The neutron bomb wrecking the global economy

We should start thinking about how to deal with a global depression, starting with massive public works projects and an NZ Super-style Universal Basic Income for all funded by the Reserve Bank buying of Government bonds. Bernard Hickey comments.

This is an article I hoped never to have to write, but now is the time.

The world economy is going into a Covid-19 lockdown that could last up to two years, causing a global depression that we won't avoid without unprecedented Government action to support incomes and activity. The Government here is expected to announce tougher social isolation measures and borders are closing all over the world. 

There is about to become a new normal that requires us to throw out all our assumptions about who funds what, who pays who, who can travel where and what places are open for everyone. Those 'rules' and debates about Government spending, taxes, borrowing, infrastructure ownership and how we live our lives are about to change irrevocably.

New Zealand businesses, governments and citizens generally need to get ready for the global economy to go into a depression with 20 percent unemployment in much of Europe and the US. We need to work out how to work from home and look after each other. There will be a completely new normal for months and months, and potentially years. We will be able to buy groceries and get our pharmaceuticals, but not an awful lot more.

We should be thinking about what a world with little cross border travel and intense social isolation would look like for a couple of years until a vaccine is produced, tested and distributed.

It would (at the least) likely mean closure of our international tourism industry (8-10 percent of GDP), the virtual end of luxury food (fish/wine) exports, the substantial closure of the live entertainment, conferencing, hospitality (cafes/bars/restaurants) and commuting-based industries/businesses for months and months at a time, at the least. Collectively, large parts of up to around 30 percent of the economy will be severely hampered for months and months.

If you think this is extremely unlikely. JP Morgan forecast overnight the US economy would contract 18 percent this year, Reuters reported. That is as depression. Unemployment in Europe and the United States will head swiftly to 20 percent. The US Treasury Secretary Steve Mnuchin told US Senators as much overnight.

The way we live our lives will alter in ways we can only start to imagine. Learn how to videoconference and do as much of your work, if you have it, from home. Think about how you can help those around you in a safe way. We are entering a time that I have only read about in history books and seen in documentaries, where war-time-like conditions and powers bring the community together and we look after each other on our three islands.

UBI funded by RBNZ lending to Government required

In my view, we should be preparing for the Government to start paying a Universal Basic Income at the same level as New Zealand Superannuation to all residents, including children and the 300,000 guest workers and students who can’t get home. The Government should pay for that by selling bonds directly to the Reserve Bank. That is essentially money printing, but would be necessary to offset a deflationary shock.

Meanwhile, everyone should prepare for a multi-decade period of global turmoil and help renew the communities and government tools needed to stabilise and rebuild.

However, it is also an opportunity to invest (let's say $500b over 10 years) in our local economy, infrastructure and people to solve our underlying housing affordability and climate change  crises. That would reassure businesses and consumers that there would not be a complete slump. It would also start solving some of the long term problems we know we have. The

That means massive Government-led investment in public transport, affordable housing, education and health to be ready for when the global economy returns to life with much better wellbeing and productivity levels. Railway lines, apartment buildings, electric bikes, hospitals, schools and the like.

The Christchurch example is instructive. The previous Government broke the 'rules' during the crisis in the aftermath of the February earthquakes. The RMA was essentially suspended and the central Government broke its own habits of the last 30 years by investing central money in local infrastructure. The end result is Christchurch is the only big city in the country with remotely affordable housing to buy and rent.

This should be a bi-partisan effort and it must start today. National Leader Simon Bridges needs to join the cabinet and stop thinking about the election. There will not be one.

What could a 'grand coalition' do (This part below was written a couple of days ago when it all seemed unlikely - I was frankly concerned it would seem off the planet)

This is a bit out there, but these are unusual times, and some Chinese philosopher or Harvard Business School professor is bound to have said that behind every crisis lies an opportunity. Many politicians have definitely said no one should waste a good crisis.

I also have a few moments to step aside from the nowhere-near-normal-madness of this current news cycle to think outside the square of the usual rules Parliamentary politics under MMP and conventional fiscal and monetary policy. That's because some unthinkable things have happened in the last few days and I have a couple of spare minutes on my hands while most people are still sensibly asleep.

That's because I'm self-isolating in a Wellington apartment for few days with a mild headache and a few sniffles that I'm sure is just a garden-variety head cold. (I don't qualify for a Covid-19 test, but that's another issue altogether...) See the latest on that here from Newsroom's Marc Daalder.

Like everyone else now, I'm having to do things a little differently.

The unthinkable things

First, some people in usually partisan places are thinking aloud about a Covid-19 'war' coalition. I don't usually link to David Farrar's Kiwiblog and I wouldn't recommend reading the comment thread, but he was one of Prime Minister John Key's closest advisers and regularly takes the pulse of the nation with opinion polls for the National Party. He's worth reading on this:

"I think consideration should be given to forming a Government of National Unity, as was the case in WWII. Around 2,000 NZers a year died in WWII and we could see the same or higher here. Plus the economic and system shocks will be like nothing we have seen since WWII," Farrar wrote.

He suggested a war cabinet with three Labour ministers, three National ministers and one each from New Zealand First and the Greens. That would about match the current polling at least. Former National NZ First MP Tau Henare has also suggested it on Twitter.

Some people on the right of politics and around business have also been saying unusual things about how Government could or should operate to deal with this crisis.

Business needs help too

BusinessNZ CEO Kirk Hope, who is a sensible and thoughtful person anyway, said something I thought I'd never see from the country's biggest business lobby group:

"Frankly, if we need to move beyond the BRRs to deal with an economic and health shock of this magnitude, I don't think anyone would have any problem with that," Hope said

The 'BRRs' he's talking about there are the Labour-led Government's Budget Responsibility Rules, which stop the Government from going much above its current net debt levels of 19.5 percent. These 'rules' about net debt and running surpluses have effectively set the base line for the size of our Government for the last 30 years. They were dreamed up somewhere in the bowels of Treasury in the 1990s to put an 'anchor' on the risks a Government would borrow too much and repeat the drama and pain of the Muldoon-era borrowing. But things are very different now

Our borrowing costs are fixed in NZ dollars

Firstly, interest rates are nowhere near the 8-10 percent they were in the 1990s. Secondly, New Zealand now has a very liquid and floating currency and the Government borrows for longer terms in New Zealand dollars. For example, the Treasury has issued almost $20b of bonds in New Zealand dollars that don't mature for another 15-20 years that have fixed costs for the Government of 2-3 percent.

That's about a third of the debt we have on issue at the moment. This means that if the New Zealand dollar was to crash or interest rates globally were to spike up, which was a constant fear in the 1980s and 1990s, then it makes no difference to the New Zealand taxpayer.

The whole point of issuing fixed interest long term bonds such as 10 year and 20 year Government bonds in New Zealand dollars is that the New Zealand dollar cost is fixed for the Government for those 10 or 20 years. That wasn't the case in the 1980s and some of the 1990s when Robert Muldoon had personally negotiated shorter term foreign currency deals with bankers in Switzerland and London. That meant that when the New Zealand dollar was devalued and lenders put up their interest rates, then the servicing costs exploded in real time.

Interest rates are much lower

Many of those old hands in Treasury in dreamed up the 20 percent net debt limit are still committed, despite most of New Zealand's other AA-rated peers having much higher debt levels and interest rates being structurally lower and headed to zero percent. And they are still very wedded to it if you read their advice to previous Treasury Secretary Gabriel Makhlouf (pages 14 to 16) and to Robertson from just last year.

Although it is useful to look at a speech Makhlouf gave last year, in which he said New Zealand could have an upper net debt limit of 50-60 percent, with a mid point of around 30-40 percent that included a 20 percent buffer for shocks (like the current Covid-19).

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