Opinion: Compared to Europe's economic woes, New Zealand has a far lesser case of the same ailment but is applying the same austerity medicine, says Gareth Morgan. Your view?

Opinion: Compared to Europe's economic woes, New Zealand has a far lesser case of the same ailment but is applying the same austerity medicine, says Gareth Morgan. Your view?

By Gareth Morgan

The IMF reckons the high debt levels our households face remain a barrier to economic growth.

The Minister of Finance has responded to this by saying reducing government debt is the appropriate policy.

His argument is that by the Government reducing its debt ratio, which, by the way, is not high by international comparison, it will underpin low interest rates, a low exchange rate and hence an export-led recovery that will enable households to escape their debt burden.

Rather than amputating an arm in order to cure the infection from a leg with gangrene, why not deal to the leg directly?

The IMF recognises, like most of us, the world is going through a major correction from 30 years of credit excess which has led to such a distortion in capital markets that economies face major constraint from this legacy of bad debt.

That constraint is crimping the generation of income (GDP) for their citizens.

The great financial crash that was precipitated by a collapse in housing finance (sub-primes) has reverberated across the world and house prices have collapsed to a varying extent in response.

Here in New Zealand, the rate of mortgagee sales has just hit a record and is still rising.

If anything, we have been inordinately slow to purge the excess in our own housing market, but it's happening - albeit like a slow train wreck - and there is plenty of excitement ahead in that sector.

But what of the Bill English logic?

It's true that if the Government wasn't borrowing a possible, but not guaranteed, outcome would be that having one less borrower in the market would take pressure off interest rates.

Of course this is always the case, no matter what stage of the economic cycle we're in, so it's a curious argument that holds now is an especially appropriate time for such fiscal austerity.

I'm trying to figure what economic theory he's deploying - it's certainly not Keynes, as that would advocate government stimulus during a private sector contraction.

It's not monetarism as it would simply argue for a monetary policy in accordance with the inflation objective.

So it appears to be some kind of home-bake that holds excess in one sector is most appropriately addressed by contraction of another.

It's definitely a circuitous logic, so let's see what the possible rationale could be.

In many other countries we've seen governments having to either take over the debts of delinquent private sector borrowers or shore up the capital of their banks to prevent a collapse of local banking systems.

Even in New Zealand we saw some of this as the Government dusted off its implicit depositor guarantee and made it explicit for finance companies such as South Canterbury.

In Europe this has happened to such an extent that the Governments themselves are now in turn so indebted that these countries are being downgraded on the international credit markets and are facing interest rates too high to ignite economic recovery.

As we saw with Spain at the weekend, the Government there has been left with no choice but to request a subsidy from Germany - oh, to have a sugar daddy like that. But let's focus on the New Zealand variant.

Here the banking crisis is not so severe although, for sure, in line with Reserve Bank directives, the banks extended way too many loans to ordinary New Zealanders speculating on house prices.

In the midst of that orgy, Governor Bollard wrung his hands and said he wished Kiwis wouldn't cause such an asset price bubble, but on the other hand he excused his impotence by adding the central bank couldn't do anything about it. Shameful. That has landed us in the mire.

Now as it all unwinds and the huge household debt is exposed more and more as house prices fall away, it is obvious that households are not in a position to underwrite a domestic-led expansion.

Indeed, it's quite the opposite - savings are rising as households try to correct the excess.

Meanwhile, the other potential source of income generation for the economy - net exports - is in a spot of bother as a slowing world trims exports faster than our own lethargy reduces our demand for imports.

So two out of three sectors are in the doldrums - the private domestic and net export sectors.

For businesses, this offers little reason for investment and employment.

Enter stage right the government sector, always the plaything of the politicians of the day.

While they remain in office they have the power to expand or contract this at will.

Certainly the will is with us - the Key Government has decided this is a great time to trim its sails, that apparently there exists oodles of waste that can be cut away, freeing resources for the private sector to then take up.

As if the private sector was scrambling for capacity right now.

Anyway, it's in with the Super Ministry and out with the plethora of ministries that amount to nothing but waste; it's time for the teachers to stretch to a new extent; time to carve to the bone departmental votes such as those of Mfat, DoC and a host of others.

To shrink the state sector because of a political mandate to shrink it is one thing - and arguably the return of National with an increased majority has provided precisely that ideological mandate.

But the art of politics is seldom to call a spade a spade, so we've been asked to believe the Bill English logic - which holds that government can be trimmed with no impact on its production, and so no loss of productivity from the infrastructural sector, and the financial sector impacts (lower interest rates) will thrust us into economic recovery, or at least prevent things getting worse.

It's somewhat of a stretch to suggest fiscal austerity, during times when the private sector and net exports are struggling, is the appropriate medicine.

Perhaps it would be a little more honest to admit that the Government deficit, which has ballooned due to lower taxes because of recession plus the cost of Christchurch, will lead to a credit downgrade for the country if it's not reined in.

It's this that requires the fiscal austerity, rather than any nebulous argument that austerity is the key to prosperity, as the political spin would suggest.

Cutting government spending as a response to the budget deficit, and selling assets to reduce government debt is the simple approach.

But is it the cleverest?

Southern Europe is suffering from the effects of government austerity as the response to the consequences of past private sector excess.

That suffering is in the form of enormous unemployment, economic contraction and loss of confidence from foreign lenders.

New Zealand, by contrast, has a far slighter dose of the same underlying ailment, yet is applying similar medicine.

Across-the-board austerity as the path to prosperity is an unproved formula, and it looks increasingly as though Southern Europe will not follow this through.

Rather, its saviour will be subsidies from the North that relieve the burden of the austerity medicine.

Where's our sugar daddy?

The banks, meanwhile, continue to acknowledge that more and more of their clients have borrowed well beyond their repayment capability, and that the time to give them the flick is here.

Bankers' patience in waiting for the fruits from Mr English's export-led recovery to trickle down to households will need to be very high indeed.

Wouldn't the Government be better to focus on the causes of the household excess, to instruct the Reserve Bank to correct its prudential guidelines to banks so that a repeat of speculative housing demand raising pressure on interest rates simply wouldn't happen, to actively encourage investment in skills and lending for business development, to plug the holes in the tax regime and reform the welfare system so they're both efficient and equitable?

Never has there been a better time for structural reform - a Government with a strong mandate, little to no pressure on resources from speculative property investment, and an electorate with modest expectations.

It seems such a waste to embark on an ideological purge of state spending that risks adding momentum to the downturn anyway.

---------------------

Gareth Morgan is a director of Gareth Morgan Investments.
This article first appeared in www.nzherald.co.nz

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

20 Comments

Comment Filter

Highlight new comments in the last hr(s).

Well I can't understand this government's obsession with balancing the books when as stated above there is little on the horizon in terms of economic stimulus from either the domestic front or the export sector.
It certainly is a do nothing government along with it's do even less fiscal policies. 

Trouble is we are beholden to the bond markets...they are right wing voodoo monetary focused economics, plus 28 years olds playing with many many millions who know diddly of the real world (and JK etc have to suck up to these)....and other economic models.....then we have this bunch of pollies who are similar, but older........Funny really, some years back JK was that 28 year old v Roger Douglas(?).....now the boot is on the other foot.....
Take a look at our bond rates, in the 5~6% band.....look what has happened to Spain and Greece and more and more Italy.....heading past 6%......and they have a sugar daddy and we do not.....and we are seen as a risk commodity currency......Also when the bond vigilanties run with their money it will be un-stoppable and happen in at most 3 months.....tripping that exit is the last thing we want to do.
So while I agree austerity seems and is a bad idea....we are up against humans who hold views that are not logical and not listening to sound maths/economics....
rock and a hard place....
regards
 
 
 
 
 

Well penned.........
Right now I see the ppl being made redundant or go onto short term contracts is quite high......the impact of that is fear. This means they spend less and save more...at best....if they were a 2 person working household and are now one then spending is severly curtailed and so is saving. Do this to enough ppl and the impact is deflationary not jsut for them but the ppl they know see it happening and do likewise.  Try walking around Noel Lemon, Bond and boob and tricky dickie and see how empty they are. The few ppl in there are 50+ and are driving hard cash bargins....as an example, 55inch SONY LED TVs dropped from $2700 to $2000~$2300 as a list price in 3 months....and even that seems negoitiable.....when you say I'd like a cash deal.....and this downturn hasnt even started yet.....
regards

In what way does a NZ household buying a chinese made $2,000+ tv help the NZ economy? 

ho hum.....it could be a $250 ipod, $25 tee shirt.....really the fact you asked about such a specific without thinking of a wider context and past it tells me there is probably no point in me trying to explain it to you..mainly I dont think you want to understand or even listen to what I'll say anyway....
regards

"The IMF recognises, like most of us, the world is going through a major correction from 30 years of credit excess which has led to such a distortion in capital markets that economies face major constraint from this legacy of bad debt.
Is it 30 years of credit excess or centuries of crap economic theory? Maybe it's time to change the mantra Gareth instead of blindly following the same crap economic theory.
That constraint is crimping the generation of income (GDP) for their citizens."
GDP is purely a measure of consumption at various levels of the supply chain.  So the more we consume the more income we have - BS!!
Time to reset the value of everything - money especially.
 

IMHO one of the major components of our current financial malaise is that Gov'ts throughout the OECD are too large a part of the economy.  Therefore to suggest that they form a larger part of the economy will not solve the problem it will just extend it. 

No.....Sweden has a higher Govn %, its doing fine....NZ has one of the smallest and yet we are not....The UK is doing austerity its doing badly, Ireland has already and its in a bad way.....
Its not the size but the spend..  Value for money is also important....public health for instance takes 8% GDP, the American system 17% GDP...that in effect is a tax at a double level.....the collectors of that tax are just different. So a public health system is less intrusive and detrimental...its a lower overhead....and not who holds the overhead that counts.
right wing (or even left) blinkers make you blind.......
regards

GM argues there is a housing bubble and certainly the Median Multiple bears That out.
 
But how to prick it???
 
- without crashing the banks' balance sheets (those inflated loans are assets)
- without the ability to merrily inflate it away (the US ZIRP solution)
- without adding to the mortgage sales and foreclosures - the Zombie Inventory which Doctor Housing Bubble has faithfully charted in SoCal for many years now
 
One way out could be some combination of the following:
- CGT on urban land within a MUL which is a designated multiple of the land outside the MUL (for AKL, this multiple is around 6 - 9).  This causes mucho pain to land-bankers, and may release large swathes of said land for development, hopefully crashing the price per.
 
- ditch the LBP (which has already led to the formation of nice cosy Cartels which hoover up the licensed tradies and screw the punters) and allow all residential building to go ahead whatever:  a large increase in activity will see to some real GDP growth - it's been horribly depressed for years now.  Peter Cresswell has the goods here.  Inspections (the old way) are sufficient - after all, how many Chch folk were killed by Unlicensed Extensions to Residential Premises?
 
The objective here is simple:  treat building/shelter as a basic human right, and tax/regulate away the obstacles to the free flow of its provision.  Win/win, I'd say.
 
After all, it's happening anyway:  obstacles just get routed around, and its a real pity that so many of these obstacles are regulatory and Do-Good Intentions, carried out by power-crazy Councils and minions with clipboards.
 
</rant>

Building wont be real GDP growth as you claim, I cant see how it is, let alone the more det involved....its just adding to the ponzi.....a bit of can kicking praying that it will get better....
regards

As a renter, I am all for pricking the bubble but this will prove very unpopular with the majority of the (overpriced house-owning) voting public. However, acute short term pain will outweigh chronic ongoing pain.  A burst bubble will reset the economy and force out all "investors" who are investing without a sound business model (i.e. relying on capital gains) and those who have over-leveraged (most people who have bought since 2002).
 
So what are the altenatives?
 
1 - put in more air than is coming out i.e. inflate away the debt. This will only postpone the problem, not fix it as poeple who didn't get burned will quite happily borrow high multiples of incomes at low interest rates. The bigger the bubble, the bigger the bang.
 
2 - gently let the air out of the system. This is the equivalent of letting the market stagnate while waiting for incomes to catch up. This is effectively what has been happening in the Japan where house prices have gone nowhere  but wages have increased which lowers the median multiple. The risk of this approach is that it relies on future growth over many years which is unlikely in the current environment. All it needs is a downturn and the air will start rushing out of the bubble.
 
I would suggest that the first is more politically palatable. This is short term thinking but it gets you re-elected.

Incomes catch up, ah now there's an idea.

or costs go down, ah now there's an idea.

you just look at one aspect......when the bubble bursts the job losses will be eye watering followed by hardship...is your job safe?  Taxes would have to cover it.....if your tax bill went up 50% how would you feel/cope?
be careful what you wish for....
regards

http://www.debtdeflation.com/blogs/2012/06/12/chris-marterson-interview/
30mins he starts to talk about BH's point on BBs....but anyway its all fasinating.
regards

Does anybody know the true percentage of mortgage holders. The commonly banded figures seem to be 40% renters, 30% freehold home owners and 30% mortgaged home owners. Of those 30% not all will have excessively high mortgages that will be exposed badly by big price falls.
 
If the figures are correct 40% have an interest in or indifference to house price deflation and 30% would be unaffected (buying and selling on the same market) and by compression of the rungs of the property ladder would probably even benefit. Yet all the political capital goes towards keeping 30% and their banks happy and scaring the crap out of the 30% who are freehold into maintaining the status quo.
 
Are trusts distorting the figures? Are mortgage holders a bigger percentage of the population than they appear at first glance?

It doenst have to be a big % of the population.
I suspect the problem is the banks leverage.....even small percentages going underwater say 5~10% has a huge effect because of the high leverage (ours is 14 to 1? USA 30 to 1?  rising to 100 to 1?). Banks are suddenly writing down asset values, then that means their leverage increases as their assets backing their loans are worth less so need to re-capitalise ie borrow as the leverage ratio has gone bye bye....they may even be classed insolvent....then they close........depositors lose their $s or the Govn ie me as a tax payer has to guarantee it......yet of course im an innocent 3rd party in this.....
The interesting point is the PIs and not trusts I suspect....Im not sure what effect  or distortion they have....I suspect they are hugely leveraged on some houses but not others so they are easy and worthwhile targets for banks to do mortgagee sales to recover money...kind of spports the present level of PI mortgagee sales....maybe....
Also as part of that leverage backstop banks hold not only cash but other high grade assets..., if these prove over-valued let alone toxic.....ouch....yet more borrowing.....its one huge down sprial when it starts....
regards
 
 

Reform?  Y'er joking mate!
 
Life's too good here "muddling through" with Pete 'n Tari, Banksie and the Dunnster in tow.
 
What's the old saying about being judged by the company you keep?
 
 
 
 
 

Garath, you have no business talking about debt without first addressing the sustainability of the system as a whole.
 
It is like you are chatting to Bernie Madoff about which fund of his has the best risk/return ratio.

Steven's not doing much work today, he's posting an awful lot on this article it would seem.