If you had a friend with an expensive house, nice car and a business, what would you think if he told you for the last 6 years that he had been able to keep his business going and maintain his lifestyle by borrowing huge sums of money against his assets, hoping that things would get better and he would be able to start making inroads into that debt eventually. Would you think he was a financial genius? Overly optimistic? Deluded fool?
I doubt it would be financial genius, yet that is what John Key and Bill English would have us believe.
We all know the widely accepted narrative. The “unforeseen” Global Financial Crisis; the Christchurch earthquakes; the relative out-performance of the New Zealand economy based on widely recognized statistical measures like unemployment and GDP; the return to budget surplus next year. That all things considered National have done extraordinarily well to navigate the country through some very difficult times.
What is less commonly spoken of is how John Key and Bill English have ramped up government debt: when John Key took office in 2008, net government debt stood at $10 billion and 5% of GDP; it’s now over $60 billion and 25% of GDP, and has yet to peak. It will get bigger not smaller for a few years even if there is a return to a budget surplus.
Private debt, which fell a little after the GFC, has climbed back and looks ready to exceed its previous peak shortly on the back of the property market. Look at the Total Overseas Debt chart and ask if government or private debt is the bigger issue? Remember this chart is to 2012 and private debt has since turned back up along with govt and total debt. By 2017, IMF and Treasury economists have warned, we will have net foreign liabilities of 90-100% of GDP, higher than troubled countries in Europe like Spain and Portugal.
Russel Norman and Winston Peters have spoken out about our debt position but most commentators and news reports focus on English’s reassuring statements about a return to a budget surplus, no matter how small that surplus might be – if it arrives.
The government’s budget is important; if expenditure consistently exceeds revenue then it has to be financed by public debt or public asset sales; but the government has a lot of power at its disposal to cut costs or raise taxes should it choose to.
The current account is more difficult to control because this includes the private sector and financial flows outside of the government’s direct control. In concert with the Reserve Bank it can encourage or discourage certain behaviour but under the deregulated market based philosophy of the last 30 years has been reluctant to do so, believing the market will self correct any imbalances.
Key did inherit an economy in recession. There had been a massive spike in the price of oil and the credit crunch that became the Global Financial Crisis. Commodity prices had fallen. On top of that came the Christchurch earthquakes.
But on the plus side Key and English enjoyed a fiscal buffer from the Clark/Cullen government. Labour, like the government before it, had run budget surpluses and paid down a huge chunk of public debt. This gave Key and English room to maneuver, borrowing to buffer New Zealanders from the worst of the resulting recession, without alarming financial markets.
There were several other distinct advantages that National enjoyed in 2008 that were not present in the 70’s and 80’s. Inflation was low. Also both government and private foreign debt was mostly denominated or hedged in New Zealand dollars so when the currency plunged, the debt burden was not materially changed. It was this that caused the devaluation crisis in 1984.
Muldoon dispatched Labour in the 1975 election by attacking their “huge overseas borrowing” and their “boom and bust” policy of “borrow and hope”.
In an ironic reversal of politics, this is the same criticism Labour leveled unsuccessfully against Key in the 2011 election campaign, that he had squandered their surpluses.
Both sides had a point. Key left himself open to the charge of hypocrisy over his statements around the ratings downgrades in 2011. When in opposition he had claimed a downgrade would be a sign of economic mismanagement. When it happened to his government he claimed in Parliament;
“With the greatest respect, I’m not responsible for what happens in Europe and the United States, nor technically was I in government when there was the enormous build-up in private sector debt.”
He was quite right to say that Labour had presided over the huge run up in private debt, most of it on both rural and residential property. As even potential coalition partner Russel Norman admitted;
“In terms of fiscal position it’s hard to criticize Labour, but in terms of economic broader policy or indicators, it was really bad. So you had a current account deficit going out to 8% thereabouts of GDP, you had the Net International Position going out to 90% or thereabouts of GDP, you had housing prices doubling 2002-2007… Incredible when you think about that. And you had the tradable sector basically in decline. Those structural imbalances were made worse…..the structural imbalances got worse under Labour.”
Yet there is no evidence that National would have done things any differently.
At the National Party Conference in August 2008, just before the election and as the GFC was unfolding, John Key’s only reference to deficits or debt was an “infrastructure deficit” and how National would be spending more than Labour on infrastructure;
“Because right now New Zealand doesn’t have a debt problem, it has a growth problem.”
Both Labour and National were happy to leave warnings about private debt to the Reserve Bank.
All the way through Labour’s term National had been criticising them for having too big a surplus and not cutting tax. There was no suggestion of using it to pay down debt. Yet if that fiscal buffer of low public debt had not been there, New Zealand may well have been in a more precarious position and the markets less forgiving.
National criticized Labour for its “electoral bribes” of dropping interest on student loans and Working for Families, yet even faced with the GFC and the need to economise, did not reverse them.
It also supported the Labour government’s guarantee for bank deposits and wholesale lenders. Indeed it extended the guarantee to cover the remaining finance companies that hadn’t already failed, leading to the debacle around South Canterbury Finance and its collapse. They were very lucky that the Reserve Bank provided liquidity to the banks, debt markets gradually unlocked and New Zealand property did not fall substantially as it did overseas. Labour and National had us all potentially liable for tens of billions of mortgage debt.
National in 2008 were quite willing to borrow to maintain costly Labour programmes. In addition they went ahead with tax cuts for the top income bracket, also effectively funded by debt. Far from being frugal the Key government was as willing as any previous government to borrow to maintain consumption and prop up living standards.
But despite the rapid growth in public debt the biggest elephant is private debt owed to foreigners, as Ireland discovered to its cost.
After the financial deregulation worldwide in the 80’s, private debt started to rapidly escalate. Under the new prevailing theory, it didn’t matter because; 1) the private sector, the market, was more “efficient at allocating capital”, 2) People were self interested “rational” consumers and, 3) economies were always in, or tending to equilibrium.
The theory doesn’t allow for financial manias like share or property bubbles because whatever prices are paid is determined by this wonderful efficient market full of rational participants whose self interest would prevent them being irrational!
The theory doesn’t allow for massive breakdowns like the GFC which is why most orthodox economists didn’t see it coming. Everything including debt was supposed to gently self adjust by market mechanisms. Venerated sages like Alan Greenspan were “perplexed”. The gentle, guiding “invisible hand” of the market had instead shoved entire economies in front of a bus.
Now, given the role property and debt played in the GFC, and with the Irish economic miracle imploding along with its housing market, you would think National would have made the issue a priority here. Instead, apart from a few intermittent grumbles from English about property inflation, they have done little to address real estate prices or the debt that backs them.
Minor changes were made around depreciation that property investors could claim and there have been threats made to local government about freeing up land and speeding up the building consent process. These supply measures will take years to have an effect.
Meanwhile the demand issues raised by the Reserve Bank and Treasury’s Savings Working Group (SWG) have been ignored, dismissed or resisted. For instance the SWG raised the following points in 2011 regarding the high level of Net Foreign Liability (NFL).
“Unsustainable booms increase borrowing and debt accumulation, usually with adverse consequences for the whole economy. Policy action to reduce borrowing is an option for increasing saving and wealth on a more sustainable basis and should be considered (including higher prudential ratios against mortgaged lending during economic expansions).”
It went on to warn that although the NFL had improved as people and businesses reduced borrowing;
“With economic recovery, NFL are predicted to deteriorate again. The IMF has estimated an increase to above 100% of GDP in the next five years, while Treasury’s latest forecast is that it will increase to about 90% of GDP in the next five years….Given the uncertainties involved and the serious implications of rising NFL, it would be wise to operate on this basis and take precautionary steps now.
Immigration is high, National refuses to look at a Capital Gains Tax and property retains significant tax advantages over other forms of “investment”. Key went out of his way to try and persuade Graham Wheeler that the LVR restrictions weren’t a good idea. New Zealanders on the whole have remained deaf to English’s half hearted jaw boning and continue to pour money into real estate.
Like Labour before them, Key and National either don’t believe the property market and mortgage debt are a major issue or simply that property and the mortgage debt to the banks is “too big to fail”. Supporting this premise, both Key and Cunliffe have made explicit statements that they do not want to see property prices fall. So much for a free market.
The Greens, New Zealand First and increasingly Labour want to see a partial return to the interventionism of Muldoon and his predecessors, that the government should be providing a lead rather than borrowing and hoping that things return to 2007 with the private sector doing most of the borrowing. As Gareth Morgan pointed out in 2012;
“As we contemplate economic recovery some thought at least should be given to the quality of the recovery we’d prefer – do we want it to be a housing-led one again where we all seek riches through a speculative race for property; do we want it to be a business-led type where jobs and incomes take priority; or do we really not care? Is it all too much to think about?
The sense one gets is that politicians at least couldn’t care less, just bring recovery on, any recovery.”
Haven’t this National government, like many others globally, only “kicked the can”, buying themselves some time with a run up in public debt hoping the global economy will jump start into a pre 2008 state? Is this possible and is a return to this state even desirable given it spawned the GFC? Is the dairy boom, Chinese demand and the Christchurch rebuild going to deliver high sustainable growth or will it be another short lived boom and bust. Norman for one believes boom and bust. This seems to be playing out now with log and dairy prices.
“Bill English described it as debt fuelled consumption boom and that feels exactly what we’re doing again, another debt fuelled consumption boom. And National have completely failed to get us out of that, basing our exports on a couple of basic commodities, forestry and milk powder to one or two markets whereas I think that that’s a very irresponsible strategy…..And the only way to avoid that is government intervention…. the government throwing lots of resources towards innovation and making sure that they use whatever levers they have to push their economy towards a more complex, intellectual based economy rather than simple commodities.”
Nice in theory. Every government including Muldoon’s has talked about diversification of export commodities and markets. We seem to have been discussing “adding value” for eons. And how many Knowledge Wave or Job Summits have there been?
New Zealand First are in agreement with the Greens (except inexplicably immigration where the Greens are vague on how higher immigration ties with sustainability). In a no holds bar speech in Parliament earlier this year, Winston Peters, sounding rather like Muldoon attacking Labour in 1975, slammed National on debt, housing, manufacturing and immigration amongst other things.
National is a government of non-achievers with a woeful record of failure. … Nothing has been done to address the massive overseas debt – and it’s still rising. The exchange rate is crippling exporters and manufacturers, and again the Government refuses to act….Let me sound a warning about this rock star economy…. Is this part of some brilliant economic plan known only to the inner circle? New Zealand’s external balance sheet is still in an awful state.
Like Norman, Peters warned of the risk of the government not being proactive.
Over the past five years of National Government we have failed to diversify our economy base. We are now even more vulnerable to a “black swan”, an unforeseen event or shock. We have an economy characterised by:
– one dominant export product – milk powder
– one dominant export company – Fonterra
– one dominant export market – China
– one dominant import – people – immigration
The stark – ugly truth is that New Zealand is nowhere near paying its way in the world. And it is clear that this Government is clueless as to how to address that.
English noted that gross international debt was forecast to hit $250 billion by 2014, up from $100 billion in 2000,
“So we have a big task to turn this economy around and rebalance it towards savings and growth.”
Yet a year later in 2011, National Radio reported English as saying the Government is not considering changes to existing policies to help strengthen domestic savings and the export sector and conceding that stronger economic growth and the extent of foreign ownership of New Zealand companies might make New Zealand’s current account deficit worse as company profits go overseas.
National is still wedded to the orthodox theory that keeping government spending down as a percentage of GDP, running a small fiscal surplus, reducing taxes and borrowing only for a few pieces of critical infrastructure will unleash the private sector who will innovate and borrow for export businesses, correcting our current account deficit and repaying debt, as well as stimulating productivity improvements that result in more jobs and higher wages.
This is a pipe dream without major structural reform away from property. Why be an exporter with the hassle of fickle markets, a volatile exchange rate on top of the usual business risk when banks are gagging to lend on property and capital gains look a sure bet. To most self interested individuals that’s not rational. Echoing Gareth Morgan, Bill Rosenberg, economist for the CTU put it in 2011;
“Maybe not this year or next year, but if the economy isn’t turned around so that there is money to be made in investing in the productive sectors, then we will go back to the old ways of speculating in property prices.”
The government talks the talk now and then. Bill English would do well to revisit his 2010 Budget speech.
Too many New Zealanders have discovered that growth driven by debt, Government spending and property speculation does not create permanent, worthwhile jobs….New Zealand’s largest single vulnerability is now its large and growing net external liabilities. New Zealand owes the world $168 billion, or around 90 per cent of GDP.
Private sector debt to foreign lenders has grown steadily over the last decade and our vulnerability will be increased by growth in government debt to foreign lenders over the next five years.
The dangers of too much debt are well illustrated by a number of European nations who are currently undergoing painful changes, involving increasing taxes, cutting public services, or both.
The Government is committed to policies that will reduce our vulnerabilities by tilting our economy away from debt and consumption toward savings, investment and exports.
Fine words but it is not in the current National government’s DNA to “direct” investment away from property and into the tradeable sector. Indeed exports as a share of GDP have declined significantly in the last few years. Part of this is ideological. Part of it is political expediency. Like Labour before them National does not want to be a party pooper or be accused of “nanny state”. Debt fueled consumption and rising property prices feels good for much of the electorate. Easier to leave it to the Reserve Bank to be the bad guys.
This is frustrating for the Reserve Bank. As successive RB governors have pointed out, monetary policy and interest rates can only do so much without the government doing its share. The RB can try and control private debt by changing its cost via interest rates or with its new prudential measures, but it cannot control where the credit goes in the economy. Only the banks themselves (highly unlikely given their record profits from mortgage lending) and the government via tax incentives/disincentives can do that. Also interest rates are a blunt tool that can cause as much damage to the tradable sector as the property market.
Even with the low interest rates, deregulation and resultant asset price booms of the 80’s, 90’s and 2000’s, western economies have struggled to maintain GDP growth rates. Credit and the asset bubbles that they prompt have been the main source of “growth”.
In 2008 Ireland had an economic meltdown of monumental proportions. Like New Zealand it had very high levels of private international debt via its trading banks, most of it invested in its property market. Its growth rates were good, it mostly ran surpluses and its public debt was low. Yet a few years later the government had assumed the bad debts of its trading banks, its property market was down 50%, unemployment had risen over 15% and it was running major budget and current account deficits. It was forced to accept an IMF/ECB bailout with the associated austerity cost cutting. It was in a depression. John Key’s poster child for deregulation and financial innovation was facing two decades of bitter medicine to get back into the black. Almost unbelievably, Key continued to push for an Irish style financial hub/tax haven until 2012.
Ireland experienced a “sudden stop”. Almost overnight foreign creditors had become unwilling to roll over existing or extend new credit. This is the real risk that New Zealand faces with its persistent current account deficits funded by foreign creditors. It is something that pushed us into depression in the 1870’s and the 1930’s. We almost had to default in 1938 and experienced a major crisis in 1984. We survived the 2008 credit crunch because the government had a buffer of low public debt and a Reserve Bank that was able to act as lender of last resort to our trading banks until markets settled down.
But it also required a government guarantee for deposits and wholesale lenders. It matters little to creditors and ratings agencies whether a nation’s debt is public or private.
Once financial markets decide you are a bad bet a “sudden stop” happens and a small nation like New Zealand, like Ireland, is faced with bailing out the banks and repaying their foreign lenders by taking private debt onto the public balance sheet, or letting their banks collapse and default. Forget the Open Bank Resolution. No one really believes it would stop a systemic run on the banking system
As Iceland and Ireland showed, foreign lenders have no mercy on minnows. They demand under threat of sanction (via their home governments) that the private liabilities be assumed by the state. German, French and British governments put enormous pressure on Ireland on behalf of their banks. As a panel set up in 2012 to test Treasury’s assumptions pointed out;
“The financial position of the private sector is particularly important to consider due to the speed with which economic circumstances in the private sector can flow through to the government’s finances. Ireland was cited as an example where, during the GFC, general government debt rose dramatically from 11% of GDP in 2007 to over 100% in 2012, due in part to the structure of the Irish banking sector and the role the government played in supporting the private banking sector….”
After the GFC Ireland had limited choices. If the same thing happened here it would probably be because some external shock, either a collapse in our terms of trade from a fall in commodity prices or another financial crisis involving our main trading partners (China?) In which case how would we trade out of the situation? The currency would fall and our exports would be more competitive but demand would also be falling. Import prices would escalate rapidly but with the gutting of New Zealand manufacturing in the last couple of decades, could NZ even substitute for many imports anymore or would we just have to go without?
Recently a London based hedge fund manager suggested New Zealand was like Ireland in 2007. This naturally raised the ire of Bill English.
English rightly pointed out New Zealand is not hamstrung by a common currency and most of our external debt is denominated or hedged into NZD. When our currency devalues, acting as a shock absorber, our external borrowings do not become larger. Nor has New Zealand’s property “bubble” been anywhere near the proportions of Ireland’s in either the prices paid or sheer numbers of houses built.
But the analyst’s observation that New Zealand, like Ireland had “a growth model based on debt and credit, low savings rates, and current-account deficits.” is quite correct. At what point it ever becomes a major issue again for foreign creditors, no one knows. It may never happen or it could be next week. All it takes is a single event or combination of events to suddenly change perceptions and focus markets once more on New Zealand’s vulnerability. Prudence suggests keeping that debt vulnerability as low as possible.
Both recent and distant history shows our economic adjustments have not been smooth but the Long Depression and the Great Depression aside, we have survived relatively unscathed. Foreign creditors have been remarkably forgiving with New Zealand and willing to look through the persistent current account deficits. This is probably because we have not had in recent times public and private debt simultaneously at high levels as we do presently. The real risk now is that neither National or Labour governments will have the will or means to restructure kiwis away from consumption and debt, especially in property, and into exports, even assuming new markets and products can be developed.
If anything the GFC exposed what a defunct model debt funded consumption growth was. Do we need to ignore the politicians with their economic snake oil and accept that what we have been collectively doing for the last few decades is unsustainable or do we continue the boom and bust cycle this country has been stuck in and hope for the best.
Debt is not an election issue this year with consumer and business confidence levels where they are, but if history is a guide, that will only be temporary. New Zealand remains too exposed and too vulnerable to its foreign creditors. Labour seems to be slowly realising the error of it ways. National is still stuck in a pre GFC mindset. Neither party looks inclined to address private debt. We just have to hope that whatever hue the next government is, it can create another buffer and breathing space by paying down enough public debt before the next inevitable crisis hits. Time is running out.