PM John Key's Address To APEC CEO Summit
Prime Minister John Key's Address to the CEO Summit, APEC Business Advisory Council (ABAC)
Thank you for that introduction, Dato Timothy Ong.
Let me acknowledge Dr Jose Miguel Morales, the Chairman of the CEO Summit, Mr Juan Francisco Raffo, the Chairman of ABAC, and the many other distinguished guests here today.
It is a privilege to open this discussion on a topic that is on everybody’s minds at present. Like everyone else, I am looking forward to hearing the insights of such a distinguished panel.
Today I am delivering my first formal address since being elected Prime Minister of New Zealand less than two weeks ago. I made a point of attending this summit and the APEC Leaders’ Meeting because of the opportunity APEC provides to discuss how best to respond to the global economic turmoil affecting us all.
APEC’s strength is that it represents a broad group of economies with like-minded views and considerable economic weight.
Of particular value is APEC’s track record of involving business in its work.
In my view, economic co-operation between economies and businesses is exactly what is needed in times like these. As a former businessman I understand how important it is for you to have confidence that your political leaders are taking the steps needed to strengthen the economic fundamentals on which the world’s prosperity rests.
And, in turn, I know that it is your responses to the current crisis that will ultimately determine the speed and timing of the global economic recovery.
I want to set the scene for this morning’s discussion by tackling the last two parts of the topic. Where is the global world heading and what is the economic outlook for 2009?
It is no news to anyone that the global economic outlook for 2009 is weak.
Not since the Great Depression has the world experienced such a significant financial crisis as we have seen in recent months. We have seen an expansion of credit and leverage at levels that were so unprecedented and arguably so uncontrolled that they now threaten the very stability of the world’s banking system.
The implications for the real economy are likely to be profound and widespread.
Looking ahead, as economies weaken new credit losses and new stresses on financial institutions are likely to be apparent.
There is no precedent for such a large and widespread leverage boom as we have experienced in recent years and hence little way of knowing how far the unwinding process may have to run.
As I see it, the world’s ability to put this crisis firmly behind us will rest on two factors.
First, how quickly we are able to determine what changes are required, in terms of policy settings and regulation, and how effectively global leaders are able to implement those changes.
Second, how prepared we are to accept the interconnected nature of the global economy and as such how much we are prepared to join forces to combat the global financial crisis.
The early signs of the world’s reaction have so far been encouraging, by each of these measures.
Political leaders have taken fresh approaches to address the challenges arising from this financial crisis. We’ve seen state-supported bank bail-out packages, fiscal-stimulus packages worldwide, co-ordinated reduction in interest rates, and the special G20 summit to address the crisis.
These actions are a step in the right direction, although more may be needed.
To understand the potential scope of the changes that may be required is to understand the changes in the global economy over the past 10 to 15 years.
Over the past decade or so the global economy was fuelled by a private sector credit boom made possible by a combination of large macroeconomic imbalances with and between economies, relatively low global inflation, new waves of financial innovation, and huge amounts of leveraging by hedge-funds and other financial institutions.
These forces were, in turn, fuelled by excessive optimism in asset markets, and a more relaxed, and in many cases, recklessly complacent attitude to risk.
The result was a global credit boom like none other.
In terms of the wider impact of this credit boom and then credit bust, the effects have differed from economy to economy.
Today I’m going to address the implications of the global financial crisis and the possible responses to it from the perspective of a small economy, firmly located in the APEC region – New Zealand.
New Zealand is, as you may know, a small and very open economy. We have a freely floating exchange rate, our monetary policy is administered independently by the Reserve Bank of New Zealand, we are vocal advocates for free trade, and have few, if any, restrictions on goods entering our markets.
Our banking system is in good shape when compared internationally. Our banks have, in large part, escaped significant exposure to the destructive products such as the sub-prime market that has wreaked havoc in other jurisdictions. Neither have they, to date, suffered significant losses when it comes to failing counterparties.
Even so, New Zealand has followed suit with other major economies and has taken the prudent step of introducing guarantees on bank deposits and wholesale credit lines. Nevertheless, and despite a backdrop of strong fiscal and monetary policy, our economy has slipped into recession.
As a country we are acutely conscious of the impact the unfolding financial crisis will have on our trading partners, our export industries, and our growth prospects.
New Zealand knows very well that one of the critical factors for getting out of this current downturn will be our ability to trade our way out of it. We’re a small cog in the global economy and we know that the only way we can lift our living standards is by growing our role in global markets.
This I believe is true for all of the economies represented in this room, particularly the small and developing economies. Indeed, APEC was founded on the collective goal of pursuing an open trade agenda. There is no doubt in my mind that the APEC region still stands to be the growth engine of the world.
The G20 has pushed the idea that Doha should be resolved – and I can’t speak loudly enough to that. The G20 leaders have put their reputations on the line, calling for an agreement by the end of this year on the crucial decisions needed to take this Round to a successful conclusion. Our Trade Ministers at this meeting have issued a similar strong call for action. I am certain APEC leaders will follow suit.
Let me put it bluntly. Against the backdrop of those political statements and against the background of the international economic turmoil, a failure to follow through in Geneva and deliver the results we need would represent nothing short of a political failure.
Now is most definitely not the time for any individual country to allow their worsening domestic economy to lead to a retreat from global trade and engagement.
It is here that business leaders such as yourselves have a vital role to play. The task falls to you to urge your governments to make the moves necessary to deliver further trade liberalisation.
Beyond our ability to trade and interact with each other, the second and most obvious effect of the financial changes of the past 10 to 15 years has been a large increase in asset prices, greatly increased demand and, most crucially, a huge expansion in credit.
This in itself isn’t new. The difference is in the magnitude and scale relative to the real economy and the inability to quantify the risk due to a lack of transparency.
This has led to two new challenges. First, relating to the effectiveness of monetary policy in dealing with asset cycles and price bubbles in particular, and second, relating to the adequacy of regulation of financial institutions.
The increasingly interconnected nature of global capital markets, while carrying crucially important benefits, has meant that asset bubbles can grow in one country because of liquidity growth in another.
Again, New Zealand’s case is illustrative. We have in recent years experienced a housing market boom built on easy credit.
For well over a decade a glut of global credit created an illusion of almost limitless liquidity that in turn fuelled an unsustainable credit boom. This capital was mainly sourced from offshore.
The result of these seemingly unlimited foreign-capital flows was that New Zealanders were able to rely on cheap fixed-rate debt, which in turn drove house prices ever higher.
While the Reserve Bank worked hard to lean against these trends, the credit glut weighed against our Reserve Bank’s power to contain demand through monetary policy adjustments.
Many of you will have had similar experiences. As a result, governments and central banks around the world are turning their minds to what they can do to prevent, or at least alleviate, such soaring booms, and their resulting busts, in the future.
In particular, central bankers across the world are grappling with the issue of asset price cycles and their consequences for price stability. Housing market booms occurred this decade not only in New Zealand, but throughout this region and the world. The aftermath of these booms is at the heart of current financial market dysfunction.
The question is: faced with this situation again would we do something different to address it? To my mind, this question should lead economies to consider whether monetary policy, fiscal policy, and prudential policy should be more counter-cyclical, and lean against credit growth in an upswing.
The second challenge I sign-posted relates to leverage and the regulation of financial institutions.
In recent months the world has focused on the spectacular collapses of companies like Lehman Brothers and my old firm, Merrill Lynch.
What is now apparent is that as the pressure to boost profits grew, Wall Street assumed more and more risk. The quantity, and also the complexity, of this risk saw investment banks evolve into pseudo hedge funds with balance-sheets and risk exposures well beyond what anyone would have previously deemed acceptable.
But leverage wasn’t, and hasn’t been, the sole preserve of the banks.
The hedge-fund community has mushroomed in size and significance. Gone for the most part is the traditional macro hedge fund, where risk was based on the views of an individual trader who undertook conviction trades that bore some sense of balance when compared to the overall size and structure of the market.
Today, hedge-fund leverage is for the most part unregulated, opaque and, arguably, globally unmanageable. The regulation that does occur is for the most part focused on the fitness of the manager to report to their investor.
All of these factors have helped contribute to the explosion in credit, completely out of proportion to the real economy, with cheap equity leveraged to the hilt.
So now the party is over and the taxpayers of the world are left to underwrite – in one form or another – the liabilities and obligations of banks and, by extension, their hedge-fund clientele.
We can no longer afford to ignore the fact that the amount of risk that hedge funds are able to take through the leverage of their funds is arguably completely disproportionate to the real economy.
These realities and the associated bailout of financial institutions are expected to prompt a widespread review of financial regulation. This is entirely appropriate.
I emphasise, however, that this will require a change of mindset and a global approach – especially as the home of many financial institutions, including hedge funds, is no longer the traditional economies.
We must proceed with caution.
Reforming the global financial system will require a balancing act between, on the one hand, moving away from the largely unregulated environment of today and, on the other, ensuring we do not completely undermine financial markets.
Let us not forget that global growth over the past couple of decades has bought hundreds of millions of people out of poverty.
For global growth to continue, the world needs financial markets to function and it needs liquidity. Furthermore, the world needs to trade and to interact.
The way through is not yet clear and I don’t stand here today with a silver bullet.
What we all know, however, is that transparency is possible and must be demanded.
Before I open the floor for discussion let me sound a positive note.
I have been heartened by the willingness of global leaders to act decisively and co-operatively to face the unprecedented challenges stemming from the financial crisis before us. The actions taken so far indicate there is substantial political will for working together regionally and globally to confront the financial and economic challenges in front of us.
The task of this forum then is to build on that will and muster it to a good end.
My Government is firmly committed to working with other governments and businesses like yours to not only grapple with the immediate pressures on our economy but to, in turn, address the underlying issues that led to today’s financial crisis.
Finally, as Chief Executives, can I say again that as a politician who came from the business world I know the contribution you make to economic growth. The strength of APEC is its willingness to engage and blend politics and business. Without business on board driving for change and improvement, the drive towards global economic strength will fail. But, with you on board, it can and will succeed.