By Bernard Hickey
Prime Minister John Key has defended the government's focus on returning to budget surplus and reducing the government's debt load, saying it made sense to strengthen the nation's balance sheet through government debt reduction, given households remained indebted and foreign debt was still high.
He also warned that higher debt could trigger credit rating downgrades that increased New Zealand's interest rate premiums.
His comments followed intense debate over the last month in Europe and the United States over a strategy of reducing government debt to improve economic growth rates.
The strategy has relied on academic research by US economics professors Carmen Reinhart and Kenneth Rogoff into the connections between government debt and economic growth, in particular in this academic paper 'Growth in a time of debt' published in 2010. It suggested a tipping point was reached when government debt rose over 90%, significantly reducing growth rates to below zero%.
However, those conclusions were questioned last month in another academic paper which said the Reinhart/Rogoff was based on a spreadsheet error and was skewed by the omission of data on episodes of high debt, including, most importantly, in New Zealand from 1946 to 1949, when our country showed both high growth and high debt.
The debate over this theory known as 'expansionary austerity' -- whereby reducing government deficits and debt improved overall growth as the private sector was freed from crowding out -- has intensified in the last fortnight as this strategy championed by Germany in the European Union and the David Cameron-led coalition in Britain has failed to ignite growth. The IMF and others have called on Europe to abandon its 'expansionary austerity' strategy. IMF research from late 2011 showed such 'expansionary austerity' actually contracted economies in the short term. The US Federal Reserve, meanwhile, has argued the US government's sequestration-driven spending cuts are slowing economic growth and forcing it to continue with its quantitative easing (money printing) programme.
However, Key said the government remained committed to its strategy of returning to surplus by 2014/15 and then reducing debt from almost 30% of GDP in 2017 to 20% of GDP by 2020. The Reserve Bank pointed out in its March Monetary Policy Statement that the government's austerity strategy was driving a tightening of fiscal policy equivalent to 3.2% of GDP over the next four years, which was a factor dampening momentum in the economy.
Key told a post-cabinet news conference the government had run up significant amounts of debt over the last five years to ease the economy through the Global Financial Crisis and the Christchurch earthquakes.
"It hasn't been like we haven't been prepared to use the balance sheet. But we're a small country. We're an open, trading nation. We have considerable private sector debt and we're relying on foreign savings to finance our future. On that basis, if we are excessive with our spending and therefore build up debt, then eventually some generation of New Zealanders are going to have to pay that back," Key said.
"I think New Zealanders would rightly feel quite concerned and vulnerable that the government couldn't actually respond," Key said, referring to the heavy and urgent spending funded by debt to support Christchurch after the earthquakes.
"My view is that as a country we haven't suffered (from the drive for surplus)," he said, referring to New Zealand's economic growth rate being currently stronger than most other developed nations and possibly even Australia.
Higher risk premium?
I then asked Key why the government was so worried about debt when research showed growth rates were not affected until debt got much, much higher, and given the relative ease New Zealand's Debt Management Office is having selling government bonds.
"It's one thing to be the reserve currency like the United States of America and have very large levels of debt because they, in principle, have ways to cope with that," he said.
"In the end, if we have high levels of debt, eventually the ratings agencies will downgrade us again, and over time that leads to a bigger premium on the borrowing that New Zealand companies do."
Standard and Poor's and Fitch downgraded New Zealand's credit rating in September 30, 2011, sparking fears that interest rates would rise in absolute and relative terms.
However, New Zealand's 10 year government bond yield has fallen from 4.39% on September 30 2011 to around 3.2% now. The premium being paid for New Zealand 5 year government bond yields over US 5 year government bond yields has also fallen from 2.39% on September 30, 2011 to 2.01% now. See risk premium chart here and below.
Key said New Zealand interest rates were still higher than those in America and there "may still be a higher risk premium".
"But in the end it depends on your view, and my view is that New Zealand is a much stronger country by having a good healthy balance sheet and we're trying to preserve that."
Risk premiums
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28 Comments
As much as I hope you are correct in your prediction, I just don't see the fundamentals lining up in support of your assertion. I bought $kiwi at 60 cents US, or there abouts, when I moved here in the mid 90"s. I have been seriously considereing moving back to the USA and nothing would make better than paritiy on the dollar. Unfortunately, I just don't see it happening, although I still hope you;re right!
Sincerely,
HGW
Dreamers !! i dont think so myself , with the exchange rate where it is our main exporters are stil making good money , as a business you learn to trim the fat when needed , it is the loss of value in the USD ( reserve Currency) the world would not end if parity was reached , when the printing presses stop around the world and interest rate skyrocket i know which country i would rather be in , one with little debt and hence lower interest rates.
I certianly do....ie everywhere expansionary austerity has been tried its failed, miserably. Examples go back decades if not centuries. Everywhere Govn has been "carefully" spending in depressed or zero trap bound economies it has worked.
So we should be saying "is it the same" but in fact by saying "why wouldnt it be the same", its pretty much economics 101 so for NZ not to respond / work in the same way would be "magical" to say the least.
regards
Expansionary Austerity....
Great use of the english language... I always ..kinda thought... that these 2 words had opposite meanings..
A bit like someone who wants to lose weight... but gives up because he thought he could do it by eating more..
Eating less was unacceptable ...because he wanted to lose weight without any discomfort or pain..... without really changing his ways..
Reducing debt levels..in an aggregate sense.... and expecting aggregate GDP growth sounds like some form of modern alchemy.
"Could have been a spreadsheet error". and "New Zealand in the 1940s". Sounds like a useless academic discussion to me.
Anyway, All congratulations to Bill and John. We do need to reduce debt and they are doing it.
Their problem of course is New Zealanders, whose values are that the government should give each of them more money than they give it.
Reducing Govn debt while in a slow or even depressed economy where the private sector is also de-leveraging and/or struggling is one sure way to make things worse. We can see that from examples of the Great depression and on and on until today.
On top of that NZ Govn could borrow at about 3.2% for 10 year bonds, that is almost borrowing at zero cost, to do work now that needs doing anyway.
regards
$84.2 billion (40.2% of GDP)... When is it too much? Who's going to pay the interest your proposed extra borrowing?
You say our economy is struggling but it's growing steadily and being held up as a example by much of the rest of the world. Comparing NZ economy today to the great depression is just not a fair comparison.
I then asked Key why the government was so worried about debt when research showed growth rates were not affected until debt got much, much higher, and given the relative ease New Zealand's Debt Management Office is having selling government bonds.
"It's one thing to be the reserve currency like the United States of America and have very large levels of debt because they, in principle, have ways to cope with that," he said.
"In the end, if we have high levels of debt, eventually the ratings agencies will downgrade us again, and over time that leads to a bigger premium on the borrowing that New Zealand companies do."
Where is the pressure coming from that demands fervent conformity to the austerity model?
I doubt the rating agencies voice their preconceptions of debt as strongly as the neoliberal institutions such as the IMF and World Bank.
Whatever, the obession to please seems to have overwhelmed those charged with the responsibility of reporting outcomes.
Let's take a look at the Gross debt comment in yesterday's media release from Treasury in respect of the Financial Statements of the Government of New Zealand for the Nine Months Ended 31 March 2013:
Gross debt was $1.8 billion below forecast at $84.2 billion (40.2% of GDP), mostly due to the Reserve Bank purchasing $2.7 billion more Government bonds than forecast, reducing the amount of debt owed by the Crown to third parties.
Yes, the RBNZ did buy ~$2.7 billion of the recently redeemed 2013 government stock issue as part of it's open market operations agenda. The focus of the purchases was centred around executing a money flow smoothing operation when the 2013 expired on 15 April 2013. But the purchase credits formed part of the RBNZ's prefunding operation of settlement cash balances to maintain O/N interest rates around current levels of OCR.
Inevitably, the dealers that sold the notes to the RBNZ returned the cash sale credits including the accrued coupon to create the necessary RBNZ liabilty that offset the note asset position until redemption.
The Crown was hardly rid of the liability associated with these note purchases, as of 31st March 2013. It should not be so keen to present a distorted picture of the reality in it's endeavours to show gross debt is falling to third parties when the legacy paper trail proves otherwise.
I noticed the comment about the RBNZ buying 2.7 billion in NZ Govt debt as well. I dont pretend to understand how the on market operations work but it did strike me that buying treasuries and gilts is what the Fed and BoE call quantitative easing isnt it?
On the main point though, I wish Bernard would stop describing Fiscal policy here as Austere. He sounds more like an opposition politician all the time. Our debt has expanded and still is under this government. Given earthqukes and a global recession that may not have been a bad thing with such low interest rates. The economy has been kept out of a real rough without debt service increasing all that much. The signs are we are now getting a bit more cash flowing the Governments way and it seems prudent to use at least some of that to get our debt back down to where it was. If we still have high debt and higher interest rates next time the excreta hits the spinning object we may become a South Seas Greece pretty quickly.
I noticed the comment about the RBNZ buying 2.7 billion in NZ Govt debt as well. I dont pretend to understand how the on market operations work but it did strike me that buying treasuries and gilts is what the Fed and BoE call quantitative easing isnt it?
Nice try - take it up with the Open Market Operations Desk at the RBNZ - but to be clear here, the outstanding settlement clearing cash liability at the RBNZ was in place before the 2013 note purchase operation began.
The prior liabilty of printed NZD was primarily against a USD asset through the auspices of a currency swap - that position was closed and replaced with the NZ Government note and a freshly printed NZD liabilty. No extra liquidity was pumped into the system unlike the US and UK central bank large-scale asset purchase operations.
It must be noted the redemption of the 2013 issue and the launch of a new note etc resulted in a net Crown debt paydown of $8.120 billion over April 2013.
Thanks for that... I think.
Are you saying that the effect of the RBNZ purchase was to retire a foreign borrowing ( USD) and replace it with a local debt that the Government owes to the RBNZ? I know the number is small ( although bigger than the Mighty River float and look how much fuss that has caused) but if it was that easy to pay off overseas debt why doesn't everyone do it all the time?
No, you are slightly confused - not that I expect otherwise. The banking institutions borrow the USD to pledge as collateral against the RBNZ lending them NZD that are then deposited with RBNZ for collateralised clearing purposes. The NZ Government 2013 issue is just another form of collateral that served a double purpose around the redemption date.
hey iconoclast ...hope this is helpful...
Fractional-reserve banking is the practice whereby a bank retains funds equal to only a portion of the amount of its customers' deposits as readily available reserves (currency on hand at the bank plus deposit accounts for that bank at the central bank) from which to satisfy demands for payment. The remainder of customer-deposited funds is used to fund investments or loans that the bank makes to other customers.[1] Most of these loaned funds are later redeposited into banks, allowing further lending. Because bank deposits are usually considered money in their own right, fractional-reserve banking permits the money supply to grow to amultiple of the underlying reserves of base money originally created by the central bank.[2][3]
To mitigate the risks of bank runs (when a large proportion of depositors seek withdrawal of their demand deposits at the same time) or, when problems are extreme and widespread,systemic crises, the governments of most countries regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.[2][3] In most countries, the central bank (or other monetary authority) regulates bank credit creation, imposing reserve requirements and other capital adequacy ratios. This limits the amount ofmoney creation that occurs in the commercial banking system, and helps ensure that banks have enough funds to meet the demand for withdrawals.[3]
Fractional-reserve banking is the current form of banking in all countries worldwide.[4]
oooh BTW...what's the go with Winnie then...?has he been hatching deals with Key...? he says no way hose B....but Key begs to differ...!
The RBNZ wishes to lend NZD to prefund the cash settlement account - admittedly on a dynamic basis to facilitate daily interbank clearing functions, but to keep maket interbank interest rates near the target OCR interest rate - borrowing pressure to meet liquidity demands need to be addressed in realtime fashion and the reverse.
However, the RBNZ never lends NZD on an unsecured basis to it's accepted banking counterparties. So in the case I mentioned those needy institutions borrow USD and FX swap the proceeds with the RBNZ in return for NZD. There is not a one to one match with those getting bank liquidity and those contributing to the settlement account - some banks have liquidity to burn others don't, hence the need to secure the lending to each and every institution that engages with the RBNZ.
Look, I know I'm dense on this stuff, but
Surely the US lender wants some collateral?
Why not just use that collateral-security direct with the RBNZ?
Why the double-dealing with FX
You've explained two of the trips
Bank gets on phone to US lender, Gets USD, got that
Walks in the front door of RBNZ, deposits USD, got that
Whips around to the side door and borrows an amount of NZD, then
Whips around to the back door and deposits it in another account?
What am I missing?
It's a while since I studied this process in detail - here is an RBNZ explantion of the Settlement Cash system.
Ok - the The US banks lend our NZ banks USD without collateral for periods up to 90 days as far as I know.
This is perplexing in that it does not make sense - not all legs get reported for on-balance sheet purposes - other than the RBNZ has a collective liability to return the cash it receives from institutions, along with the collateral asset on the other side. Remember there are the hidden off-balance sheet transactions, one example being the RBNZ printing the money to credit the counterparties in the first instance.
I am pleased Stephen said it was perplexing and does not make sense because I certainly dont get it. One more dumb question. If this 2.7 billion of NZD denominated Govt stock purchased by RBNZ has retired USD swaps does that mean we have replaced private sector ( bank ) USD borrowing with private sector ( bank ) nzd borrowing and isnt that a good thing?
No, because the NZ government stock 2013 purchased by the RBNZ has since been redeemed and the NZD banks have reverted to borrowing USD to collateralise their NZD borrowing from the central bank.
The magnitude of the FX swap transactions undertaken by the RBNZ to affect secured lending of NZD to accepted NZD banking institutions can be viewed in section 10 here.
An added complication is that this total is always outdated, ie currently March, and includes excess Government cash deposits lodged with the RBNZ that have been also lent to the banks. View that release here. There should be an approximate reconcilation when the settlement cash amount is accounted for from lines 8 and 9 in the already linked D10 release.
If not one has to look for another method of collateralised lending undertaken by the RBNZ and it's counterparty banks - namely Reverse Repurchase Agreements - another explantion in itself. Money can be drained from the system with Repurchase Agreements - google for explantions but remember the US does the opposite of NZ practice - ie Reverse repos in the US drain system money whereas the opposite applies here. Depends upon which party initiates the trade.
You must have added the last paragraph while I was trying to make sense of the Reserve Bank documents you referenced. I think the upshot of all this appears to be that this 2.7 billion transaction has already become historical because the instruments purchased by RBNZ have already been redeemed by the Crown. Much ado about nothing really but interesting.
In the same spirit of inquiry can you explain what you meant in your post above about the redemption of the April 2013s representing a net reduction of about 8 Billion in Government borrowings. I thought the debt was still rising.
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