Modern Monetary Theory (MMT) economists have argued from the outset that using rate hikes to curb inflationary pressures may actually increase those pressures through their impact on business costs. Businesses with outstanding trade credit or overdrafts will use their market power to pass on higher borrowing costs to consumers. More recently, we have seen other mechanisms by which central bank rate hikes actually fuel inflation. Regular readers will know that I’ve been discussing how landlords are passing on higher mortgage costs in a tight rental market, creating a vicious cycle — higher interest rates, higher rental costs, higher CPI (since rent is a big component), higher inflation, higher interest rates. repeat. The tight rental market is partly the result of a neoliberal austerity bias that has resulted in grossly under-invested government in social (low-income) housing. In recent days, we have witnessed a frenzied reunion of neoliberalism and destructive policies. Earlier this month, Australians received word from the company that supplies them with electricity announcing that the Australian Energy Regulator (AER) had approved electricity price increases of between 19.6 per cent and 24.9 per cent across the east coast states. How did this happen, especially with world coal prices falling rapidly and below pre-pandemic levels? How has the bias of monetary policy exacerbated this situation?
Over time, it has become apparent that the various components that have in part defined the neoliberal era—the deregulation and privatization of public utilities (water, electricity, telecommunications, etc.), the outsourcing of public services to the private sector, the deregulation and collapse of industry regulation, especially concentrated industries such as energy, banking, and the austerity bias that led to the collapse of public housing investment, and the primacy of monetary policy over fiscal policy—are inherently problematic and have failed to deliver on their promises.
But it’s much more than that.
We are now seeing how these factors combine to have unintended adverse consequences for citizens.
Today, I want to talk about electricity prices, as a significant increase in electricity prices has just been passed on to consumers in Australia.
The chart below shows Australian thermal coal (Newcastle/Port Kembla export ports) prices (USD/tonne) from June 1993 to May 2023.
I sometimes live near Newcastle, the largest coal export port in the world.
Huge quantities of coal leave the port every day by head in large tankers that line the coast, waiting their turn to pull into port and load onto the massive coal loaders that transport coal from further afield in the Hunter Valley.
This obviously presents a major problem for the region, which must wean itself off coal as soon as possible.
But that’s another topic.
The purpose of the graph is to show how much coal prices have fallen since their peak in September 2022 ($430.81 per tonne).
By the end of June, the price was $139.42 and was falling fast.
They are now below pre-pandemic levels.
Natural gas prices in world supply markets follow a similar pattern.
Electricity Prices and Inflation
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The chart below shows the index change for the CPI for all groups and the electricity and natural gas components from the March 1975 quarter to the March 2023 quarter.
It is clear that since the turn of the century, energy prices have risen faster than overall price levels, and this trend has been particularly acute in the current period.
what is going on?
In terms of weight in the overall CPI, electricity and natural gas and other household fuels belong to the housing group, accounting for 23.24% of the overall index.
Housing is also the most important component of the overall index.
Within this category, electricity accounted for 2.52% of the total CPI and natural gas and other household fuels accounted for 0.97% of the total CPI.
Very important.
Therefore, changes in electricity prices will drive large fluctuations in the consumer price index.
This would prompt central bankers influenced by the current NAIRU ideology to raise interest rates.
So therein lies the problem.
Supply disruptions caused by the situation in Ukraine, weather disruptions in Australia and other factors have sent coal prices soaring, driving up costs for energy suppliers.
Firms in highly concentrated energy markets then pass on these costs in the form of higher prices.
Then pushed up the CPI.
This then prompted the central bank to raise interest rates.
This results in higher business costs.
Then pass it to the consumer.
Then pushed up the CPI.
This then prompted the central bank to raise interest rates.
That’s the way it is.
But in Australia’s case, the issues are more complex and driven by past government decisions.
Ask yourself, why have energy prices risen so much when coal prices have fallen sharply and wages in the industry haven’t risen significantly?
Coal-fired power stations still dominate Australia’s electricity generation, although the pace away from coal-fired power stations is gathering pace.
Australian Department of Climate Change, Energy, Environment and Water website – generate electricity – Notice:
Fossil fuels account for 71% of total electricity generation in 2021, with coal (51%), natural gas (18%) and oil (2%). Coal’s share of the electricity mix has continued to decline, compared with more than 80% of electricity generation at the start of the century.
In 2021, renewable energy sources will account for 29% of total electricity generation, especially solar (12%), wind (10%) and hydro (6%). The share of renewable energy generation increased from 24% in 2020.
So despite the rapid adoption of renewable energy, coal still dominates.
In Australia’s privatization frenzy in the 1980s, state governments sold public energy companies and split them into wholesale, pole and wire, and retail businesses, arguing that this would provide competition and better service at lower prices.
This is a myth.
To overcome the criticism that these are effectively natural monopolies and that new companies still wield enormous market power and are able to extort money from consumers for providing essential services, the government has created a regulatory environment.
The Australian Energy Regulator (AER) oversees the system and you can find details on their website: Energy Industry Regulation – Place.
The regulatory structure has various components.
But the problem starts with the conditions of sale.
In most cases, to avoid embarrassing sales, the government set conditions for privatization that favored buyers.
In many cases, the prices at which assets were sold were artificially low, and the expected returns for new operators were irrelevant to the real-world conditions the industry was experiencing.
That is, the government offers guarantees of returns to new operators to entice them to enter the market.
In New South Wales, for example, a syndrome known as pole and wire “gilding” has been identified.
The phenomenon was discovered as electricity consumers in NSW were hit by a sharp increase in prices.
Companies that own wires and poles bypass the regulatory structure by “overinvesting” (i.e. “gilding”) their networks and passing those costs on to end users, the regulator has revealed.
Following an investigation, regulators attempted to establish a reasonable investment rate, but were challenged by the operator, who subsequently won a lawsuit on the issue in federal court and continued to sabotage the system with impunity.
Obviously there can’t be competition on poles and wires because the wire has to go to the house and the company that owns that wire has a monopoly and can charge you what they want.
However, the privatization arrangement allows the newly created company to obtain a guaranteed ROI on the network.
You can learn about the way regulators treat returns: AER – Rate of Return Tool – February 24, 2023.
Essentially, regulators set some baseline ROI that energy companies can treat as minimums and prices regardless of market conditions — because they’re effectively monopolies.
If the central bank raises rates, benchmark returns rise.
AER states:
In summary, the methods and parameters we have chosen for the 2022 instrument are essentially the same as for the 2018 instrument. However, the returns derived from the 2022 instrument at this time are higher than those in December 2018. This is due to an increase in underlying market rates in recent years rather than a change in our methodology.
However, when interest rates are low, AER is concerned about “the adequacy of our return on equity during periods of low interest rates.”
So there’s an asymmetry in how the regulatory system works, which works in favor of operators.
But the point is:
1. The RBA raises interest rates.
2. AER increases the allowable rate of return.
3. Privatized firms use their monopoly power to drive up prices.
4. The proportion of electricity price is relatively large, and the growth rate of CPI is accelerating.
5. The RBA further hikes interest rates.
Interest rate hikes aimed at curbing inflation fueled inflation.
Things got worse.
If higher rates cause demand to stagnate, companies can push prices up even further to ensure they earn an adequate rate of return.
So, just because the prices of coal and gas have fallen, privatized firms can still drive up prices based on past investments.
This is the price society pays for wrongful privatization.
in conclusion
In the past, these utilities were public services whose metrics were not based on private profits or returns.
In this case, we will not fall into the above-mentioned vicious circle.
The fact that the government has guaranteed returns to attract investment in the privatization process has turned the power monopoly into an unrealistically efficient profit-making mechanism.
This means that RBA rate hikes are themselves inflationary.
Enough for today!
(c) Copyright 2023 William Mitchell. all rights reserved.
