By Andrew Gawith*
Five years into the global financial crisis, high debt continues to dog the economic fortunes of many countries, including our own.
Governments have helped clean up private-sector debt doo-doos, but they've mostly swept those messes on to their own (the public's) books.
Our Government's deposit guarantee scheme, for example, has essentially nationalised a truckload of dud property loans.
Getting debt ratios back down to the levels they were in the early 2000s could take a decade or so. After all, the developed world has been indulging in debt-fuelled living, investment and growth for quite some time.
New Zealand began pigging out on debt in the 1970s as part of a simplistic plan to avoid adjusting to a series of oil crises.
The 1980s was a decade of inflation so debt was a smart way to make money, and bank deposits were a quick way to destroy your savings.
While private-sector debt rose and we enjoyed solid economic growth over the early 2000s, the New Zealand Government was able to run Budget surpluses and reduce the ratio of public debt to GDP substantially - it hit a low point of about 17 per cent in 2008.
So we entered the global financial crisis in remarkably good fiscal shape, although the level of household debt was dangerously high.
It was the reckless levels of debt in the broader property sector, including parts of the farming industry, that have caused the most heartache.
The fiscal cost of the deposit guarantee scheme is testament to the delinquency of finance companies and their lending standards.
And then came the Canterbury earthquakes, the cost of which has sent the Government's deficit and public debt ratio skyrocketing.
The Treasury is predicting the public (gross) debt ratio will peak at close to 40 per cent of GDP this year and stay high for a couple more years - still a creditably low ratio by developed economy standards, but a sharp turnaround from the very sound position we were in six years ago.
The problem with carrying too much debt is that you become vulnerable to economic weaknesses such as a high dependence on a narrow range of exports, an inefficient tax system and shifts in market sentiment.
The tragedy unfolding in Greece is a sharp reminder of the crisis that can engulf a highly indebted country with little fiscal discipline and a dysfunctional tax system at a time when financial markets have turned super-cautious.
The run-up in debt in Europe over the past two decades fuelled property prices, household spending and, to a degree, economic growth.
Unwinding that debt overhang in Greece, Ireland, Spain, etc, is going to be a challenge, especially if a quick unwind is required.
These countries have become so dependent on debt that there is no politically and socially painless way to sharply lower that dependency.
The aggressive austerity programme demanded by Germany and the International Monetary Fund (IMF) as the condition for providing funding to keep Greece nominally solvent is the cold-turkey approach.
A longer rehab programme with some growth sweeteners is what Presidents Obama and Hollande are advocating for the highly indebted euro economies, and that may be the only politically viable approach.
New Zealand does not come close to the delinquency of the Greek Government, but in a world increasingly wary of high debt ratios and the ability to service and repay debt, New Zealand needs to be particularly cautious in the fiscal decisions it makes so that it is able to absorb further bad economic news.
Financial markets' intolerance of debt and poor fiscal policy could quickly translate into higher interest rates and increased debt servicing costs even for New Zealand.
The recent slide in commodity prices will result in a growth-sapping decline in our terms of trade and an unwelcome increase in the current account (external) deficit and the national debt ratio. It will also stunt the Government's tax take - something it can ill afford in its quest for a balanced Budget by 2014/15.
Another risk for the Government is that the euro crisis is likely to drag on for at least another year or two, cramping world growth, and the United States economy is by no means back to full health.
Slow economic growth makes it particularly difficult for economies to work their way out of fiscal deficits and work down their debt.
The current deleveraging cycle - repayment of debt/increase in savings - is likely to last at least five more years for the government sector, although probably a shorter period for businesses and households.
The latter two have been shielded by their governments from the worst aspects of the global financial crisis.
Give it another five years and we might be back to more manageable levels of public debt and a more rational use of debt in the developed economies.
Debt is very useful when used for the right things, lent and borrowed by prudent people and applied in the right amounts.
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Andrew Gawith is a director of Gareth Morgan Investments.
This piece was first published in the NZ Herald. It is used here with permission.
3 Comments
The decision to take the longer low road happened well in the past now, we socialised bank bond holders and they took it and ran.
Perhaps it was a poor choice, many would argue with the benefit of hindsight it absolutely was but we are not realistically in a position to change course yet.
"And then came the Canterbury earthquakes, the cost of which has sent the Government's deficit and public debt ratio skyrocketing."
No it was already zooming up under National (one of the few growth areas it has managed); not helped by uneconomic roads of national significance wastage and tax cuts that have cost us $2 billion so far and counting.
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