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Balance of Payments and Macroeconomic Policy

The balance of payments' current account deficit (CAD) in the year to September 1999 was $6,610 million compared with a $6,217 million deficit for the year ended June. These figures, released on Tuesday, do not include an important new class of "invisibles" - e-commerce - which almost certainly means that the deficit is understated.

The 1999 CAD is a problem for New Zealand because it adds to the already large indebtedness of New Zealanders to the rest of the world (about NZ$100 billion). It's as if every annual deficit is a new credit card. Each new credit facility pays the interest on previous years' credit while raising the total interest bill.

In order to both pay for our imports and service our debts, we (New Zealand residents) need to export about 30 percent more or import 30% fewer goods and services than we do at present. Our land, labour and capital resources are being used increasingly to provide income for our international creditors instead of for ourselves.

We live nevertheless as if the problem did not exist. The international creditor community continues to advance us the credit that funds the ever-increasing interest payments. The key decisions that affect our future are now made in the boardrooms of New York, Sydney, Tokyo, Frankfurt and not in the Beehive.

International credit is like a drug for us. We accept it - indeed crave it - even though we know the harm it is doing to us. If the credit supply that funds our current account deficits and adds to our national debt were to dry up, we would go cold turkey.

Actually it's worse than that, as the experiences of Thailand and Indonesia in 1997 and 1998 showed. If our creditors ceased to advance us credit, the annual net capital inflow of around $6billion would be immediately replaced by a massive net outflow as New Zealanders seek to protect the international value of their liquid assets. Most of New Zealand's imports would stop, almost overnight, at least until the situation could be stabilised. The value of the $NZ dollar would plummet. And the brain drain would turn into a flood.

Eventually, as a nation, we would have to work for our living instead of bludging off the international creditor community. That means importing about $6billion less than we export every year, just to hold our national debt at its present level.

Why do we import foreign capital, each year extending our dangerously high overseas debt, instead of working harder or smarter to produce more? We are not lazy. And we are not congenitally poor savers. We import foreign capital because we have become attractive to foreign investors; and because we are conditioned to accept foreign capital whether we need it or not. We are attractive to international investors because we give them a return as good as if not better than the returns they gain from investments in other countries.

The main problem is the 1989 Reserve Bank Act (RBA). Through it, we attempt to suppress domestic inflation by raising our attractiveness to international investors. In particular, we raise our interest rates whenever we anticipate a rise in inflation. As a result, more credit flows in, import prices fall and the official CPIX inflation rate falls.

Thus, we choose to incur a net surplus on the capital account of the balance of payments in order to keep the lid on inflation. It's a simple political trade-off. Through the RBA, the annual CAD has become the price we have paid for low inflation.

Actually, countries like Australia and USA which have not adopted anti-inflation strategies like ours have also had low inflation. While there are no inflation benefits arising from the RBA, the costs of that trade-off have been high.

It is a mathematical truism that a deficit on the current account is equal to the net capital inflow. Cause and effect can work in either direction. If a balanced current account is disturbed by a reduction in domestic savings, the ensuing excess demand is accommodated through a capital account surplus. This is the situation most economists speak of.

Conversely however, a decision in Wall Street to invest more in New Zealand bonds creates a capital inflow that induces a deterioration of our current account balance. An inflow of capital initiated in New York, unless matched by an equal outflow initiated in New Zealand, causes our exchange rate to rise. Our exports become more expensive overseas and imports become cheaper. So we end up substituting our own products with imports.

The conventional "not enough savings" story posits that we have a CAD because the domestic economy is booming to the point of being overstretched. Imports are assumed to augment rather than replace domestic production. In reality, our balance of payments problem persevered right through the long recession from 1987-92 and the short recession of 1998. In these years the domestic economy was understretched

As a result of our accepting foreign capital inflows that we didn't need, we imported more than we otherwise would have, while producing much less than we could have.

Jim Anderton was quoted by Ruth Laugesen in the Sunday Star Times (12 Dec) as saying: "If [fiscal] surpluses tracked higher than expected the Alliance would be looking for extra spending on the most vulnerable [New Zealanders]. However, this would be conditional on the impact on the current account deficit."

I am worried that the new government is already setting itself up to use a conventional interpretation of the balance of payments problem as an out; as a convenient excuse for a possible failure to deliver gains to those New Zealanders whose living standards have fallen in the 1990s.

With political will, we can eliminate the CAD in 2000 simply by adopting a policy of zero net capital inflows. Capital inflows can be tempered through the use of a "Tobin Tax" on foreign exchange transactions.

Britain did something more interesting in 1932. An "exchange equalisation account" was used to create sterling outflows to offset gold inflows. As a result, an appreciation of sterling was averted and Britain recovered early from the Great Depression.

A "zero net capital inflow" policy is not the same as an anti-foreign investment policy. Rather, for every dollar of foreign capital that comes in, a New Zealand dollar must be repaid or invested overseas. If we have a net capital inflow of zero, it is true a priori that we cannot have a balance of payments deficit.

This simple zero net capital inflow policy is unlikely to happen, however, for two reasons. The first is denial within the economics profession. Most economists are entrenched in the view that a CAD is caused by excess demand and that capital flows passively adjust to excessive expenditure demands. Most economists ignore the possibility that capital flows might be the active ingredient in a country's balance of payments' mess.

Second, the implication of my analysis is that the $NZ remains significantly overvalued. Adoption of the policy that I have suggested would see the $NZ settling down at less than 40 US cents to the NZ dollar. Such a currency depreciation would be a bad look in the eyes of the creditor community we bludge off. Also, a rapid currency depreciation of over 20% would lead to a few months of inflation in excess of 3%.

The balance of payments problem will continue to aggravate New Zealand's indebtedness to the rest of the world until either (i) we suffer from a crisis comparable to the Thai crisis of 1997, or (ii) the Reserve Bank Act is repealed or drastically modified. The Reserve Bank should be asked to manage a zero net capital inflow policy through an exchange equalisation account and/or through a "Tobin Tax" on foreign exchange transactions.


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