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Opinion: Why we must abandon the economic orthodoxy and embrace capital, trade and exchange rate controls
By Bernard Hickey
I feel like a priest who has been wrestling with his belief in god and has now decided god does not exist.
It's time for me to recant and to say what I've been thinking for months: the economic god of completely free markets and capital flows is not worth believing in anymore and we must look for other things to believe in and do.
I think New Zealand needs to have a debate about capital controls, about foreign ownership of assets, about measures to control our currency and about being openly nationalistic rather than internationalistic about our economic policy.
I think the Global Financial Crisis and the preceding decade of debt-driven instability in global capital markets and trade flows have demonstrated the failure of the economic model most New Zealand policymakers have adhered to for nearly 3 decades.
I think we need to rethink the way we run monetary policy, the way we allow foreign ownership of assets, the way we encourage savings, the way our financial institutions are regulated and change the things we are aiming for.
We should debate more specific controls on who owns what assets, whether monetary policy should still use the Official Cash Rate to focus on inflation alone, and whether banks should still be free to lend however much they want to whomever they want.
But first some background because this is not something that has come out of the blue. I've been thinking about this for a while.
I used to believe in the primacy of markets and economic freedom.
I used to believe that New Zealand's interests, and the world's, were best served by completely free movement of capital and trade.
I railed against the tariffs and the exchange rate controls of the mercantilests and protectionists.
I argued in favour of unfettered free trade with China.
I despised the 'Think Big' policies of the Muldoon era and all the import licenses and exchange rate controls that went with them.
I believed the reforms of the late 1980s were ultimately good for New Zealand and if only we had gone a little bit further and a little bit faster we would have been OK.
I believed a free-floating exchange rate and the removal of tariffs and other trade barriers was a good idea. I believed in the law of comparative advantage and how encouraging companies to specialise the means of production in different countries ultimately made everyone wealthier.
I pointed to the amazing reduction in the number of people living in poverty in China as proof of what free trade can do.
I thought the 'Great Moderation' between 2002 and 2007, where interest rates and inflation was low while growth was high, was real.
But I think many of those beliefs are now wrong.
The Great Moderation was a Great Fraud
It's clear now that the explosion of global capital flows and low interest rate debt over the last decade was a direct result of those unfettered capital flows.
The 'Great Moderation' was actually a Great Fraud perpetuated by financial engineers in Manhattan and London who targetted massive short term bonuses by creating financial instruments that gave the appearance of reducing risk, but actually massively increased risk.
These investment bankers exploited all sorts of holes in financial regulations and in the way pension funds are allocated to enrich themselves at the expenses of middle and under classes in developed countries. The created a long term mess for short term gain. They privatised profits for themselves and socialised the losses for us all.
They worked in tandem with the managers of often publicly listed multinational corporates who specialised their operations in different countries, often moving manufacturing and services to lower wage economies in an endless hunt to lower costs and increase profits (often for their own personal benefit).
This seemed like a good idea at the time and even seemed noble, spreading the wealth around. But all it did was reduce real wages for the middle and under classes in developed economies, who then promptly borrowed more to keep spending as if they were richer. It was a recipe for instability.
All this debt-fueled consumption growth in the developed world that was funded and supplied by savings and production surpluses in the developing world.
It could not last. Like any Ponzi scheme, eventually the debt keeps rising until the interest bill overwhelms the ability of the borrower to pay.
Once asset values start falling then we find out who has been swimming naked.
This exposure and collapse of a giant fraud is what we have seen in the last two years. It has expressed itself in the usual way.
Now the fallout
Financial crisis has followed financial crisis. Banks have gone bust. Savings have been wiped out. Economies have gone into deep recession. Ponzi schemers have been put in prison.
Currencies have swung wildly. Unemployment rates have risen. Asset prices (both property and share prices) have plunged.
Governments have tried to put their fingers in the dyke to stop their economies being wiped out after the collapse of the levee walls. They are trying and failing.
Firstly, governments rescued those same banks that had engineered the explosion of debt. Private debt was transferred into public hands to try to save the system. The bankers were allowed to keep going, generating bonuses for themselves. Now the publics in those countries where this happened in the biggest way are waking up, albeit in a messy way.
However, this didn't stop the inevitable implosion. It just delayed and extended it.
Now investors are rightly worried that governments may not be able to afford the extra debt taken on to keep their economies pumped up after September 2008 and the toxic debt they took on that the banks couldn't handle.
The financial systems in many of these economies remain broken, but more importantly, households know they have too much debt already and won't borrow more to spend like they were. The great de-leveraging has begun and nothing can stop it.
So the tide really is going out and now we're discovering the underlying structure of the global economy is flawed.
Emerging economies such as China want to industrialise in a mercantilist way, holding down their currencies to subsidise producers at the expense of consumers.
The global economy is now dependent on production and saving in one or two parts of the world, China and Germany, offset by consuming and borrowing in other parts of the world, America, Britain, Southern Europe, Australia and New Zealand.
This is fine as long as the savers have somewhere safe to put their capital surpluses and the borrowers can keep borrowing. But it all ends when borrowers run out of borrowing capacity and the savers lose faith in the paper they're exchanging for the product they're producing.
There are some short term fixes. One is to cut interest rates to zero and hold them there forever. America is trying that right now. The other is to try and win a race to the bottom in a game of competitive devaluations. In a way they are the same thing. America, Japan and Europe are all trying that right now.
All this specialistion and separation of production, saving, borrowing and consumption in different parts of the globe has done is make it more unstable.
The most convincing argument I've seen on this is from Nassim Taleb, the author of the Black Swan, who says that financial and capital systems need to have redundancies and inefficiencies built in to cope with shocks, just as Mother Nature does. Here's his argument in a must read piece in the New Statesmen.
We need some redundancy
Essentially, I'm saying we need to build some redundancy into the systems for global trading and capital flows.
We need to realise that sometimes the system doesn't work. We need to have something in reserve.
We need to accept that a completely free and unfettered system of global muilti-national capitalism driven by an elite of CEOs and investment bankers will inevitably blow itself up in a frenzy of borrowing, bonuses, short term thinking and self interest.
If we're not careful there will be the sorts of revolts, political unrest and global tensions that sparks wars and revolutions. It's happened before. To think it won't happen again is naive.
So what has this got to do with New Zealand?
Surely this is all going to happen independently of us and we just have to open ourselves up and hope for the best.
We tried that and it failed. We increased our foreign debt by NZ$97.5 billion inside the last six years, but all that happened is our per capita GDP actually fell over that period.
We borrowed from the free and easy and low interest rate global capital flows to pump up asset prices and go on a spending spree. All we have left for it now is some leaky homes, a big debt and a hollowed out workforce.
We need to recognise that in a world of competitive devaluations, growing trade tensions and nakedly selfish vested interests (governments, multinationals and global investment banks) that we have to defend ourselves and be just as nakedly nationalistic.
We have to assume, just as Marx pointed out, that free markets will eventually overheat and blow up if we allow them free rein.
Income needs to be redistributed to offset the concentration of wealth that naturally occurs in such a globalised, free flowing world of capital. Ownership of assets needs to be monitored and controlled. The growth of foreign debt needs to be restricted.
Consumers and bankers need to be saved from themselves.
That is what I think we're starting to see filter through to our politicians from the grass roots upwards.
Stop the fudging and have a debate
The government's fudgey decision this week to give ministers discretion to reject foreign bids for large tracts of farmland is the first sign.
I'd much prefer we had a debate about this.
John Key is as aware as anyone that the inevitable result of these dislocations of capital and the means of production, along with competitive devaluations, is a global land grab for hard assets such as arable land, mines and technology. Bits of paper don't cut it anymore. No wonder the price of gold hit a record US$1,300/oz overnight.
No wonder the Chinese want to buy our dairy producing land and factories. Or the mines in Australia. (Interestingly the Australians wouldn't let the Chinese buy the mines).
China likes free trade because it wants to build factories and sell stuff to the rest of the world. It wants to own assets in other countries that can provide it with the raw materials and food it needs to keep that export machine going and employing workers from the countryside.
But China will not allow others to buy those assets in its country. It is point blank refusing to allow its yuan to appreciate quickly versus the US dollar.
US politicians, under pressure from voters, are revolting against the multi-national free trading system in a messy way, looking to impose tariffs. The Tea Party movement, however flawed, is a reaction to the failure of this global system and the way it has been distorted by vested interests to transfer wealth from the middle classes to the richest Manhattanites.
This is not going to stop and we can't ignore it.
America is trying to devalue and print its way out from under its debt. Europe will eventually have to do the same, if only to stop its single currency from exploding from within. China will not stop and Japan is about to announce a massive new stimulus in the wake of its second currency intervention inside a week.
Brazil has declared it is engaged in a currency war to try to stop its currency from rising.
Brazil, like Australia and New Zealand, has a freeish floating currency that is rising as others try to devalue and buy into countries with hard rather than paper assets.
So what do we do?
The Reserve Bank of New Zealand has already taken a baby step down this route to intervention to save ourselves. Its Core Funding Ratio (CFR) essentially directs our big four banks to stop dipping into these global capital flows and to fund much more of their lending from local sourxes.
That has stopped the mad dash into property and higher debt, although households have also worked out for themselves that the game is up.
The Reserve Bank could do a lot more. It could direct banks to have maximum loan to value ratios. It looked at this in 2006. It could require banks to put aside more capital for the 'wrong' types of lending into housing and consumption.
Remember, that in the last two years of the crisis our banks have lent more to households and to farmers against the value of property, but lent less to businesses, Reserve Bank statistics show. Farm lending is up NZ$7 billion to NZ$47 billion and household lending is up NZ$8 billion to NZ$181 billion, while business lending is down NZ$4 billion to NZ$72 billion.
The government could consider limits on foreign ownership of major assets and restrictions on profit repatriation.
Savings into New Zealand KiwiSaver funds and the New Zealand Superannuation funds could be directed into New Zealand investments.
Much more could be done to protect ourselves and reduce the possible damage from future booms and busts.
I don't have all the answers./I'm not saying we should throw out the baby with the bathwater and return to Muldoon-era currency controls. But other open trading countries, such as Singapore, have ways to control their capital flows and exchange rates. Why shouldn't we?
I'd just like to have a debate and start looking for a new way to run our economy.
Because the current way isn't working.