Matt Nolan

There is no such thing as a free lunch

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A column in the Sunday Star Times actually discussed an interesting issue this weekend; how the biofuel revolution will lead to higher food prices. They are exactly right, you increase the demand for corn, and the price of corn will increase. Now corn is a substitute for other foods, so the demand for other foods rises, increasing their price. Furthermore, corn is an input in the production process of milk, beef, chicken etc – so you shift the supply curve left, and the price goes up. Anyway you think about it, biofuels will push up the price of food.

Furthermore, when the government enforces regulation, what happens? The government makes petrol stations sell biofuels. As they aren’t already, they must be uneconomical, implying that they will be more expensive than normal fuel. As the government is saying that petrol companies have to sell a minimum amount of biofuel, they will have to cross-subsidise the price of biofuels with petrol, leading to an increase in petrol. Now, biofuels should reduce world demand for fuel, so the world price of petrol must fall, however I’m not sure which factor will be dominant when the price of fuel is determined.

It might be annoying that the price of food (and maybe fuel) will rise. We know that the most heavily affected will be the poor. Third world countries will face highly escalating prices for agricultural products, now even though some third world countries are food exporters, many of the poor in these countries have to pay the world price for food (in the same way we pay the world price of milk). As a result, rising food prices will make life even more difficult for the very poor in the age of biofuels.

Given this, it is difficult to know what would be optimal for the global community. The US is subsidising biofuels in order to provide a substitute for/reduce dependence on foriegn fuel. As oil is a non-renewable resource, we should be interested in finding substitutes. However, food is a necessity. Rising prices for food will affect outcomes, especially for the very poor.

The reason the price of food is rising, is that their is a limited supply, and governments are trying to use it as both food and fuel. Now you may argue that the supply of food will rise, and the price will again. This is a fair argument, however it is important to realise that the price of agricultural goods will be set such that the MC=MB for the least efficient plot of land. If the marginal cost of production on new land is significantly higher than on currently used land, we can expect prices to be a lot higher.

Ultimately, we have to realise that there is some tradeoff between these, and accept the consequences of the choice we make.

Matt Nolan

A little bit of risk is a dangerous thing

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So, our dollar has fallen 5% against the US, and 8% against the yen in the last few days. While some people may think that the prospect of no more interest-rate hikes is the driver, the truth is that market participants have become a bit more risk-averse.

A little bit of wobblying in the US stock markets, and suddenly a bunch of people have decided to unwind carry trades, and as we are the number one carry trade country, our exchange rate eased. That is why we are only down by 2% against the Aus$ since Thursday, they were a carry trade currency as well.

I expect us to stay around in the mid-70’s, we might even climb up a bit against the US. After all, this new found risk is based on subprime lending worries in the US, and the fundamentals of the strong NZ$ (high interest rates, strong commodity prices) are still in place. However, if asset prices (especially housing) start to ease too quickly, our exchange rate might be in for a bumpy ride.

Will Taylor

A Strict Application of “Kiwi Made” Actually Hurts Our Exporters

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While I am all for supporting the domestic economy, I think that a strict interpretation of the requirements for a good to be labelled “Made in New Zealand” actually harms our exporters. People get upset when they find out that something that is “Made in New Zealand” is manufactured using inputs purchased from another country. Any attempt to put pressure on exporting firms to use entirely NZ inputs is detrimental given that we are a small open economy with a very volatile exchange rate. The argument I’m making has absolutely nothing to do with price or quality but instead centres on a corporate finance concept known as “Natural Hedging”. Put simply if you have a company that sells its output in a foreign currency, purchasing your inputs in that currency naturally hedges movements in the exchange rate.  A good example of this is Navman who appear to be doing fine because they purchase a lot of their inputs in US$

While I accept that a good should still in essence be New Zealand made, I  believe that when the firm is an exporter, they should outsource as much of their inputs as possible.