GFC Part II
The collapse of Lehman Brothers in September 2008 ushered in the global financial crisis, and seemed to bring an era to an end. The orthodoxy that had prevailed for thirty years crumbled overnight. Markets, it was realised, are not infallible and self-correcting; private business skills and disciplines are quite different from those needed to run a whole economy; governments are not obstacles to economic development but its indispensable guarantor.
Suddenly, lifelong sceptics sought salvation in Keynesian prescriptions, for fear that the crisis would turn into full-scale depression. The taxpayer shelled out billions to save the global economy from total collapse.
The prescriptions worked. The depression was averted. The banking system was shored up. We lived to fight another day.
But the stimulus to make good the sudden collapse in global liquidity took us only so far. It was enough to steady the ship but not enough to prevent the vessel from foundering in the longer term.
Most of the taxpayers’ money went directly to the banking sector where it was used to re-build balance sheets and resume the payment of large bonuses. Surprisingly little went to re-build the economy, with the result that employment, investment and production continue to languish. But it was not only the banks that were keen to return to business as usual.
The global establishment quickly – and without waiting for the recession to be over – put Keynes’ General Theory of Employment, Interest and Money back on the shelf. In a surprisingly short time, the old orthodoxies were re-asserted.
Paradoxically, the main lesson drawn from a crisis that had been created by private sector failure and averted only by government intervention was that the role of government should be wound back. It was constantly asserted that governments should behave like private individuals or companies and must cut back their spending, irrespective of the deflationary impact on economies still struggling with recession.
The Keynesian lesson that governments have a responsibility for the economy as a whole and not just for their own finances was quickly forgotten. While some economies – like China and, on the back of a mineral commodity boom, Australia – continued to prosper, most others plunged willingly into austerity programmes that, in effect, closed down their economies.
The theory was that austerity was needed in order to preserve credit ratings and to reduce the need to borrow. The money markets, it was calculated – the same money markets that had created the crisis in the first place – had to be placated. If they did not have confidence that deficits would be reduced, they would be less willing to lend.
But, like most fairies, the “confidence fairy” has failed to materialise. Despite doing what the money markets are assumed to want, economies continue to languish. Austerity continues to do its depressing work and remains the order of the day.
In Europe, countries like the UK press headlong on into austerity programmes, even while the economy is stalling and less ideologically committed commentators look in vain for anything that might bring the recession to an end.
The financial crisis in Europe is of course exacerbated by the disaster that is the eurozone – a project that subjects weaker economies to monetary conditions that are dictated by much stronger economies, that denies to them the usual escape route of devaluing the currency, and therefore requires them to deflate savagely so that they are less and less able to afford – let alone repay – the huge borrowings that are needed simply to keep them afloat.
How is debt to be repaid and deficits reduced by economies that are going backwards? Can we be surprised that the world economy is increasingly threatened as the contagion spreads from Greece, Portugal, Ireland, and Spain to a growing group that includes Italy, Belgium and possibly others?
The picture is equally depressing in the United States. An expensive but only partial stimulus programme slowed down but did not solve the crisis. Unemployment continues at a high level and the recession persists, yet – reflecting an almost religious zeal – a minority of legislators has ignored those pressing problems and artificially elevated the raising of the government’s debt ceiling into the USA’s number one economic problem. The consequent US credit downgrade leaves the real problems more intractable than ever.
Almost everywhere we look, in other words, policy-makers seem determined to ensure that the conditions for recovery are displaced by the requirements of a failed ideology. Can we wonder that even the architects of these errors, as they survey the results of their handiwork, have lost confidence in the outcomes, and that another round of crisis is threatened?
We in New Zealand will of course be directly affected if the global financial crisis is given a new lease of life. It may be thought that there is little we can do to influence the situation. But we cannot escape responsibility for making our own small contribution to the general malaise.
We have – like so many others – treated unemployment, investment and productivity levels as of little importance and denied that government has any responsibility for them. We have eschewed intervention and treated the reduction in a modest government deficit as our over-riding priority. By placing ideology above common sense, we have played our own small part in prolonging an avoidable disaster.
Bryan Gould
7 August 2011
If Things Are So Good, Why Are They So Bad?
It is a measure of how subdued is the national mood and how modest are our current ambitions that we expect so little of our elected governments. Even nearly four years after our own home-grown recession began, we are, for example, expected to acclaim as a triumph of economic management the first signs of a patchy and fitful recovery that still leaves us well short of 2008 levels.
We might have expected much better. We were largely insulated from the direct effects of the global financial crisis. Our two major export markets remained surprisingly buoyant. And we have enjoyed record high commodity prices.
Yet, to hear our leaders tell it, even our woes are a sign of success. The soaring kiwi dollar, we are assured, shows that foreign investors see us as a “safe haven” – a claim that sits oddly alongside the repeated warnings about the risk of a credit downgrade and of the need to wind back public spending so as to reduce a rampant government deficit.
The truth is that the soaring dollar reflects a conviction on the part of overseas speculators – based on 25 years of experience – that our governments will go on paying them a premium and that the short-term demand for our currency thereby engendered will produce a capital gain as well.
This is entirely consistent with the growing evidence that, as the recovery at last manifests itself, we will use the opportunity to repeat the recurrent mistakes of the past 25 years all over again. We will continue to treat any prospect of growth as an inflationary threat, to be knocked on the head by a combination of high interest rates and an overvalued currency. We will continue to express puzzlement as to why – in this policy framework – productivity languishes and our economic performance falls behind that of our competitors.
There are occasional flickers of interest in a change of policy. Geoff Simmons, for example, points to the prospect of using tighter rules for bank lending as a counter-inflationary tool and as an alternative to high interest rates. But he also warns that the Reserve Bank – with its single focus on inflation (and it is, after all, a bank) – is unlikely to change course.
And governments, of course, particularly at this stage of the electoral cycle, may wring their hands at the high dollar, but will secretly welcome the consequently cheaper imports – a short-term advantage that helps to holds down a soaring cost of living through to election day but that is bought at a huge cost to our long-term economic performance.
It could be said that these problems are like old friends; they may be a nuisance and somewhat boring, but they are at least predictable, and it is true that there is a certain comfort to be drawn from getting what you expect. A right-of-centre government could be expected, for example, to stick closely to monetarist theory, and to pin its hopes for an improvement in economic performance on tax cuts for the well-off, asset sales, cutting government spending, taking a tough line on benefits, and seeking free-market solutions to most problems.
That is exactly of course what we have got and presumably what people voted for. In the past, after giving these measures a fair trial, they have judged that they have not worked and then voted to get rid of them. This time, the policies look like surviving for a little time yet. It is not that the policies are different – merely that the salesman is better.
But there is one consequence of current policy that even the most brilliant salesmanship cannot so easily sell to the public. The now unmistakable evidence of rising poverty, with children as the most vulnerable victims, is the inevitable result of widening inequality, higher unemployment, falling real incomes for the poor, less effective public services, and rapidly rising living costs.
The myth that families choose poverty as a lifestyle option can only be sustained in a society that is divided – where the well-off are comfortably shielded from the realities of life for the worse-off.
One of the advantages of being well-off is that it is possible to buy your way into a better neighbourhood, to go to better schools, to mix with better-off work colleagues and friends.
You do not then need to venture into the poorer neighbourhoods, to sit around the table to share inadequate and poor-quality food or to feel the cold and damp in overcrowded bedrooms. You do not feel the humiliation of being rejected for job after job or having to present yourself for close questioning as the condition for receiving a weekly benefit which – in a well-off family – might be entirely spent on a single meal for family and friends at a good restaurant.
Individual instances of hungry children might be dismissed as cases of fecklessness and inadequate parenting. But a rising tide of such children, whose health, education and very lives are threatened by hunger, is a social phenomenon with widespread social and economic causes. It might be – indeed, is – a predictable consequence of current policies, but that, surely, does not make it acceptable? Predictability in this case should not produce resignation but rather a clarion call for action.
If things are so good, why – for so many of us – are things so bad?
Bryan Gould
27 July 2011
This article was published in the NZ Herald on 2 August.
Don’t Be Wimps!
“Don’t be wimps,” seems to be the advice on offer to exporters groaning under the burden of the overvalued dollar. “Lie back and enjoy it,” advises one sage. “Get on with it – there’s nothing you can do about it anyway,” says another.
Such wrong-headedness would matter little if it involved only a handful of disaffected exporters. But it affects us all – as it has done for decades now, and will do for the foreseeable future.
But surely there is nothing we can do about it? The rate for our currency – floating as it is – will be decided by the foreign exchange markets, and not by the policy-makers? The answer to that is a resounding “No!”
There is no such thing as a clean float. The view that foreign exchange markets take of our currency will be influenced by many factors, most of them inevitably within the control of our policy-makers.
The legendary Japanese housewife or Belgian dentist knows nothing of our economy; if they knew about our slide down the OECD tables and our perennial trade deficits and record overseas borrowing, they might have been less keen to buy our dollars.
But what persuades them to buy our currency is the virtual guarantee that we will go on, as we have done for decades, paying them an interest rate premium. And, because so many are attracted by that risk-free windfall , and the demand for and price of the dollar therefore go up, short-term investors can usually expect a capital gain as well.
To top it all off, they are confident – after nearly thirty years’ experience – that we will not change our willingness to keep on doing it, even though it is plain by now that the more we borrow, the higher the interest rates we have to pay, and the higher rates we pay, the further the dollar’s value rises, and the further the dollar rises, the less we are able to produce and export, and the less productive we are, the more we have to borrow.
But isn’t the dollar’s recent rise (except against the Aussie – they have their own similar but more manageable problems) the result of high commodity prices? Yes, high commodity prices have helped to fan the flames, but the baseline was already established at an overvalued rate, where it has been for most of the past three decades. High dairy prices have simply exacerbated the long-term problem, making life even more difficult for other producers.
But what about the up-side of a high dollar – the cheap holidays and the low-priced imports? Aren’t they worth having?
Yes, there has always been an argument in the short term for overvaluation. Politicians are particularly fond of it, because it means that every overvalued dollar will buy more imports (or foreign holidays) than it should, so that people have the temporary illusion that they enjoy a higher living standard than they can really afford, at least until election day.
But the price we pay for that illusion in the longer term – in jobs, services and living standards – is a heavy one, particularly if governments (with our three-year terms) try to maintain it from one election to the next.
The high dollar means that our producers get less for everything they sell into international markets, including our own. Even our most successful enterprises and exporters find it harder to penetrate international markets, and when they do, their margins are decimated.
With smaller market share and lower profits, they find they have less capital to re-invest in new technology, new capacity, new product development, new skill training, new sales promotion, new export support – all the bases covered by their successful competitors from overseas. So, job growth is held back, service levels fall behind, the living standard gap with Australia widens still further.
Even our most successful exporters – currently our dairy farmers – find that the cream is blown off the top by the overvalued dollar, so that even in the goods times they have less to spend and invest in our economy than they would otherwise have.
If the over-valuation, or the threat of it, persists for any length time, there is then a second-order range of consequences. Bright graduates cease to go into productive industry; they prefer to try their luck in asset speculation, finance and retailing – anywhere that is protected from foreign competition. People look to non-productive assets like housing as the place to make their fortune. Capital moves to wherever it is possible to make a quick buck. Our successful businesses move overseas or are sold to overseas buyers. Corporate headquarters move to Sydney or Shanghai. Does any of this sound familiar?
In the longer run – a generation or more – the culture itself changes. Borrowing – in the belief that the word owes us a living – becomes a way of life. We lose faith in saving, investing, and producing goods and services for sale as a way of providing for ourselves.
It was Einstein who said “Insanity is doing the same things over and over again and expecting different results”. Our results are not about to change any time soon.
Bryan Gould
21 June 2011
Catching the Knowledge Wave?
The briefcase I use to carry my papers and laptop to meetings bears a multi-coloured logo and the words “Catching the Knowledge Wave”. As Fran O’Sullivan recalls, the outcomes produced by that high-level conference in 2001 – designed to unlock the secrets of economic success as overseas luminaries revealed brilliant ideas and initiatives that had hitherto eluded us – proved disappointingly humdrum.
It turned out that there were few mysteries to divulge. The explanations for economic success were all too obvious and commonplace. Ireland, for example, in whose apparent prosperity there was a great deal of interest, was the beneficiary of European Union largesse which created an asset bubble that eventually burst. Australia, as has become increasingly clear, has the great advantage of being able to dig up its barren interior and sell the product to a mineral-hungry world.
Other explanations are equally obvious. Developing economies like China and India now, and Japan and Korea before them, do well if they can access mass international markets and exploit economies of scale by combining cheap and plentiful labour with rapidly growing technological expertise.
And wealthy mature economies that focus on re-investing in new wealth creation, like Germany, will do better than those, like Britain and now the US, that give priority to the protection of existing asset values and to consuming more than they produce.
Developed economies that suddenly benefit from a new source of wealth, like the discovery of oil, will do badly if they simply spend the proceeds through allowing the exchange rate to appreciate – as the British and the Dutch did, as the Australians may be in the process of doing with high mineral prices, and as we are in danger of doing with high commodity prices.
Those, like Norway on the other hand, that invest the proceeds in new assets so that they go on producing wealth after the initial benefit has dissipated, can enjoy a long-term benefit to economic development.
Yet, despite these commonsense conclusions, we in this country still persist in seeking the magic elixir that will propel us into the economic top league. We still believe that one more Jobs Summit, one more nostrum from the latest management guru, one more ministerial exhortation to improve productivity, one more brilliant new piece of research, will do the trick.
We have been unwilling to face an obvious truth – that economies are such large, complex and multi-faceted fields of activity that it is very unlikely that single, focused initiatives – even if worthwhile – will make much, if any, difference.
Of much more importance in determining whether economies perform well or otherwise, and whether or not they are stimulated to innovate and develop, is the broad context in which they operate. It is that context we should focus on. But that is precisely what we’re not prepared to do.
There are of course some contextual factors, such as the terms of trade, we can’t control. But even when those factors are, as they are today, the most favourable in nearly thirty years, we still manage to negate that advantage by allowing the rising dollar to reduce the return to our primary producers and to create a two-speed economy by penalising the rest of the productive sector.
And we insist that every such improvement in our national income is an inflationary threat, rather than an opportunity to strengthen our productive capacity. It is as though we have no faith in the propensity of a market economy to grow and develop.
But it is when it comes to managing those factors that we can control that we fail most spectacularly. We kid ourselves that we are focused on the need to save, invest and export more, and that we must consume, borrow and import less. But our policy settings actually encourage exactly the opposite.
Our narrow focus on inflation means that every opportunity for growth is sacrificed to shackling the inflation bogey. The decades-long use of high interest rates means that investment is constantly deterred. And because perennially high interest rates create an over-valued dollar that buys in the short term more than it should, we encourage people to consume rather than save and to import rather than invest in our own productive capacity.
The poor return on productive investment –and the high dollar means that margins and market share are driven down, and our productive sector is less profitable than it should be – further discourages saving and investment, other than in non-productive assets like housing, where asset inflation is fuelled by reckless bank lending. Our attempt then to maintain a standard of living that our poor performance means we cannot afford makes overseas borrowing and asset sales more and more necessary.
These are not short-term issues. They have been endemic for nearly three decades. And we are about to do it all again, as overseas opportunists drive up our dollar, confident on the basis of thirty years’ experience that we will be stupid enough to continue to pay them a premium.
If we really want to change our fortunes, these are the issues we must address. Instead of vainly looking for the silver bullet, what about catching the commonsense wave?
Bryan Gould
11 June 2011
This article was published in the NZ Herald on 14 June.
Rebutting Tina
Much of the comment on (and criticism of) the budget has focused on the impact of the specific measures designed to rein back the government’s deficit. But, as the dust settles, we can see that the budget’s real failing was not in the specifics. Quite simply, it identified the wrong strategic target.
A casual observer could be forgiven for assuming, on the basis of what we were told about the budget’s objectives, that the country’s most pressing priority is to cut government spending. But, on the facts, that should be the least of our concerns. As Brian Fallow showed conclusively before the budget, our government’s gross financial liabilities as a percentage of GDP are the third or fourth lowest in the OECD.
Indeed, we could say that the government’s financial position is, comparatively speaking, one of the few bright spots in an otherwise pretty gloomy scenario – and it is strong because the government’s predecessors ran surpluses and prudently paid off debt over most of the preceding decade.
So, why is there so much emphasis on the deficit? And why do so many people believe that, because “we” are living beyond our means, the government must therefore cut back?
The answer is that confusion rules. There is of course a debt problem – but it is not the government’s. It is ours. While the government’s financial position is amongst the strongest, the country’s indebtedness – what we owe to others – places us at the bottom, along with Greece, Ireland, Spain and Portugal.
So, the budget – and much of public opinion – addressed the wrong problem. Does it matter?
Yes, it does. It means that, contrary to the story we have been told over recent years, we can and should be using the government’s financial strength to build our recovery. That was the point of paying off debt in the good times.
We have to assume that our policy-makers understand this perfectly well and that it is not economic rationality but political dogma – the ideology that, whatever the circumstances, government should play a smaller role in the economy – that determines that priority should be given to cuts in public spending.
But that focus means that our recession drags on for longer than it should. Those who pay the price are the unemployed, the sick and the poor, but it is also bad news for small businesses and producers, for the profitability, productivity and competitiveness of our industry, and for the economy as a whole.
Paradoxically, it is also a recipe for continuing government deficits, since a contraction in government spending, allied to contraction everywhere else in the economy, makes it virtually certain that the recession will endure and that tax revenues will stay flat.
Yet many people are persuaded that, until the government cuts back, we cannot afford to expand the economy.
But both common sense and overseas experience confirm that this is to get things the wrong way round. There is increasing evidence that recovery must come first, and deficit reduction second, and not the other way round.
Those countries, like Greece, Ireland, and now the UK, which have pursued an austerity programme in the hope that this will build confidence and thus stimulate recovery, have found that contraction is exactly that – contraction – and not the path to expansion through the hoped-for ministrations of the confidence fairy.
Other countries, like Canada, have demonstrated that getting recovery under way, by stimulating economic activity, is the best and necessary pre-condition for tackling a budget deficit. The Canadians have successfully undertaken – in that order – both exercises.
Moreover, while it would be good to return to government surpluses as soon as it is sensible to do so, it is not as though debt is itself such a frightening concept. A modern economy depends on debt, largely created by the banking sector; and the debt that really is a cause for concern is not the one we owe to ourselves but the debt we owe to overseas creditors.
That outsize debt – the one we all, you and I, owe to foreign lenders – is a function of our overall economic failure and our insistence on consuming more than we produce. That is the problem we should prioritise.
A government that applied common sense rather than ideology would, in other words, have identified quite different strategic targets. They would have focused on substantially reducing our overseas borrowing – the most significant step we could take towards protecting our credit rating.
As stepping stones towards that goal, they would encourage, not discourage, savings. They would give priority to restoring full employment. They would set about reversing the increase in inequality and the growing poverty in our society. They would halt the selling off of our important assets to foreign owners. And they would back this up with a reformed macro-economic policy that gives priority to the competitiveness and profitability of our productive sector.
None of these goals featured in the budget. Each should have had a higher priority than the strategic focus that was in fact selected. Shouldn’t we expect better?
Bryan Gould
22 May 2011