Sludge Report #73 – Borrowing And Saving

In This Edition: English’s Point On Borrowing And Saving Hits The Mark - Alternative Ideas Deserve A Look

NOTE: Authors of this report will be anonymous and wide ranging, and occasionally finely balanced. Indeed you are invited to contribute: The format is as a reporters notebook. It will be published as and when material is available. C.D. Sludge can be contacted at sludge@scoop.co.nz. The Sludge Report is available as a free email service..Click HERE - http://www.scoop.co.nz/mason/myscoop/ to subscribe...

Sludge Report #73

English’s Point On Borrowing And Saving Hits The Mark

The controversy that the National Opposition is set upon rousing over the relationship between the government’s borrowing programme and its plans to put funds in a collective Superannuation Fund raise some interesting issues.

National’s Bill English points out that Government plans to borrow around $3.5 billion over the next three years coincide with plans to allocate a very similar sum to the planned Super fund.

On the face of it English has a good point. What is the point of borrowing $3.5 billion from foreign bankers (note: In NZ all banks are foreign) with the intention of promptly investing an identical sum in a savings fund?

Such a move is not unlike a household extending their mortgage in order to invest in a diversified investment fund. While there is a chance that the super fund savings may earn more than the around 6% interest cost charged on the borrowing, there is also a chance that it won’t.

And you can safely assume if the super fund fails to match the interest cost on the borrowing then Bill English will waste no time in pointing out the folly in the policy.

Dr Cullen responds that the $3.5 billion the government is planning on borrowing from banks is not necessarily the same $3.5 billion that he plans to salt away in his Super scheme. Indeed, he says, this $3.5 billion might well be the money being spent on defence, or for that matter health, or the Kiwi Bank.

But this argument, like most of the attempts at post-budget justification by Ministers of this Government, lacks all credibility.

To use the household metaphor again, it is like saying the money you are borrowing against your mortgage is not the same money you are putting in your savings portfolio, rather it is money needed to buy a new car. While this may well be your intention, it is nevertheless a fairly clear example of sophistry. Would your friends buy into this logic were you to outline your plan to them?

And thus Sludge reckons English is probably onto a winner with his current argument.

However, from Sludge’s perspective the issue being raised here – i.e. governmental borrowing and saving, and the acute shortage of cash faced by this government and the people of New Zealand - raises other, far more important issues which, thanks to the Super debate, may now get an airing.

Sludge is probably being unduly optimistic on this point, but given the frustration at the manner in which their budget is being perceived, it stands to reason that new ideas about these matters deserve at least a first look by this Government.

Alternative Ideas Now Deserve A Look

Sludge’s first question about the Government’s borrowing and savings plans is this. Why are New Zealand government’s borrowing money from foreign banks at all?

Under the Reserve Bank Act as it stands this is unnecessary. The Government owned Reserve Bank is empowered to lend to the government at a zero interest rate, without borrowing the money first from foreigners.

It doesn’t do so of course, and hasn’t done so for decades, but it can, even if most people including the PM have forgotten.

Since the 1984 Roger Douglas/Rod Deane monetarist putsch now mere mention of this power is considered economic heresy in mainstream economic fora – but why?

Sludge has no doubt about the causes of New Zealand’s economic woes, lack of money (see also… Sludge Report #20: Our Vegetable Economy)

In order for any economy to grow there needs to be money supply growth. Even mainstream economists will agree to this, though they will argue that money supply growth is an entirely “demand driven” phenomena and it is essentially a chicken and egg argument. That is they say that money supply growth will follow economic growth, if and when it occurs.

But, Sludge asks, why since the election of the Labour Government in November 1999 has money supply growth slowed by around 50% from what it was on average for the previous decade?

And, if money supply growth is a demand driven phenomena and it is growing too slowly – which it is (if you remain skeptical look at the M3(R) table at http://www.rbnz.govt.nz/statistics/monfin/c1/data-01.html#P171_617 which shows growth of just 5.2% year on year) – then why is the Reserve Bank pricing New Zealand money more expensively than any of our trading partners?

Justifying his decision to hold NZ interest rates high, Reserve Bank Governor Don Brash last week remarked to a Rotary audience in Auckland. “Monetary policy is not a race, with every central bank trying to get to the finishing line first. It is about adjusting interest rates to influence demand within a specific economy to ensure price stability in that economy. What is right for one country might well be entirely wrong for another. “ (see also Brash’s full speech… Should the RB have eased as fast as the Fed? and Sludge on the latest Reserve Bank interest decision… Sludge Report #63 – More Steak Less Vacillation)

Sludge thinks it is a good thing that monetary policy isn’t a race, as if it was New Zealand would be at least a couple of laps behind everyone else in the running. As for the rest of Don Brash’s justifications for strangling the New Zealand economy, he might as well be talking out a different hole for all the sense his analysis of what is happening to New Zealand makes.

Taiwan for example has enjoyed average growth rates of close to 8% for a couple of decades, while New Zealand economists would be putting a positive spin on the situation if they claimed NZ had expanded at an average rate of 2.5% a year in recent times.

So what is the difference between Taiwan and New Zealand? The answer is simple - financial market deregulation.

New Zealand effectively has no banks of its own. And its central bank has been de-toothed and de-clawed. Taiwan, on the other hand, like Japan, Singapore and the USA, has real banks.

New Zealand, thanks to Roger and Rod’s putsch, has effectively no controls over the formulation of its capital base. We have no capital flow controls, no liquidity controls, and following the removal of the overnight cash settlement regime, no controls on when or by how much banks expand or limit money supply growth.

The only manner in which New Zealand impacts on financial markets is via the Reserve Bank setting of the price of capital via the official interest rate. Unfortunately, as the sluggish nature of the NZ Domestic economy stands testimony, this is an extremely blunt instrument.

No better illustration of the extent of the problem New Zealand faces is needed than the state of the economy at present.

New Zealand has been over the past two years been experiencing an export boom. Thanks largely to record low currency levels, annual growth rates in the export industry have approached 25% in recent times. Prices for commodity exports (in New Zealand dollars) remain at all time highs. And yet the New Zealand economy is barely treading water. Why?

Dr Cullen and the Government in their Budget say they want to assist the NZ economy to make a step up, for it to move to achieving 4% annual rates of growth, as opposed to the close to 2% growth presently forecast. But conditions for the New Zealand export and Tourism sectors (our big foreign exchange earners) are at present ideal. Fantastic growth rates are being achieved in these sectors, and yet NZ remains firmly in the doledrums. Why?

One would think that such circumstances would scream out to the government that its policy settings are not working. But not so. Instead Dr Cullen accuses NZers of failing to achieve internationally competitive productivity growth. Tell that to pastoral farmers who are now farming more than twice as many stock units per labour unit than they were only a few years ago. Tell that to Newspaper journalists who are now putting out their papers with half the staff they had in the early 1990s.

So what else can be done?

Simply put the only solution to New Zealand’s economic woes is for the Government to go back to managing money supply, just as it did prior to the 1984 monetarist putsch.

If foreign banks insist on starving the New Zealand economy of money, then lets start making it for ourselves.

And a very good place to start might be for the Reserve Bank to supply the money we are planning to collectively salt away for our retirement. In principle there is no obstacle to the $3.5 billion that the government is planning on borrowing from foreign banks, to be borrowed instead from the Reserve Bank, at an interest rate of zero per cent. A side effect of such a move would be to satisfy Bill English’s concerns.

But doesn’t this just mean the government printing money? And won’t it therefore cause inflation?

Sludge has no doubt this is what the bankers, and Don Brash, will say.

And yes it does in effect mean the government, or the Reserve Bank, would be printing money. But the truth is that that is exactly what the bankers are currently doing themselves. That is, creating the money out of thin air and then charging us for the use of it, while all the time telling us that we are lazy.

And if that argument does not convince you, have a look at how things work in Japan, Taiwan and Singapore, countries where, unlike New Zealand, the quality of life for the folk has improved over the past decade,

As for inflation, inflation is caused when money supply grows too fast, and the value of money is thereby devalued. There is little risk of this in an economy in which the real money supply (money supply minus the interest cost of money) is shrinking – as it is at present.

But if there are concerns about this happening then again the answer is simple. Re-regulate the banks so they can’t create money has fast as they desire, like they did between 1984 and 1987, the last period during which we suffered from excessive levels of inflation.

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