What we do in the shadows of a phantom
Bernard Hickey writes this election's argument over who will repay government debt faster is a dangerous and pointless replay of a 30-year old debate rendered obsolete by today's financial facts
Often the myths and legends of the past are more powerful in the minds of politicians, bureaucrats and voters than the reality. Just the fear of a monster, even if it doesn't exist in the abandoned mansion on the hill, is enough to change our behaviour. We scuttle down another street and glance over our shoulders at the big house with no lights. We whisper to each other about just how terrible the mansion's monsters could be, and tell each other stories how many years ago little Johnnie from the down the road once disappeared in a puff of purple smoke when he ventured too close.
Yet here New Zealand is, all over again, debating just how scary higher government debt is and worrying about a day of reckoning when foreign investors pass judgment on us before sinking their fangs into our economy and sucking us dry.
We look set to have an election and a debate about the future size of government that is dominated by ghost stories and a belief we must do everything to avoid the vampire vigilantes in the world's bond markets. We are frightening each other without good and current reasons to avoid walking down a particular street towards a size of government and other forms of tax that are perfectly normal and effective in the most successful parts of the world. Politicians from both sides of politics are arguing about which is the best way to avoid the ghost mansion, but they both still believe in ghosts.
Opposition Finance Spokesman Paul Goldsmith let slip to a group of financiers late last month that a National government would aim to drive net debt down from a forecast high of 53.6 percent of GDP in 2023/24 to around 30 percent within a decade, but he didn't detail how that would happen. It was a broad statement of direction, rather than a plan. Former Labour Finance Minister Michael Cullen would have described it as an ideological burp, although Cullen was just as guilty of using that debt limit language to scare away any big spenders in his own caucus or coalition partners.
Treasury ties on the debt anchor
Goldsmith hadn't created a costed plan to get there, and appeared surprised that such a goal was considered newsworthy or somehow exceptional. 'Doesn't everyone believe this?' he seemed to be saying.
That's true in that Treasury has advised generations of politicians since the mid-1980s that this "debt anchor" of "prudent debt" of around 20 percent of GDP was the central aim of government with a rise to around 30 percent as the outer limit. Goldsmith was just channelling the advice from Treasury. Labour has also committed to cut debt back to around 20-30 percent.
Treasury advised Finance Minister Grant Robertson as recently as April last year that he could talk about a 15-25 percent band and a rise to 30 percent was the outer edge of prudent.
"We recommend maintaining net debt within a range that is wide enough to allow for a degree of forecast uncertainty and is centred around current levels. For example, the fiscal strategy could specify a range for net debt of 15 to 25 percent of GDP, subject to any significant shocks," officials wrote in a memo to Robertson.
"If in the future a materially greater scale of high-value public investment is identified and capacity constraints ease, there would be a case for increasing the target range up to a maximum of 30 percent of GDP while still remaining at a level that could be considered prudent," they wrote.
"We would not recommend increasing the target range up to 30 percent of GDP at the current time because doing so would increase the risk of exacerbating capacity constraints and/or funding low-value investments, which would limit the ability to fund high value investments in the future."
Shortly afterwards, Robertson announced the dropping of the 20 percent rule from Labour's Budget Responsibility Rules and the adoption of a 15-25 percent band, which allowed a slight increase in net debt from after 2021/22 without breaching Labour's 2017 election promise. It allowed Labour's Infrastructure Upgrade programme to take to this year's election. Covid-19 has since blown that debt track out of the water.
Pointing at ghosts in the vacuum
Robertson and Prime Minister Jacinda Ardern then promptly inserted a scary vision into the vacuum behind Goldsmith's wafty target, saying it meant National would have to embark on $80b worth of cuts in public services. Marc Daalder's piece this week dives into what that 'fiscal hole' meant and didn't mean, but it's all predicated on the idea that debt must be dragged back to 20-30 percent. Their debate is more about how quickly, and how. Both sides assume this has to be done.
Ardern and Robertson argued it should be done more slowly, but are already using the language of austerity themselves, saying the fiscal position is now "tight".
"We have to maintain that fiscal management and discipline," Ardern said on Monday.
Goldsmith back-pedalled on the hardness of his timeframe for getting back to 30 percent, but stayed with that number as his anchor, because Labour uses broadly the same anchor and the same language about needing to build up a rainy day "buffer" by getting debt back down.
Here's Ardern again on Labour's original pledge to get debt down to 20 percent:
"I stand by that decision because now when that rainy day of Covid arrived, we are now in a position where even at its peak, we will have debt levels lower than some of those countries in the OECD that we compare ourselves against, before they even went into Covid," she said.
"And so that is something that I maintain as being important. We have to maintain that fiscal management and discipline. We are a country that tends to experience shocks. The pandemic in this case that everyone is experiencing, but our earthquakes are something that are unique to us. And so I do think that careful management is still required."
Goldsmith is just as convinced on the rainy day theory: "Our sense is we need to demonstrate a path back below 30 percent, in the first instance, within a decade, give or take a few years," he said, although he has later clarified this to say 30 percent was not a hard target, more of a "goal" or "a sense of direction."
He thinks he can do it without massive cuts and instead rely on three percent-plus GDP growth, ending contributions to the NZ Super Fund and efficiencies to achieve it. He even sees the eventual opportunities for tax cuts, but not when the Government is borrowing $60b this year, which he describes as "eye watering sums."
“All New Zealanders recognise that you can’t just keep doing that forever. You do have to have a plan to get things back on track, we do live in a small isolated country that’s prone to crises and there will be another crisis,” Goldsmith told Stuff this week.
The 'vulnerable NZ' fallacy, especially now
Both sides of politics are convinced of the idea that New Zealand should fear the consequences of having a crisis and needing to borrow money from the rest of the world to 'rescue' us, be it from an earthquake or some sort of bio-security disaster such as Foot and Mouth.
So where does this idea come from: that we are small, vulnerable and would be unsupported in a crisis? Why are both Labour and National so worried that somehow the world's financial markets would cut off New Zealand and we would be immediately broke, or that international bankers would start ordering us around like some sort of failed state, forcing up taxes and cutting benefits, just to pay the interest on the foreign debt.
It comes from the age of Muldoonism and what happened in the aftermath of the 1984 exchange rate crisis, when it is reputed New Zealand was so broke that our diplomats overseas had to use their personal credit cards to buy essential items in foreign currencies. The story goes that we had literally run out of money and couldn't repay our foreign creditors.
A short ghost with a long shadow
It is true that Muldoon borrowed heavily in overseas currencies to fund Think Big projects in the late 1970s and early 1980s. Treasury and Reserve Bank officials from that time have told me how Muldoon personally negotiated the terms with Swiss and British bankers on trips to Europe. These were often loans in Swiss francs with variable interest rates, which meant that any fall in the New Zealand dollar and surge in interest rates was almost immediately catastrophic. That happened a lot during the 1970s and 1980s at a time of oil crises and various trade slumps. It's the reason why Muldoon hung on to a fixed exchange rate for so long: it avoided the pain of a massive increase in Swiss franc interest payments.
The scale of the crisis in 1984 and a similar one in the early 1990s when then-Finance Minister Ruth Richardson and then Treasury Secretary Graham Scott jumped on a plane at short notice to fly to New York to beg Standard and Poor's not downgrade New Zealand's credit rating by two notches. After she promised massive spending and benefit cuts, the agency only cut New Zealand by one notch.
Back in 1985, the New Zealand Government was paying long-term interest rates of 17.7 percent and by 1991 it was still 10.1 percent. Before the financial reforms and the floating of the New Zealand dollar, foreign investors would only lend in their own currencies and interest rates were variable.
Fixed interest bonds issued in NZ dollars
But from the early 1990s onwards the Government began borrowing much more through domestically issued Government bonds in New Zealand dollars, which were fixed interest bonds. That removed the risk that sharp fall in New Zealand dollar or a jump in international interest rates would immediately and massively increase the interest costs of that debt.
New Zealand has also developed its own big pension funds that buy these Government bonds, such as the New Zealand Superannuation Fund, ACC and a multitude of Kiwisaver funds. That has seen the proportion of Government debt owed to foreigners drop from over 80 percent in the early 1990s to just 64 percent by 2000 and 41.4 percent at the end of June this year.
Not only has the Government removed the currency and exchange rate risk, but it has lowered the ultimate risk of a foreign revolt by reducing the proportion owed to foreigners.
Many also worry that the combined private and public overseas debt meant we were also at risk of a revolt in markets against our big four banks' borrowings. But that has also reduced under pressure from the Reserve Bank. The ultimate measures of New Zealand's total foreign indebtedness show a fall from almost 80 percent of GDP in the mid-1980s to 45.1 percent by the end of March this year. This, along with falling interest rates, means the share of export receipts required to finance our foreign debts, which is both private and public debt, has fallen from 14 percent of receipts as recently as 2000 to 6.1 percent at the end of March this year.
The Government's own interest costs have also slumped, as this Budget 2020 chart shows.
We're relatively less indebted too
The other reason why the ghost of Muldoon's debt is nothing to fear is that New Zealand's Government debt is now not only lower than most of our peers with a AAA credit rating, but will still be lower even after the Covid-19 splurges around the world.
As this chart from Budget 2020 shows:
So the ghost of Muldoon's debt crises should be slayed once and for all.
The best measure of that is what New Zealand's current 10 year bonds are currently trading at. They are now trading at 0.78 percent. The chart above includes a forecast from Treasury based on its assumption that 10 year Government bond yield will rise back to nearly 4.0 percent over the next decade, in large part because it has a long term assumption of 5.0 percent.
No one in the investment world right now, especially the ones betting their own money, see that as likely in the next decade or two. If anything, they see interest rates falling further into negative territory, which would mean foreign lenders pay our Government extra money to lend their money to our Government.
As of last week, more than US$16 trillion worth of government bonds, or over a third of the bonds on issue, were trading with negative yields, including the likes of Japan, which has government debt at over 200 percent of GDP.
And our politicians are worried to the point of competing to see who can cut ours to 30 percent of GDP fastest.
Here's Paul Goldsmith to emphasis just how worried he is about the debt monster: “Any responsible government will set a long-term target to get the huge amount of debt we are taking on under control so that the country can respond to the next crisis."
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