New Zealand Herald, 12 June 2012
Gareth Morgan, Director at Gareth Morgan Investments
The IMF reckons the high debt levels our households face remain a barrier to economic growth. The Minister of Finance has responded to this by saying reducing government debt is the appropriate policy. His argument is that by the Government reducing its debt ratio, which, by the way, is not high by international comparison, it will underpin low interest rates, a low exchange rate and hence an export-led recovery that will enable households to escape their debt burden. Rather than amputating an arm in order to cure the infection from a leg with gangrene, why not deal to the leg directly?
The IMF recognises, like most of us, the world is going through a major correction from 30 years of credit excess which has led to such a distortion in capital markets that economies face major constraint from this legacy of bad debt. That constraint is crimping the generation of income (GDP) for their citizens. The great financial crash that was precipitated by a collapse in housing finance (sub-primes) has reverberated across the world and house prices have collapsed to a varying extent in response. Here in New Zealand, the rate of mortgagee sales has just hit a record and is still rising. If anything, we have been inordinately slow to purge the excess in our own housing market, but it's happening - albeit like a slow train wreck - and there is plenty of excitement ahead in that sector.
But what of the Bill English logic? It's true that if the Government wasn't borrowing a possible, but not guaranteed, outcome would be that having one less borrower in the market would take pressure off interest rates. Of course this is always the case, no matter what stage of the economic cycle we're in, so it's a curious argument that holds now is an especially appropriate time for such fiscal austerity. I'm trying to figure what economic theory he's deploying - it's certainly not Keynes, as that would advocate government stimulus during a private sector contraction. It's not monetarism as it would simply argue for a monetary policy in accordance with the inflation objective. So it appears to be some kind of home-bake that holds excess in one sector is most appropriately addressed by contraction of another. It's definitely a circuitous logic, so let's see what the possible rationale could be.
In many other countries we've seen governments having to either take over the debts of delinquent private sector borrowers or shore up the capital of their banks to prevent a collapse of local banking systems. Even in New Zealand we saw some of this as the Government dusted off its implicit depositor guarantee and made it explicit for finance companies such as South Canterbury. In Europe this has happened to such an extent that the Governments themselves are now in turn so indebted that these countries are being downgraded on the international credit markets and are facing interest rates too high to ignite economic recovery. As we saw with Spain at the weekend, the Government there has been left with no choice but to request a subsidy from Germany - oh, to have a sugar daddy like that.
But let's focus on the New Zealand variant. Here the banking crisis is not so severe although, for sure, in line with Reserve Bank directives, the banks extended way too many loans to ordinary New Zealanders speculating on house prices. In the midst of that orgy, Governor Bollard wrung his hands and said he wished Kiwis wouldn't cause such an asset price bubble, but on the other hand he excused his impotence by adding the central bank couldn't do anything about it. Shameful. That has landed us in the mire. Now as it all unwinds and the huge household debt is exposed more and more as house prices fall away, it is obvious that households are not in a position to underwrite a domestic-led expansion. Indeed, it's quite the opposite - savings are rising as households try to correct the excess.
Meanwhile, the other potential source of income generation for the economy - net exports - is in a spot of bother as a slowing world trims exports faster than our own lethargy reduces our demand for imports. So two out of three sectors are in the doldrums - the private domestic and net export sectors. For businesses, this offers little reason for investment and employment. Enter stage right the government sector, always the plaything of the politicians of the day. While they remain in office they have the power to expand or contract this at will. Certainly the will is with us - the Key Government has decided this is a great time to trim its sails, that apparently there exists oodles of waste that can be cut away, freeing resources for the private sector to then take up. As if the private sector was scrambling for capacity right now. Anyway, it's in with the Super Ministry and out with the plethora of ministries that amount to nothing but waste; it's time for the teachers to stretch to a new extent; time to carve to the bone departmental votes such as those of Mfat, DoC and a host of others.
To shrink the state sector because of a political mandate to shrink it is one thing - and arguably the return of National with an increased majority has provided precisely that ideological mandate. But the art of politics is seldom to call a spade a spade, so we've been asked to believe the Bill English logic - which holds that government can be trimmed with no impact on its production, and so no loss of productivity from the infrastructural sector, and the financial sector impacts (lower interest rates) will thrust us into economic recovery, or at least prevent things getting worse.
It's somewhat of a stretch to suggest fiscal austerity, during times when the private sector and net exports are struggling, is the appropriate medicine. Perhaps it would be a little more honest to admit that the Government deficit, which has ballooned due to lower taxes because of recession plus the cost of Christchurch, will lead to a credit downgrade for the country if it's not reined in. It's this that requires the fiscal austerity, rather than any nebulous argument that austerity is the key to prosperity, as the political spin would suggest.
Cutting government spending as a response to the budget deficit, and selling assets to reduce government debt is the simple approach. But is it the cleverest? Southern Europe is suffering from the effects of government austerity as the response to the consequences of past private sector excess. That suffering is in the form of enormous unemployment, economic contraction and loss of confidence from foreign lenders. New Zealand, by contrast, has a far slighter dose of the same underlying ailment, yet is applying similar medicine. Across-the-board austerity as the path to prosperity is an unproved formula, and it looks increasingly as though Southern Europe will not follow this through. Rather, its saviour will be subsidies from the North that relieve the burden of the austerity medicine. Where's our sugar daddy?
The banks, meanwhile, continue to acknowledge that more and more of their clients have borrowed well beyond their repayment capability, and that the time to give them the flick is here. Bankers' patience in waiting for the fruits from Mr English's export-led recovery to trickle down to households will need to be very high indeed.
Wouldn't the Government be better to focus on the causes of the household excess, to instruct the Reserve Bank to correct its prudential guidelines to banks so that a repeat of speculative housing demand raising pressure on interest rates simply wouldn't happen, to actively encourage investment in skills and lending for business development, to plug the holes in the tax regime and reform the welfare system so they're both efficient and equitable? Never has there been a better time for structural reform - a Government with a strong mandate, little to no pressure on resources from speculative property investment, and an electorate with modest expectations. It seems such a waste to embark on an ideological purge of state spending that risks adding momentum to the downturn anyway.
Gareth Morgan is a director at Gareth Morgan Investments. Any opinions expressed in this column are Gareth Morgan's personal views and are not made on behalf of Gareth Morgan Investments.
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