Keith Rankin Analysis – The Ponzi financial model and New Zealand’s monetary policy

Analysis by Keith Rankin.

Today I read this article (David Seymour calls for sweeping changes to make the Reserve Bank more accountable, NZ Herald, 26 October) showing David Seymore’s wish to double-down on New Zealand’s financial model.

The Ponzi financial model operates much more broadly than the fraudulent Ponzi schemes associated the likes of players Bernie Madoff and Charles Ponzi. In particular, the model can and does operate without the fraudulent deception of these renowned schemers. And it can operate on a global scale.

Ponzi finance takes place when ‘investors’ (people wishing to make money from unspent money) advance saved funds to ‘players’ (understood by ‘investors’ as ‘intermediaries’ such as banks or funds managers). Ponzi players then use the funds for their own gratification (gambling or consumption) rather than reinvesting those funds into a venture which would be expected to yield a profit. Instead of servicing the ‘investors’ with genuine earnings, Ponzi players service existing ‘investors’ by borrowing from new ‘investors’. A Ponzi player ‘borrows from Peter to pay Paul’, rather than paying Paul out of income earned. Peter and Paul are example ‘investors’. (In a fraudulent scheme, one could say ‘rob’ instead of ‘borrow’; although even in fraudulent schemes ‘investors’ only actually lose when the scheme unravels.)

(Note that ‘investor’ is one of the most ambiguous words in the English language. In correct economic language, a saver is not an investor; but a true financial intermediary – such as a legitimate bank – is an investor. An investor is a spender, or a direct financer of spending; a purchaser or manufacturer of new assets. A true investor is neither a saver nor a consumer nor a purchaser of existing real or financial assets. Essentially, an investor operates a productive business or acts in a businesslike way, sinking capital and awaiting an eventual return in the form of profit or interest. Investment is ‘giving up something real to create greater future value’. Investment is not the purchase of existing assets in the hope that those assets can be sold in the future at a higher price; such speculative behaviour is gambling, though not all gambling is imprudent. Genuine investment may be called productive gambling, whereas speculative ‘investment’ is unproductive gambling.)

Non-fraudulent Ponzi finance takes place when there is no overt deception. ‘Players’ and ‘investors’ are open about their activities, though there may be degrees of naivete or self-deception on the part of either.

The nation-state Ponzi model

A ‘nation-state actor’ is not the same as a government. A nation-state such as New Zealand, when considered as an economy or as a financial actor, may be called New Zealand Incorporated (NZ Inc. for short). The chart here (Intersectoral financial balances from 1980: New Zealand, from Visualising Countries’ Deficits and Debts, Surpluses and Credits, Evening Report, 29 May 2023) shows, from 1993, the telltale fingerprint of a nation-state ‘player’ adopting the Ponzi financial model as its ‘business model’. New Zealand Inc. is the player in this chart. ‘Peter’ and ‘Paul’ are represented (in green) as the ‘foreign sector’. Paul has always been very happy to ‘invest’ in New Zealand Inc. because Peter keeps supplying the funds which pay Paul. Likewise, Paul pays Peter. There is an ongoing long-term flow of funds from foreign savers to New Zealand consumers as well as to other foreign savers. Much of it is channelled through asset markets; thus the end-consumers are often people who sell their houses or shares to speculative ‘investors’.

The funds from foreign Paul and foreign Peter are channelled into the New Zealand private sector, supporting a mix of private consumption, private speculation, and private investment. The Government gets its cut, indirectly, by taxing the indebted and profligate private sector. In New Zealand, unlike some other nation-state economies, the government is usually able to collect most of the taxes that it levies; so the government is enriched by the process while looking ‘squeaky clean’; the government is taxing debt rather than incurring debt.

While the Ponzi financial model was not fully operable in New Zealand until 1993, it was established in 1985 with the deregulation of the financial sector and the adoption of a monetary policy which ensured that interest rates would be high enough to attract Peter’s and Paul’s money.

We should note that, before 1985, it was also normal for New Zealand to receive a substantial net inflow of foreign funds. But, until then, New Zealand Inc. was following a traditional development model. In that development model, New Zealand – and especially the New Zealand government – was an active borrower, with the foreign sector sufficiently responding to New Zealand’s requests for investment funds. As an active borrower, those pre-1985 debts would be serviced out of incomes generated because of those debts.

In the development financial model, government deficits are a central feature, driving the economic development of the nation-state. In the Ponzi financial model, governments feed off private deficits; while not always in surplus, governments tend to be surplus-seeking. In the development model, governments are the active party. In the Ponzi financial model, the Reserve Bank – the immediate player – sends interest-rate signals to foreign Peter and foreign Paul; Peter and Paul become the rentier ‘investors’, and the banking system of the nation-state is the Ponzi intermediary. In New Zealand at least, the Reserve Bank plays this financial game in part of its own volition; and in part because it is mandated by the government to do so, through the Policy Targets Agreement which David Seymour wishes to modify. The irony is that the Policy Targets Agreement is the ultimate in Government intervention, which is most strongly advocated by those who otherwise claim to be anti-interventionists.

National economies which pursue the Ponzi financial model have overvalued exchange rates for their national currencies; this is the result of the ongoing inflow of foreign funds from the many Peter and Paul ‘investors’. That is the key feature and consequence of setting elevated interest rates, where ‘elevated’ means interest rates sufficiently high to successfully bid for Peter’s and Paul’s spare money.

Excess elite consumption in New Zealand is thus underwritten by foreign ‘investors’, foreign Peter and foreign Paul; indeed, such excess consumption – debt-financed enjoyment – has been funded in that way in New Zealand since 1985, when the floating exchange rate mechanism was introduced. New Zealand has become one economy in which the foreign-exchange market is dominated by ‘investors’ and ‘players’ rather than by exporters and importers. Not in the top-fifty economies in the world based on gross domestic product (GDP), New Zealand Incorporated is among the top 15 in foreign-exchange transactions.

While private sector deficits in New Zealand did not become prominent until 1993, we may see from Governments run financial deficits; it’s their role to do so (Evening Report, 17 Oct) that private sector surpluses are the global norm, and when global private sector balances approach zero then trans-national financial crises are the result. New Zealand only shows private sector surpluses during financial crises, and even then these private surpluses are smaller than in most other countries.

To see the converse financial model, we may note these two countries: Netherlands and Denmark. These countries, with their financial signatures opposite to New Zealand’s, in slightly different ways pursue the ‘mercantilist financial model’, which relies on an undervalued exchange rate. (Noting that a central feature of the Ponzi nation-state financial model is an overvalued exchange rate.) Netherlands, if you like, is Paul. And Denmark is Peter. Whereas New Zealand’s consumers – especially its elite consumers – overconsume, Netherlands’ and Denmark’s underconsume. Netherlands’ Paul and Denmark’s Peter transfer material enjoyment to New Zealand consumers. In general, in the Ponzi financial model, ‘investors’ transfer consumption enjoyment to ‘players’.

Netherlands is a small nation-state within the Eurozone of the European Union. And Denmark, though in the European Union, has its own currency and banking system, untied to the European Central Bank. Denmark Inc. is the closest to being the antithesis to New Zealand Inc. As such, it became the best-known country in the world for its negative interest rates, which its Reserve Bank operated from 2012 to 2022. (Refer Reuters 22 July 2022, Denmark’s decade-long experiment with negative rates seen ending soon.)

The Netherlands’ case is more complex; it is linked to an unstable (and perhaps unique) example of the Ponzi financial game; the example which operated within the Eurozone during the first decade of this century. In that 2000s’ scenario, inflation in the southern European Union countries created an effective currency overvaluation there, and an effective currency undervaluation in the north of the Eurozone. Netherlands became the northern exemplar, while Greece was the southern exemplar. The dynamic in this case was the ‘investors’ in Eurozone north whereas the south was the ‘player’. In this case the game crashed in the early 2010s, and now the Eurozone as a whole is playing the role of ‘investor’ in the same global Ponzi game which New Zealand and Denmark (and others) have been playing since the 1990s.

Why do I call this game a ‘transfer’ from ‘investors’ to ‘players’? If we look back over the decades, we see a direct subsidisation of ‘player’ living standards by ‘investors’. Under conventional financial principles, this would be called a player ‘liability’ rather than a ‘transfer’. However, the issue is that players’ debt to income ratios have not been increasing, thanks to a mix of economic growth and inflation. (This economic growth is largely despite the engagement with Peter and Paul, not because of their ‘investment’ in us.) New Zealand as a player has never had to repay its debts to its Peter and Paul ‘investors’. NZ Inc. services these debts with ease, by enlarging these debts. This debt servicing becomes even easier when global inflation diminishes the accrued debts as well as the interest payable. Nevertheless, New Zealand continues to play the Ponzi game; in order to keep its exchange rate overvalued, New Zealand must pay Paul by borrowing more from Peter than it is paying to Paul. The player pays its interest (and any repayments) from newly borrowed funds.

Iceland’s banks played the same Ponzi game in the mid-2000s. It got severely burned by the 2008 Global Financial Crisis. But, after what amounted to a painless bankruptcy, Iceland Inc. recovered soon enough.

What applied in the past will not necessarily apply in the future. Global deflation, if that happens in the future, would increase the debt-to-GDP ratio of NZ Inc. But global stagflation looks to be a much more likely bet for much of the next twenty years. New Zealand’s accumulated debts to date would then largely disappear into the ether of financial history. New yet-to-be-incurred debts would probably enjoy the same fate. Nevertheless, New Zealand’s financial game will end when there are no longer willing Peters to facilitate New Zealand’s servicing of Paul. Paul might even ask for repayment in full. New Zealand’s exchange rate would then fall, and Paul’s payout in New Zealand dollars would convert to a lesser amount of Euros. The only substantial consequence for New Zealand would be that the Peters and Pauls of this world would no longer see New Zealand as exceptional; would no longer see New Zealand as a player who would pay them higher ‘risk-free’ returns than other players.

Is it a Problem?

This state of affairs is not (and has not been) a problem for any of the participants, because they are all ‘consenting adults’, and all parties have been rewarded so far. Indeed as noted in my Governments run financial deficits; it’s their role to do so (Evening Report, 17 Oct), this is a case where two wrongs do seem to make a right. Two forms of destabilising financial behaviour – mercantilist and Ponzi – offset each other. So long as the Danes and the Dutch keep playing their game, they (taken together) do not want to be paid out simultaneously; they want to keep playing. Repayment for them would mean that their incorporated countries, long-used to private sector surpluses, having to enjoy deficits; they would have to spend more than they earn, something they are not used to and have never been comfortable with.

Looking back over the last 30 years, New Zealanders have benefitted; and Dutch and Danes have lost, though they would have lost by more if they had ‘invested’ elsewhere at lower interest rates. They have been the givers, and New Zealanders have been the takers; and have been the takers without any form of systemic financial default.

However, this Ponzi financial model is a past and present problem in that it has substantial adverse distributional implications for New Zealand (high domestic wealth and income inequality); and, distributional implications for Netherlands and Denmark too (less domestic inequality than they otherwise would have had). In this sense, it is Netherlands and Denmark – not New Zealand – who become the winners of the game.

The differences, domestically, are linked to the interest rates. New Zealand’s financial model depends on setting interest rates above the norm for economically advanced nation-states. Netherlands and Denmark’s mercantilist model depends on setting interest rates below that norm. High interest rates create inequality; and perpetuate cost-of-living crises; crises which are ameliorated by the overvalued exchange rate keeping elite consumption cheap. Low interest rates in Netherlands and Denmark diminish inequality, reduce the costs of housing and other basic needs, and, through their undervalued exchange rates, raise the prices of elite consumables.

Summary

The New Zealand economy has worked according to a simple Ponzi model since 1985. The model relies to a degree on New Zealand exceptionalism which works by creating the perception in world financial markets that New Zealand is a sure bet: both ‘safe’ and providing ‘investors’ with relatively high returns. The model relies on the government’s anti-inflation mandate to justify the higher domestic interest rates required.

Interest rates in New Zealand are set to ensure an inflow of foreign savings which stimulates (while indebting) New Zealand’s private sector, and which sees significant amounts of that credit pass through the private sector into government coffers.

New Zealand’s Ponzi financial model is stable so long as New Zealand retains its exceptional status in foreign perception. Is New Zealand’s Ponzi financial model stabilising? Yes, given the mercantilist games played elsewhere in the global financial ecosystem. How will the model fare in the next Great Depression? Possibly no worse than Iceland fared in the 2008 Global Financial Crisis.

Should New Zealand Incorporated shift to another financial model? Yes, because ultimately two wrongs do not make a right. And because this model underpins the increasingly grotesque inequality we see in Aotearoa New Zealand. And because the two extranational Ponzi games which we are familiar with from the late 2000s, that played by Iceland’s banks and that played by the Southern Eurozone (including Ireland who got away with it; see Economic Growth, Ireland compared to Australasia, Evening Report, 12 Oct 2023), both crashed and burned soon enough.

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Keith Rankin (keith at rankin dot nz), trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.