A Kiwi Haircut?
We have grown accustomed to treating crises in the euro zone as having little to do with us. So, there will have been a restrained response to the news of yet another crisis, even one that has provoked “outrage and panic” in Cyprus where it has arisen. But we should perhaps take a closer look, because what has happened in Cyprus could – in essence – happen here as well; and, if it does, we too would respond with outrage and panic.
This particular crisis does of course involve issues that are specific to Cyprus. Like many other euro zone economies, Cyprus is in urgent need of a bailout; and, as a condition of that bailout, European finance ministers are proposing that a somewhat unusual contribution to the cost of the bailout should be made by those who have placed their cash for safekeeping in Cyprus banks.
European finance ministers have announced (after markets closed last weekend) that the $25 billion bailout (Europe’s fifth) will come with a huge twist – a levy of 6.75% on deposits in Cyprus banks of less than $190,000 and 9.9% on deposits greater than that. The measures will raise, from those with deposits in Cyprus banks, about $10 billion.
The finance ministers are playing a dangerous game. They have their eye on the huge deposits kept in Cyprus banks by Russian oligarchs who apparently (but not for much longer) see Cyprus as a safe haven where not too many questions are asked.
But the risk they are taking is huge. If depositors find that their savings are not safe in Cyprus banks, there will not only be a mass withdrawal of funds from those banks (as is already happening), but from banks in other “bailout” countries as well. The euro zone crisis is on track to return with a vengeance.
What has this got to do with New Zealand, you may ask? The answer may surprise you. Our own Reserve Bank is well-advanced on just such a measure that would, in certain circumstances, present a similar threat to New Zealand depositors as well.
The “Open Bank Resolution” policy being proposed by the Reserve Bank is well-advanced and is framed in terms of settling in advance the question of who should bear which liabilities in the event of a banking collapse – whether of a single bank or on a much wider scale.
The current options in the event of a bank failure are limited – liquidation, government bail-out or takeover by another bank. The post-GFC history of the impact on government finances of bailing out failed banks has obviously reduced the appetite for such operations, and in most such cases there will not be a long queue of institutions willing to take over the failed entity.
The remaining option – liquidation – however, would immediately threaten the security of customers’ deposits, a political risk that governments would be reluctant to take. The Reserve Bank argues that in these circumstances the main priority should be to keep the failed bank afloat and functioning. They therefore propose that the bank should close for just 24 hours while a statutory manager is appointed and an assessment is made of the bank’s financial position.
A calculation should then be made of the proportion of customers’ deposits with the bank that would be needed to cover the bank’s liabilities and that proportion would then be frozen. The bank would then re-open, but the frozen deposits would be retained for the statutory manager’s use so that the bank’s financial situation could be stabilised. Any unused portion of the deposits could then be returned to the depositors. The balance (an as yet undetermined proportion) would be retained and lost to the depositor. Similar processes would be applied to shareholdings in the bank.
This proposal for what is popularly called a depositors’ “haircut”, on which the government and commercial banks are currently being consulted and which could well take effect this year, is presented in terms of a response to the failure of a single bank. But the measure would have its most significant impact in the event of a banking sector meltdown, such as might be triggered by a renewed global financial crisis – and who would bet against that?
As in the case of Cyprus, the New Zealand proposal is an astonishing assault both on the property rights of depositors and on confidence in the banking system. The mere fact that such a proposal is even being contemplated should ring alarm bells, even for a typically complacent New Zealand public – and if they were, like the Cypriots, actually denied access to their savings as they disappeared into the banks’ coffers, that would certainly be enough to trigger Cyprus-style “outrage and panic”.
The supposed need for such a draconian measure arises entirely because banks not only enjoy the unique privilege of creating money out of nothing but are also entitled to use their customers’ deposits for their own trading purposes. There can surely be no more compelling case for a fundamental review of the way banks operate in our economy. Shouldn’t we know more about this proposal and be consulted about it before it is too late?
Bryan Gould
18 March 2013
The Reserve Bank Governor
Alan Bollard is a big man – well over six feet [around 1.9 m?] tall – but even his shoulders are not broad enough to bear the burdens placed on them. To point this out is not so much to criticise the Reserve Bank Governor as to lament the role in which he is cast.
He is, after all, lumbered with virtually the sole responsibility for what passes in this country for macro-economic policy. He alone must decide every six weeks on the direction in which monetary policy should be taken. He is given a single instrument – interest rates – and a single target – inflation.
Beyond that, macro-economic policy is virtually non-existent. Little matter that inflation might be low on the list of economic policy concerns, or that cutting interest rates might make little difference to anyone in an economy mired in recession. Faced with our manifold problems, the Governor- with his tiny armoury of largely irrelevant and ineffectual weapons – is on his own.
Little wonder then that – in deciding last week what to do about interest rates – he should have opted to share the responsibility by talking to the Minister of Finance. There was after all the small matter of continuing recession, with little sign of the much-touted recovery – and on top of that, the further blow of the 22nd of February Christchurch earthquake.
There was, however, much tut-tutting that the Governor should have opted, by consulting with his political masters, to depart from the principle of absolute independence for the Reserve Bank. Many commentators and practitioners seemed discomforted by the thought that the elected government might be asked to bear some responsibility for the fortunes of our economy.
The doctrine that macro-economic policy is a simple matter of setting interest rates – a task entrusted exclusively to the Reserve Bank – is of course greatly convenient for government. It means, in our current situation, that they can disclaim responsibility for a recession that is now well into a fourth year. Not only is it nothing to do with them but – according to the doctrine – anything they might try to do would be counter-productive.
The paradox is that governments that are unwilling to intervene in macro-economic policy, on the ground that the economy is best left to look after itself, are likely to end up being more interventionist than they expect. As the economy languishes because macro-economic policy settings are inappropriate, governments typically resort more and more – and with greater and greater desperation – to micro-economic intervention of various kinds.
So, we find more and more fiddling with tax rates and labour laws, more and more target-setting and micro-management for science and research and the delivery of education at all levels, tighter and tighter limits on benefits and public spending programmes – all in an increasingly futile drive to reverse our poor productivity and declining competitiveness.
But, surely, it will be asked, the Governor’s interest rate cut was a step in the right direction? Well, yes, it had a certain value as a psychological boost and as a small benefit to those with mortgages – but it is hardly likely to stimulate spending and investment to the point where the recovery really gets under way. That will require measures of a quite different nature and order of magnitude.
If monetary policy was really the key to recovery, we should surely have seen it by now. We have, after all, had falling and historically low interest rates for years now, and the economy has hardly stirred. As I and others argued in 2008 and 2009, using monetary policy as the only stimulus to an economy in a recession is like pushing on a piece of string.
The Governor has, in other words, done what he can, but what he can do is pitifully inadequate and beside the point. His recourse to involving the Minister of Finance last week suggests that he might be moving to this view as well.
No one doubts that our problems are endemic and that the Christchurch earthquake has added to the government’s difficulties. But the failure to take any decisive action over a couple of years means that the earthquake cannot be identified as the primary cause of our problems.
The government has in effect contented itself with trying to look after its own finances, and has been happy to let the wider economy look after itself. The paradox is that public finances are the healthiest part of our economy. Focusing primarily on getting the government’s deficit down, while ignoring the need for a whole-of-economy perspective, has reflected an ideological rather than practical priority, and has left the economy ill-equipped to grapple with its problems – among which, sadly, the consequences of the Christchurch earthquake now loom large.
Surely governments should be held to account for what they are elected for – providing an effective stewardship of the economy – and the Governor of Reserve Bank should no longer be abandoned to his lonely and irrelevant vigil?
Bryan Gould
12 March 2011
This article was published in the NZ Herald on 16 March.
There Are Other Options
The Reserve Bank Governor, Alan Bollard, used a speech last week to defend the policy that has been applied in this country for over two decades – a policy that he inherited and has since perpetuated. That approach to running the economy essentially revolves around monetary policy – and Alan Bollard’s advice to his critics was that they should accept a monetary policy framework which takes inflation targeting as its central element as the best means available of achieving good economic outcomes.
His critics are unlikely to be convinced. It is not just that our economic performance over more than two decades has been less than impressive and has seen us slide down the OECD tables. It is also that the Governor seems to misunderstand the nature of the criticism.
If we are to take his argument at face value, he is rather like a pastry chef who – using only flour – produces a flat and tasteless cake and then tries to rebut critics by insisting that flour is a very important and valuable ingredient. Most would argue that eggs, butter and sugar might also be helpful – just as, in economics, the Governor’s critics would say that to rely entirely on monetary policy is to ask it to do too much, including much for which it is not suited, and its exclusive use therefore prejudices the chances of achieving a buoyant and successful economy.
No one says, in other words, that monetary policy should be abandoned. But what the critics do say is that we would do better if we used other policy instruments as well.
The irony is that, if we read the Governor’s speech carefully, he seems to agree with this. And it may be better to watch what he does, rather than what he says. Whatever the headlines may say, Alan Bollard indicates very clearly that he is increasingly looking to other elements of policy, even while still focussing on the very narrow definition of his responsibilities with which he is saddled by our legislation.
Let us take, for example, the Governor’s plea to the government that it should get fiscal policy under control by mid-year. We can put to one side whether or not he is right to call for a reduction in government spending, which seems a little misplaced, given that we are still bumping along on the bottom of the recession. What is significant is his argument that an effective fiscal policy will reduce the burden that has to be carried by monetary policy – an acknowledgment that monetary policy needs help from an integrated fiscal policy, even when the policy focus is as narrow as simply controlling inflation. How much more true would that point be if we widened the focus to the wider and proper goals of economic policy?
He is also right to call for a re-appraisal of taxation policy, particularly as it affects the taxation treatment of housing as an investment proposition. This again is a recognition that taxation policy, by focusing on the micro-economic mainsprings of inflation, might have a useful role in a counter-inflationary strategy.
And, the Governor’s rehearsal of the tighter regime he has applied to the banks in respect of their lending policies may find its justification on prudential supervision grounds, but it also has the merit of addressing one of the most significant of factors contributing to inflation – excessive bank lending, particularly for residential property. Again, the Governor has identified an important and additional ingredient – beyond interest rates -in a sensible policy mix.
Alan Bollard, in other words, may talk a good fight against the critics of an exclusive reliance on a monetary policy focused on inflation targeting, but his actions tell a different story. The call for a new debate about macro-economic policy has not fallen – in his case – on entirely deaf ears.
It should be acknowledged that the Governor made some points in his speech that even his fiercest critics would support. His rejection of an Anzac currency, as a means of achieving greater currency stability, is entirely right. A common currency could only work within the context of a common monetary policy; and a common monetary policy could be applied in a democracy only by a common government. Unless we see our future as an Australian state, we should maintain our own monetary policy – and currency.
He was on less convincing ground when he also rejected the kind of competitiveness target that has worked so successfully for Singapore. But whether or not he is right in this, he has at least recognised that a debate on these issues is desirable and appropriate. We are at last making some progress by consigning the mantra that “there is no alternative” to the dustbin of history!
Bryan Gould
1 February 2010.
This article was published in the NZ Herald on 8 February