Categories
Investing

Inflation Risk In NZ

As I approach retirement, inflation (which was formerly my friend) is becoming my foe. While saving for retirement I’ve used cheap debt (mortgages) to fund various investments which have returned higher rates than the cost of the debt. Essentially I’ve leveraged the bank’s money to profit, rather than my own (comparatively pitiful) savings. This has had a two-fold benefit over the years. Firstly it has enabled me to get rich from someone else’s money, and secondly inflation has made the cost of my debt lower as time goes by. For example, a $240k mortgage to buy a $300k house 10 years ago isn’t much when the house is now worth $1m and my salary is double what it was.

Unfortunately inflation is the enemy of the retired. The value of the savings a retiree has are eroded by inflation. So as a “young” retiree (I’ll be nearly 40 when I retire next year) my retirement strategy will have to consider inflation. Whilst my strategy does consider inflation (I plan to have a component of my income to cover my costs and another component to grow), recently proposed political policies have made me concerned. Specifically I’m concerned that inflation may not be evenly spread across all asset classes, which creates risk to business (and therefore potentially my investments) and risk to my future living costs / lifestyle choices. I’m also concerned that inflation may be greater than the growth on my income.

It’s important to be aware of inflation whether you’re retired, planning retirement or currently investing because it will probably affect your strategy / opportunities.

Lewis Hurst

Let’s look at the inflation risks that are present in the current economic and political environment (existing policies put in place by the current government are in darker text, while policies proposed in the recent Climate Change Report are accented in a lighter colour. As I’m an opinionated fellow, I couldn’t help adding my opinion of the policy, but I’ve put this in italic so you’re free to ignore the italic text if you wish):

  • Increased minimum wage. This should cause general inflation as people have more money to spend, which creates increased demand and an ability to pay more for any particular goods or services. It has been hypothesized by economists that distributing more money amongst the poorest of the populace is the best way to spur an economy as all the extra money gets spent, vs. more affluent people who may save some of the additional money.
    At the time I thought this was a bad policy because the inflation would cancel the some of the gains, and therefore there are better ways to achieve what the policy set out to achieve. Additionally the policy was risky because it could put many businesses out of business. The policy also came at a really bad time with COVID19. However, after the policy was implemented, most businesses seemed to be able to handle the new costs, so it was probably the right thing to do (although I think there was a lot of luck in the success of this policy).
  • Quantitative Easing (QE, AKA Printing Money). There is currently a massive amount of QE going on in NZ and around the world. Both QE and increasing the minimum wage are policies that create general inflation.
    I believe that Western countries around the world have been using QE in a battle to reduce the value of their currency, in order to make themselves more competitive exporters and at the same time deflating their debt with the inflation that goes along with QE.
  • Banning oil exploration. This policy is inflationary because it reduces supply of oil, which therefore pushes the price up.
    I believe that this is another of Labour’s policies that does the opposite of what was intended because it doesn’t reduce demand, so demand will just be fulfilled from oil imports – which will create more strain on the environment as extra fuel is used to import the fuel. The argument for the policy was to create strain on the market to produce motors that use alternative fuel sources, but as NZ has no such motor industry, will import the fuel anyway, and is too small to influence foreign motor industries, I believe that no such technology will emerge from this change. Again, there are better ways to achieve what this policy set out to achieve.
  • KiwiBuild. This policy is inflationary because builders were attracted away from the NZ private sector (who would have otherwise been building houses) to build houses for the government. This inflates the price of builders as it creates extra demand, while at the same time not increasing supply as those builders would have otherwise been fulfilling private demand for housing. Increasing the cost of builders makes new housing more expensive.
    Additionally the government bought houses from the private sector for political reasons, so they could tout the success of the failing build rate of the KiwiBuild policy. This temporarily inflates the price of housing because it creates temporary extra demand as the private sector bids for housing against the government.
    Another Labour policy that did the opposite of what it was intended to do, whilst at the same time adding inefficiency into the market in terms of admin cost, and in the case of houses that were built as part of the KiwiBuild policy, placing houses where people didn’t want them – further increasing house prices due to an effective reduction of supply due to lack of housing in areas that required it.
  • Reducing the amount of dairy cows to reduce methane emissions. This will reduce the supply of meat, which will inflate the price.
    I imagine it would be better to put restrictions on the thing they are trying to regulate (the emissions) rather than the thing creating the emissions. That way the free market can find the best way to reduce emissions, leaving the reduction of herds as a last resort.
    There is talk suggesting that NZ dairy farms have lower emissions than foreign farms. If this is true, this will be another Labour policy that does the opposite of what it intends, because demand for dairy will not decrease, so foreign supply will fill the gap, resulting in an over all increase in emissions.
  • Phasing out natural gas. This will decrease the supply of energy, increasing the demand on other sources such as green electricity. Probably a good thing, but this will cause inflation in the price of alternative sources as supply decreases.
  • Ban the importing of cars with combustion engines. Again, reducing supply increases prices.

Regardless of political views, these policies are inflationary. Having a quick look at the list, it seems that existing policies are generally inflationary, with a leaning towards inflating transport and housing; while proposed policies could cause inflation in food, energy and transport.

To summarize my position, as I intend to get part of my income from rental income, NZX.SUM, NZX.SCL and gentailers, I only have transport costs to worry about. Still, with all this additional inflation, I may need to ensure that the growth rate of my income is more heavily weighted. This means that I may need more money to be able to retire safely. As usual, I’ll be playing it by ear, and evolving my strategy to my situation as it changes.

Sources:

Categories
Business

Do I Need To Repay The Wage Subsidy?

A few weeks ago I wrote an article about the economic future of NZ, in which I praised the government’s reaction to COVID19 and the associated financial policies arising from it. Specifically I said that I liked the wage subsidy as an implementation of Helicopter Money.

Why I liked it so much, is because it directed money straight to all businesses (small and large), and forced those businesses to ensure their staff were looked after. Trickle- Down Economics, anybody? I think this is better than Quantitative Easing because the money goes straight where it’s needed (though arguably there are better ways to implement Helicopter Money).

Every business owner I talked to, had applied for and got the wage subsidy. Comments on the no-questions-asked ease of acquiring the subsidy, along with the soft eligibility requirements of “…a 30% decline in predicted revenue…” and soft wording on repaying it, stating that you can repay it if you become no longer eligible, all suggested that the wage subsidy was actually Helicopter Money.

Now it seems that numerous large law firms are repaying the wage subsidy and the wage subsidy page on the Work and Income website is dominated by large red text talking about repayments.

So the question for employers is do i need to repay the wage subsidy? I don’t have the answer to this, but I suspect that the fact that the law firms are repaying it might be a clue.

In some ways it’s no surprise that the government is asking for the money back. In fact, I stated that there would be a need to replenish the coffers in the very same article in which I praised the wage subsidy policy. I’m just a little disappointed in the way the Work and Income website phrased the repayment, because for me, to say that you are eligible if you predict a 30% drop, then say that it has to be paid back if you are no longer eligible, I would have thought that having had predicted the 30% drop made you eligible.

Additionally I think that in the case of a growing company (especially those who have recently done capital raises or increased investment to fund growth), it’s quite possible that revenue could be up from last year, but 30% less than predicted. This could validly cause an increase in staffing costs that is not sustainable as returns didn’t fit the anticipated financial modeling, and such a company could be in need of the wage subsidy.

I think there’s scope for arguing a position here, but I suspect that increased need to replenish the coffers in the coming year may result in the IRD comparing past and present returns for those who kept the subsidy, and correspondingly auditing those who didn’t report at least a 30% drop. I expect that this will result in a lot of unpleasant words like “fraud” being thrown around.

It is my understanding that in cases where tax law is based on your opinion (such as whether you’re a share trader or share investor), the opinion of the taxman overrides any thoughts the business owner may have had on their intentions.

To leave on a positive note, while we may not have got any Helicopter Money, the alternative methods of replenishing the coffers are less attractive.

If you are wondering whether you need to repay the wage subsidy, you may wish to talk to your lawyer, accountant or ring the number on the Work and Income wage subsidy page that offers advice on whether you need to repay (though I expect in the case of any ambiguity, a ruling would not be in favor of these business).

Categories
Investing

The Economic Future Of NZ

Following the Black Swan event of COVID19, NZ is left in a state of uncertainty while we await the response of the economy to see how the recovery will look. One thing that concerns me more than the possibility of recession caused by businesses failing to survive the lockdown, is the possibility of NZ’s economy being changed for the longer term.

Firstly, while I am the last person to support the Labour government and Jacinda Ardern, I have to say that from what I can see they’ve done a great job with COVID19. The number of cases in NZ has been easily handled, there has only been one death (which represents a very low percentage, and the person had other medical complications), and I think the financial stimulus response has been excellent (QE + Helicopter Money via the Wage Subsidy) – though I have to say that I’m not impressed with the abuse of the State of Emergency which they have used to pass irrelevant social policy, but that’s beyond the scope of this website.

The negative effect of QE and the Wage Subsidy is that the government will need to replenish their coffers once all this is over, which means increased interest rates, increasing government debt, and/or increased taxes. Each of these have their own negative implications for NZ.

Increasing Taxes

The implications of increasing taxes is fairly obvious – this weakens the economy. Taxes on people reduce available income and reduce consumer demand for goods and services. Taxes on companies cause companies to make more effort to avoid taxes, such as becoming tax residents of foreign countries. Both types of tax reduce demand for goods and services, which reduces demand for labour, reduces wages, reduces demand and prices of property, which reduces consumers overall wealth and borrowing capacity, etc.

One would hope the government would only be able to do this when the economy has fully recovered and is healthy, though I expect that the idea of CGT may raise it’s head again.

Increasing Government Debt

This is also bad because it defers and compounds the problem as debt levels increase over time.

Increasing Interest Rates

This is actually the option that scares me the most. The Reserve Bank of NZ (RBNZ) could increase interest rates to recover funds back into the government coffers. This would have a direct and almost immediate effect on peoples wealth, through higher mortgage rates for property, pushing down prices and increasing costs, putting people into a negative equity situation, increasing rental costs for businesses, reducing demand for goods and services as people have reduced spending capacity, reduced borrowing capacity causing risks that weren’t previously there.

In addition to this, it could cause the value of the NZ Dollar (NZD) to increase compared to other currencies. This would be a problem for exporting companies, and cause a shift in the way NZ does business and increasing the trade surplus.

All this is a big problem because NZ relies heavily on it’s exporting industries (dairy, forestry, meat, and to some extent tourism as NZ would be more expensive to visit). New Zealanders also rely heavily on property investment, which is the staple investment for the average Joe investor (mum and dad, and many retirees).

How To Invest?

Assuming that this doesn’t cause further economic collapse, and of course assuming that this all transpires, investors might react by investing in stocks that benefit from a strong NZD, Importers, and companies with little or no debt. At the moment I’m waiting to see how the economy and government react, and building up some cash reserves so I’m ready to move when the opportunity presents itself.

Addendum (10/07/2020): Thinking about it, as things get worse, money will likely retreat to the USA, so the NZD may actually become weaker, rather than stronger. It all depends on the state of foreign countries relative to the impact on NZ, which is quite unpredictable so far out.