Labour and the dairy debt

It often isn’t clear quite what the Labour Party means.  Andrew Little is reported as follows:

Little said the banks needed to be “stiff-armed and told we’re not going to see, wholesale, farmers pushed off the land”.

His only argument for this sort of intervention –  whatever it means in practice –  appeared to be that

“We expose more New Zealand farm land to the risk of overseas ownership and I think that is a matter in which there is a national interest the Government should be alert to, and take action on.”

Which all sounds quite dramatic, and yet what follows seems like a rather damp squib.

A summit should be called and dairy cooperative Fonterra should be at the table. Farmers needed to agree on a long term plan for the cooperative to move its products up the value chain, even if that meant taking less cash out once the immediate crisis was over, to allow Fonterra to invest to generate better long term returns.

Government assistance should be provided to get farmers over the crisis, in a similar way to the help offered during drought, but it did not need to be any more than that.

So, apart from more talk, what is Labour actually proposing?

Keen as any individual bank might be to be rid of some of the more questionable exposures in its dairy book, it seems unlikely that banks, as a group, will be that keen on precipitating large scale exits from the dairy industry.  Force one farmer to sell and there won’t be any material impact on the value of dairy farms more generally.  Try to force several thousand to do so, and (a) it will be next to impossible to find buyers in the short-term, and (b) the value of the collateral banks hold could collapse.  The Reserve Bank talked last week of an extreme scenario in which dairy farm prices fell by 40 per cent, but in an illiquid market like that for dairy farms there is no reason why land values should not fall by much more than 40 per cent if serious stresses were to develop.   No one really knows what dairy land is worth in the longer-term (where will oil prices settle, where will the New Zealand real exchange rate settle are just two of the many relevant questions) but it is the sort of market where it is quite easy to envisage a severe overshoot.  I’ve been tantalized for several years by parallels to some of the very illiquid mortgage-backed products in the US –  not the ones that eventually saw huge defaults, but the ones where prices massively overshot in a climate of fear and illiquidity.

If each bank would prefer to be rid of some of its dairy exposures, each of them also knows that farm lending is going to be a major area of credit exposure in New Zealand for decades to come.  It isn’t like lending to, say, a new industry which comes to nothing and goes away.  If some individual farmers will leave the industry, the rural sector will still be around and collective memories can be powerful forces for good or ill.  Banks were scarred by their experiences in the last major rural debt shake-out  in the 1980s, and I doubt they will be eager to burn off goodwill among future potential clients.  That doesn’t mean there won’t be forced sales, but it is hard to envisage the major rural lending banks rushing for the door  (no matter how much unease the risk departments of bank HQs in Sydney or Melbourne or Utrecht might be feeling).

In some ways, a more concerning scenario for banks might be borrower panic.  If enough farmers concluded that they were working for nothing and that there was no prospect of serious relief in the next few years they could, one by one, just choose to (try to) exit the industry.  Of course, they’d still have to find buyers, but in a climate like that collateral values could collapse anyway.  From the perspective of banks, it may be preferable if most farmers doggedly fight to stay on the land, allowing banks to make the calls on who to sell up and when, having regard to the potential impact on the rest of their national dairy portfolios.  No individual farmers cares much about that.

But I still have no idea what, if anything, Labour is proposing the government or the Reserve Bank should do to “stiff arm” the banks, to prevent widespread sales.  I’m pretty sure there are no existing legal powers that could appropriately be used for that purpose.  Of course, behind the scenes all sorts of threats and pressures could be brought to bear, but surely that isn’t how we want to country to be run?    So if Labour’s call means anything much they must be talking of new special legislative provisions.    There was a great deal of resort to such measures in New Zealand during the Great Depression of the 1930s –  allowing writedowns of loans, and of interest rates. Perhaps one could mount an argument for those interventions –  on a basis of a totally unexpected collapse in the entire price level, an issue in macroeconomic mismanagement  –  but what would the case for intervention now be?

It seems pretty clear that any dairy debt losses are not likely to be large enough to threaten the health of the financial system –  especially, as this is a slowly developing situation in which banks have plenty of time to bolster their capital buffers if that is required.   And to bailout individual farmers, or the sector as a whole, would represent a material new source of moral hazard –  a message to borrowers that they need not bear the consequences of their bad choices.  That would only increase future demand for debt –  in an industry that seems likely to continue to face considerable output price fluctuations

Of course, it may be that there is nothing much to Labour’s call at all –  other perhaps than a desire to be heard.  I’m not a fan of government assistance to farmers experiencing drought conditions –  if managing weather risk is not one of the things farmers have to do, I’m not sure what is –  but if Labour is talking of things only on that scale then I probably couldn’t get too excited.  Then again, action on that scale doesn’t seem likely to make the sort of difference that would prevent “wholesale” exits and large scale increases in foreign land ownership.

Perhaps that “foreign land ownership” issue is really at the heart of Labour’s call.   I’m not an absolutist on foreign ownership of land.  After all, to be blunt, large scale English purchases of New Zealand land in the 19th century –  even if mostly, individually, on a willing-buyer/willing-seller basis, did rather dramatically and permanently change the character of the country.    But in the current situation we seem very far from that sort of risk.  And in the shorter-term, the best hope for embattled farmers, and lenders, is the presence of a contested market of keen potential buyers.

And what of the call for a summit?  It seemed like a pretty tired old suggestion, and it isn’t obvious what the role of the government is in such industry issues.  We’ve heard endless talk over the years of “moving up the value chain” and farmers (the Fonterra owners) might reasonably be sceptical of the results to date.   But summits about long-term industry strategy don’t seem that relevant to the issues of the current overhang of farmer debt.

Do I have any sympathy for indebted dairy farmers?  Yes, to some extent.  There are individuals and families involved, and the stresses –  as in any struggling small to medium business –  must be pretty intense and hard to cope with.  It isn’t something those of us who spent our working lives as government officials never face.  Then again, the upsides in the good years are also pretty extreme.  Running a leveraged business is a high-variance operation.

Cyclically, of course, farmers would be somewhat better off if we had a Reserve Bank that was doing its job better.  With core inflation probably around 1 per cent, and real interest rates higher than they were a couple of years ago (and real retail rates probably higher than they were at the start of the year), there is simply no need for the OCR to be anything like as high as it is now.  The OCR isn’t, and shouldn’t be, set with a view to supporting dairy farmers (or people in any other specific sector) but an OCR more consistent with the Bank’s own Policy Targets Agreement would (to a small extent) ease farmers’ financing costs and be likely to result in an exchange rate rather lower than it is now.  We saw the impact of last Thursday’s surprise (itself mostly a timing surprise).  It isn’t obvious that the OCR at present needs to be any higher than 1.5 per cent.  At that level, we’d be likely to see the exchange rate quite a bit lower again, and every cent off the exchange rate raises the prospective payout to diary farmers, materially affecting prospective profitability of people in the industry.  Not many farmers probably did contingency plans in which the TWI would still be above 71 even with WMP prices at current levels.

For the longer-term, if governments want to focus on more structural issues, there is a whole range of policy measures which help and hinder the dairy sector.

The ability to import large numbers of foreign dairy workers acts as a direct subsidy to the industry –  holding down industry-specific wages rates – and has probably largely been capitalized into rural land prices.   Water quality rules have been being tightened, but the ability to pollute, and pollute without paying, is another subsidy to the dairy industry.  Subsidised irrigation schemes go in the same direction.  None seems well-warranted.

And on the other hand, all tradables industries in New Zealand suffer from our very large scale immigration programme.  Whatever monetary policy is doing, the resulting quite rapid growth in the population keeps upward pressure on the real exchange rate, driving up the price of non-tradables relative to the (largely fixed) global price of tradables.  That makes it harder for firms operating here to compete in international markets, and helps explain why the per capita output of the tradables sector as a whole is no higher now than it was 10-15 years ago.    We shouldn’t be reorienting our immigration programme around the short-term needs of particular industries, but the biggest single factor New Zealand has some control over that would help the dairy industry at present would be a lower exchange rate.  A much lower immigration programme would, among other things, achieve that.  It might also allow a more hard-headed longer-term conversation about some of those industry subsidies.

10 thoughts on “Labour and the dairy debt

  1. Over the last 3 years international tourist arrivals increased by 615,000. Net migration gains over the last 3 years of 144,000 made up of international students and returning Kwis make up most of the net increase in migration. I am still at a loss as to how the impact of 144,000 poverty stricken students and redundant returning kiwis would impact more than the 615,000 additional tourists which now number in excess of 3.2 million every 12 months,

    “keeps upward pressure on the real exchange rate, driving up the price of non-tradables relative to the (largely fixed) global price of tradables. ”

    How does the $2.85 billion spend by international stiudents have a significantly greater impact on the NZD than the $11 billion spend by international tourists??


  2. Very briefly…since we’ve been over this ground numerous times

    1. Our residence immigration programme has nothing to do with students
    2. Students and tourists represent export earnings. Those they pose pressure on demand – all output does – but they generate external earnings that support our consumption.
    3. Residence approval migrants generate demand, and then the economy “has to find” new export-earning jobs to sustain them.


    • 1. Of course it has everything to do with international students. As we can see from NZ Statistics, real permanent migrant arrivals for 12 months is only 14k a year but as the government targets 40k to 50k, the difference as you have usually argued comes from international students as we have provided them an additional incentive on completion of their study program. You need to be more consistent with your statements.

      2. No arguments there. Yes they do generate export earnings but also it is clear that a significant amount of the short term demand pressures on resources and on the NZD has to be related to be related to a significantly larger number of people associated with international students and tourists as they are people. They do require accomodation and goods and services.

      3. Residence approval migrants are usually here because they have a skill that is in demand by a employer therefore the job is already there for migrants to be gainfully employed. Of course the question then is why are there so many migrants who are trained doctors driving cabs? That is more a practicing licence issue rather than a immigration issue.

      The problem with export is that you are actually overproducing what your population actually needs. For example, NZ is the largest exporter of milk products but not the largest producer of milk products and thats why when the big boys decide to point their gigantic production capacity at us, we are literally blown out of the water. You cannot expect to export and be market leader without a decent sized domestic market when you have built sufficient brand loyalty and a loyal consumer base. This brand loyalty is never achieved overnight. When we export we are trying to take market share from someone else. Sooner or later they will respond.


      • On your final point, I’m not sure it is true at all. If you are exporting raw commodities (oil, iron ore or even milk powder, brands don’t matter much if at all). and if you are exporting sophisticated products, many producers go straight to a global market anyway.

        There is no sign that countries with smaller populations are poorer (or growing more slowly) than those with large populations


      • Of course we are branded. It is called NZ Inc. We have a clean green image and people are prepared to pay a premium. We are niche market exporters and need a premium sale price due to our high NZD.


      • I don’t think there is much evidence for the value of the brand. There are rare exceptions – eg milk powder post Melamine – but mostly we sell pretty basic commodity products (actually even on export education – all the PTEs aren’t exactly Oxford or Harvard)


  3. It seems Labour often feels it must say something, almost anything, to differentiate itself from the government, and I understand the urge to do so. But then it ends up hand waving while Bill English smiles benignly, takes the high ground and assures us all is well. We like to feel calm.

    But basically, the business model is, at the margins, coming to a natural end: international supply competition is affecting our farmers just as it is US shale gas extraction companies; capital is flowing into import substitution in our biggest market; the externalities of pollution dependent farming are generating widespread local and international hostility; and consumer tastes are fickle, anyway.

    As a manufacturer who lived through the abandonment of that sector in the 80s, at the only time export focused manufacturing was granted a level of government support approaching that of farmers – not to mention as a child growing up in a rural setting and observing the extraordinary privileges granted farmers in that era – I have always harboured a degree of resentment that the dairy sector is so coddled, for what appears to me largely political purposes, but I must park that as it’s not useful.

    We need to change the business model, of that there is little doubt. Political parties and public servants aren’t going to be able to decide to what extent change is necessary and what use the failed farms and their land can be put to. That is up to consumers and producers, surely. But perhaps we could atone for our methane pollution by planting them with trees!

    What a government can do – and I’m sure is doing – is to keep in communication with the major banks and be ready to step in with support (for the banks, primarily) in the event of a social catastrophe occurring i.e an ongoing price slump and falls greater even than 40% in land values. But we must bear in mind that for the majority of farmers, the former is more of a problem than the latter, and in the ordinary course of events will not lead to catastrophe – the market will bottom and incomes rise, eventually. With very low debt and very low interest rates, the government is well placed ensure the overseas banks act more in line with the public interest than their private (perceived short term) interests, and based on past history I think will do so. Crises have a way of obscuring left/right divides.

    In the longer term, your recent analyses of immigration in the New Zealand context is pretty compelling, and I hope your message gets through.


    • The message is not about immigration it is about a preference for a lower population in NZ. In other words 4.2 million people is too many people for a country as isolated as NZ from the rest of the world. This is the gist of Michael’s thesis.


  4. Dairy farmers owing $10 million on their properties are not necessarily the focus of dairy industry leaders marshalling the troops to support struggling farmers on low payouts.

    About 10 per cent of the most indebted dairy properties owe a combined $11 to $12 billion, about 30 per cent of total dairy debt.

    DairyNZ says some, but not all, of the properties are at risk and the first priority is to support vulnerable sharemilkers who own cows, but have no land assets.

    DairyNZ chief executive Tim Mackle said Fonterra’s lowering of the forecasted milk price by 25 cents to $3.90 a kilogram of milksolids would mean that farmers would receive even less milk income than expected this winter and spring.
    Puts it in context.


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