Pretending it can, or that the Reserve Bank of New Zealand can function independently from the rest of the world, could generate a financial crash. 

The very joining of monetary policy and fiscal policy into a single phrase is a criticism of the neoliberal macroeconomics. The reconfiguration under Rogernomics assumed that the two could be administered independently of one another, and gave an authority and power to monetary policy beyond what any reasonable analysis would conclude. It did exactly the opposite to fiscal policy, assuming that the management of taxation, public spending and public debt can do little to sustain the economy or contribute to public welfare, except by keeping each as low as possible. That is not the view of today’s serious analysts who have become much more vocal since the Global Financial Crisis.

However, the crude neoliberal – monetarist – position continues to dominate the New Zealand public discussion even though, if you follow it carefully, the Reserve Bank takes a far more sophisticated approach.

The fact is that the Reserve Bank has much less power than the monetarists think, especially when two key prices – consumer prices and housing prices – have quite different inflationary trajectories.. But even were they in sync, the Reserve Bank’s influence over the economy is limited as long as New Zealand is a small part of the international economy.

Imagine Te Awamutu establishing its own central bank with the belief it would have a massive effect on the local welfare, independently of what the Reserve Bank of New Zealand was doing. As absurd as that assumption is, New Zealand has about the same relative size in the world economy as Te Awamutu has in the New Zealand economy.

The fact is that Te Awamutu cannot issue a currency which operates independently of the New Zealand dollar and monetary conditions. The New Zealand dollar has about the same independence of the international currencies used in the world economy.

Yet much New Zealand commentary ignores such obvious facts, pretending that our Reserve Bank has the same power and influence as has, say, the US central bank. The Federal Reserve has the power to issue an international currency, which New Zealand’s central bank has not.

This column focuses on a single problem which illustrates the interdependence between monetary and fiscal policy. Many people say, why shouldn’t the New Zealand government run a fiscal deficit, spending more than its current revenues and borrowing the difference? After all, the New Zealand government debt is low by international standards – very low actually. What the advocates do not consider is that the offshore debt of our trading banks is high by international standards. All that international banking debt could end up a charge on the New Zealand government.

That is because trading banks can go to their central bank if they get short of cash when access to international funds dries up. That may solve their immediate problem but the effect is that the central bank, and therefore in our case, the New Zealand Government, would in effect become liable for the international debts of the trading banks. Those liabilities are, of course, matched by assets, which are liabilities of the trading banks. The catch is that the Reserve Bank assets are in NZ dollars, but its liabilities are in US ones. Its balance sheet becomes vulnerable to changes in the exchange rate and a substantial depreciation – a likely part of this scenario – would cost the taxpayer hugely –  among other things.

That almost happened during the Global Financial Crisis. In the circumstances the Reserve Bank and the Treasury handled the situation brilliantly – much better than the business commentator and other self-appointed monetary experts seem to be able to even understand. At one stage the government ended up owning, in effect, a chunk of the house mortgages of New Zealand.

As sketchy as I have been here, I think we can draw some lessons.

First, the New Zealand government is exposed to substantial foreign-exchange-denominated debt. This fact is quite in contrast to the neoliberal position that private debt has no relevance to government affairs, which is yet another example of neoliberal economics crashing as forcefully as did the world financial system during the Global Financial Crash.

Second, there is not nearly as much room for running a fiscal deficit as it might seem. In my view any additional spending causing a deficit should be on investment, especially income generating investment such as (affordable) housing or some types of infrastructure so it is less of a burden on future generations.

Third, New Zealand will not be as well placed if there is another local or global financial crisis as it was in 2008. The Reserve Bank is to be commended for the prudential measures it has taken (which shift some of the risk from the government to the private sector) but there is no longer the fiscal room we had then.

Sadly, and worryingly, much of the overseas borrowing has gone not into income-generating investment but into the transaction costs of housing speculation – on real estate agents, valuers, conveyancers and the like – into gambling really, with the croupiers making tidy profits. When housing prices turn soggy, or worse, it will not be possible to recover that spending because it is not an investment; it will also be difficult to levy those who benefited from the capital gains from the speculation.

This is a serious caution; there will be a future New Zealand government whose time will be dominated by the problems of high overseas debt (not for the first time in our history). Those on the watch whose negligence caused the high debt will be out of power and hardly held to account.

 

 

This column is a revised extract from Unfinished Business - What the 5th Labour Government Did Not Do and the 6th Should a paper to the Fabian Society,.

 

 

Comments (15)

by Stewart Hawkins on October 24, 2016
Stewart Hawkins

Oh heck, Brian. I agree. Isn't capitalism wonderful?

by KJT on October 25, 2016
KJT

Te Awamutu may be too small. I don't know if their is a fixed  lower size limit, but practicality dictates that the region has to have enough variety of skills and resources.

Certainly having their own central banking system has not done any harm to North Dakota.

 

by Rich on October 25, 2016
Rich

Could you post an image of a North Dakotan dollar?

by Murray Grimwood on October 25, 2016
Murray Grimwood

Capitalism - as is obvious to anyone monitoring the physical world - is destroying the biosphere we require to support us. Continue as we are and we're heading for extinction.

It shouldn't matter what size community you serve, as long as you don't charge interest. If you do, the resource-base will be drawn down. Do it long enough, and it will be depleted. Read Jared Diamond and Joseph Tainter.

What any 'dollar' looks like, is irrelevant, so presumably 'Rich' is a spinner?

The smartest dude in this regard was Henry Kissinger - a man I am reminded of whenever there's a heavy dew. When Nixon unpinned the US dollar from the gold standard (1970 - the year US oil peaked, and I contend it's no coincidence) it became unrelated to anything. Kissinger ensured that oil was 'traded' in US dollars - resulting in them being related to the most essential wealth-underwrite of them all. He must have known exactly what he was doing, and why.

My question about people who talk about 'the productive economy' vs 'invesing in housing', is: What is an economy but people building boxes and filling them with consumables? If they didn't do that, what exactly is left still happening? Who would be consuming the produce?

And my last question - always -  is why we don't discuss the ever-lessening possibility of repaying debt in a future which has to include an ever-decreasing supply of available energy.

 

by Peter A. Williams on October 25, 2016
Peter A. Williams

Murray, if only it were a matter of interest. As I am sure you are well aware from Diamond and others, societies die from a whole bunch of specific causes, mostly related to resource depletion driven largely by population increase, as per Erhlich. The mantra of the need to invest more "productively" would only hasten this process in the NZ case. Eg, say we stopped "investing" in houses and built 20 more Mdf manufacturing plants as we have here in Nelson rather than just exporting logs.....vastly more electricity and water would be required and more immigrants required (population increase) to run the plants, and then fill their houses with stuff. Result, further environmental degradation and the day of reckoning a fraction closer. 

by Antoine on October 26, 2016
Antoine

Brian

I'm too ignorant to understand this bit:

> That is because trading banks can go to their central bank if they get short of cash when access to international funds dries up. That may solve their immediate problem but the effect is that the central bank, and therefore in our case, the New Zealand Government, would in effect become liable for the international debts of the trading banks. Those liabilities are, of course, matched by assets, which are liabilities of the trading banks. The catch is that the Reserve Bank assets are in NZ dollars, but its liabilities are in US ones. Its balance sheet becomes vulnerable to changes in the exchange rate and a substantial depreciation – a likely part of this scenario – would cost the taxpayer hugely –  among other things.

Could you be so kind as to spell it out in more detail, or to point us to a longer explanation for novices somewhere?

A.

by Rich on October 26, 2016
Rich

Antoine: https://www.amazon.com/Stigums-Money-Market-Marcia-Stigum/dp/0071448454

is the classic text. I'd suggest reading through and understanding it.

 

by Antoine on October 26, 2016
Antoine

Thank you Rich

A.

by Murray Grimwood on October 26, 2016
Murray Grimwood

"A complete overview of the large and ever-expanding money market arena"

Exponential growth on a finite planet, then, Rich? Is there any part of it which addresses the physical underwrite of 'money', and the obvious limits to same? Any part of it which addresses the when/why/how of the inevitable post-growth epoch?

 

by Brian Easton on October 28, 2016
Brian Easton

Dear Antoine,

The following example might help. It is loosely based upon what could have happened at the time of the GFC.

Suppose the world money markets were to seize up (as they almost did). Then the NZ trading banks would not have been able to roll over their foreign loans, so they would pay off their foreign debts but, unable to borrow more offshore, would no longer have the cash to lend to their customers. (Complicated things happening here to the exchange rate.) Rather than calling in their (housing, say) loans, to pay off their foreign creditors, they would go to the Reserve Bank and borrow from them, using their assets (including house mortgages) to secure the loans.  The Reserve Bank would respond because that is the traditional role of a central bank and, if it did not, credit would dry up making business unable to function and consumers would face having their borrowings (including mortgages) called in.

So what we have is that the trading banks keep functioning and business and households are protected, but now the central bank has the task of finding the foreign exchange to pay off the trading bank’s previous foreign borrowings. (In fact credit swaps were arranged between the central banks. No, the US Fed (central bank) was not keen to get hold of NZ dollars; rather they will were willing to take on the $NZ and other currencies in order to keep order in the international money markets They were acting as a kind of central bank to other central banks – something they could do because they were in charge of THE international currency $US.)

Suppose the Reserve Bank had been unable to obtain the foreign currency to pay off the foreign debts the trading banks had incurred (or, inconceivably, we had chosen to default on our foreign debts). What happens next involves even more assumptions and complexities so it is hard to predict. But it would be chaotic. .

Hope that helps,

Brian. 

by Murray Grimwood on October 28, 2016
Murray Grimwood

Not just chaotic, Brian - inevitable, I suggest. And it can't be that far away.

Since 1980, energy-per-head has been falling. Debt has been increasing - through credit card limits, more and bigger mortgages, HP, etc. 2005 saw peak conventional oil (best EROEI energy source we ever had) and the debt overhang - never bigger - couldn't be underwritten by future work. Future work which needs future energy.The debt overhang has been increased more since then, while the underwrite potential has concurrently been being used up. Down to fracturing rock, digging deep underwater - in a word, dregsville. The trend-lines are increasingly divergent.

The can was kicked down the road, but by folk who either don't have a clue as to what underwrites money, or who don't want the problem known by the general public. Mass panic being what is is.

The result has been Central banks going more and more towards zero interest rates (the only rate which fits - temporarily - the top of the Hubbert curve). Thereafter, if they want to try to keep the system going, those rates will have to trend negative (it's the only trends which fits) as will investments, and inevitably profits - in some combination which will no doubt be fought over.

The problem I suggest was that the base cause of the 'GFC' (only called that because of our myopic fixation on money at the expense of reality) is getting 'worse' - there's ever-less oil of high EROEI.

So another GFC-type event is inevitable, is it not? But this time, less chance of credible bail-outs?

 

by Antoine on October 29, 2016
Antoine

Why is the Reserve Bank required to lend foreign currency to NZ's banks?

I could see why they would be required to lend NZ$s at a specific rate, but other currencies...?

A.

 

 

by Antoine on October 29, 2016
Antoine

And why do NZ banks borrow large amounts from overseas?

A.

by Antoine on October 29, 2016
Antoine

PS Murray, for the avoidance of doubt, I am not reading your posts

by Brian Easton on November 03, 2016
Brian Easton


Dear Antoine,

Why is the Reserve Bank required to lend foreign currency to NZ's banks? I could see why they would be required to lend NZ$s at a specific rate, but other currencies...?

It is very hard to predict exactly what would happen.

It is true that the RBNZ would lend in NZ currency to the trading banks. The trading banks would then convert the NZ currency into foreign currency to pay off the debts they owed. (Recall we are talking about a situation where there has been a seizure in the foreign exchange markets and they can neither borrow nor roll over debt in foreign currency markets.) That would probably collapse the exchange rate, inducing rapid inflation, unemployment and impoverishment. (This assumes, as is almost certainly true, that the supply-side responses from exports would be slow.) A further complication is that trade credit would probably dry up so that it would be difficult to export or import. 

At least that is what we fear but it is difficult to be sure because there would be so much chaos elsewhere in the world economy too.

What the RBNZ did during the GFC was arrange a ‘swap’ with the US central bank (possibly also with the British, European and Japanese central banks). In effect the RBNZ would have been able to borrow US dollars from it. (Remember that borrowing from any central bank is costly.)

And why do NZ banks borrow large amounts from overseas?

Much easier to answer, Antoine. Trading banks make their profits (largely) from charging a margin between what they pay for borrowing and what they charge for lending. The more they borrow/lend the bigger their profits.

Brian.

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