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Experienced banker makes a case for the RBNZ following the Bank of England in directly financing the Government, as the period of peak central bank independence ends

Experienced banker makes a case for the RBNZ following the Bank of England in directly financing the Government, as the period of peak central bank independence ends
Adrian Orr

It won’t be long before Treasury and the Reserve Bank (RBNZ) enter taboo territory and work together more closely to keep the economy afloat.

This is the view of Sean Keane - the founder and managing director of Triple T Consulting, who is also a Jarden non-executive director and former Credit Suisse Asia-Pacific managing director of global money market funding and short-term interest rate trading.

Wearing his Triple T hat, Keane believes the RBNZ will keep buying New Zealand Government Bonds on the secondary market, as it currently is under its Large-Scale Asset Purchase, or quantitative easing, programme launched last month.

But in the “near future” it will follow the Bank of England and Bank of Indonesia and additionally buy bonds directly from Treasury.

The end point would be the same, regardless of whether the RBNZ buys bonds direct, or from banks and other investors that already own them - the Government raises money and the debt goes on the RBNZ’s balance sheet. The difference is that cutting out the intermediary saves taxpayers money.

Period of peak central bank independence has passed

While neither RBNZ Governor Adrian Orr nor Finance Minister Grant Robertson have said they intend to do this sort of direct financing, they haven’t taken it off the table either.

Orr recently said he would remain “open-minded” to the concept, while Robertson a fortnight ago told it was being kept “under review”.

Robertson said if there comes a time the market can’t absorb all the New Zealand Government Bonds being issued, then “of course” he would look at the RBNZ buying the bonds directly from Treasury.  

Keane maintains it’s significant Orr hasn’t clearly ruled out broaching the revered moat that separates the central bank from the government, as his Australian counterpart has.

“Orr certainly has a reputation as a central banker who is prepared to try new things, and who does not feel constrained to obey past norms or principals. In the current environment therefore, it is worth paying close attention to what the Governor is saying,” Keane said.

For some time now, he’s believed “the period of peak central bank independence” has passed globally.

“Central banks are operationally independent only to the extent that their people wish them to be so, and the degree of independence that is granted changes with economic and political cycles,” he said.

RBNZ should buy bonds at market rates

So, how would Treasury and the RBNZ go about direct financing, without losing their credibility and ruining pricing tensions in the bond market?

Keane explained: “The RBNZ could buy bonds directly from the Debt Management Office [which is part of Treasury] by announcing prior to each auction the amount of bonds that it is willing to purchase in the tender.

“The DMO would carry out its tender as usual, but the offer of bonds to the street would be reduced by the amount reserved for the RBNZ.

“The tender process would remain market competitive and the rate that the RBNZ would buy at would be the same as the issuance rate set at the market tender.

“There are three benefits that go with this approach:

  1. “The RBNZ is transparent in announcing its intentions and revealing its actions
  2. “The rate at which the government (DMO) transacts with the RBNZ is determined independently by the market and can therefore be considered fair and reasonable
  3. “The cost to the NZ taxpayer is reduced by the fact that two different parts of government are not paying away the bid/offer spread to the market.”

Motive needs to be boosting inflation, not funding the Government

Keane said the Monetary Policy Committee would have to be clear it’s doing this form of QE to meet its mandate of keep inflation between 1% and 3% and employment at a maximum sustainable level - not to finance an increased government borrowing programme.

He also believed it was important for it to continue buying bonds on the secondary market. Under its current programme, it has committed to buying up to $30 billion of New Zealand Government Bonds and $3 billion of Local Government Funding Agency bonds.

Keane said the market has responded quite positively to this. Investors have continued to buy government bonds because they can be confident there’s a buyer for these bonds - namely the RBNZ - should they wish to on-sell them.

“There may be some market pullback if the RBNZ is no longer directly active in the local bond market,” Keane said.

“For that reason, it would be appropriate for the RBNZ to continue executing some portion of its QE program on-market, thus maintaining the focus of the dealer community and the support for bond prices.”

The RBNZ is expected to comment on its direction of travel on QE on May 13, when the Monetary Policy Committee releases its next quarterly statement.

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It seems to me that the Reserve Bank is undermining the very reason for its existence.

How bad the economy is and will be is evident, how no one has any clear idea of what to do or how to tackle the economy and everyone is in experimenting mode ( Not knowing the outcome but guessing) similar to corona virus which no one having clear understanding and are experimenting with different medicines and lockdown to contain it.

Yeah, like all these economic projections of V-shaped recovery in the US being based on no second wave, when a second wave looks like a mathematical certainty barring some sort of miracle cure. No one has a clue.

Good to hear this, about time too. That way the government debt is effectively owned by ourselves. In the old days this was called social credit.......but it's taken us 90 years to accept it as being sensible.

The sooner people wake up and realize that central banks are ruining world economies the better. Arsonist Adrian is no different than all the other lemurs running to the cliff. Get rid of it all together and let interest rates and markets normalize.


Okay, we've realised it. Now what? How can we actually do anything to prevent those crooks from destroying the economy?

Q. What most needs replacing in the NZ economy? A. International Tourist Spend 17 billion per year.
Estimate 2 million taxpayers in New Zeland aged over 18 that paid tax on work income exceeding 10k gross for FY 19/20. Not WINZ or Investment income. Give each of those taxpayers 800 per month of virtual money. Coins or Points. 1 point/coin = 1 NZD. Currency lives in account online tied to your IRD number. Access and pay via the web or phone app. Direct to service providers. Qualifying service providers that would usually have some claim of tourist-related income can register to take payments in the virtual currency. Example. Restaurants, Bars, Cafes, Hotels, Attractions, Domestic Airlines, Car Hire, yadda yadda. Providers only can exchange received points, coins for NZD from crown account. Use blockchain for security. Points can only be exchanged for goods or services with registered providers. If a provider commits fraud to receive your points in exchange for cash or other fraud type and you can prove it by any means. You receive bonus points and the provider loses all points and the right to receive points in the future. This would inject money into the economy from the bottom to support employees in the tourist sector and their ability to support the NZ economy in turn. Cost 1.6 billion per month

ummm. Dont' be so stingy..lets make it $30k per month and be done with it.

Or maybe time to accept we won't get out of this mess by playing with computer digits.

Has QE worked anywhere? Don't think so.

I think it has usually been a disaster because it is hard to stop once the taboo is broken (leading to rampant inflation and guillotining of shopkeepers when tried in France). Having said that, I think it has been done responsibly too, Jersey did it I think. We need to understand the boundaries that should not be crossed. I doubt if the powers that be have a clue about where they lie. It's open slather for election goodies. Should be interesting.

Set it up now. Wait for level 2 and do it for one month. Max cost 2 billion. Measure the effect. If it doesn't work stop. Worst case 2.0 billion is injected into the economy from the bottom. 260 million comes straight back as GST. More comes back from PAYE on workers wages that would otherwise be collecting the dole. Even if unemployment only goes to 8% that is another 100000 people. That's $280 per week each.120 million a year. Who knows what other benefits and subsidies per person would be on top of that. But it is still chicken feed compared to the 1-2k per week they were earning and had built their lifestyle and debt obligations around. We need to do something or carnage is coming. Maybe the unemployed and homeless hordes will descend on the marinas of Auckland and start living in all those beautiful luxurious empty boats.

OBR is about 2.5 years in horizons, before that is the Banks mergers etc. - Before that? is like this article 'suggestion input' that is to maintain at any cost the F/Finance part/Banking within the F.I.RE economy, central bank support of govt. Anyone remember about 6-9 months before this Covid19? Two big giants already ahead showing example (Deutche & HSBC Banks) on maintaining their credits..'Shed Their Work Force'
Worldwide Airlines already showing the same steps. Now here's my take, at any cost/measures both OZ/NZ govt. will prevent those actions of Deutche, HSBC & Airlines.. but how long? they can hold the pressure.. when the rest of global banks.. will just have to follow my advise?.. then the pizza effect (..domino I mean).

This is probably the most interesting period in monetary policy since the RBNZ's initial independence.

The biggest factors here are that a) nearly all developed economies are doing this b) NZ is starting from a strong public debt position.

The next step will be widening the scope of instruments for prudential liquidity portfolios.

Housing I.O.U.s. Sorry, I mean house purchase promissory notes, ie, residential mortgages.

That's like feeding ham to pigs though.

At that point why would you need banks? People could just get a credit from a central bank for a house and it would be guaranteed not based on income (because as we've seen that is now out of peoples control to generate) but instead on your social record (i.e. have you been a good boy or girl?) and you just pay the debt back as you can.

At the moment the banks just appear to add inefficiencies to the market and could be viewed as a deadweight loss on the economy (given that ultimately it only seems to matter what the central banks balance sheet looks like)

Interestingly, I think a lot of traditional societies used to do just that, ie all pitch in and build a house for a newly wedded couple. The building societies came from 15 blokes in a pub in Birmingham who all agreed to pay into a fund that would pay for one house a year until they all had a house, drawing lots for who was next. State housing is another take on the same idea. Maybe we can come up with something really good.

If it stops people here complaining about it, I'm in.

Motive needs to be boosting inflation, not funding the Government

There is no basis in global reality to expect the former. LSAP programmes undertaken by ECB and BOJ have never generated inflation near forecast expectations.

Moreover: The only thing you need to know about bank reserves: they go up, it's bad

I don't see how you can't understand that QE globally has offset deflation, rather than causing inflation.. It's not hard.

QE has definitely caused inflation - in asset prices. The transmission mechanism from monetary policy to consumer inflation is broken - or if you're cynical like me, never existed to begin with.

I understand this clearly:

As I wrote not all that long ago, low rates do not signify stimulus nor abundant liquidity, they often describe just this sort of monetary tightness and chaos. Abundant liquidity means everyone gets funding; lack of liquidity, which does show up in low rates, means that money dealers are being prohibitively discriminating. Link

You know the tram has come off the tracks when this is suggested.

Hilarious. Wonderful smoke and mirrors. You couldn't make it up:

Keane said [in a suitably deep and serious tone] the Monetary Policy Committee would have to be clear it’s doing this form of QE to meet its mandate of keep inflation between 1% and 3% and employment at a maximum sustainable level - not to finance an increased government borrowing programme.

After enjoying a piece of Whittaker's chocolate, he summarised as follows:
"Woohoo. Unlimited free dosh all round. Let me buy you a drink Minister."

Modern Monetary Theory tells us exactly how the governments finances operate. All government spending is made by creating new money just from using key strokes on a computer at the Reserve Bank. This spending creates commercial bank reserves which are later reduced by the use of bond sales, not for the purpose of funding the government but for the purpose of maintaining the reserve Banks interest rate settings.
Bonds sales and taxation do not fund the government, it is a sovereign currency issuer, spending must come first so as to create the currency.

Money is created by debt. The money doesn't actually exist until you take that debt and start paying it back. So what your doing is pulling money in from further and further into the future the higher and higher the debt level. What could possibly go wrong ?

Deleveraging eventually if we can't generate the incomes to service the created debt. In the past we would simply drop interest rates to make the serviceability easier - but we can't do that now given that we're at zero. Next step is for further QE, but that just creates asset bubbles which require more debt (e.g. for first home buyers entering the market). But again, we don't have the incomes to support those debt levels.

Next step is defaults/deleveraging - and a game of hot potato to see who is going to be left holding the debt. So say you own corporate bonds right now - sure you've got the final claim (you're not subordinated), but what happens if there's nothing left over? Even the safety of bonds isn't looking so safe over the next few years...unless of course central banks buy all of them.

No problem in the internal mechanics of MMT. It fails ala Argentina. No Argentine trusts the peso. He keeps his savings in USD, preferably in a US bank. MMT destroys everyone's trust in the institutions of society when the currency fails. Usually resulting in a lot of bloodshed (most famously the French Revolution, which was going fine until MMT; and of course Weimar Germany, which led to the rise of he who must not be mentioned). The Argentines had General Galtieri, famous for dropping students out of helicopters into the sea, in large numbers.

There be dragons. Exactly what wakes them up isn't clear.

Taxation deletes currency and what isn't taxed away becomes our savings, look up Sectoral Balances.Only the government can create net financial assets for the private sector to save. Why is household debt in NZ so high? because the government forces the private sector to borrow it's money supply. Argentina doesn't meet the definition of a sovereign currency as it borrows in foreign currencies.

No problems with the mechanics or the maths. The maths is Pacioli's double entry bookeeping, which is right up there with Newton's calculus as far as I'm concerned. My point is at some point the system becomes unstable and the boundaries around that transition are not clear. You are quite right that all my examples are from a different monetary epoch and thus may not be relevant.

As Benoit Mandelbrot points out in his "(Mis)Behaviour of Markets", though, complex systems can transition from a state of mild volatility to a state of moderate volatility to a state of wild volatility. The advocates of MMT assume that a state of mild volatility will be maintained forever. Actually, they don't even know they assume it, as they have been trained to think about complex systems as if they were simple linear ones, as have we all.

The concept of an ecosystem comes from Mandelbrot's work on complex systems. In a complex system, you cannot predict whether a change in an input will just be absorbed, or produce an expected result, or cause the entire system to become unstable. The economy is a complex organised system, an ecosystem. Changing an input can have unexpected results, sometimes drastic ones.

MMT is a powerful and dangerous technology, which does not mean we should not use it (so are kitchen knives). It does mean we need to be alert to its dangers, particularly as we haven't used it much and so we don't know what they are or how to avoid them.

I would suggest that exchange rate volatility is a likely concern. We are used to mild exchange rate volatility, so the step up to moderate exchange rate volatility would be a sign all is not well. People have already started to question what an NZD is. They are searching for something more dependable, whether it is USD, gold, bitcoin or houses. Our confidence in the NZD is slipping away. There be dragons.

MMT is not something to be introduced or adopted, it is a description of how our system works here and now. It is high levels of private sector bank debt that always leads to economic problems. When our government has been fixated on running surpluses this is exacerbated as Sectoral Balances show us.

Michael Pettis says that foreign capital inflows into an advanced economy usually cause either more debt or more unemployment, based on the same logical application of accounting principles. This seemed to me to be the more powerful factor under National and the previous Clarke/Cullen Labour government, forcing us to increase debt levels. I can't quantify it, but it is where I would look for the explanation of our current silly house prices and debt levels.

For the last thirty five years every NZ government has committed itself to running budget surpluses. In this time we have been running current account deficits also. Under this scenario private levels of debt must increase as the three sectors must balance to zero. Listen here to economist Randall Wray explain it.

Only taxation can cancel government created money and when bank created credit is repaid that money also is cancelled. Banks create money when they issue loans, not when the loan is repaid.

It's reported and commented upon on this kitco video.

Gold investors are not a good source of knowledge and understanding of how our monetary system operates. They have a vested interest in having people buy gold for their own personal gain.

Can we actually do this? What is going to happen to the value of NZD?

inflation only occurs once spending has exceeded the capacity of the economy to produce goods and services. Unemployment is always an indicator that spending is not great enough.

Money is about to lose all meaning... Mine is heading off to the Perth mint as we speak

After going through all of this and not understanding much of it other than its mostly uncharted waters, I have one question. Are Kiwi bonds still much less of a risk than a term deposit in one of the big four.

Short answer. Yes. Your deposit in the big four is backed only by Wayne and Sharlenes income. Enough of them lose their jobs and default on their mortgages then your deposit will take a haircut. The bonds are backed up by all taxpayers and the ability of the Reserve Bank to create as much money as it needs too as a buyer of the bonds. The interest rate difference between the bonds and the term deposits is massive in percentage terms. Term deposits are say 300 basis points vs 50 for the bonds. 6 times higher because of the huge risk.