Eco-Economy: Banking Reform in New Zealand
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Speech to the Mana-Tawa Grey Power in the Pataka Community Room on March 13 at 1:30 pm.
Banking and Banking Reform in New Zealand
By Finlay Thompson.
Good afternoon and thank you for inviting me to speak. I would like to compare and contrast two bank reform movements that attempted to shape the New Zealand financial scene.
Firstly there is the Social Credit movement, born out of the Great Depression and Major Douglas’ writings. Although Social Credit remained (and still remains in the form of the Democratic Party) an important political force throughout most of the 20th century, they have been largely unsuccessful in terms of bank reform.
In contrast the Free Market reformers, active since the seventies (at least), have been very successful. Indeed it is not too much to say that they have dictated the structure of our financial system since 1984. After being voted into power as a Labour Party MP, Roger Douglas later set up the ACT Party that continues to lobby for the Free Market reformers.
What were these two groups of reformers actually talking about? Any why were the Free Market advocates so successful? What killed the Social Credit movement?
New Zealand has a long tradition of radical reform. This typically involves supporters with strongly idealistic points of view, backed up with convincing rhetoric and, most importantly, electoral victory. Most of these reforms have been successful and mostly New Zealanders are proud of our pragmatic, egalitarian and progressive traditions.
The banking industry has not been immune to this progressive reformist agenda.
Bank Reform in the 1980’s
The financial deregulations that came with Roger Douglas’ term as Minister of Finance were some of the most radical, and idealistic, reforms ever attempted in New Zealand or anywhere else for that matter. The idealism and the accompanying rhetoric that accompanied this reform are well documented: the key notion coming from the idea that a “Free Market” would provide more “efficient” services than a strongly regulated economy. Before the deregulations the New Zealand economy was very much controlled by the government, both directly through the large state owned enterprises, and through protectionist interventions: tariffs, quotas, etc…
This interventionist approach, although tried and tested, had gotten very cumbersome. It had become difficult to adapt quickly to the international events of the 1970’s. We were punished by the oil shock and then the deterioration of our Terms of Trade when Britain joined the EEC. The economy was in a pretty bad way by the end of the 70’s.
Advocates of the Free Market agenda were swept into power in 1984 and they started immediately. The New Zealand financial and banking system was completely and radically reorganized. It is interesting to note that the same agenda was introduced in 1976 but the then PM and Minister of Finance, Robert Muldoon, quickly changed his mind and the reforms were dropped.
The electorate bought into the dream because it was thought that a more efficient economy would provide a greater standard of living for all New Zealanders. Efficiency gains would “trickle down” to the people and make us all wealthier. It is important to remember that Douglas’ was a Labour Party MP, and was at least publicly dedicated to advancing our society along an egalitarian track.
But what happened?
Despite the endless stream of misinformation and upbeat talk about the “New Zealand Experiment”, the consequences of our financial deregulations are well known to those of us who have lived through the process:
- Enormous increases in foreign ownership of New
Zealand’s productive assets,
- Much increased volatility of interest rates and exchange rates,
- Shrinking public expenditure, including health and welfare,
- Increasing levels of indebtedness, particularly amongst the young.
I recently talked to Dr Arthur Grimes, keen advocate and active participant in the reforms, and principle author of the Reserve Bank Act 1989. For him the terrible demise of our economy as just mentioned cannot be linked to the financial deregulation. For him the only consequence of the deregulation has been price stability, the reforms have successfully tamed that dastardly beast called inflation.
When I asked him for an explanation of what might have gone wrong, he informed me that New Zealand bank managers were inexperienced in the 1980’s, that our people are spend thrift, that we do not save enough, etc…. In other words, “it is our own fault”. He is happy that all our banks a foreign owned, they do a better job.
This attitude is typical. I have come across it many times while talking to the economists and officials who run our banking system.
The Social Credit Movement
As many in Grey Power will know, bank reformers have been debating money and banking issues for a long time in New Zealand.
Long before the 1980’s the Social Credit movement had been advocating financial and banking reform. This movement dates back to the experience of the Great Depression of the 1930’s.
People were shocked and alarmed at how the economy could get so “broken”. New Zealand was, and is, rich in the basics: food, air, water, and shelter. And yet people were out of work and hungry. Food riots shattered the calm of colonial New Zealand.
Suddenly people were looking closely at how the finance system actually works, and examining what might have gone wrong. Among the many reformers that came out of the period, Major Douglas (what is it with that name!) was the most popular. Although he was scorned by bankers and economists, people flocked to come and hear him talk as he toured New Zealand.
He had a popular message: We do not have to be constrained for lack of money! For Major Douglas, money is a social construct, created by society, and should be organized to serve the good of all people. We must not allow money, or the people who run the money system, to restrict the real world activity of the people.
Out of this enthusiasm Michael Savage was swept into power. He immediately implemented Major Douglas’ ideas and propelled the economy out of the depression. People were back at work and things were good again. He was also involved in bank reform: the first act of Parliament for the first Labour government was to nationalize the Reserve Bank.
However after Savage, the Labour party adopted more internationally acceptable practice and retreated from Major Douglas’ approach. In the 1950’s the Social Credit party was formed. It was an important third party for many decades in New Zealand, gaining 10% of the vote in 1954 and 22% in 1981. Even today the present government depends on Democrat support, albeit indirectly through the Alliance.
But what did they advocate? What happened to their ideas and how do they relate to the Douglas’ deregulations?
What Happened to Social Credit?
The Social Credit movement did not succeed in bringing about any meaningful reform of the banking sector. However it is interesting to think about what they wanted to do.
As far as Social Credit was concerned, the problem with the existing financial system was that private commercial banks were being allowed to create money and lend it to the government for public works. For them this placed an absurd restriction on what the government could do. Moreover why should the government put itself into debt unnecessarily? The Reserve Bank is able to create money and lend it to the government, and on much better terms.
Michael Savage’s government did use Reserve Bank money to build hundreds of state houses in the 1930s, pulling the country out of the depression. However this practice was stopped when Savage died. The government went back to borrowing money from commercial banks, according to the Keynesian prescription.
But the issues were very murky back then. Banking was mysterious and most people really didn’t understand how banks operate. New Zealand still held on tenuously to a gold standard of some sort and the idea that commercial banks create money out of nothing was something that economists of the time did not want to admit. These days the process that allows commercial banks to create money is explained in dozens of economics textbooks in a matter-of-fact kind of way. However no justification for why bankers should have this power is ever provided.
As a result of the electoral success of the Social Credit Party in 1954, a Royal Commission on Monetary, Banking and Credit Systems was held in 1955. In talking to many Social Credit people I have been directed to the Reserve Bank’s submission, in particular page 59! In that document it clearly states that:
…it might with some reason be said that “banks create credit out of nothing”…
This was seen as a major concession: The bankers were finally admitting that they create money “out of nothing” when they lend it. In terms of bank reform, this minor victory was the closest the Social Credit movement got.
Two Ways to Create Money
New Zealand dollars come into existence through one of two processes.
The Reserve Bank can print notes or mint coins. As everyone knows this is a very profitable business, and the government strictly enforces its monopoly right to create cash. The Reserve Bank also creates money when it lends to the government. These loans were once a major component of deficit funding in the years before 1984.
However Reserve Bank money makes up less than three percent of the money circulating in the economy. The rest comes from commercial banks.
Commercial banks create money every time they lend it. If they lend you $100,000 the bank does not get the money from somewhere else, it simply makes two entries in the books: an asset: your loan to the bank, and a liability: the new deposit in your current account. This is called asset sheet expansion. The money is created by the agreement between yourself and the bank.
Commercial banks have been doing this for centuries of course. The question is a matter of degree. New Zealand governments before 1984 placed many constraints on how much money the banks could create. Mostly Reserve Bank credit amounted to about 14% of the money supply.
Interest rates were tightly controlled, reserve requirements were enforced and bankers were regularly advised into which sectors of the economy they could lend.
The Social Credit Party advocated extending State control over the financial sector. They wanted to stop banks from creating money out of nothing. They wanted the government to use Reserve Bank credit for public capital works.
Then Robert Muldoon said “Funny Money” and the Social Credit Party was dead.
Roger Douglas Turns on the Money Tap
The first act of the incoming Labour government of 1984 was to drop all reserve requirements. Immediately the banks started lending huge amounts of money into the New Zealand economy, creating enough new money to double the money supply by 1987. Most of this new money went to a new group of young businessmen, many of whom have become (in)famous for getting rich rather fast.
The result, as is well known, was the stock market crash of 1987. The final result was to allow foreign companies to buy, at bargain basement prices, almost all the productive industries in New Zealand.
But the scandalous thing is that the Labour government simultaneously implemented another policy: to fully fund the deficit by borrowing from banks!
This forced the government to tightly control spending. The government sacked much of the state sector and government services were slashed. All because there wasn’t enough money!
But hold on. These same people had just allowed the private commercial banks to create billions of dollars and lend it out to their mates.
In other countries this kind of behavior might be considered fraudulent and corrupt. Here in New Zealand the political establishment, albeit encouraged by international support, heaped praise on those farsighted reformers. Roger Douglas was a courageous political realist. Michael Fay was the model businessman.
At the same time the Social Credit movement went into a serious decline. Proponents of Social Credit were isolated and ignored. How silly they seemed in the new world of global deregulated financial markets. But was there any debate on the key issue? No. No one mentioned the fact that private commercial banks were cheating the government, and the people of New Zealand, out of billions of dollars. And the cheat has two effects: in the short term the government had less money to spend, in the long term we became heavily indebted.
Social Credit had argued that this would be the result. They were right and they still are. The existing system does not work in our favor. Instead it acts to push us further and further into debt, forcing us to pay more and more to foreign creditors.
New Zealand Banking Reform
In May 2000 Deirdre Kent, Nathan Goodhue and I met and decided to form a lobby group. The result is New Zealand Banking reform. We have held public meetings, issued two newsletters and set up an email group.
But why set up a new group?
NZ Banking Reform is not a political party; we want to have a single-minded focus. We will simply shed light on the financial system, open up discussion and advocate bank reform.
We also felt that a new approach was necessary: we will be focusing on the existing financial system instead of proposing a new one. The approach of Social Credit was to make concrete proposals. However orthodox economists and bankers cut them down because it is easier to argue against a hypothetical system than an existing system.
Thus we have not made any specific proposal about how to reform the financial system. Instead we want to focus on clarifying the existing system, and making the call for just and healthy banks. There are alternatives.
By the way, our next meeting will be on April 30 at Connolly Hall at 7:30pm. We will be focusing on local body debts, on the possibility of reducing the cost of financing public works. The title of the meeting is: “Lower your Rates by Dumping the Debt”.
New Zealand Banking Reform,
Wellington New Zealand.