New Zealand's "rock star" economic growth of the past couple of years has been attributed to two things: high dairy prices and the Christchurch rebuild. One of them has gone. The decline in dairy prices that started in February has steadily continued since. It long ago passed the point where it might be passed off as a correction from a high peak. The latest international auction has caused Fonterra to lower its price to farmers to $5.30 a kg of milk solids, which is below their average break even point. Many dairy farms will be running at a loss from here on. They ought to have ample reserves after five years of good prices though about a quarter of farms are said to be carrying high debt and all will be cutting costs this season.
The pinch will be felt particularly in rural towns and servicing industries but city dwellers will feel it too if the dollar depreciates, raising the cost of petrol and other imports.
The dollar was not dropping as the Reserve Bank thought it should in response to declining world demand for our dairy and forestry commodities. Last month, the bank has revealed, it sold $500 million into the currency market to bring about a fall. Its intervention had limited success, and had a little more last week when the bank announced what it had done. But at US78c on Friday, the dollar was still stubbornly buoyant, well above the US65c the Prime Minister says it should be. A lower dollar helps cushion the fall in milk prices and boosts all export returns, which is why the Government might welcome it. If the exchange rate also reflects rising confidence in the United States, it is doubly welcome. New Zealand needs foreign markets to enjoy a stronger recovery than they have seen so far. China's demand for milk powder was the main driver of the dairy boom. Now it has ceased importing while it consumes stocks and New Zealand has received another reminder that it can be too dependent on one commodity in one market.
If ever there was a salutary lesson in the limitations of commodities it was provided last week by the Tatua Dairy Company. The small Waikato co-operative reported a 27 per cent increase in earnings before tax for the year to July, compared to a 50 per cent drop in Fonterra's earnings over the same period. Tatua does not deal in wholemilk powder, it produces value-added products that sell on six-month contracts. Their prices do not fluctuate as sharply as commodities, in fact Tatua benefits from lower milk prices that reduce its input costs.
It would take a thousand Tatuas, though, to equal the 1.58 billion kg of milksolids Fonterra's farmers produce. Wholemilk powder will be this country's principal primary export for a long time yet. The collapse of prices this year does not reflect the long-term outlook. It is a reflection not only of China's glut but also Russia's suspension of imports in retaliation for Western sanctions over Russian aggression in Ukraine. That tension will pass, as will China's surplus of powder.
