on lower interest rates sooner and for longer than the Fed is now saying. This morning the Fed forecast quite high rates for quite a bit longer.

Is it safe to come out now?

Spring is in the process of springing in the housing market for first home buyers, thanks to strong income growth, low unemployment, lower prices and early signs mortgage rates have peaked.

FOOP (Fear Of Over Paying) is about to flip back to FOMO, unless global central banks pull the rug out from under the market heading into summer with big new rate hikes to beat down un-cooperatively high inflation rates. See more detail here in my Thursday email detailing signs that first home buyers and some investors are nudging back into the market.

Another captured state

Liz Truss’ extraordinary embrace of Reagan-style supply-side economic theories that are now widely debunked from people as conventional as the IMF stood out this week. It is another case where the populist leaders of a democracy win power and then promptly cut taxes in a way that makes their wealthy backers vastly wealthier.

The brazenness and cravenness is something to behold. Now even financial markets are calling out the economic lunacy of tax cuts paid for with borrowing. The bond vigilantes stirred back into life this week and drove British ‘gilt’ bond yields higher in the biggest and fastest way in modern history.

Quotes of the week

‘I’m not bluffing’

“To those who allow themselves such statements regarding Russia, I want to remind you that our country also has various means of destruction, and for separate components and more modern than those of Nato countries and when the territorial integrity of our country is threatened, to protect Russia and our people, we will certainly use all the means at our disposal. It’s not a bluff.” Vladimir Putin in a presidential address, via The Guardian

‘I’m also not bluffing’

“We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.” US Federal Reserve Chair Jerome Powell in a news conference on Thursday, via PBS.

‘I think trickle down will work this time’

“I don’t accept this argument that cutting taxes is somehow unfair. People on higher incomes generally pay more tax, so when you reduce taxes, there is often a disproportionate benefit because those people pay more taxes in the first place.” UK PM Liz Truss this week, via CNBC

‘Trickle-down has been tried and failed’

“I am sick and tired of trickle-down economics. It has never worked. We're building an economy from the bottom up and middle out.” US President Joe Biden in a tweet a day before meeting Truss.

Ka kite ano

Bernard

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: The podcast above is a recording of our Weekly ‘Hoon’ webinar for paying subscribers. We do this every Friday for an hour at 5pm and it’s one of our most popular features, along with my Ask Me Anything session from midday on a Friday. Yesterday’s was a cracker.

This week’s guests on the ‘hoon’ were University of Otago Foreign Relations Professor Robert Patman and Kiwibank Chief Economist Jarrod Kerr.

This week I was in the Parliamentary Press Gallery in Whanganui-a-tara and co-host Peter Bale joined us from Tamaki Makaurau.

The five things of note I’ve focused this week included:

* Christchurch City Council voting against the Government’s densification directives and doubling down by promising to charge developers extra if they don’t have enough trees;

* the Government completely dumping the ‘traffic lights’ system of Covid controls, including vaccine mandates and mask mandates, but not seven-day isolation for Covid sufferers;

* REINZ figures showing Auckland City and Wellington City house prices down 17-23% from the peak in October/November, but with signs the market is warming up again in Auckland in particular;

* Wellington City Council voting to limit speeds on most city streets to 30 km/hr, triggering accusations of being ‘anti-car’ as voting papers are mailed to potential council voters; and,

* an inflationary surprise in the United States unnerving investors hoping the Fed won’t have to crunch the global economy into a recession with sharply higher interest rates.

But also overseas:

* Ukraine’s amazing counter-offensive that drove Russian troops out of 6,000 square kilometres of eastern and southern Ukraine, and have sparked the glimmerings of dissent in Russia;

* Vladimir Putin met with Xi Jinping overnight and Putin reported Xi was not thrilled with his invasion of Ukraine; and,

* Europe announced windfall taxes on energy firms.

Here’s Peter’s always excellent weekly bulletin email on international affairs that goes out on a Thursday via the Spinoff. Sign up here

I also started the Substack ‘threads’ trial on the Substack iOs app.

Chart of the week

ANZ lifted its OCR forecast peak to 4.75% from 4%

Quote of the week

“We’re making Earth our only shareholder.” Patagonia founder Yvon Chouinard said while announcing he and his family had given the company to two trusts dedicated to fighting the climate crisis.

Other places I’ve been

A fun thing. I want one.

Mā te wā

Bernard

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: As council voting papers go out today, the elections are shaping up as pseudo referendums reacting against Government edicts on urban densification, mode shift away from cars and co-governance of water infrastructure.

So far, the signs are councils are in full revolt mode with the risk of a wipe out of Labour and Green candidates by pro-car, anti-rate hike, anti-cycling, anti-townhouse and anti-Three Waters candidates who throw a whole tool box in the Government’s strategies to address housing shortages and climate emissions. Already, legal clashes are looming, along with the potential appointment of Commissioners, as was done in Tauranga.

Elsewhere in the news overnight, the NZ dollar hit a two-year low against a rampant US dollar, there was a report Air NZ is looking at reviving its Virgin Australia alliance through a potential takeover or merger and US mortgage rates hit a 14-year high.

Paying subscribers can see and hear more detail and analysis below the paywall fold and in the podcast above. They can also watch out later today for my weekly Ask Me Anything and ‘hoon’ webinar email invites at midday and 5pm respectively.

In geo-politics, the global economy, business and markets

Two-year low - The NZ dollar fell overnight to a two-year low of 59.6USc as US investors kept increasing their forecast peak for America’s version of the OCR to 4.5%, which would be above Aotearoa-NZ’s forecast peak of 4.1%. The US dollar’s strength is effectively exporting inflation to the rest of the world, including us.

Housing rate pain - The housing market in the United States is cooling rapidly because of higher interest rates and that pain will intensify. Last night, average 30-year fixed mortgage rates, the main ones Americans use, hit a 14-year high of 6.02%, up from 5.89% a week ago and 2.86% a year ago. WSJ-free

Too tight? - That spike in mortgage rates is mighty steep and it’s beginning to worry a few macro economists around the world. Last night, a paper via the World Bank asked if a global recession in per capita terms was imminent because of the fastest synchronous tightening of fiscal and monetary policy in 50 years. WSJ-free

Or soft landing? - However, the economic noise from the United States is still…well…noisy. Last night, we also got fresh signs of a ‘soft landing’, with lower than expected jobless claims and higher than expected retail sales.

China stimulating - China’s state-run banks cut their deposit rates overnight for the first time since 2015 as Beijing grapples with an economic slowdown driven by Covid lockdowns and a property development implosion ahead of a key leadership meeting next month. Nikkei Asia

Just briefly:

Damaging US rail strike averted at the last minute. CNN

Adobe to buy Figma for US$20b. CNN

In Aotearoa-NZ’s political economy

Back to the future? - Air NZ is in early talks to buy or merge with Virgin Australia, The Australian’s Bridget Carter is reporting behind a paywall this morning from unnamed sources.

Sources say that discussions have been held between New Zealand’s national carrier and Virgin in recent weeks, although they do not suggest that the pair have necessarily progressed towards a deal at this stage.

But DataRoom understands that the plan would involve a back door dual listing here and across the Tasman of Virgin into Air New Zealand, providing an expansive trans-Tasman network for both groups in what would be somewhat of a move back to the future.

So what? - This would be something of a return to the future for Air NZ. It owned a 19.9% stake in Virgin Australia and had an alliance with it until 2016, when it was sold under then-CEO Christopher Luxon. Air NZ then shifted its alliance to Qantas. Doing this new deal under current CEO Greg Foran would unravel that Qantas alliance and require approval from our Government and Commerce Commissions on both sides of the Tasman.

Ansett 2.0? - Also, the history of Air NZ deals with those across the Tasman is…er…chequered. Air NZ’s purchase of Ansett 22 years ago almost killed the-then privately owned Air NZ and forced its nationalisation.

Water contractors - Jason Walls is reporting for NZ Herald in front of the paywall this morning that DIA paid consultants $16.3m for work on Three Waters.

The problem(s) with Tiwai Point - The Tiwai Point smelter’s continued operation is problematic for our climate emissions reduction plans. Until we know if and when the smelter closes, power generators won’t be confident about investing in new renewable capacity. Europe is closing smelters because of high power prices, which makes it even more profitable for Rio Tinto to keep it going.

Revoke the consents? - That means the future of our climate plans is hostage to the whims of overseas shareholders. Unless the smelter’s consents were revoked. And why wouldn’t you when finding out it is still polluting and cleaning it up could cost $1b. Here’s detail via RNZ yesterday from an Environment Southland report.

Report the delays - Small Business Minister Stuart Nash is set to announce plans later today to make companies with revenue of over $33m per year and Government departments and agencies report publicly on how long they take to pay invoices. Jenee Tibshraeny has the story in front of the paywall at the NZ Herald this morning.

Council says no to tiny homes - The number of homeless people being put up in Rotorua’s ‘MSD mile’ of motels has dropped 10% recently, outgoing Mayor Steve Chadwick has told Felix Desmarais via RNZ. But it’s still obviously dominating the election campaign there. Former NZ First MP Fletcher Tabuteau is running to be Mayor and wants to build tiny homes on unused airport land to house the homeless, instead of the motels. The council is saying no because there are airport noise control issues...

Quietly quitting on densification - Here’s more passive aggressive ‘quiet quitting’ from a council in response to the government’s urban densification laws. Tina Law reports for The Press this morning that the Christchurch City Council wants to charge developers extra if their development has less than 20% tree cover. Outgoing Mayor Liane Dalziel told RNZ yesterday she thought the Government might appoint a Commissioner to force the changes through.

National ahead again - FYI on the political side, the latest Taxpayer Union-funded poll taken by Curia in the first nine days of September found National back above Labour (again and Christopher Luxon catching up to Jacinda Ardern as preferred PM again). National rose three percentage points to 37%, Labour fell 1.8 points to 33.4%, ACT rose 1.9 to 12.4% and the Greens fell 0.4 to 9.9%. Te Pāti Māori fell two points to 1.5%. On these numbers National and ACT could govern alone (just) with 63 seats in a 120 seat Parliament.

Number of the day

1.7% - Aotearoa-NZ’s real GDP growth in the June quarter from the March quarter was 1.7%, Statistics NZ reported yesterday. That was better than most economists forecasts for around 1.0% and just below the Reserve Bank’s forecast last month of 1.8%. ASB increased its forecast peak for the official cash rate by 25 basis points to 4.25%, but the rest were unchanged. Transport and hospitality were the star performers as the Covid restrictions eased.

Chart of the day

Up, but still 3.5% below the pre-Covid trend

Climate record of the day

The rate of sea-level rise around Aotearoa-NZ doubled in the past 60 years, Statistics NZ reported yesterday.

Quotes of the day

Why Patagonia’s founder gave his US$3b company away

“I was in Forbes magazine listed as a billionaire, which really, really pissed me off. I don’t have $1 billion in the bank. I don’t drive Lexuses. ” Patagonia founder Yvon Chouinard quoted in the New York Times exclusive yesterday revealing his plans to give away the company to a charity to fight climate change.

Chouinard actually threatened to sell the company if his staff couldn’t find a way to create the charity.

“One day he said to me, ‘Ryan, I swear to God, if you guys don’t start moving on this, I’m going to go get the Fortune magazine list of billionaires and start cold calling people.’ At that point we realized he was serious.” Patagonia CEO Ryan Gellert

However, he has competition. Barry Seid, an US electronics manufacturing mogul, just gave his US$1.6b company away to a charity to promote conservative causes, including efforts to stop action on climate change and ban abortion.

Unlike Seid, Chouinard structured his deal so he and his family paid US$17.5m in taxes on the gift.

“Hopefully this will influence a new form of capitalism that doesn’t end up with a few rich people and a bunch of poor people.” Chouinard

Some fun things

Ka kite ano

Bernard

PS: Here’s the link for today’s ‘hoon’ zoom webinar with Peter Bale and myself discussing the week’s events in geo-politics, the global economy and the local political economy, often with special guests. It starts at 5pm and goes for an hour. We aim to have Otago University Foreign Affairs Professor Robert Patman and Kiwibank Chief Economist Jarrod Kerr on today.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: In this week’s ‘hoon’ webinar in podcast form above, Peter Bale and myself invited on ANZ Chief Economist Sharon Zollner and talked about:

* Europe’s energy crisis and how Governments were intervening in markets to impose windfall taxes and pay hundreds of billions in energy subsidies to households;

* the European Central Bank’s biggest rate hike in 24 years and why this meant Peter would finally get some interest on his euro deposits;

* what the election of Liz Truss means for Britain’s debt and taxes;

* Sharon’s view house prices may not fall as much as previously thought; and,

* Emmanuel Macron’s speech about the ‘end of the age of abundance’.

We also briefly talked about the Queen’s passing, including Peter’s recollections from meeting her a couple of times. The podcast above is available for all paying and free subscribers as part of this weekly sampler email. Subscribe in full to support my public interest journalism on housing affordability, climate change and child poverty and to join our community debating these issues daily.

My Five Things to note this week

Our housing crisis writ large in Rotorua

TVNZ’s Sunday programme (below) aired a startling documentary exposing bullying of homeless people in Rotorua motels by a charity with unlicensed security guards with gang connections. Opposition parties called for an inquiry. The Government said it hadn’t found anything untoward.

The exposure of the ‘Golden Mile’ highlights again the failure of 30 years of infrastructure under-investment allied with a structural taxation bias in favour of residential property. The Government, like the last one, is now scrambling with short term solutions, but won’t address the core issue:

* our taxes and infrastructure investment rates are too low;

* we don’t tax capital gains or wealth, unlike every other developed country; and,

* there is no immediate political prospect to break this log jam, largely because home-owning median voters like it just the way it is, until they see the end results of child poverty, social dysfunction and rising welfare costs in their faces every day.

The immediate solution is to push the social problems ‘somewhere else.’ That somewhere else in the middle of the North Island is Rotorua. The same ‘Golden Miles’ are in place in many provincial cities up and down the country.

Here’s my weekly ‘When the Facts Changes’ podcast via The Spinoff talking about the housing supply issues with Kiwibank economist Jeremy Couchman, and the Golden Mile documentary below that.

Europe intervenes massively in energy markets

Faced with Vladimir Putin’s act of economic warfare of cutting off their gas supplies completely, European governments are intervening massively in markets to impose price caps and redistribute profits and resources from asset owners to households, or to simply park the cost as public debt and let the owners reap the rewards from more taxpayer-funded bailouts.

European Union countries this week announced plans to imposing windfall taxes on the winners from exploding wholesale gas and electricity prices in order to pay over €500b euros in subsidies to households so they can afford to pay their gas and power bills this winter.

Britain’s new PM Liz Truss announced plans to borrow over £150b to freeze household energy bills. She also announced Britain would start fracking for gas and remove its energy levies designed to reduce climate emissions. She is effectively paying taxpayers’ money to fund profits and cash returns for the energy companies on the right side of the price spikes, and to rescue those on the wrong side.

Europe is now re-organising parts of its economy for a long war, which means pivoting production for war aims and imposing the sorts of rationing and price caps used in war. The video below that emerged this week of French President Emmanuel Macron’s first call with former comedic actor and now Ukraine President Volodymyr Zelensky on the first night of the war is remarkable. It introduces the phrase ‘total war’ to the conversation.

Europe scrambling to contain inflation headed for 10%

The European Central Bank hiked its main interest rates by the most in the 24 year history of the euro this week. It is battling inflation that is headed for 10% across the continent and faces the prospect of a recession later this year at the same time as double-digit inflation.

Europe’s other problem is it hasn’t yet matched its single monetary policy and currency with a single Government or fiscal policy. It means the ECB has ended up printing money to buy Greek, Italian and Spanish bonds to contain their interest rates, which would normally be much higher because their Governments have higher debts than the rest of Europe. Rising interest rates and the stresses of the winter will put this fundamental weak point in the global economy under enormous financial and political pressure in the months to come.

Vladimir Putin may be losing on the battlefields of Ukraine, but his acts of economic warfare on Ukraine’s immediate suppliers of support and arms is having an extraordinary effect. As Peter points out in the podcast above, Italy’s leaders are now openly talking about trying to negotiate with Putin to resume gas supplies.

We talk about Europe’s economic and political woes with Sharon in the podcast above, as well as whether the US Federal Reserve will win its battle of wills with markets. The Fed reiterated again this week it is very determined to squeeze the US economy with rate hikes until the pips squeak to beat down inflation, while markets see inflation solving itself and the Fed eventually relenting so asset prices can stay high.

Underlying all these problems is the very live issue of whether central banks can maintain their independence in the face of political pressure to solve Government debt and economic growth problems by just inflating away the debt.

‘The end of the age of abundance’

On August 24, Macron gave a sobering short speech to his first post-summer cabinet meeting on what faced them. In the process, he became the first world leader to openly talk about ‘de-growth.’ This is the idea that the planet is hitting its physical limits and the task now is to manage a decline in GDP and a redistribution of resources to stop the earth from cooking and dissolving into a Mad Max-style hellscape of wars over energy and water.

Here’s what he said:

“What we are currently living through is a kind of major tipping point or a great upheaval … we are living the end of what could have seemed an era of abundance … the end of the abundance of products of technologies that seemed always available … the end of the abundance of land and materials including water.

“This overview that I’m giving, the end of abundance, the end of insouciance, the end of assumptions – it’s ultimately a tipping point that we are going through that can lead our citizens to feel a lot of anxiety. Faced with this, we have a duty, duties, the first of which is to speak frankly and clearly without doom-mongering.” Emmanuel Macron talking to his cabinet. Guardian

I wrote a piece on Wednesday about how 30 years of magical thinking had led us to this point. Here’s the guts of it.

This magical thinking says voters in a property-owners’ democracy can have:

* low taxes, low debt, low interest rates and rising asset prices into infinity;

* without having to invest much in repairing or preventing the damage to the environment, or in new technology to use energy more efficiently;

* or having to invest in affordable housing or transport for the generations of youth sentenced to live as renters on precarious wages for decades to come;

* or don’t have to worry about election revolts from those unborn generations who will have to pay both rent and taxes for the publicly-funded pension and healthcare costs for today’s asset owners;

* that democracies can easily survive the social stresses and lower economic growth rates caused by widening inequality, over-consumption of physical assets without paying for externalities, and unaddressed climate change; and,

* that autocracies competing for those resources with democracies will not take advantage of this dysfunction to protect and grow their own share of those resources.

The bottom bottom line - None of this really computes in the long run and it’s beginning not to compute in the short run either as climate change accelerates into growth-sapping events in the near-to-now future.

For example, just overnight:

* offices closed and data centres were flooded in the global outsourcing capital of Bangalore after record-setting torrential rains allied with poor water infrastructure investment; (ABC)

* California, the world’s fifth biggest economy, is in severe drought and faces power blackouts and water shortages because of climate change Reuters;

* a third of Pakistan, which is being bailed out by the IMF, is under water and it’s trying to widen a breach in its biggest lake to avoid it overflowing even more Reuters; and,

* Shenzen, the globalised supply chain’s component assembly centre, is locked down with a disease (Covid) initially transmitted zoonotically on a planet that transmits more diseases zoonotically as it warms Reuters.

The unpriced-and-unpaid-for externalities generated by over-consumption, under-investment and deliberately widening inequality over the last 30 years appear to be coming together in a poly-crisis moment. The bill feels as if it’s coming due all at once in a series of climate events and wars that accelerate each other into a series of feedback loops into yet more crises.

Covid restrictions are ending here too

Our Cabinet will meet on Monday and is expected to let Aotearoa-NZ’s remaining Covid restrictions on mask use lapse by the end of the week as case numbers and intensive care occupancy rates head back to February levels.

Marc Daalder from Newsroom wrote a strong commentary piece on this prospect:

This would be a foolhardy move, when even the Government's own variant plan spells out an uncertain future of recurring pandemic waves which represent "a substantial increase in the overall burden of disease".

The fortunate situation we find ourselves in is unlikely to last forever. New variants could push baseline case numbers to levels where masks and other protections are still warranted, as happened after the first Omicron peak.

New variants and rapidly waning immunity will also fuel new waves, necessitating the imposition of more stringent but short-lived health measures to flatten the curve and dampen transmission.

The problem is that, with no framework like the traffic lights or alert levels to enable the reintroduction of protections on either a semi-permanent or temporary basis, the Government simply won't. We'll all suffer a much higher burden of disease and death for that failure. Marc Daalder via Newsroom.

Have a great weekend.

Ka kite ano

PS: My apologies to subscribers and Peter who dialled into this week’s live ‘hoon’ webinar. I was a few minutes late due to a scooter battery issue. I would not do well in Mad Max world.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: The world’s second most important central bank hiked its official interest rates by slightly more than expected overnight as continental Europe grapples with consumer price inflation headed for 10% and producer price inflation of over 30%.

Meanwhile, Britain unveiled a £150b bailout for consumers and businesses, whereby it will pay energy companies to freeze their power bills for two years. The British Government and the Bank of England are also offering £40b in cheap loans to electricity companies unable to cope with spiking power prices.

Elsewhere in the news this morning: the Queen died, Ukrainian tanks broke through Russian lines near Kherson and EY plans to split into separate audit and advisory divisions.

Paying subscribers can see more analysis and detail below the paywall fold and in the podcast above. They’re also welcome to join our weekly ‘hoon’ webinar with co-host Peter Bale and myself for an hour at 5pm today on this link. I’ll also be sending an invite to paying subscribers for my weekly Ask Me Anything chat session for an hour from midday today.

In geo-politics, the global economy, business and markets

‘Jumbo’ hike - The European Central Bank announced a 75 basis point hike in its official interest rates overnight, including a rise to 0.75% for its main deposit rate. That was slightly larger than most expected and the biggest single rise in the rate since the inception of the euro zone nearly 24 years ago. ECB President Christine Lagarde said the central bank would probably need to hike rates another two to five times to drag down inflation, which was currently “far too high” at 9.1% across the euro zone. The key two-year German ‘bund’ yield rose 28 basis points to an 11-year high of 1.37%. European stocks fell around 0.6%. Reuters

Another bailout - New British PM Liz Truss confirmed overnight that the Government would borrow another £150b to pay electricity and gas companies the difference between annual household energy bills at an average of £2,500 from October and spiking wholesale prices. Britain’s Treasury and the Bank of England also plan to offer £40b in discounted loans to those energy companies unable to handle the spike in electricity and gas prices since Russia’s invasion of Ukraine and its decision to cut off its gas supplies to Europe completely.

‘Drill baby drill’ - Truss also promised to immediately start fracking for gas in Britain and removed a green levy from power bills designed to encourage a shift to net zero emissions by 2050. She also launched a review of the target to see whether it was economically appropriate.

Just briefly

Scotland announces rent freeze BBC

Quote of the day

Talking the talk before walking the walk again

“We need to act now, forthrightly, strongly, as we have been doing and we need to keep at it until the job is done.” Fed Chair Jerome Powell speaking in an interview at a Cato Institute conference overnight (from 5 mins on in the video below), which was seen as confirming the Fed would hike its key rate another 75 basis points to a range of 3.0% to 3.25% at its next policy meeting on September 21.

Number of the day

‘The scariest economics paper of 2022’

7.5% - A new paper titled Understanding U.S. Inflation During the COVID Era was presented at a conference overnight that forecast the Fed might have to hike interest rates and crunch the US economy to the point where US unemployment rate might rose to 6.5% from 3.7% now in order to get inflation there back down to 2.5% by the end of next year. Currently, the Federal Reserve is forecasting it will only have to push unemployment up to 4.1%. The conference draft paper from two IMF economists and a John Hopkins professor was described by former Obama-era White House official Jason Furman in this WSJ column as the "scariest economics paper of 2022."

However, Powell said in the interview above he was hopeful still-anchored low inflation expectations would help avoid that level of pain.

“We think we can avoid the kind of very high social costs that Paul Volcker and the Fed had to bring into play.” Jerome Powell, referring to Volcker’s eventual hiking of US interest rates into the high double digits and the rise in unemployment to 10.8% by late 1982.

Chart of the day

Happy days for oil pumpers, gas drillers and shipping lines

Longer read of the day

Scoop of the day

A fun thing (H/T Lynn)

Ka kite ano

Bernard

PS: See you all at midday for the Ask Me Anything and 5pm for the weekly hoon.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: Cabinet appears set to decide next Monday to let the current ‘traffic lights’ system of Covid controls expire completely by the end of next week, effectively ending Government mask mandates.

The NZ Herald reported this morning Cabinet will decide to scrap the current system enabled by the Epidemic Preparedness (COVID-19) Notice 2020 Renewal Notice (No 2) 2022, the last of which was signed on June 12 and is due to expire within three months, which would be next Monday. The notice itself came into force on June 16 and states it will not expire until Sept 16, next Friday, but can be ended earlier.

Elsewhere in the news this morning, the pound, the euro and the yen fell to multi-decade lows against the surging US dollar and export figures from China were weaker than expected. The NZ$ briefly fell below 60 USc, which is still above its March 2020 lows.

Paying subscribers can see more detail and analysis below the paywall fold and hear more in the podcast above.

In geo-politics, the global economy, business and markets

King (US) Dollar reigns supreme - The pound, euro and yen fell sharply again this morning to multi-decade lows as investors and traders eyed up the prospects of higher US interest rates at the same time as:

* Britain’s new tax-cutting-and-spending Government is increasing its budget deficits and debt in a way that is unnerving foreign investors; and,

* the Bank of Japan is continuing on its own path of pressing down on interest rates to boost (yes boost) inflationary pressures.

The yen fell to 144 to the US dollar, which was its lowest level since 1998. It is down a fifth in 2022, which is doing the job of boosting inflationary pressure on import costs, but is beginning to unnerve the Japanese Government. It has suggested it might intervene to stop it falling soon. The euro fell to a 20-year low, although is being held up somewhat by growing expectations the European Central Bank will decide tonight to increase its key interest rate by a ‘jumbo’ 75 basis points to (wait for it) 0.75%. CNBC

A looming independence showdown - The pound fell to its lowest level against the US dollar since 1985 as the Bank of England’s Chief Economist Huw Pill told a Parliamentary select committee the Government’s plans to spend (after borrowing) £150b to freeze winter energy bills was likely to force the central bank to raise interest rates. That would pit one arm of the British Government trying to lower costs for consumers against another arm trying to increase borrowing costs. New British PM Liz Truss has previously challenged whether the Bank should remain independent.

“We have to take the actions we have to take to hit the inflation target, hard as though those may be in terms of the consequences.” BoE Chief Economist Huw Pill overnight via FT-$$$

China slowing fast - China reported exports rose 7.1% in August from a year ago, which was less than half economists’ expectations and points to slowing factory activity. Imports were up just 0.3%, which was less than a third expectations and tallies with signs the ‘factory to the world’ is importing fewer components for assembly and re-export. Meanwhile, more Chinese cities warned residents against holiday travel due to Covid. Reuters

California sweating - California’s governor Gavin Newsom has warned residents of the world’s fifth biggest economy to prepare for power blackouts for the first time in two years because of a record-setting heatwave.

‘Ferme la fonderie’ - Aluminium Dunkerque, which consumes as much electricity as Marseille, France's second largest city, announced plans overnight to cut output by about 22% in the fourth quarter. No wonder Tiwai Point wants to stay open.

Just briefly

An anti-E.S.G. activist investor wants Chevron to pump more oil. WSJ

In Aotearoa-NZ’s political economy

Gone by Wednesday? - The Government is set to decide on Monday whether to completely drop the entire Covid traffic light system and other legal restrictions by next Wednesday, the NZ Herald reports this morning.

The Herald understands Cabinet on Monday will be deciding on a recommendation to scrap the traffic-light system altogether rather than tweaking the settings or moving to green.

If it goes ahead, it would come into effect as soon as next Wednesday – when the main legal instrument under which the Covid-19 orders are issued will expire if Cabinet decides not to renew it.

That Epidemic Preparedness (Covid-19) Notice 2020 is one of the over-arching legal instruments under which the Government and health authorities have exercised special powers in the Covid-19 response: including the traffic light system. If not renewed, all orders associated with it will also lapse.

If Cabinet gives it the nod, Covid-19 would be treated similar to the way the flu is managed.

Health officials could still require masks in public health settings, such as hospitals, and advise their use elsewhere such as on public transport. However, the Herald was told it would otherwise be up to businesses and providers to decide whether to adopt their own mask rules.

However, it’s worth knowing the notice does not formally expire until Friday. Covid case numbers are at their lowest levels since February.

Covid-19 Modelling Aotearoa co-lead Michael Plank and University of Otago epidemiologist Nick Wilson were quoted as saying the mandates should be eased more gradually.

"Governments, they want their votes and they will often sacrifice what is the right thing to do from a science and public health perspective because they want to win an election." University of Otago epidemiologist Nick Wilson

Just briefly

Chief Human Rights Commissioner Paul Hunt says he’s “horrified” by what was revealed in a TVNZ Sunday expose about emergency housing in Rotorua. 1News

Lotto has been warned a $25m plan to create an online bingo service will harm vulnerable communities. RNZ

An auction yesterday of Emission Trading System units by the Government saw the price clear at $85.40, which is up from $70 at the last auction in March.

Scoop of the day

David Enrich, the business investigations editor for The New York Times, has an investigation out today into how Abbott Pharmaceuticals kept its poisonous infant formula from becoming a scandal. Fonterra and A2 peeps might find this interesting.

Quote of the day

‘Profit margins need to fall too’

“How long it takes to move inflation back down to 2 percent will depend on a combination of continued easing in supply constraints, slower demand growth, and lower markups, against the backdrop of anchored expectations.” US Federal Reserve Vice Chair Lael Brainard in a speech this morning in New York on ‘Bringing Inflation Down’

Chart of the day

A good time to be a car dealer in the United States

Brainard also pointed in particular to how car dealerships and retailers had increased their profit margins during Covid and hadn’t put them back down again.

“After moving together closely for several years, starting early last year, the new motor vehicle consumer price index (CPI), which measures the price dealers charge to customers, diverged from the equivalent producer price index (PPI), which measures the price dealers paid to manufacturers. Since then, the CPI has increased three times faster than the PPI. This divergence between retail and wholesale prices suggests an unusually large retail auto margin. With production now increasing, and interest-sensitive demand cooling, there may soon be pressures to reduce vehicle margins and prices in order to move the higher volume of cars being produced off dealer lots.” US Federal Reserve Vice Chair Lael Brainard in a speech this morning in New York on ‘Bringing Inflation Down’ (Bolding mine)

Number of the day

A good time to be a US retailer

30% - Brainard also called out retail profit margins in the United States.

“Similarly, overall retail margins—the difference between the price retailers charge for a good and the price retailers paid for that good—have risen significantly more than the average hourly wage that retailers pay workers to stock shelves and serve customers over the past year, suggesting that there may also be scope for reductions in retail margins. With gross retail margins amounting to about 30 percent of sales, a reduction in currently elevated margins could make an important contribution to reduced inflation pressures in consumer goods.” US Federal Reserve Vice Chair Lael Brainard in a speech this morning in New York on ‘Bringing Inflation Down’

Longer read of the day

Longer watch of the day

Cartoon of the day

Australians are worried the RBA is hiking too much

Profundities, spookies, curiosities and feel-goods

A fun thing

Ka kite ano

Bernard.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: European leaders are warning of a ‘Lehman Brothers moment’ in their financial markets because of the ten-fold increase in gas prices and a more-than-tripling of electricity prices caused by Russia’s decision to cut off the gas Europe depends on to generate power.

In the last 48 hours, the Swedish, Finnish and Swiss Governments have offered over €30b in loans and credit guarantees to their largest power generators and retailers as the European electricity industry faces €1.5t in margin calls linked to spiking prices.

Meanwhile, new British Prime Minister Liz Truss signalled overnight she was set to unveil over £130b worth of energy subsidies and tax cuts paid for by Government borrowing. Financial markets in Europe and the United States reacted by pushing wholesale interest rates sharply higher this morning.

Here in Aotearoa-NZ, Treasury is reported to be scrambling to find ways to pay for transport ‘mega-projects’ that somehow don’t involve higher taxes or much higher core crown borrowing. Also, the gang-linked security firm and ‘wrap-around’ service provider at the centre of this week’s Rotorua’s motel story is now under official investigation 1News.

In my view, all of the above are examples of short-term political and financial responses to the inevitable effects of the magical thinking that western democratic societies can ‘get away’ with consuming more resources than the planet can handle without much more long-run investment, and of piling up much more wealth in the hands of too few at the expense of low investment and self-defeating erosions of democracies caused by the inevitable stresses on the ever-poorer.

In geo-politics, the global economy, business and markets

Europe’s ‘Lehman moment’ - The Swiss, Swedish and Finnish Governments have announced emergency loans in the last 48 hours for their biggest electricity generators and retailers as the wider European electricity industry faces combined margin calls estimated by Equinor to be €1.5t. Reuters Bloomberg-$$$ FT-$$$

Liz’s magical moment - New British Prime Minister Liz Truss promised overnight to deal to looming spikes in winter energy bills and to cut taxes by borrowing an estimated £130b-plus or the equivalent of about 5% of GDP. She also promised to transform Britain into “an aspiration nation” by increasing its economic growth rate and massively increasing gas production from Britain’s dwindling North Sea reserves.

Not that magical financially - Financial markets, who worry about Truss increasing Britain’s Government debt-to-GDP ratio from over 100%, pushed up the 10 year British ‘gilt’ or Government bond yield by 16 basis points to 3.1%. That’s its highest point since 2014 and caps a 90 basis point rise in a month, the fastest rise in the yield since 1989. This represented financial markets calling b******t on Truss’ magical thinking that tax cuts would both generate higher economic growth and keep interest rates low. Reuters

US bond markets having a moment too - Meanwhile, the US 10 year Government bond yield, which the financial world’s most-closely-watched long-term wholesale interest rate, rose 15 basis points to 3.34% this morning on fears the US Federal Reserve will have to hike more aggressively to contain inflation. This followed stronger than a stronger-than-expected US supply sector survey. All this helped strengthen the US dollar overnight, and saw the NZ dollar hit a low for the year of 60.35 USc. Reuters

Russia’s ‘Russian speaking’ moment - Be careful before learning Russian. It may mean Vladimir Putin wants to ‘protect’ you. Putin yesterday approved a new foreign policy doctrine based around the concept of a "Russian World", an idea used to justify intervention abroad in support of Russian-speakers. The 31-page "humanitarian policy" Russia should "protect, safeguard and advance the traditions and ideals of the Russian World." Reuters

Just briefly:

* VW plans to float Porsche for up to €85b in the world’s biggest IPO in 11 years WSJ

* California power prices soar to highest since 2020 in heat wave Reuters

* Xi’s Covid Zero Strategy Is Facing Make-or-Break Test in Chengdu Bloomberg

* Russia buying millions of shells and rockets from North Korea AP

In Aotearoa-NZ’s political economy this morning

More magical thinking - Thomas Coughlan reports from official documents in the NZ Herald-$$$ this morning that Ministry of Transport and Treasury officials are wracking their brains for ways to pay for ‘mega projects’ such as ‘Lets Get Wellington Moving’ and the Auckland CBD-to-Airport railway without either increasing Government debt or tax rates. The options include congestion charging, public-private-partnership-style infrastructure bonds, increased fuel taxes and road user charges, value capture rates when land values rise and using emissions trading scheme revenues.

Here’s a few details from Thomas’ piece quoting officials hunting for ‘other’ ways than simply using the Crown’s balance sheet or higher core Crown debt. Remember that is an unstated but very real bipartisan '30/30 rule’ that core Crown tax revenues and net debt not increase over 30% of GDP, which effectively stops the Government from even considering using the balance sheet simply or increasing income or GST rates, or even taxing wealth.

"[T]he direction of travel is for a beneficiary pays model, which does not presume that the Crown should fund a significant portion of the costs," the official said.

The official suggested different wording, which stressed the risks to the Crown rather than the benefits. "[T]here is a significant risk that the Crown may have to fund a large proportion of the costs if local authorities or alternative funding tools such as value capture and IFF [Infrastructure Funding and Financing] are not used," they said.

The official also suggested removing entirely the idea that fuel taxes would need to rise to fund the cost of these projects. "[T]here's very few worlds where FED and RUC don't need to increase," the official said.

Treasury officials weighed in with their own advice. They said that questions over funding and revenue would be resolved elsewhere, including two pieces of policy work: one on transport revenue and the other on the funding of "Mega Projects".

The Government has commissioned a "Revenue Review" to look at options for replacing fuel tax and road user charges, the current way most transport projects are funded. Findings are due next year. One of the early results of the review is a separate work programme on "Mega Projects", led by Treasury.

In the context of these projects, the reviews could look at things like congestion pricing and value capture and the way the revenue from those tools is split between local government and central government to fund large projects. Thomas Coughlan reports from official documents in the NZ Herald-$$$ this morning.

Framing the problem away into the future

The key questions here are how this ‘Mega Project’ work is being framed. What are the limits set for Treasury on what it can (or can’t) do with core tax revenues and debt in the long run? Who is setting those limits? How is the Public Finance Act being interpreted in setting those self-imposed and un-debated limits?

So what? - All this displacement activity and hunting for magic money trees to build these projects without increasing taxes or debt are a symptom of decades of inter-generational wealth transfer engineered by the 30/30 rule over the last 30 years. Under this effective bipartisan policy, insufficient Government and Council investment in infrastructure allied with defacto fast-population-growth-with-low-wage-temporary migration created the conditions for low interest rates, continued budget surpluses and low Government debt to create $1t of leveraged tax-free capital gains for home and business asset owners.

The bottom line - The magical thinking inherent in Truss’ crude version of trickle-down economics on show this week is not that different from the low-tax and low-investment default setting of both Labour and National Governments over the last 30 years. This magical thinking says voters in a property-owners’ democracy can have:

* low taxes, low debt, low interest rates and rising asset prices into infinity;

* without having to invest much in repairing or preventing the damage to the environment, or in new technology to use energy more efficiently;

* or having to invest in affordable housing or transport for the generations of youth sentenced to live as renters on precarious wages for decades to come;

* or don’t have to worry about election revolts from those unborn generations who will have to pay both rent and taxes for the publicly-funded pension and healthcare costs for today’s asset owners;

* that democracies can easily survive the social stresses and lower economic growth rates caused by widening inequality, over-consumption of physical assets without paying for externalities, and unaddressed climate change; and,

* that autocracies competing for those resources with democracies will not take advantage of this dysfunction to protect and grow their own share of those resources.

The bottom bottom line - None of this really computes in the long run and it’s beginning not to compute in the short run either as climate change accelerates into growth-sapping events in the near-to-now future.

For example, just overnight:

* offices closed and data centres were flooded in the global outsourcing capital of Bangalore after record-setting torrential rains allied with poor water infrastructure investment; (ABC)

* California, the world’s fifth biggest economy, is in severe drought and faces power blackouts and water shortages because of climate change Reuters;

* a third of Pakistan, which is being bailed out by the IMF, is under water and it’s trying to widen a breach in its biggest lake to avoid it overflowing even more Reuters; and,

* Shenzen, the globalised supply chain’s component assembly centre, is locked down with a disease (Covid) initially transmitted zoonotically on a planet that transmits more diseases zoonotically as it warms Reuters.

The unpriced-and-unpaid-for externalities generated by over-consumption, under-investment and deliberately widening inequality over the last 30 years appear to be coming together in a poly-crisis moment. The bill feels as if it’s coming due all at once in a series of climate events and wars that accelerate each other into a series of feedback loops into yet more crises.

Just a thought - Maybe it’s time we stopped with the magical thinking and instead consumed less, invested more, shared more with those most in need and slowed down a bit.

Quote of the day

The ‘L’ word that makes bankers’ blood run cold

“Here were all the ingredients for the energy sector’s version of Lehman Brothers.” Finnish economy minister Mika Lintilä announcing overnight a €2.35b loan package for the state-controlled Fortum, which is Finland’s biggest power generator and its biggest company by revenues. This package was on top of a €10b loan package for the wider industry announced on Sunday. Reuters

Chart of the day

If you think NZ’s 30% debt-to-GDP ratio is a problem…

Number of the day

The bill shock heading Europe’s way

€2t - Energy bills for European households will rise by two trillion euros by early next year, Goldman Sachs forecast in a research note released on Sunday. At their peak, these energy bills will represent about 15% of European GDP. This is why European governments are scrambling to intervene in energy markets to cap household and some business energy bills, paid for in part by windfall taxes on energy companies profiting from the higher wholesale prices. Bloomberg-$$$

Long read of the day

Substack of the day

The Craic

A fun thing

Ka kite ano

Bernard

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: As I wrote about on Friday, Liz Truss won an election of just under 142,000 Conservative Party voters to become the British PM-elect overnight. In true magical thinking fashion, she wants to loosen fiscal policy with tax cuts and energy subsidies, while growing a UK economy that she plans to cut off from Europe’s economy even more decisively.

All this means higher interest rates and inflation for Britain at the same time as Russia shuts off its gas supplies to Europe indefinitely, forcing rationing and interventions in electricity markets to rescue consumers and impose windfall profit taxes.

Paying subscribers can see more detail and analysis below the paywall fold and in the podcast above.

News in geo-politics, the global economy, business and markets

An ugly inbox - Liz Truss will be sworn in tomorrow as the new UK PM tomorrow after winning an election of Conservative Party voters overnight by 81,326 votes to 60,399 against Rishi Sunak. Truss faces having to spend up to £100b within weeks to support consumers and businesses facing massive spikes in winter energy bills.

Magical thinking - Truss has pledged to cut income taxes for the richest while also unravelling a trade agreement with the EU that could spark a trade war and further worsen inflation set to top 20%. The pound fell below US$1.15 this morning, near its lowest levels since the mid-1980s. The British 10 year bond or ‘gilt’ yield rose eight basis points to 3% for the first time since 2014 on fears of a fresh blowout in Government debt and a 1970s-style foreign exchange crisis.

Nyet more gas - European gas prices spiked 30% overnight after Russia said it would not restart gas supplies through Nordstream 1 until sanctions were lifted and a G7 plan to cap Russian oil prices was removed. The euro fell below 99 USc to a 20-year low this morning and European stocks fell as much as 2%. US markets are closed for Labor Day.

Nicht so much profit - The EU is accelerating plans for electricity and gas market interventions to ease the pain for consumers and businesses. Germany announced windfall profit taxes on energy company profits over the weekend to pay for €65b worth of support for consumers.

Not so much oil - Opec+ surprised everyone overnight by announcing a 100,000 barrel per day cut in production to stabilise falling prices. Brent oil prices bounced more than $2 per barrel to over US$95 per barrel.

So what? - This is going to be an ugly winter for European consumers and democracies, let alone its economies and financial markets. Most see the various news events as both inflationary and recessionary for the global economy. That might mean less demand for our exports, but the strong US dollar is offsetting some of that pain. However, that weak NZ dollar (around 61 USc this morning) also heightens inflationary pressure from overseas.

The bottom line - Geo-politics right now equals volatility in interest rates, inflation, growth and asset prices. In the past, that led to lower interest rates, asset market bailouts and yet-more wealth-effect growth. Now central banks are pledging not to bail out asset owners again and instead get inflation down. We’ll see. The asset owners usually win these political battles.

Quote of the day

Geo-politics today

“European electricity prices could reportedly hit new highs this week, when the flood of problems already flowing from energy prices is already staggering: 6 out of 10 British manufacturers may go the wall; experts warn of energy rationing that could see Brits told not to cook until after 8pm, pubs close at 9pm, and three-day weeks at schools; aluminium smelters and steel mills are closing; fertilizer companies are shuttering; the Netherlands warns of a plunge in flowers, fruit, and vegetable output, with that of bricks also tumbling; Spanish output of ceramic tiles has halted; and a slew of Italian firms didn’t come back after the summer break. Regardless of gas storage levels for THIS winter, Europe faces an industrial supply-chain collapse – and just as it is has pledged to re-arm to face a worrying geopolitical future.” Rabobank economist Michael Every.

Number of the day

68 - The number of Chinese cities now in full or partial lockdown.

Chart of the day

A fun thing

Ka kite ano

Bernard. 

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe

TLDR: This week on the weekly hoon webinar, we talked about the Government’s GST U-turn, the likely election of Liz Truss as UK PM, Ukraine’s counter-attack in Ukraine, and National’s relaxed reaction to a UN report on China’s oppression of Uighurs.

I’m keeping this short this week as I’ve been focused on getting out my interview with Adrian Orr earlier this morning.

The audio from the webinar on Friday night for paying customers is in the podcast above for all subscribers.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit thekaka.substack.com/subscribe