Who’s In Charge?

Who’s in charge of the economy?  We need to know the answer and to know that someone is taking responsibility.  As is becoming clearer by the day, we are entering a very dangerous phase.  If we are to avoid an increasingly likely calamity, someone will have to bring in the measures that are needed to steady the ship.  We need to know who that someone is.

Our economy, which we tell ourselves is doing quite well, is in fact overloaded with debt.  The sense that things are going well is engendered by no more than our propensity to borrow and to demand a standard of living that we cannot afford.  It is a fool’s paradise.

The huge and alarming rise in house prices is the product of record lending by the banks on mortgage.  That in turn helps to fuel a consumer boom, as home-owners are encouraged to borrow against the reported rises in the value of their equity and to spend large sums on imported consumer goods.  The banks will continue to lend without limit to house-buyers and consumers alike for as long as they are allowed to do so.

The result is a dangerously inflated bubble of house prices, consumer spending, and imports, none of which reflects any actual increase in wealth or is sustained by anything other than borrowing.  History tells us that bubbles of this kind do not go on inflating ad infinitum and only rarely deflate gently.  If we insist on continuing our rake’s progress, the day of reckoning is sure to come and it will be painful.

In the meantime, the injury we are doing ourselves is not just in the economic short-term.  Rising house prices continue to exacerbate the housing crisis and widen social division.  The consumer boom diverts our resources away from productive investment and saving.  The import spree widens our trade deficit and forces us to borrow more and sell more assets to fill the gap, with the result that we lose more and more control over our own affairs.

So much is now widely understood and is scarcely denied.  It is when we ask what is to be done and even more, who is to do it, that we enter the realm of controversy.

It might be thought that the answer is obvious.  What else is a Minister of Finance for, after all?  But it is not as straightforward as that.

It is an article of faith for our government that their role is a limited one.  Monetary policy is contracted out to the Reserve Bank.  There is some responsibility for fiscal policy but that is largely focused on cutting public spending and making changes to top-end tax rates, for largely political rather than economic reasons.  Otherwise, the theory goes, the economy is best left to its own devices – or to big business.  The market can be trusted to produce the best outcomes and should not be second-guessed.

The government is of course concerned about “the deficit” but it is not the country’s deficit that worries them.   It is the imbalance in their own finances that monopolises their attention. The private sector’s borrowing and consuming boom, and the country’s perennial and growing trade deficit, on the other hand, are best left, it seems, to look after themselves.

The results of the government’s efforts to cut its own deficit are very apparent.  As The Economist reports this week, New Zealand spends a lower proportion of GDP on public social spending (excluding health care) than most other advanced countries.  Not surprisingly, it has experienced a corresponding widening of inequality and become one of the most unequal countries in the developed world.

The Minister of Finance may feel, according to his own priorities, that this is a proper reward for his efforts to cut spending.  His Prime Minister’s contribution to resolving the country’s problems – excessive borrowing, consuming and importing – has been, however, to indicate that he will engineer a further boost to spending with $3 billions of tax cuts.

If we cannot expect much action from the government, who can we look to for an effective response to the dangers we now face?  The other obvious candidate is the Governor of the Reserve Bank – and there is reason to hope that help might be more forthcoming from that direction.

There are increasing signs that the Governor is aware of the problems and has analysed them correctly; he may even recognise that the central problem is excessive bank lending – a factor, after all, that emerges right at the heart of the Governor’s responsibilities.

The problem here, though, is that the Reserve Bank’s central duty is to protect the banks’ viability – which can all too easily mean simply their profitability.  It is unlikely that he will dare to come up with macro-prudential measures that will really make a difference.  The banks themselves, however – as witness their decision not to lend to foreign borrowers – recognise the risk to their profits if the Governor is eventually forced to act.

The outlook therefore is bleak.  The problem may be clear, but there is no one ready to step forward with a solution.  The government disclaims responsibility for correcting it and is ready to make it worse, gambling that the chickens won’t come home to roost till after the next election, while the Reserve Bank will continue to put its loyalty to the banking system ahead of the country’s well-being.  Poor New Zealand!

Bryan Gould

10 June 2016