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Inflation Targetting Catastrophe

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From the New Zealand "Herald" (in the blog):

Economy on 'death spiral' due to exchange rate

11:09AM Thursday July 19, 2007

Steve Hanke

Steve Hanke

Should the Government invoke extraordinary powers to prevent another interest rate hike?

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The New Zealand economy is on a death spiral by having a free, floating exchange rate combined with inflation targeting, according to a leading US economist.

Steve Hanke, fellow of the Cato Institute and professor at Baltimore's Johns Hopkins University, said New Zealand should abandon its free-floating exchange rate and peg it to a key larger currency such as the US dollar, or a basket of currencies.

His comments come as the New Zealand dollar continues to soar towards US80c, a record since it was floated 22 years ago. It has risen 27 per cent this year alone, crippling many exporters.

The kiwi peaked around 4am at US79.45c but later slipped back and was at US79.26c at 11.57am.

Finance Minister Michael Cullen cause a storm when he hinted yesterday he could use emergency powers to suspend the Reserve Bank's sole focus on inflation.

Most economists expect the Reserve Bank to put further upward pressure on the exchange rate next week by hiking interest rates for the fifth time this year and economists from at least two leading banks said a sixth hike is probable in August.

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Prof Hanke, an adviser to the late former president Ronald Reagan, told Radio New Zealand today the currency cannot be allowed to continue its violent fluctuations.

The current framework left New Zealand "like a dog chasing its tail".

To fight inflation the Reserve Bank hiked interest rates, but because New Zealand had higher interest rates than other developed countries because it is a small economy, that attracted a flood of capital from offshore where rates are lower, which pushed up the exchange rate.

He said that aggravated the inflation problem and the central bank then had to increase rates again and start the whole cycle again.

"In a way it's a kind of death spiral you're in."

Prof Hanke said it was inappropriate in a small, open economy to have a system of inflation targeting and a free, floating exchange rate.

"It's obvious to everyone that this isn't the paradise that everyone thought it was."

He said the opposition National Party's suggestion that the problem could be fixed or alleviated by cutting spending was politically unrealistic.

Another "fix" to impose capital controls such as reserve asset ratios on banks was a poor alternative, he said.

What could save the day, he said, was a system modelled on Hong Kong's where the New Zealand dollar would be pegged to the US dollar. Just as easily, New Zealand could fix its currency against a basket of currencies.

The exchange rate would be fixed but freely convertible and fully backed by foreign reserves.

"That is the only way out -- that will keep the economy open, free. There will be a free market mechanism that will get rid of the violent swings in the exchange rate that cause no end of trouble."

Prof Hanke doubted there was the political will to change New Zealand's monetary policy and exchange rate system. There was likely to be a long, drawn-out debate before any change.

Sounds a lot like the UK is going the same way. When are the govt going to wake up to the fact that inflation targetting is a disaster? It reassures investors that whatever risks they take, the govt/central bank will smooth out the effects on the underlying economy. So we all pay to shield investors from the collateral damage from their activities, while they cream off their profits. Absolutely insane - welcome to the economics of the madhouse.

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From the New Zealand "Herald" (in the blog):

Sounds a lot like the UK is going the same way. When are the govt going to wake up to the fact that inflation targetting is a disaster? It reassures investors that whatever risks they take, the govt/central bank will smooth out the effects on the underlying economy. So we all pay to shield investors from the collateral damage from their activities, while they cream off their profits. Absolutely insane - welcome to the economics of the madhouse.

Indeed - and all this is the outcome of the Yanks trashing their own currency in a desperate last-ditch attempt to retain their global pre-dominance. The rest of the English speaking white world is locked in step with them, whether they choose the same inflationary route or pay the cost of defying it, like NZ.

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You can't fix the exchange rate to hide an imblanace. Currency speculators have a lot more money than central banks do, and will win any arms race with the government.

Furthermore, putting interest rates causing a stronger currency does not cause inflation, it reduces inflation because a) imports are cheaper so there are more of them and B) exporters can't sell their goods so they are sold on the domestic market, when again there are more of them. A strong currency is disinflationary not the other way round.

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Would it be any better if they targetted monetary expansion? Genuine question.

Seems like the Yen is creating many problems all around the world with its artificially low IR's.

HAL

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You can't fix the exchange rate to hide an imblanace. Currency speculators have a lot more money than central banks do, and will win any arms race with the government.

Furthermore, putting interest rates causing a stronger currency does not cause inflation, it reduces inflation because a) imports are cheaper so there are more of them and B) exporters can't sell their goods so they are sold on the domestic market, when again there are more of them. A strong currency is disinflationary not the other way round.

Agreed on both counts. But if you can not export the economy will go into recession.

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The whole system is showing its inevitable contradictions.

The contradictions arise because we begin with a false assumption. Namely, that the rate of discount is matter of policy rather than a market apraisal of the basic phenomenon of originary interest.

It will blow up spectacularly.

Edited by Far Out Bear

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This (the OP) is a very interesting article on what is wrong with the global currency system(s). NZ is under attack from

currency speculators because the NZD is not pegged to anything. It is a small currency, so this is easily possible. However,

even the largest of them all can come under pressure - like the USD recently. If you run a basket and are fully backed

(by other currencies and/or commodities), this just can't happen.

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This (the OP) is a very interesting article on what is wrong with the global currency system(s). NZ is under attack from

currency speculators because the NZD is not pegged to anything. It is a small currency, so this is easily possible. However,

even the largest of them all can come under pressure - like the USD recently. If you run a basket and are fully backed

(by other currencies and/or commodities), this just can't happen.

I disagree goldfinger. What you're describing are symptoms. I describe above what is basically wrong with the monetary regime. Recap

"The whole system is showing its inevitable contradictions.

The contradictions arise because we begin with a false assumption. Namely, that the rate of discount is matter of policy rather than a market apraisal of the basic phenomenon of originary interest.

It will blow up spectacularly."

I would also add to that this as an underlying root problem.

That governments think they know better how to spend your money hence high taxes and inflation to transfer purchasing power for social planning as opposed to consumer induced planning.

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very similar to iceland, which has 13% interest rates.... CPI peaked at 8% last year after a dramatic rise

http://www.sedlabanki.is/?PageID=196

8% is along way from the target of 2.5% :o the risks of staying above the target for too long?

http://business.timesonline.co.uk/tol/busi...ticle611289.ece

inflation0607.JPG

post-552-1184842150_thumb.jpg

Edited by moosetea

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I disagree goldfinger. What you're describing are symptoms. I describe above what is basically wrong with the monetary regime. Recap

...

That governments think they know better how to spend your money hence high taxes and inflation to transfer purchasing power for social planning as opposed to consumer induced planning.

So, what exactly is your point? Should we have free currency competition? That's what I want!

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I have alternated between living in Britain and NZ for 12 years, so I am well placed to compare the two. I own legitimate businesses in both countries - by legitimate I mean that they employ people, make a profit, pay taxes etc.

It strikes me that much of the problem may be down to the fact that NZ hasn't quite got the hang of massaging inflation figures as well has Britain has. In particular, houses are a part of the NZ price index and, together with profligate spending under a Labour government, the NZ central bank argues that it is HPI is the main driver of Kiwi inflation. I presume that if the Kiwi inflation formula was applied in Britain, you would have similar interest rates there and vice-versa. My personal experience is that inflation is worse in Britain. As it is, the $NZ is out on a limb - even India with its higher official inflation and inherent risk has lower interest rates, which seems absurd.

The bank is frustrated that a well known tax dodge allows wealthy BTL landlords to write off losses against personal income, safe under the knowledge that capital gains taxes on property are rarely applied and trivial to avoid. As interest rates rise, landlords get to make a bigger loss and pay less tax because they can deduct rental losses from their personal income. Since income tax is 39% on income over $60,000, hardly anyone middle aged and on a decent salary does not have a BTL or two although most are at least slightly embarrassed by the fact.

Tax-offsetting Kiwi landlords argue that the tax code is fair - that their businesses legitimately incur losses. Not true. The NZ tax code is very specific on what constitutes a legitimate business - it requires that it must be overall profitable and the IRD should not tolerate enterprises that declare deductible losses year after year with no prospect of turning that around. I sincerely hope that landlords who deduct $10's of thousands of "losses" off their self assessment forms every year are held to account over the fact that anyone who buys property when the mortgage rate is 10% and yields are at 3% plainly had no intention of making a taxable profit, only a capital gain. However, until a few of these get the inevitable awkward tax inspections they deserve, the central bank will miss its target - Wealthy Kiwis will continue to offset taxable income now against tax-free gains in the future by investing in property, fueling inflation and pricing out hard working families.

The following is an article written by my tax adviser - someone who knows NZ and Britain very well. I like his article but I wish he and others would join the dots and reach a bolder conclusion. Rampant property inflation has been global in its reach. Britain blames immigration/planning, NZ and Australia blame tax policy, America blames dodgy lending practices etc, etc. These local factors are being pinned on the problem after the event - none of them are ubiquitous so none can be the cause - that can only be a coordinated policy by reserve banks around the world. The big questions are why did they deliberately inflate this bubble and what is their exit policy? We had better all hope it is high interest rates not soaring inflation. I'm hopeful because when NZ rates were where British rates are now, there press here was full of writers calling the peak - 2 years on and these same writers are confident rates will go even higher. Inflation and asset bubbles are both self-fulfilling but whereas all bubbles have burst, history shows that once inflation is at large, it is incredibly difficult to control. Some kinds of inflation like rising taxes and house prices are kept under the radar but once you have inflation in food prices and fuel you can't hide it any more and a wage-chasing spiral becomes inevitable. We have just seen the price of milk powder double in a year, and the advent of bio-diesel will ensure that a whole raft of other foodstuffs go the same way. Meanwhile, I suspect we are two major storms away from $100 oil. I think NZ is just ahead of the curve and the currency will fall as rates elsewhere catch up.

Cullen plan to end tax subsidy is fair

The Press | Wednesday, 27 June 2007

Michael Cullen's suggested crackdown on tax breaks for landlords is worth supporting, writes MARTIN RILEY.

Speaking as someone who has been involved in taxation for almost 20 years (mainly in the United Kingdom) it has annoyed me to read some of the headlines and comments in the press during the last week or so.

In my opinion, the tax breaks on rental property in New Zealand are far too generous and we should all get behind Finance Minister Michael Cullen in his attempt to fight inflation and make houses more affordable – and I'm speaking as someone with no political allegiances.

Whether his proposals to limit the use of rental losses to future rental profits will actually achieve those goals is, of course, debatable but something must be done and if it only increases tax revenues then that won't be a bad thing. Let's face it, we have to pay tax in order to pay for the education system, the health service etc. A good tax system should be fair – and it seems to me that some landlords are simply using the tax system to create tax-free capital gains for themselves.

What New Zealanders don't realise (and why should they?) is that Kiwi landlords enjoy three significant tax advantages in comparison to their British counterparts. Firstly, they can use their rental losses against total income. Secondly, a Kiwi landlord can claim depreciation – which will help him create a loss in the first place – and thirdly, there is no capital gains tax when the property is sold.

It was interesting to read the comments made by New Zealand Property Investors' Federation president Martin Evans in The Press (June 21) when he said: "Property investment is like any new business, like running a truck – it doesn't make money straight away." The fact is that property investment is not like any other business – because the risks involved are generally much less. If a property investor is unable to service the mortgage then the worst-case scenario is normally that the property is repossessed and the bank goes through the process of a mortgagee sale. Compare that to an unincorporated manufacturing business which is struggling because of the high value of the Kiwi dollar. The bank overdraft is probably secured on the owner's home (which may also be the case if the business is operated as a limited liability company). If the bank overdraft exceeds the agreed limit then the business owner could be left homeless.

This is why in Britain the deduction of rental losses is restricted to future rental profits and not deductible from other income – unlike trading losses. The rules reflect the risk undertaken by each business, which is fair. I'm not saying that property investors don't undertake any risk but, let's face it, a landlord with good tenants can basically sit back and the rents come rolling in – it can often be a fairly passive investment.

Readers should also realise that Cullen's proposals will not hurt to any great extent the property investor who is truly in business – whose only source of income is from his rental business.

That type of investor will normally have a large number of properties and will generally be making profits, so any change in the rules on losses will not be a major concern. The people who will be hit the hardest are the part-time investors – those on high salaries who take out large mortgages on the rental properties with the intention of creating a loss to be set against their high salaries.

This is perfectly legal tax avoidance under the current rules. But these people are claiming tax refunds every year to subsidise the mortgage and then after a few years they sell the property with a tax-free capital gain. It's Mr and Mrs Joe Public who are helping to fund their tax-subsidised tax-free capital gains. Now, I'm not suggesting for one minute that we should introduce a capital gains tax – but maybe the Government should take away the tax subsidy that currently exists.

Martin Evans also suggested that Cullen's proposal would hurt recent heavily mortgaged investors. Well, what a shame! Those investors should have realised that setting up a business where the mortgage payments are greater than the rents received was not a very sound business plan. The large mortgage was their own choice – within their control. I know that the interest rate increases were outside their control but the increases have not been huge – they haven't suddenly jumped by 3% or 4 %.

I have a lot more sympathy for those who are truly in business employing a sizeable workforce, dependent on exports and who are struggling against the high kiwi dollar – something which is totally outside their control. The tax system should be more generous to those sorts of risk takers.

So, speaking as a Pom, I think it's time that part-time property investors stopped whingeing. A change of this sort in the UK would almost certainly have been made without any prior warning – it would have been included in the Budget and passed as legislation a few weeks later. At least here there is a little more debate and opportunity for professional bodies to give their views.

I would hope that if the new proposals do become law then there would be a period of at least nine months before they take effect. This would allow those "recent heavily mortgaged investors" to sell their investment properties if they feel that the tax subsidy was such an important factor in their business plan.

If they are high-salaried property investors they could put some of their well-earned cash into a KiwiSaver account next week and swap an out-of- favour tax subsidy for a Government-favoured tax subsidy instead. How good would that be?

* Martin Riley lives in Christchurch and is director of Sterling Tax Services Ltd, a company which specialises in advice on UK taxation. His email address is martin@isistax. co.uk .

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Rampant property inflation has been global in its reach. Britain blames immigration/planning, NZ and Australia blame tax policy, America blames dodgy lending practices etc, etc. These local factors are being pinned on the problem after the event - none of them are ubiquitous so none can be the cause - that can only be a coordinated policy by reserve banks around the world.

Good post Geekers... the truth about the bubble is of course as you describe it, and its origins can be traced back to the implosion of the Japanese bubble in 1989 and the consequent low rates that have inflated bubbles elsewhere instead of domestically, as intended. Indeed, a clear relationship can be discerned between a series of ever-larger bubbles that have occurred throughout the world ever since Bretton Woods broke down in 1972. Subsequent relaxation of currency controls has only exacerbated this as money flows have become ever hotter and raced around the world inflating asset values wherever the fashionable asset hotspot may be.

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Furthermore, putting interest rates causing a stronger currency does not cause inflation, it reduces inflation because a) imports are cheaper so there are more of them and B) exporters can't sell their goods so they are sold on the domestic market, when again there are more of them. A strong currency is disinflationary not the other way round.

Exactly!

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You can't fix the exchange rate to hide an imblanace. Currency speculators have a lot more money than central banks do, and will win any arms race with the government.

Furthermore, putting interest rates causing a stronger currency does not cause inflation, it reduces inflation because a) imports are cheaper so there are more of them and B) exporters can't sell their goods so they are sold on the domestic market, when again there are more of them. A strong currency is disinflationary not the other way round.

But in reality New Zealand doent have all that many exports.....lamb and lamb?

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Very interested to hear that HPI is included in the inflation measure in NZ. Perhaps they are the only western nation to do this?

It's also interesting that mortgage rates are 10%, yields are 3% yet people are still buying. It suggests people have lost confidence in their currency, yet their currency is appreciating against other currencies. It's a paradox.

The crazy thing is that the banks must still be lending to 'investors' in this environment. It's like a collective hallucination!

I guess that's the definition of a bubble!

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Very interested to hear that HPI is included in the inflation measure in NZ. Perhaps they are the only western nation to do this?

It's also interesting that mortgage rates are 10%, yields are 3% yet people are still buying. It suggests people have lost confidence in their currency, yet their currency is appreciating against other currencies. It's a paradox.

The crazy thing is that the banks must still be lending to 'investors' in this environment. It's like a collective hallucination!

I guess that's the definition of a bubble!

Indeed - they have shedloads of white hot money flooding into the country that demands prompt investment. The medicine is just feeding the disease. In fairness to RB, he had previously argued along similar lines in respect to Sterling, with some justification.

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New Zealand has a small economy, population about 1/2 the size of London and is insignificant to the global economy.

that's all i'll say!

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Exactly!

Not so fast.

A rising currency, if freely exchangeable with other currencies, will attract an influx of foreign money. This money gets deposited in local bank accounts where it is used to purchase local assets, which is inflationary. The Kiwi is chasing itself around in a circle because foreign money keeps entering market. The central bank is trying to limit money expansion by increasing interest rates, but all this is doing is attracting more money from around the globe, specifically USD.

The same is happening all over.

Edited by Pluto

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So what are the Central Banks up to?

My theory is that all minor currencies are under attack. They are going to keep appreciating until their economies cannot take it anymore and the PEOPLE demand a change. The change will result in these currencies being abandoned or pegged (same thing really) to one of major currencies: EURO, DOLLAR (AMERO), or far eastern one to be developed.

This will achieve the aims of the NWO will public consent.

Edited by Pluto

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This will achieve the aims of the NWO will public consent.

Don't know anything about NWO, but basically Japan's caused this mess, so have they

an interest in what is referred to here as NWO?

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So what are the Central Banks up to?

My theory is that all minor currencies are under attack. They are going to keep appreciating until their economies cannot take it anymore and the PEOPLE demand a change. The change will result in these currencies being abandoned or pegged (same thing really) to one of major currencies: EURO, DOLLAR (AMERO), or far eastern one to be developed.

This will achieve the aims of the NWO will public consent.

I totally agree.... is the pound a big or a small currency?

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I've been reading this thread with interest. I'm off to NZ in December for 3 years (I'll be working there, GF is a Kiwi). There's the possibility of staying there long-term if the job prospects are good.

House prices are more unaffordable than even the UK, and the currency is very strong. I'm resigned to the fact that I won't be buying property there for the next few years, but it does raise the question mark over where to put my house deposit savings. What do you think? GBP or NZD? Both look like they're cruising for a fall!

So what are the Central Banks up to?

My theory is that all minor currencies are under attack. They are going to keep appreciating until their economies cannot take it anymore and the PEOPLE demand a change. The change will result in these currencies being abandoned or pegged (same thing really) to one of major currencies: EURO, DOLLAR (AMERO), or far eastern one to be developed.

This will achieve the aims of the NWO will public consent.

If the NZD is going to link up with another currency, the Australian dollar is the natural counterpart. IIRC this has been discussed seriously in the past, and Australia is the closest trading partner. Seems that most NZ firms are owned by Australian corporations anyway!

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I totally agree.... is the pound a big or a small currency?

The goal will be for the UK to join the Euro. The Elites want UK citizens to go in voluntary, so the best thing to do is to "kill" the currency by ice or fire.

Edited by Pluto

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I've been reading this thread with interest. I'm off to NZ in December for 3 years (I'll be working there, GF is a Kiwi). There's the possibility of staying there long-term if the job prospects are good.

House prices are more unaffordable than even the UK, and the currency is very strong. I'm resigned to the fact that I won't be buying property there for the next few years, but it does raise the question mark over where to put my house deposit savings. What do you think? GBP or NZD? Both look like they're cruising for a fall!

If the NZD is going to link up with another currency, the Australian dollar is the natural counterpart. IIRC this has been discussed seriously in the past, and Australia is the closest trading partner. Seems that most NZ firms are owned by Australian corporations anyway!

My opinion is that the Kiwi and the Aussie Dollar will join the to be created Eastern Currency based on the Yuan. There will be three currencies. Amero, Euro, and Yuan based. All other currencies will have to pick sides based on trading patterns. Eventually these three will merge into one. This is the elites wet dream - one currency - and the ability to be on one side of every transaction worldwide. They will be able to set interest rates in negative territory, which means we will all be slaves.

Edited by Pluto

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