The building case for big and long fiscal stimulus everywhere
Central bankers around the world are running out of interest rate room and need their governments to abandon austerity to help both stimulate and re-engineer their economies to massively improve productivity, housing affordability and climate emissions. Bernard Hickey explains this global and local problem.
Except for China, central banks all over the world are pleading for monetary policy mates and their pleas are falling on the deaf ears of politicians addicted to populist calls and bureaucratic group-think focused on less government, lower taxes and less Government debt.
Yet again, the likes of Reserve Bank Governor Adrian Orr, Federal Reserve Chair Jerome Powell, European Central Bank President Mario Draghi and Reserve Bank of Australia Governor Philip Lowe face the looming spectre of being forced to cut interest rates to zero and beyond. They are having to try to flog the dead horse of economic growth without much help from their governments. After 10 years of trying, even the central bankers are wary of using the same tactics that simply pumped up the values of houses, shares and bonds, but did little to solve either the short term or the long term problems facing the global economy.
Productivity, which is the only thing that matters in the long run, is slowing globally and has been stagnant here for more than five years. Housing affordability is collapsing in most developed countries because of rising house prices, restrictions on new developments and, tragically, falling interest rates. Real climate change action is scarce because it requires massive public investment in public transport and new medium density housing close to city centres. Our skills, economies and cities need re-engineering massively if we're going to restart productivity, make housing affordable for the young and poor and achieve net zero emissions by 2050. It is a global problem, but even more acute here because we have among the worst housing affordability, productivity and climate change emissions figures in the world.
Massive investment in transport, health and housing infrastructure, education, workplace skills, business technology and research and development is required everywhere, but the central and local governments who are the only ones with the authority and balance sheets to do it are frozen in the headlights of politics and 30 years of austerity and smaller Government dogma.
Everywhere you look, central bankers are looking to their politicians for help, who are simply looking at their polling and focus groups and shrugging their shoulders.
It's not much different here. Imagine Adrian Orr asking Prime Minister Jacinda Ardern for help, and she checks first with Mike Hosking, who says 'no' because it might mean higher taxes, more bike lanes and a new apartment block near him and the other older property owners living in the suburbs and provinces. The Prime Minister is nervous that Hosking and the National Opposition will accuse her of 'wasting' his money or increasing his mortgage rate if the Government borrows and invests in infrastructure such as trains, bike lanes and 'shoebox' apartments.
Our political and bureaucratic classes are conditioned by 35 years of thinking New Zealand is almost broke and about to be punished by global investors for any sign of fiscal weakness or profligacy. It's true that New Zealand was practically broke at various points from 1984 to 1994, but has since then been a model of fiscal prudence and austerity in a way that means New Zealand's public finances are among the healthiest in the world. More on that below.
'Please borrow from us'
The tragedy is that financial markets and the world's fund managers are literally begging for governments to borrow off them at shockingly low interest rates to unleash that multi-decade re-engineering project. The New Zealand Government 10-year bond yield hit a record low 1.24 percent yesterday. Germany's 10-year government bund yield is minus 0.54 percent. Switzerland's is minus 0.94 percent. A negative interest rate means the investor pays the bank or the government to look after their money.
The ultimate tragedy is that borrowing costs are this low because central banks invented more than US$15 trillion in cash to buy their own government bonds as part of efforts over the last decade to stimulate economies. The central bankers bought German and Swiss and Japanese and US bonds from banks and pension funds in the hope they would then invest and lend out that cash to governments, companies and people to stimulate their economies. Instead, those bankers and pension fund managers just looked to buy other government bonds, corporate bonds and already existing property and stocks, or just left it parked in cash.
For whatever reason, those fund managers are risk averse and simply want to buy assets that already have a cash flow or are backed by the power to tax. They want the borrower to take the risk with their own equity and balance sheets. What's needed is someone with a really big balance sheet and an ambition to solve some of these problems to step up and borrow. And to take a risk. In a developed democracy, that means politicians taking political risks.
So why won't this Government borrow to invest and re-engineer?
Prime Minister Jacinda Ardern and Finance Minister Grant Robertson again defended their fiscally restrictive stance this week. They adopted the previous National and Labour governments' adherence to a net debt target of 20 percent of GDP before the 2017 election and have variously said they cannot change it because it was an electoral commitment and that it was necessary to 'keep their powder dry' to have capacity for a real crisis, such as another earthquake or global financial crisis.
They are conditioned by 20 years of being intimately involved with New Zealand political life, the upper echelons of the Beehive and Treasury, and many hours in Mike Hosking's studio to believe that borrowing and spending is politically fatal, particularly for a Labour government in a modern, globally connected economy.
The now famous words about fiscal prudence from US democratic campaign strategist James 'the Ragin' Cajun' Carville have rung loudly in the ears of centre-left politicians for decades. He said in 1992 as he was helping Bill Clinton to get elected President that: "I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."
Unfortunately, this cadre of veterans forged in the fires of the late 1980s and early 1990s have not understood or acknowledged the massive shift that has happened in global bond markets and to the prospects for inflation in the last decade.
He was talking in an era when bond investors would punish borrowers by putting up interest rates if they were profligate. They were known in this era of high interest rates as 'bond vigilantes'. Politicians of both colours in New Zealand have been paranoid ever since of getting on the wrong side of global markets. Then Finance Minister Ruth Richardson and her then-Treasury Secretary Graham Scott (who went on to become an ACT Party candidate) famously flew to New York with a day's notice in January 1991 to beg Standard and Poor's not to downgrade New Zealand's sovereign credit rating by two notches. After her reassurances of a tough budget stance, S&P only downgraded New Zealand by one notch to AA minus. That set the scene for Richardson's 'Mother of all Budgets' in 1991, which cut benefits. In the end it wasn't enough to stop a second downgrade to AA in 1994.
This fear of the bond vigilantes and the potential for a sharp rise in interest rates or being frozen out of global credit markets has conditioned the thinking of both senior politicians and their advisers ever since. As recently as 10 days ago, the chief auditor of the Government's accounts from 2009 to 2017
2019, Lyn Provost, told an audience of public finance experts in Parliament's Legislative Council Chamber (Parliament's old upper house) that included Robertson, Scott and Richardson, that she remained proud of the fact that many of the people who came up with the 20 percent net debt target are still in place in the bureaucracy and have stuck to it.
But that was then and this is now
Unfortunately, this cadre of veterans forged in the fires of the late 1980s and early 1990s have not understood or acknowledged the massive shift that has happened in global bond markets and to the prospects for inflation in the last decade. Structural forces towards globalisation of services, globalisation of labour markets and labour-saving technologies are pressing down on inflation and interest rates. New Zealand's net debt position is way, way better than it was back in the early 1990s and is also much, much better than other sovereign nations with the same AAA credit rating that we now have.
Our government debt is a full 10 percentage points of GDP lower than the median for AAA rated countries, as this Moody's chart from earlier this year shows. That's because other countries had much worse recessions after the Global Financial Crisis than us and some of them had to borrow heavily to bail out their banks.
The combination of the government debt and household debt are also much less worrying than they were in the lead-up to both the 2001 dotcom bust and the 2008 Global Financial Crisis.
That's because our banks have swapped a lot of the 'hot' foreign debt behind their mortgages for local term deposits, New Zealanders are better at saving locally, and the growth of KiwiSaver and the NZ Super Fund has driven a surge of New Zealand investing in offshore assets.
All this means that a rise in government debt would not necessarily trigger the credit rating downgrade that was automatically assumed in the past. That means the 'automatic' rise in mortgage rates that caused politicians so much angst is not such a threat.
'But we're already stimulating'
Another argument put forward by Robertson and Ardern against a fiscal stimulus now is that the Government is already stimulating and therefore can't or shouldn't do much more. Just look at the 'massive' families package (a net $2.8b of spending over five years), the 'massive' new health spending in the Budget ($4.6b over five years) and the 'massive' $10.4b of capital spending in Budget 2019.
The trouble is this gives a misleading impression the Government has already expanded stimulus and therefore cannot do much more.
The change in the Government's operational and capital spending plans between the half year update in December 2018 and the May Budget were minimal, with extra health and welfare spending being more than offset by less capital spending over the two years to June 2021. That included a $3.5b reduction in forecast capital spending over the five years to 2023, slower spending through the Provincial Growth Fund and KiwiBuild, and flat budget operational allowances in 2021 and 2022. This table below shows the changes since December, which actually show net debt being $3.3 billion less than expected in the current year to June 2020.
Rather than being the fiscal profligates painted by the Opposition and suggested by the Government itself, it has actually been fiscally very conservative. All this meant the Government achieved its 20 percent net debt target three years earlier than it expected.
The Treasury's fiscal impulse measure in Budget 2019 in the chart below shows no stimulus in the current 2019/20 year and a combined detraction from economic growth of 1.3 percentage points of GDP in the next three years to June 2023.
This is just as the Reserve Bank is expected to run out of ammunition as the Official Cash Rate closes in on zero percent and the banks decline to pass on much of it to business borrowers and home buyers.
The other argument against a fiscal stimulus now is that the economy is at maximum capacity and more spending would simply push up wages and prices and 'overheat' the economy.
However, the reason the Reserve Bank is expected to cut the OCR to below 1.0 percent by the end of the year is that inflation is too weak and there is spare capacity in the economy. There are still over 100,000 people who are unemployed and looking for a job, with a further 200,000 who say they are underemployed and looking for a job. The unemployment rate of 3.9 percent is still significantly above the 3.3 percent low reached in the December quarter of 2007, which was the last time it is accepted the economy was straining at full capacity and starting to generate inflation.
'But there's capacity problems'
The Government has also argued there is no capacity to do infrastructure spending in the construction sector and that it could not spend the money fast enough. That's not what the construction sector is saying or planning and no-one is suggesting it would be all spent within a year or two. Builders are instead looking for a multi-year and multi-decade plan for infrastructure and house building to flatten out the booms and busts that have previously prevented them from scaling up and building more efficient and productive systems.
Construction sector confidence has collapsed in the last six months as builders prepare for a bust in housing construction and wait in vain for certainty on new transport, water and housing infrastructure spending. This week a survey of intentions in the civil contracting sector, which does 'horizontal infrastructure such as roads, railways and pipes, found 12 percent expected to cut staff numbers over the next three years, up from just two percent in 2017. Over three quarters of survey respondents thought the most positive impact on the industry over the next three years would be the development of a clearer pipeline of central and local government work.
It's clear the Government has the borrowing capacity (about $30 billion within the next five to 10 years), the low borrowing costs (1.3 percent currently and falling) and the need for signals to the construction sector about the public transport, housing infrastructure and health infrastructure building needed over the next five to 10 years.
If the Government is also looking for a more immediate way to stimulate the economy and boost wellbeing then it need look no further than the Government's own Welfare Expert Advisory Group, which recommended an immediate $5.2 billion per year of extra spending on benefits and accommodation supplements to reduce housing and child poverty.
So what is the Government waiting for?
Before the Budget, Robertson widened the Government's debt target from a point target of 20 percent of GDP by 2022 to a range of 15-25 percent of GDP after 2022. In theory, that gives the Government some head room to borrow up to $15 billion more (around five percent of GDP) to spend on infrastructure. Many assume some of that will be unleashed in next year's Budget before the 2020 election.
But that may be six months too late for the Reserve Bank, which needs a monetary policy mate now.
Ardern and Robertson, who were schooled in the ninth floor offices of the Beehive by the grizzled veterans of the early 1990s ... are not the progressive and transformational pair they led the electorate to believe they were in 2017 and that the rest of the world believes now.
It also doesn't address the need for a multi-decade plan for social and capital infrastructure investment to deal decisively with the need to re-engineer our cities and our skills to significantly improve productivity, housing affordability and climate emissions.
That would be a $150 billion project over the next decade or two. Let's call it the "Re-Engineering New Zealand" project. The Government's balance sheet has ample space to allow that and it would pay for itself if the productivity benefits came through because GDP growth would be faster and the Government is very efficient at collecting tax revenues from a growing economy. Bond markets are certainly signaling that they would lend New Zealand that $150 billion over such a period.
So what is the Government waiting for?
It's actually not waiting or even secretly planning. It remains stuck in an early 1990s groupthink that still believes in the ghosts of James Carville's bond vigilantes and is afraid of what Mike Hosking might say within a minute or two of such an announcement of such a multi-decade debt-funded investment in pipes, roads, railways, apartments, electric vehicles, bike paths and higher incomes from beneficiaries younger than 65.
It's dawning on us that Ardern and Robertson, who were schooled in the ninth floor offices of the Beehive by the grizzled veterans of the early 1990s (Helen Clark and Michael Cullen), are actually fiscally conservatives. They are not the progressive and transformational pair they led the electorate to believe they were in 2017 and that the rest of the world believes now.
They are showing that by not helping their Reserve Bank Governor when he needs it most. And they are not alone. In Britain, Germany, France, Australia and America, politicians are either choosing not to invest (Germany, Canada, Australia and America) or cannot because they already have too much debt (Japan, France and Britain). New Zealand has no such debt fears. But it does have fearful politicians.
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