New National Party leader Todd Muller has presented his party’s vision for New Zealand as it grapples with the economic cost of the Covid-19 pandemic. But Muller’s vision was unsurprisingly National while surprisingly short on economic detail. And, after a week where sordid privacy breaches plagued the party – leaving Muller exposed and scrambling to convince voters that National is credible, stable, honourable and ready to govern – Muller’s campaign vision was supposed to be a circuit-breaker. Instead, it left more questions than answers.

Last week private details of recently returned New Zealanders were leaked to a select grouping of media. The privacy breach was seen as the latest bungle by those charged with protecting New Zealanders against the Covid-19 virus.

National’s leader Muller was quick to apply election year politics to the breach and claim it as another example why voters should oust the Labour-led Government and vote for his National Party at the September elections.

But by Tuesday we learnt things were not as they seemed. After the Government had ordered a judicial inquiry into the matter, stating that the breach could potentially be deemed a criminal issue, a lone National MP put his hand up and admitted to have been the person who sent the private information to the media.

But how did the information come to be in MP Hamish Walker’s possession – information that named Kiwis who were in quarantine, detailed their health status, and indicated the location of their place of isolation?

At that point, National’s Machiavellian politics turned a shade dirty.

It was revealed, Walker was sent the private information from former National Party president Michelle Boag (who was also heading the deputy leader’s re-election campaign team). Boag had apparently received the information as acting manager of a prominent rescue helicopter entity, but, according to Boag, it was received via her personal email account.

By Wednesday, Boag had resigned her acting manager’s role and stood down from the deputy leader’s election campaign team.

Muller insists he knew nothing of Walker and Boag’s tactics and moved to stand his MP down stripping him of his portfolios and hinting that he should be jettisoned from the party referring the matter to the National Party’s board (the board however decided only to remove Walker as a candidate at the next election).

UPDATE: By Friday (July 10, 2020), It was revealed Boag had also provided National MP and health spokesperson, Michael Woodhouse, with private health details of patients. Woodhouse insists that ‘he deleted the information and did not pass any information on to others. He confirmed the information given to him by Boag was not the source of allegations regarding [what was reported as] lax security measures at the New Zealand border‘. (Stuff.co.nz, July 10, 2020)

Stuff reported: ‘Boag said she had sent “several” emails to Woodhouse in June. She described the emails as “comprising notification of a small number of then new Covid19 cases”‘.

Michelle Boag has now resigned her National Party membership.

Woodhouse said Friday he would cooperate fully with the judicial inquiry into the privacy breaches, led by Michael Heron QC.

But Woodhouse is not without blemish either. Earlier this week he told media the leak of patients’ health details was “another serious failing” of the Labour-led Government.

Woodhouse said: “Reports coming in this morning of personal details being leaked which reveals the identity of New Zealand’s current active cases, is yet another serious failing from this incompetent Government.“

“This is unconscionable and unacceptable that those suffering from the incredibly dangerous virus now have to suffer further with their private details being leaked.“

Woodhouse went on to say: “… it’s unfathomable that it couldn’t handle a simple task like this.“

It is ‘unfathomable’ why Woodhouse did not come clean with the knowledge that he himself had received private information of patients’ health details from Michelle Boag.

Woodhouse’s reputation now risks being in tatters. He needs to explain himself further.

What is potentially more damaging are New Zealand Herald revelations that leader Todd Muller knew Woodhouse had received patients’ private health information from Michaelle Boag. This, the Herald reported, Muller knew on Tuesday evening (July 7, 2020).

NZ Herald: A party spokeswoman said today Woodhouse told Muller this on Tuesday night.

‘Muller was specifically asked by reporters “have you checked with Woodhouse, specifically, whether he received that same information from Boag”. “No,” replied Muller and a reporter asked “why not?”

“It’s very clear from our perspective there’s a conversation that’s occurred between Michelle Boag and Hamish Walker. We are confident from what we can see that the issue here relates to Michelle Boag and Hamish Walker.”‘

‘Asked again if he had spoken to Woodhouse and if Boag was a Woodhouse source, Muller said: “No, I don’t really understand where you’re going with this.‘

‘The spokeswoman said Muller didn’t say something yesterday because “we had to look at what that information was and the nature”.

“We needed to assess the information.”‘

The whole deceitful saga leaves one with a sense that National remains bereft of a moral compass, indifferent to legal rights to privacy, manipulative of the public discourse, and prepared to manufacture scandal so as to advance its ambition to retake the Treasury Benches in 2020.

This week’s revelations expose National to a reality that Machiavellianism remains, that factions within National are prepared to operate from the shadows, that the end game justifies the means – to win at all costs.

It is reasonable to realise that Todd Muller was, at best, not respected, at worst, considered irrelevant.

But if Only It Was An Isolated Incident

With Todd Muller becoming leader, standing alongside his Deputy Nikki Kaye, many political observers considered National was sincere in removing dirty politics tactics from its 2020 election toolkit.

But since Todd Muller became leader of the National Party we have seen:

• National’s new leadership team signal its MPs to go for it… that National has a moral obligation to win.
• a culture of ‘politics placed before the public’s interest’ … gotcha politics designed to erode a public’s confidence in National’s opponents, placed ahead of serving the public interest.

Let’s look at a brief recap of previous happenings:

• Around July 17, For at least 20 hours, National held on to information that two women who were Covid positive had travelled from Auckland to Wellington
• National chose to wait so they could use that knowledge in Parliament and deliver a political hit rather than alert health officials, the Government, and the media
• The public’s right to know that information was denied them, for a time.

Clearly, the public deserved to know immediately so those who may have been in contact with the contagious women could self isolate and await to be tested.

But there’s more.

Also we have seen leaks from inside the National Party revealing how its private polling found it had been sinking in popularity after experiencing a short rise since Muller took the leadership. Its leader Todd Muller was disappointed in the leak having occurred. The leak indicates a lack of discipline inside National.

Is this an indisciplined party that is lacking in leadership, out of step with the New Zealand public’s expectations and interests? This whole saga raises the question: Is National fit to govern in 2020?

A Circuit-Breaker – A Vision – But Where’s The Plan?

After the revelations, and after National’s board failed to remove Hamish Walker from the party, Todd Muller needed a circuit-breaker to restore an impression of leadership. National’s Plan to get New Zealand working ought to have provided Muller with exactly that.

At the Christchurch Chamber of Commerce, on Thursday, Todd Muller indicated his Plan had five key pillars:

• Responsible Economic Management
• Delivering Infrastructure
• Reskilling and Retraining our Workforce
• A Greener, Smarter Future
• Building Stronger Communities.

But beyond that, Muller gave little else away. He promised that “over the coming months, and into August, I will be releasing the lion’s share of our Plan in a series of major speeches and engagements.”

He added: “Our vision, our Plan and our direction for New Zealand will place jobs at the centre and deliver the results Kiwis need. We have a track-record that shows we do as we say and get the job done.”

He continued: “Over the next 72 days my team and I will be working hard to share our Plan with you.”

He said: “National believes in: An open and competitive economy;
A broad-based, low-rate tax system; An independent central bank with the primary goal of price stability; The Fiscal Responsibility Act, now part of the Public Finance Act; and A flexible labour market, underpinned since 2000 by good faith.”

Then came a glimpse of the real plan. Muller said: “Under Helen Clark, John Key, Bill English and Jacinda Ardern, New Zealand has spent, in 2020 dollars, $505 billion on social welfare, $302 billion on health, $260 billion on education, and $27 billion on corrections. That is well over a trillion dollars on those four areas alone just since the year 2000, or well over $200,000 for every single person living in New Zealand today.

“When we see more than one in eight New Zealand children still living in material hardship; more than 310,000 Kiwis on a benefit even before Covid-19 (and now up to more than 350,000); more than a million food grants needed last year; and the state house waiting list having more than tripled since Labour was elected, then I don’t think anyone can believe we have achieved the best possible return on that trillion-dollar-plus investment.”

So what is Todd Muller suggesting here? Are we to believe that under his leadership National would embark on an austerity plan that would abandon community-led social investment, education, tertiary and trades-training investment (a raw point of failed social investment of former prime minister John Key’s so called ‘rock star economy’ that was publicly criticised by the OECD)?

Is Todd Muller suggesting a return to small government ideology akin to last century? If so, is that out of step with globalised and developed western economies that have embarked on fiscal stimulus plans more aligned with Keynesian economics than that of Milton Friedman and George Stigler’s Chicago school of economics theories that New Zealand zealously embraced from 1987 through to 2017?

Surely in the post-Covid recovery period economies will require governments to intervene, to commit to broad-based and bold fiscal stimulus, plans that lead toward a rebalancing between export-led recovery and domestic self sufficiency and societal progress?

Is there a role for business to work with government? Yes, certainly, it is a necessity. But in the immediate post-Covid recovery period the business sector will not be ready to pick up the shovel and rebuild to scale on behalf of a government that does not have the willpower to lead the effort.

Muller said on Thursday: “Let me tell you what that means in practice. In 2020/21 and 2021/22, my Government will not be scared of investing more in retraining, if we are confident it will genuinely improve productivity, lower unemployment, increase the tax take, reduce the cost of welfare and improve wellbeing over the following decade.”

Does this mean we would see an overhaul within a period of crisis where Government would constrain stimulus through targeted ‘investment’ to the private sector, relying on the latter to deliver once-government services and social programmes?

Will Todd Muller’s National Party outsource to the private sector its responsibility to deliver social welfare, health, education, corrections services?

Is this what Todd Muller’s key appointment, Matthew Hooton, has been working on since his appointment last month? Hooton’s political commentary is known to many and has contributed greatly to political discourse in New Zealand. Matthew Hooton is known as a proponent of small government, an advocate for the ideologies of right neo-liberal economics who earned his National Party stripes when the ideas of former minister of finance Ruth Richardson was all the rage. Hooton often criticised John Key and former finance minister Bill English for being too moderate and failing to deliver, while popular, reform that would further liberalise New Zealand economic environment.

If Todd Muller is to be regarded as a prime minister in waiting, then eliminating dirty politics from his party is only part of a necessary plan. Convincing a voting public that user-pays and the privatisation of essential social services – welfare, health, education, and corrections – may be truly testing.

But then, a real leader would demonstrate courage alongside convictions. And time, as they say, is not on his side.

Good or Bad?

Are there good or bad signature patterns for countries. The most obvious answer is that every country should ideally look like Portugal in 2019. Government sector and foreign sector balances would be close to zero. Private sector balances would also be close to zero, with household surpluses (net household saving) offset by business deficits (borrowing and investment spending). We cannot be sure that the private sector was actually like that in 2019; in the years before the global financial crisis there was actually a common pattern in some countries of business saving offset by substantial extensions to household debt.

In reality, the perfect signature combination for a growing economy is closest to those of Portugal in 1989 or 1992: private surpluses at about four percent of gross domestic product (GDP), with government deficits also about four percent of GDP. Further, while foreign balances are ideally about zero, foreign surpluses of upto five percent of GDP are not necessarily a problem.

In normal years in most of our lifetimes, GDP has grown by about five percent a year – three percentage points on average due to economic growth and two percentage points on average due to inflation. So signature imbalances that are within five percent should not be seen as a problem.

What is interesting from these charts is to see what is the historical norm for a country, and then to see departures from that norm as an important economic story for that country, and maybe for the world economy as a whole. Major world events should show up in all capitalist economies’ charts, as deviations from their normal financial signatures. For example, the Covid19 pandemic will show up as a significant government deficit event for all countries, regardless of what came before.

For Portugal we can see that government deficits and private surpluses are normal, but that a big change occurred from the late 1990s to the early 2010s

Early 1980s

Before 1985, for both countries there is no IMF data available for government deficits that was collected on the same basis as post-1985 data. But we do know that the early 1980s were years of very high oil prices, though ameliorated each year from 1982 by general inflation exceeding oil inflation. (The early 1980s was also a time in which, in most countries, interest rates were lower than inflation; meaning negative effective interest rates.)

Large foreign sector surpluses were normal for all oil-importing countries in the early 1980s. This meant that oil-exporting countries were lending heavily to oil-importing countries; that is, much oil was being purchased ‘on credit’ and not being paid for by commensurate imports.

In New Zealand we know of this time as the ‘late-Muldoon period’. The purple columns represent New Zealand domestic balances – private and government combined into one. We know enough about that time in New Zealand to be sure that, if we had the full information, the purple would have been essentially red.

For Portugal that is also almost certainly true until 1983 (and for the same reasons as in New Zealand), with 1984 being much like 2012 and 1985 looking more like 2013; ie blue above the zero line and plenty of red below it.

The 1990s

New Zealand’s crisis of the 1987 to 1992 period is understated by the chart. It is most evidenced by the few years of private sector surpluses; unusual for New Zealand though normal for most countries.

Portugal shows signs of a financial crisis in 1985 and 1986; after that, until 1996, it looks like a picture of normality. New Zealand moved to its new normal in 1993. Indeed Portugal joined the European Union in 1986, so it was a period of uncertainty that soon eased. In 1996 Portugal had a change of government, and took major steps towards fuller integration into the European Union; and integration that would see Portugal as an enthusiastic adopter of the Euro currency in 1999.

So, what was happening in Portugal from 1996 was a substantial inflow of ‘investment’ mainly from the richer northern European Union countries. We see that this intra-EU investment is partly supporting government spending in Portugal, and partly supporting private spending.

The 2000s and 2010s

This was a period in which Portugal’s private sector emulated New Zealand’s, but without having a floating currency. New Zealand always had the ability to rebalance through a substantial adjustment to its currency, as indeed occurred in the global financial crisis of 2008-09. Further, much of the ‘offshore funding’ to New Zealand’s private sector was conducted in New Zealand dollars, so a fall in the New Zealand dollar would not create an aggravated crisis of foreign debt. New Zealand had found a way to live with private sector deficits as its norm. Few countries have ever been able to do that.

In the 2000s, Portugal experienced about three percent inflation every year, about the norm for any advanced capitalist country. The problem was that it was part of a fixed currency zone in which the dominant country – Germany – had annual inflation rates of under two percent. (So, the easiest way to read the green in Portugal’s chart is to think ‘Germany’.)

Portugal’s economy was becoming mortgaged to, in particular, Germany’s private sector. The forces bringing this about were coming mainly from Germany; Germany’s savers were seeing Portugal as an excellent ‘investment opportunity’. Portugal could not really stop this, even if it had wanted to.

As the 2000s progressed, Portugal’s ‘real exchange rate’ increased relative to Germany’s. This situation meant that economic resources in Portugal shifted towards its non-tradable sectors (most services, and construction) whereas economic resources in Germany shifted towards its tradable sectors (especially manufacturing and tradable services). So, it meant Portugal kept importing more from Germany, and exporting less to Germany, making Portugal’s private and public sectors evermore indebted to German investors.

This situation put Portugal into deflation in 2009 and 2014, and recession from 2009 to 2014.

After that, Portugal returned to its normal signature pattern of balances. Then, from 2018, near zero inflation, slow growth and Eurozone policy seem have modified that norm, creating less willingness from government to run deficit balances.

In the meantime, New Zealand remains a darling of the foreign creditor community, with that community happy to keep enabling substantial private sector deficit spending. That community is safe in the knowledge that New Zealand poses few risks, even when New Zealand makes economic and political reforms.

2020-21

All countries will show government financial deficits in 2020 and most likely 2021. Economic crises always lead to private sector surpluses. So, both Portugal and New Zealand will show blue balances much higher than usual, and red balances much more negative than usual. Because Portugal’s normal private balance is higher than New Zealand’s, so will its Covid19 private balance be higher than New Zealand’s. And because Portugal’s normal government deficit is bigger than New Zealand’s, then Portugal’s Covid19 government deficit will be bigger than New Zealand’s. Further, although Portugal has managed Covid19 better than most of the Eurozone countries, it has still a much greater pandemic problem than New Zealand. Portugal can expect balances like 1987 or 2014 for a few years. New Zealand may have a year with a balance like 1991, then a year with a balance like 1988, and then maybe a few years like 2015.

Both Portugal’s and New Zealand’s economies have similar-sized economies, though Portugal’s GDP is less per person. The countries have very different histories, though both are renowned for their maritime trade. Portugal will continue to have to fall into line with European Union norms. New Zealand will continue to have the freedom to follow its own path, and with the benefit of a more vibrant Asia to trade with.

On Project Syndicate – and in other places in recent months – orthodox US economist Kenneth Rogoff has presented the case for deeply negative interest rates. Another financial sacred cow falls; yes, interest rates can be negative, even substantially negative. It can take a while, though, for shot sacred cows to die. Keynes, in the 1930s, mortally wounded the ‘balanced budget’ bovine. And the experiences of Japan in the 1990s, and the United States in the Second Gulf War (when taxes were cut), dealt to the hallowed cow of ‘fiscal responsibility’. Yet those ghostly cattle-beasts still stalk the minds of politicians, bureaucrats, and journalists.

Interest as a Yield

Interest is a mystery to most of us. It’s actually two conceptually distinct – though related – things. Interest in nature is better referred to as ‘yield’. We may think of a herd of beef cattle. The gross yield is essentially the calves, with the net yield being the beef and leather produced, subject to the constraint that the herd is maintained over time at its usual size.

Thus, the concept of ‘yield’ is similar to the concept of ‘profit’. In a bad year for the farm, there may be a loss, for example because a natural disaster led to the death of all the calves. In that sense, the yield – or interest on capital – can be negative. Further, with this concept of interest, negative interest is unequivocally a bad thing, and the higher the interest (ie yield) the better.

When I was a boy, we had school ‘banking’, a basic saving account using the symbol of a squirrel, supposedly a creature that saves (nuts) due to an instinct of thrift. We received interest on our school savings, something those squirrels never did on their savings. The squirrels’ yields on their hoards of nuts are always negative; some of those nuts go missing or deteriorate. (For squirrels to gain a positive yield, they would have to plant most of their nuts, then wait until the new crop of nuts could be harvested.)

I also remember my mother explaining to me the difference between a ‘savings bank’ (such as the Post Office Savings Bank) and a ‘bank’ (such as the Bank of New Zealand). She said that interest was a ‘reward’ for saving money. And she said that money held in a bank account did not earn interest; actually, customers paid fees to hold their money there. But, she said, they could draw on their ‘money in the bank’ by writing cheques to other people. So I understood the ‘principle of convenience’. I cannot say that I really understood the reason for the ‘reward’, though. It was in another, later, conversation with my mother that I learned about lending; and it bothered me then – as it bothers many – to think that, if I had money in the bank, then somebody else might be spending it; hence a reward was justified. I eventually understood banking; indeed, in the days before banks became financial supermarkets. I had to study economics academically, however, before I had any real inkling about where money comes from.

My generation – and other generations –  grew up to learn that interest is natural, and always positive. And we learned that the secret to wealth was restraint and compound interest. Thus, we came to see indefinite economic growth in the same way, as a process of accumulation rather than circulation. The idea that squirrels saving nuts indefinitely would become wealthy was always an illusion; likewise, economic growth as a process akin to compound interest was always an illusion.

I learned – when an adult, through financial economics – that interest can be a ‘price’, as well as a ‘yield’. (In fact, interest is two prices. One of these is the price of ‘risk’. Different borrowers have different risk profiles. Higher risk borrowers pay a higher price to borrow money. I am not particularly concerned here, however, about that price which is commonly called ‘risk premium’.) Interest is a price, that if set correctly, regulates economic life; it can facilitate growth when growth is needed, and facilitate slowth when slowth is needed. Very low interest rates penalise the pointless accumulation of money, and facilitate the circulation of money.

Interest as a Market Price

If we can imagine interest rates being three percent (as they usually were when I was a boy), and, the amount of money lenders wanted to lend being the same as the amount of money that borrowers wanted to borrow, then the ‘price of loanable funds’ would be three percent, and that market would be balanced.

If there was a shift in this ‘loanable funds’ market, with say more people wanting to borrow, then excess demand for loanable funds would require the interest rate to increase. Following that price increase, this market would establish a new balance.

What if there was a change in circumstances (other than a rise in interest rates) that caused fewer people to want to borrow money. Or caused people to repay loans more quickly? Or more people to want to lend money? Or people wanting to be repaid more slowly? Or more people wanting to relend money that has been repaid?

These situations would induce a fall in interest rates. And there is no necessary reason why that price fall should stop at zero.

However, if banks could lend money to the Reserve Bank and get one percent interest, they are unlikely to lend to anyone else unless the banks charge an interest rate above one percent. So, for the market to balance properly, the interest rate set by the Reserve Bank should reflect underlying conditions in the loanable funds market.

If underlying conditions require that the Reserve Bank set a negative ‘Official Cash Rate’, then so it should. It would mean that the Reserve Bank’s large wholesale customers – the banks and the central government – would be paid to borrow from the Reserve Bank.

Obviously, if borrowing from the Reserve Bank increased too quickly in response, the Reserve Bank would have to reset the rate back to positive or zero. But what if these customers were not sufficiently induced to borrow more by negative interest rates, then the Reserve Bank would have to ‘go more negative’; interest rates would keep dropping until balance is established in the loanable funds market.

If the interest rate (price) is set too high, there will be too little borrowing and spending, and many frustrated lenders. The result may be an economic recession. If the interest rate (price) is set too low, there will be too much borrowing and spending, and not enough people wanting to lend. The result may be some inflation.

It is worth noting that some economists in New Zealand – Eric Crampton (of the New Zealand Initiative) for one – favour negative interest rates (pure expansionary monetary policy) over an expansionary fiscal policy where governments borrow (and spend) enough to allow the interest rate to stay positive. This is the view generally favoured by economic liberals; economists and others who are sceptical of governments having too large a presence in the market economy. This scepticism is based partly on a general distrust of large government, and partly on a disbelief in the competence to bureaucrats to make the best spending decisions. Economic liberals generally see private spending as more efficient, at the margin, than government spending. (‘At the margin’ means considering ‘extra spending’ rather than ‘total spending’.)

Certainly, if governments fail to take on enough new debt this year, the case for negative interest rates will strengthen. And the case for deeply negative interest rates in countries more affected by Covid19 than New Zealand will be strong if governments in those countries run insufficiently large budget deficits.

Negative interest rates in the past

Except for the recent cases of Sweden, Denmark, Switzerland and Japan, I know of no historical cases of negative nominal interest rates. But negative real interest rates have been quite common. The last time we had substantial negative real interest rates in New Zealand was from the late 1960s to the early 1980s. Then, inflation rates were higher than interest rates, so saved money would buy less in the future than in the present. And repaid money could buy fewer goods and services than the money could have bought if it had been spent instead of lent.

While the capitalist world did not fall apart in the 1970s, many people felt that they were entitled to positive interest rates, without ever being able to say why. And those people instigated a revolution, called neoliberalism.

In today’s world, without inflation, negative real interest rates also mean negative nominal rates. (An interesting case, however, is Switzerland, which for a while had negative inflation and less negative interest rates, meaning that real interest rates were not negative.) Thus (unlike in the 1970s), the quoted (or ‘headline’) interest rates – at least in wholesale financial markets – would have to be negative. This is what makes some people very uneasy.

In my chart analysis of Sweden and Australia, I noted that there was a particular reason why Sweden, Denmark and Switzerland had to have negative interest rates. In order for these countries to have similar trade surpluses as their comparable countries inside the Eurozone (Germany, Netherlands and Austria), they had to avoid appreciations of their currencies. That meant they needed interest rates lower than in the Eurozone; and the Eurozone had a core wholesale rate of zero.

The Swiss Franc has been stable against the also-strong United States dollar since 2014. Many people prefer to hold money in Swiss Banks despite the negative interest they ‘receive’; to these people, it’s like paying a fee to keep their money in the best place for them; not unlike the situation my mother told me about in relation to banks in the 1960s.

Deeply Negative Interest Rates

It may well be necessary for interest rates in some countries to go deeply negative. That will mean negative retail interest rates (term deposits), and negative mortgage rates.

Imagine deposit rates and mortgage rates set at, say, minus two percent.

The situation would not be fundamentally different from that of the 1970s, when the incentive was to borrow and spend rather than to save and lend. But, the obvious new problem is that people will want to drain their interest-bearing bank accounts, as stashes of cash, and then bury this cash under the bed, or some such place.

Fortunately, the world now has an infrastructure for cashless transactions. It would not be necessary to ban cash – notes and coins – entirely, though fear of infection from paper money is probably precipitating the end of cash. While notes and coins are convenient for small day-to-day payments – especially when there are power cuts or other infrastructure failures (such as software virus pandemic) – we could still make promises (the oldest form of money ever). One benefit would be to abolish all banknotes worth more than $20, forcing the criminals with large stashes of cash to come to the bank, and explain how they acquired so many high-denomination banknotes.

Another advantage would be that, with no real alternative to electronic money, then fees charged to vendors using EFTPOS (and the like) would have to be abandoned.

The most important thing would be that we would understand that – at certain times – it is irresponsible to not spend our incomes, and that such anti-economic behaviour as money hoarding would incur a cost. It would mean that high-income frugal people would be incentivised to earn less in the market economy. There would no longer be an incentive for people to earn very high incomes, and there would be more space for today’s disadvantaged people to earn adequate incomes.

In other words, interest rates that at first sight should lead to more spending could in fact lead to sustainable living. In turn, as some people choose to earn less and lend less, then conditions would gradually come to favour a return to higher (zero or positive) interest rates.

Thinking outside the box

Even orthodox and conservative economists can think out of the box. They can apply their economics’ training to new situations, so long as they can free themselves from non-economic constraints on their thinking.

Too much of our policy chatter is conducted either by people unable to think like economists – most politicians, bureaucrats, journalists, businesspeople – or economists and financial analysts who have studied economics but whose cultural backgrounds have inhibited them from grasping the creative power that economic thinking can give them.

Substantially negative interest rates represent one very important thought experiment that well-taught students of economics can lead public discussion on.

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Bernard Hickey: Why Reserve Bank Governor Adrian Orr prefers negative interest rates to QE, Stuff, 12 Aug 2019

Susan Edmunds: What is a negative interest rate, and what would it mean for you? Stuff, 19 May 2010

Clancy Yeates: ‘Unthinkable’: Negative interest rates now routine around the world, Stuff, 23 Sep 2019

Kenneth Rogoff: The case for deeply negative interest rates. Think Outside, 11 May 2020

From an interview with Geoff Bertram, on The Panel, RNZ 22 May 2020

Wallace Chapman: “Are we setting up our future generations, our future children, to be born into a life of national debt?” [He mentions the on-line Fabian Society discussion, held on 23 May, and introduces Geoff Bertram.]

Wallace Chapman: “Need we be concerned about this massive debt that we are getting into?”

Geoff Bertram: ” I don’t think we need to be for a number of reasons. First off, we have lived with, for decades, a set of ideas about public finance that are intensely conservative. They lead to the Budget Responsibility rules, the idea that the government should be a small part of the economy, the idea that budgets should always be balanced, and most importantly, the idea that we can never print money to fund a deficit under any circumstances. Those three propositions go out the window now. You are looking at a situation where the economy has crashed; the only agency you have to pick it up and get it back on its feet is government. … The budget stimulus itself is completely manageable. … The old austerity story that most of the media tell and indeed the government itself has been telling – with the budget responsibility rules – isn’t the story we should have in our heads. … Government has an important role stabilising the economy, and in the face of a major downturn, expansionary fiscal policy is exactly what needs to be done. What happens to the money supply is a secondary concern. … “

Wallace Chapman: “Can’t we compare the analogy of a house? So, if I have a house, I have a budget for that house, and I have to even up the expenses and the incomings; I can’t be spending more than the household earns.”

Geoff Bertram: “That’s the analogy that’s completely wrong. Government is not a household.”

Wallace Chapman: “How so?”

Geoff Bertram: “Well it doesn’t have to have money in advance, it doesn’t have to have the funding in hand before it goes and buys something. If you are a household and you want to buy something, you have to have cash or you get a loan from the bank or the hire-purchase company before you can make the transaction. If you are government, you write the cheque, that’s it.”

Geoff Bertram, at Victoria University of Wellington, was my best economics’ lecturer; both from his breadth of knowledge and insight in economics, and, generally, as a teacher and communicator.

It was so refreshing to hear a view on the media that reflects economics, without the bourgeois continence that comes with so much financial commentary and policymaking these days.

Counter-Cyclical Spending: the Advantage of being a Large Organisation

The above discussion contains two main ideas – ‘counter-cyclical spending’ and ‘printing money’ – and how they relate to each other.

In a short radio interview, it can be very difficult to make fully-nuanced points; its really a matter of getting out the main message as simply as possible, something Geoff Bertram did very well.

So let’s consider the difference between a household and a government. In some respects they represent the opposite ends of an organisational spectrum, with businesses and non-government non-profit organisations in the middle. One of the important distinctions is size; the smaller an organisation generally the less able is it to spend without having prior income.

For the most part, households spend pro-cyclically, meaning they spend more when their incomes are higher, and less when their incomes are lower. (This tends to be true of businesses as well.) Nevertheless, even small households have credit facilities, such as credit cards, pre-arranged overdrafts and flexible mortgages. Additionally, households can negotiate credit facilities on an ‘as-required’ basis (such as hire-purchase). And, many households have past savings to draw on; sometimes quite substantial savings.

These households can, to some extent, spend countercyclically. This means, to spend more when household incomes are lower, and to spend less when household incomes are higher. Indeed, such spending is guided by changes in interest rates. When household incomes are lower, then interest rates should be low, encouraging households to save less (including withdraw more from past savings) and to borrow more (especially to borrow using already available credit lines).

The key message here is that deficit spending (preferably quick deficit spending making use of credit facilities already in place), at the appropriate phase of the economic cycle, has a stabilising impact on the wider economy in which these households exist.

While interest rates represent one incentive to practice countercyclical spending, the wider knowledge that such spending is stabilising for one’s community and society will also motivate some people to follow such a spending strategy. In other words – when people become ‘we’-focussed rather than ‘I’-focused, which is the mindset which we understand the Covid19 restrictions are all about – people may behave in a way that can best be described as ‘community altruism’. Countercyclical community altruists spend more when other people are spending less, and they spend less when other people are spending more.

Businesses can follow similar strategies, using their credit lines to invest at times when sales are low. Generally, bigger businesses can do this more easily than smaller businesses, because they have deeper pockets and more developed (and often cheaper) credit lines. While most businesses do not behave this way, there are some which do so; some of these do so by being smart rather than being altruistic. Such countercyclical businesses buy assets when they are cheap and sell assets when they can get a good price for them. (While these latter businesses do, incidentally, help to stabilise ‘the economy’, they may also aggravate inequality; already-rich businesses are the best placed to become even richer this way.)

How should governments behave? The neoliberals (who Bertram might call ‘extreme financial conservatives’) intimate that governments should behave procyclically, like the households Chapman referred to. Further, in this regard, four of the five parties in the New Zealand are essentially neoliberal (New Zealand First is the only exception). These four parties worship the neoliberal sacred cow of ‘fiscal responsibility’.)

The alternative is ‘old-fashioned Keynesian’ policymaking, as Geoff Bertram put it. The emphasis here is countercyclical fiscal policy. Labour (as in the biggest party of government in New Zealand) sometimes uses countercyclical rhetoric, and, as the principal party of government, has indeed agreed to expand its outlays during the Covid19 emergency. However, its willingness to do so remains very measured.

Bertram states that only governments can act in a sufficiently countercyclical way to get economies out of a ‘major downturn’. While he is correct, countercyclical spending by other parties still helps; further, countercyclical spending by a wide range of government and non-government parties able to do so generally smooths out the boom-bust business cycle, minimising the incidences of major downturns.

The message is, in troubled times, deficit spending is good; indeed, it is very good. ‘Deficit’ is not a dirty word.

Big governments are generally better placed than small governments to do this. In particular, when there is a global economic emergency, enlightened governments behave countercyclically to support the global economy, and not just to support the national economy. (This is where New Zealand First, and nationalist parties in other parts of the world, fall down.) Thus we saw, after the 2008 global financial crisis (the GFC), the Chinese government – and to a lesser extent the governments of the other BRIC countries (Brazil, Russia, India) – spent on investment projects sufficiently to get the world economy out of what some economists call the ‘great recession’.

Another reason why governments should take the lead in deficit spending is that governments – with their very large balance sheets – can generally borrow at lower interest rates (lower financial costs) than other parties. This is, for the most part, because governments have the reserve power of taxation. Creditors favour lending to governments at times when many households and businesses are practically insolvent.

Financing Government Deficits

The second main point that came up in the interview related to ‘printing money’. This is not a useful term, because it is used too easily in a pejorative way; further ‘printing money’ is a somewhat out of date term, as is the expression ‘writing a cheque’.

I find it most helpful to think of money as a social technology, a man-made medium that circulates through the economy as a lubricant. It makes no sense for any machine (in a sense, ‘the economy’ is a machine) to operate with less than the optimum amount of lubricant; further, while there is no reason why anybody would want a machine to be over-lubricated, the costs of over-lubrication are substantially lower than the costs of under-lubrication.

Essentially, Geoff Bertram was saying that the Government has no credit limit with the country’s Reserve Bank. So, when a government ‘writes a cheque’ using its account at the Reserve Bank, the Reserve Bank will not bounce the cheque. It is not only governments that have this special privilege; so do registered trading banks. But governments can make most use of this facility, because governments have ‘customers’ with substantial and immediate spending needs; new money lent to governments can be injected directly into circulation in the wider economy.

New money is created whenever a bank acquires a promise; it means that the bank’s balance sheet expands on both sides of its ledger. There is no necessary requirement for a bank to shrink its ledger tomorrow, having enlarged its ledger today.

The promise may be a new promise – which counts as a new loan; especially in our context, a new loan to the government. Or it maybe an existing promise – a bond – that is already in circulation.

For the most part, the (notionally independent) Reserve Bank of New Zealand buys existing bonds when it wishes to increase the amount of money in circulation. The sellers of those bonds – usually financial businesses – lend this new money to the government (creating new government bonds) through a competitive tendering process. In a depressed economy, interest rates will be very low.

(The other way the Reserve Bank increases the money supply is by lowering its interest rate, thereby incentivising the commercial banks to lend more to businesses, households and other organisations.)

It’s a somewhat convoluted financial mechanism, in New Zealand at least, to create money. The net effect, however, is that the government borrowing from the Reserve Bank creates new money, and injects it into circulation by spending it or by paying benefits to households. When there is ‘fiscal space’ – as in a major downturn or a pandemic – the government can draw on its overdraft facility, to the extent that it needs to.

In an economic emergency, this ‘government borrowing’ / ‘money printing’ is not in any way inappropriate or irresponsible. It is what a government must do. Further, when the economy does revive, taxation revenue automatically increases, meaning that most likely some of that government borrowing will be paid back; indeed as other new money is created due to increased private borrowing from banks, private debt can supplant government debt. But never will all that government debt be paid back, because a responsible government itself never wants to be the agent of economic depression; no government wants the economy that it rules over to have too little money in circulation.

To Finish

Money and debt are matters that – like people having sexual relations – enable sustained and flourishing intergenerational societies. Yet – like sex – they can be matters of prurience, misunderstanding, and ignorance. We do ourselves a great disservice when we hold these attitudes towards important day-to-day matters of normal life.

PS Follow this link for a chart and comments, relating to Japan’s history of budget deficits, and its resulting government debt.

Surpluses and Deficits of Different Economic Sectors

This new series of weekly charts looks at forty years of surpluses and deficits in different countries, showing what makes these countries tick, and why they were where they were – financially speaking – at the end of the 2010s. (We may note, for comparative purposes, two-decade financial balance charts for New Zealand, United Kingdom and European Union’s Eurozone were published last week.)

While we should be careful about regarding any particular financial signature as good or bad, it is probably true to say that the ideal signature would be that, for each of the main sectors – private, government and foreign – its balance would be zero. That would make for very uninteresting charts!

Second from ideal would be that features preponderant in one decade would be offset by opposite features in other decades, meaning that – in the long run – each sector would be in something close to balance. Our first country, Japan, is far from meeting these ‘ideal’ criteria.

Japan is the world’s country with easily the largest public debt, at 238 percent of GDP in 2018(compared to 19.9% for New Zealand). Yet Japan is, and has been for at least four decades, an economic powerhouse. Indeed, Japan has at least as much economic capacity (relative to population) to deal with the Covid19 pandemic as New Zealand does. The level of public debt prior to a pandemic is of little consequence.

Japan’s Signature

The dominant feature of Japan’s financial signature is its persistent – and persistently high since the mid-1990s – private sector financial surpluses. Japan is very much a nation of excess saving. (The saving sectors are the sectors with positive financial balances.)

What is generally meant to happen is that the two parts of the private sector complement each other: households save, and businesses borrow to invest. Thus, private sector balances should be close to zero, most of the time.

We see from the chart that it is normal for the Japanese private sector to not spend at least five percent of its income; that would normally be understood as Japanese businesses being unable or unwilling to invest at anything like the level required to dispose of household savings. The story however, at least from the early 1990s, is that Japan’s business sector – like its household sector – has been larging a saving sector, rather than an investing sector.

So, Japan’s private savings have been lent to other sectors. Who has spent, as debt, what the private sector could have, but didn’t?

The answer, for the most part, is Japan’s governments – especially its central government. That is indicated by all the red below the chart’s zero balance line. Japan’s government-sector debt is so large because in just about every year the government sector has run a deficit. In many of those years, the government deficits have been higher than five percent of GDP. Simply put, those many years of deficits, unbroken since 1992, have added up to an overall public debt of nearly 240% of GDP.

Not all of Japan’s savings have been spent by its government. In every year since 1980, Japan’s private sector has been a net lender to the rest of the world; to Japan’s (green) foreign sector. This shows up in Japan’s national accounts as an ongoing current account surplus; we may think of it as an excess of exports over imports. Or, put another way, Japan’s private savings (Japan’s credit) have been, to some extent, the means of payment for the rest of the world’s imports of Japanese goods and services. These imports from Japan have been paid for using credit extended by Japan; these imports have – so far – been paid for by Japanese people, not by the foreign purchasers of these imports.

While the Japanese government has spent far more than it has collected in taxes, Japan as a whole – Japan Inc. – has spent significantly less than its national income. Japan is a creditor nation, not a debtor nation; a creditor nation with a debtor government.

From Japan’s point of view, the foreign sector is the entire world outside of Japan. This ‘rest of the world’ has, in total, bought more than it has sold. This is because Japan has sold more goods and services than it has purchased; after all, for the whole world, the amount of goods bought must exactly equal the amount of goods sold.

Japan’s Financial Crisis 30 Years Ago

Japan, along with a number of other countries (eg Australia), had its big financial crisis in the early 1990s. On the chart, it is easy to see when Japan’s financial behaviour deviated from its signature pattern, in the late 1980s.

The late 1980s was a time when Japan, while still an important exporter of high tech manufactured goods, got caught up in a wave of financial speculation, triggered by a big rise in the Yen to US dollar exchange rate. This wave of speculation included an extraordinary real estate bubble. Even Japan’s businesses started borrowing heavily and spending the borrowed money on land and other temporarily appreciating assets.

These speculative private sector ‘behaviours’ were out of character for Japan. Not all Japanese indulged; Japan’s private sector only ran a deficit in one year, 1990.

The result was that huge swathes of Japanese businesses were technically insolvent through the 1990s, and even into the early 2000s. Nevertheless, most the insolvent businesses were able to carry on, so long as they were still able to sell goods to their government, and to foreigners. Japan’s private sector paid down its huge debts as fast as it could, and took on very little new debt despite record low interest rates. (Much of the huge private surpluses in the 1990s were private debt repayments, rather than new savings.)

If Japan’s government had not increased its debt – ie acted as debtor of last resort – then capitalism would have collapsed in Japan. The Japanese government did – thankfully – what all governments should do when interest rates are close to zero. It borrowed.

Japan’s Aversion to Tax Increases

Japanese people dislike paying taxes. In 2014, and again very recently, a seemingly small increase is sales tax has led to significant cutbacks in consumer spending, creating recessions.

The Japanese middle class prefers to lend to its government, rather than be unduly taxed. (It turns out that this is true for many other countries too.) Taxation is a method through which governments force households to not spend part of their income. Saving for the indefinite future – ie saving without any intent to spend the savings – is a method that enables the government to spend money that would otherwise have been taxed. The method, of governments taxing less and borrowing more, works surprisingly well.

The orthodox ‘macroeconomic’ view is that governments should run ‘cyclical’ deficits during economic contractions (eg recessions and other periods of below-average economic growth) and run surpluses during economic expansions. Japan’s government does not follow that prescription. Rather, Japan’s government run’s structural deficits because Japan’s private sector runs structural surpluses. Not only does it work, but it would work just the same if Japan’s accumulated government debt was 500% of GDP.

Japan’s Fiscal Contract

Japan’s implicit contract is that its households will only ask the government to pay back the money if they face some kind of financial emergency. Indeed individual households do face emergencies sometimes, and do get to withdraw their savings. Japan’s middle class knows that, because they happily let the government spend their money, then the chance of a major national emergency is minimised. They expect that, as a sector, Japan’s private households will almost always have savings, and who better to spend those surplus balances than the government. With wholesale interest rates around zero, the Japanese government doesn’t even have to pay interest on its debt.

It is also worthy of note that, over the last five years, Japan’s Budget deficit has been around five percent of GDP every year. Yet its public debt to GDP has only increased from 231% of GDP in 2015 to 238% in 2018, according to tradingeconomics.com.

Japan’s government does not pay back its public debt. Instead, it invests in Japan. Thus, Japan can afford the Olympic Games in 2021; because of its public debt, not despite it. Further, Japan has one of the highest life expectancies in the world, and relatively low inequality. Japan’s people have no reason to fear government debt.

Budget-related Economic Chatter

Last week in New Zealand was Budget week, and the chatter about the burden of government debt reached a crescendo. I will highlight here comments made, on Monday 11 May, by four economists with substantial media profiles, from Radio New Zealand’s Nine to Noon (hosted by Kathryn Ryan), and TVNZ’s Q+A (hosted by Jack Tame).

These economists – Brad Olsen (Infometrics), Sharon Zollner (ANZ), Shamubeel Equab – (all under 40 years old, as I understand) – and Cameron Bagrie (I think in his 40s). These are all highly capable professionals, with plenty of great insights to offer the New Zealand public.

The problem comes in two ways. Firstly, the lines of questioning such economists face reflect sets of unexamined assumptions. Secondly, most of our economists come from the same ‘liberal bourgeois’ mindplace as the journalists they engage with, and therefore are susceptible to normative assumptions infiltrating their analyses.

(Note here that use of the word ‘bourgeois’ is often associated with Marxist writing. I use the word here, not out of any Marxian sympathies, but because it is the best word to describe the mindframe that governs so much of our public discourse; and it is the mindframe that prevents so many people from engaging with even simple ideas that to not fit the liberal bourgeois sets of assumptions.)

The central issue here is that of government debt, and its presumed link to intergenerational inequity. The sense is that, when governments incur debt, they are grabbing ‘money’ (understood as a synonym of ‘wealth’) from the future, to satisfy the requirements of the present.

Some quotes

“Thursday’s Budget is set to reveal a wall of debt that will see debt-to-GDP soar. … Just how much debt can the country afford to take on?” (Kathryn Ryan)

Note the presumptive use of hyperbole [“wall” and “soar”], and the assumption that the debt of the government is the debt of “the country”. This latter characterisation of public debt leads to the ludicrous idea that creditor countries such as the Netherlands and Germany are in fact substantial debtor countries. Germany has a public debt to GDP ratio of 60%, and the Netherlands has a ratio of 49%. Indeed, under this characterisation, every ‘country’ in the world has an alleged debt; Yet, by definition, the world as a whole must have a debt of zero.

“We know what’s happening, spending and debt [are] rising….” (Kathryn Ryan)

Note that ‘spending’ is presented as a negative, a bad thing that raises debt. This idea about spending is pure mercantilism, noting that ‘mercantilism’ is to economics what ‘alchemy’ is to chemistry. The supposition is that the economic purpose of life is to ‘make money’, and that spending undermines this purpose (as in ‘the more money we spend now, the more money we must make in the future, to restore the coffers’). In particular, this mercantilist narrative sees exports as good (‘making money for a nation’) and spending on imports as bad (‘losing money as a nation’). [In fact imports are an economic benefit to a nation, exports are a cost – what must be given up – and spending is the market force without which there could be no market economy.]

“… the third rail of superannuation, will it come on the table again? …” (Kathryn Ryan)

“… I think there are a few holy cows, sacred cows that might be getting a little worried; superannuation is a biggie, the fact that it’s just universal, not means-tested, and kicks in at age 65 …” (Sharon Zollner)

Actually, the most sacred of sacred cows is the ‘financial responsibility’ rule that dictates government debt should be less than 50% of GDP, and preferably at around 20% of GDP.

The general tenor of Zollner’s comment is that taxes will have to be higher than they would otherwise be, and future benefits will have to be cut, in order to restore the government debt ratio to 20% of GDP.

Forcing older people to delay retirement at a time of potentially high unemployment makes no sense whatsoever. Retirement of workers today – and funding that retirement – is part of the solution, not part of the problem. The worst possible form of intergenerational inequity being contemplated this century is the raising of the age of qualification for New Zealand Superannuation; ironically it is the young people themselves who are most strongly promoting that policy, and the oldies who would be unaffected who are most strongly defending the rights of future generations to be able to retire and enjoy some life free from the dictates of market forces.

“… borrowed money needs to be paid back sometime, and that goes back to those issues of intergenerational fairness that you touched on … we have limited fiscal resources … it’s very important given the debt we are going to leave the younger generations with that we invest in projects that increase the productive capacity of the economy so that these things will in time pay for themselves …”
(Sharon Zollner)

“… the key thing for me is who’s going to be left with this debt; I’m a young person … this is going to fall on young people if we don’t have a plan to pay it back … the people 30 years down the track, if we don’t have a plan are going to be saddled with this higher debt, so we have to have some idea what the timeframe is, and if the government is willing to take on some of these hard decisions, or if it’s going to pass the buck down to the further generations; not only to pay it back but to make those tough choices as well … (Brad Olsen)

“… look, we’ve had many decades of not dealing with the hard issues when it comes to the fiscal situation, whether it’s around aging or the superannuation questions … we have to think about, collectively, what’s the fairest way of paying [the debt] back …” (Shamubeel Eaqub)

In the abstract we may have ‘limited resources’, but the biggest present problem we are hearing about is excess labour (indeed much of the RNZ interview was about unemployment), an abundance rather than a scarcity of resources. The narrative suggests that, due to a scarcity of resources today we must conjure up resources from the future, and that these teleported resources will have to be extinguished (paid back) in the future. The narrative is that a conjuring of resources today must be accompanied by a deconjuring of these resources tomorrow.

The amount of gold (what most of us still tend to think of as real money) that is sitting in either goldmines or bank vaults will not make any difference to what is affordable or what is not affordable in the future. Money is not a limited resource, it’s a social technology.

The real issue is about how both present and future generations can have higher living standards, noting that living standards have taken a setback in 2020 due to the pandemic. Tricks around the conjuring of money today – pretending that newly created money comes from the future (rather than the present balance sheets of our central banks) – and the timing of when that money should be deconjured are in no way helpful. Failure to do the best we can today for the people alive in the world today will make things worse for future populations, not better.

“How bad are the books likely to be? (Jack Tame)

“In a word, terrible. … [we can expect fiscal deficits larger than] what I have seen in my working lifetime … ” (Cameron Bagrie)

“How are we going to pay for this? (Jack Tame)

“That’s the million dollar question on the other side [of the balance sheet]. … Borrowing today we are putting a tax or a liability on the next generation. The options are asset sales … spending restraint.… Or tax increases; look, at some stage I think that is going to be inevitable. I think we are going to need to make some pretty tough decisions in regard to those sacred cows we don’t want to talk about, such as the likes of raising the retirement age; well sorry, that one needs to get done. But the big one is, just make the economy grow faster. If the economy is doing well we are paying more tax … but its easier said than done to get a whole lot of magical growth out of this on the other side.” (Cameron Bagrie)

If governments do not borrow now – and borrow big – then interest rates in all the main national economies might have to be substantially negative in order to get desired saving and desired borrowing into balance. The biggest question for now is what would happen to the global market economy if governments fail to act as ‘borrowers of last resort’.

Bagrie is firmly wearing his ‘mercantilist hat’ when he talks about paying back the debt, and flogging our future 60-somethings as a way to help do this. But he wears his ‘economist hat’ when he says that economic growth is the best way (indeed the historical way) of achieving lower debt to GDP percentages. One real problem that economists who think inside the box face is that economic growth, as box-dwelling economists understand it, may itself be a part of the problem that future generations will need to untangle humanity from.

(The actual solution here is to expand the ‘relaxation’ ring of the economic pie chart; and to shrink the divided pie. This will require higher taxes and higher universal benefits; not to burden the rich or anyone else, but to ensure that non-labour income is distributed less inequitably. Twentieth-century solutions to inequality that focus on ‘jobs, jobs, jobs’ not only will not stem rising inequality; logically labour income cannot provide a solution when it represents a falling share of total income.)

How did the New Zealand government ‘repay’ its debt after the GFC?
Did the Australian government repay its debt? The UK?

New Zealand did not raise taxes to repay the post-GFC (global financial crisis) government debt. Nevertheless, that debt did fall back to under 20% of GDP. (See Chart Analysis – National Income, Spending and Debt.) The debt fell back in large part because of economic growth; one feature of that growth in New Zealand was the government running Budget surpluses from 2015, shown in red in the third chart. By definition, Budget surpluses means the repaying of net debt on the government’s balance sheet.

There was no policy in New Zealand to repay debt. No new taxes were used to repay that debt. No benefit cuts were introduced to repay that debt. Rather, the private sector in New Zealand became confident to run financial deficits; these private sector deficits are the main drivers of economic growth, and of rising tax revenues in entrepreneurial capitalist economies.

Back in 2009 there was much angst about the prospect of a decade of deficits’. We were worried then about how we would ever pay it all back. Not only was it so easy to pay back that we didn’t notice we were doing so, but the amount of new government debt incurred was less than we thought. The media narrative at the time was that the debt would be huge.

Australia, which did not experience a recession in 2009, did however experience a decade of government deficits. It had similar economic growth to New Zealand, powered also in large part by private sector deficits. But the Australian government did not prioritise the doctrinal sacred cow of ‘fiscal responsibility’. (Australia had other priorities, like funding cancer treatments, and tax cuts.) It did not pay back the government debt it incurred over the last decade, to the point that government debt in Australia reached 41.5% of GDP in 2018. Despite its failure to pay back the debt, compared with almost all other advanced capitalist countries, the Australian government serves an example of fiscal rectitude.

In 2010, the United Kingdom tried to implement an austerity policy – called fiscal consolidation – to repay its GFC-incurred government debt. It tried to do this before the private sector was ready to run financial surpluses. Thus, the Cameron government snatched fiscal defeat from the jaws of victory. Only the 2012 Olympic Games prevented the United Kingdom from moving into a post-recession recession. The United Kingdom experience is shown in the fourth chart of Chart Analysis – National Income, Spending and Debt. The result of the United Kingdom trying to repay its government debt was a government debt to GDP percentage of 83% in 2017, up from 34% before the GFC. In the UK the government tried to reduce its deficit at the same time that the private sector was trying to repay its debt. The result was that economic growth was suppressed, and government deficits remained at over 5% of GDP until 2015.

The European Union and the rest of the World, in the long run.

The European Union had the same idea as the United Kingdom. But, in the Eurozone, the private sector showed no interest in running deficits. Thus, government deficits accommodated private surpluses. However, by Eurozone edict, governments were determined to get their deficits down. The Eurozone succeeded by running a mercantilist economy, using low interest rates and exchange rates so that the Eurozone could run large foreign sector deficits (otherwise known as current account surpluses). The Eurozone wanted to make money by exporting much more than it imported. The Eurozone sees itself as an export economy.

Government debt levels remain high in the Eurozone; for example 60% of GDP in Germany. The fifth chart of Chart Analysis – National Income, Spending and Debt reveals the Eurozone’s long run strategy. On government debt, the plan is to run balanced budgets; and I expect that the European Commission will try to revert to that plan as soon as possible, following Europe’s severe Covid19 emergency. They do not plan to ‘pay back’ the government debt; rather their plan is to let the debt percentage fall as a result of export-led GDP growth.

The guts of the Eurozone strategy, shown by the Eurozone chart, is to have annual private sector surpluses at about 4% of GDP (in blue), matched by current account surpluses (foreign sector deficits, in green). And to do this into eternity.

What it effectively means is that, over time, the Eurozone hopes to give away 4% of its GDP every year. This is because, each year, countries outside of the Eurozone will buy 4% of the Eurozone’s output on tick, and will never repay that debt. If the world economy grows each year, these countries will have a stable debt percentage of their GDPs. These countries will never need to repay their debts to their Eurozone creditors. Further, Eurozone investors and exporters will continue to knock on the doors of these countries, asking them to keep importing goods and services from Europe, without asking for payment for those imports. Because Europe wants to perpetually export more than it imports, it therefore wants the rest of the world to import more than it exports, into perpetuity.

Giving away 4% of its GDP seems a strange wish for Europe to have. But it’s a reflection of the same sorts of mercantilist thinking that New Zealand’s liberal bourgeois journalists and economists indulge in when they claim that future generations of New Zealanders will have to pay back, as a burden, the money that we today appear to be conjuring from their future.

The chart above shows how a spending pie-chart may differ for a closed economy, compared to its income chart. For this example, the government sector has a financial deficit (ie a budget deficit) while the household sector has a financial surplus.

In this case the government sector slice is 30% of the spending pie instead of 25%, meaning that the government is spending 20% more than it is earning in taxes. The government deficit represents 5% of the gross domestic product (GDP, which is the total divided pie). The government deficit is financed by a household sector surplus, which as also 5% of GDP. Households spend less than they are entitled to; they save, which is what households normally choose to do. The only matter of interest is whether it is the business sector or the government sector that runs a deficit to match the household surplus. (In this case, the business sector is running a zero balance.)

The chart above differs from last week’s chart, by including a foreign sector. The foreign sector can only be depicted for debtor economies (which includes New Zealand and the United Kingdom, but not the European Union). [Pie charts cannot show negative numbers.]

Here, the foreign sector earns 5% of all income generated in this economy. It is a net figure, the difference between what foreigners earn in this economy, and what locals earn in foreign economies. In this example, the whole divided pie is gross domestic product (GDP), and the part that excludes the foreign sector is gross national income (GNI).

If we choose to call this economy New Zealand Inc, then the fact that GNI is less than GDP defines New Zealand Inc as a debtor economy.

New Zealanders may spend more than GNI; indeed they may spend more than GDP even if GNI is less than GDP. This third measure is gross national expenditure (GNE). If GNE is more than GNI, as it almost always is in New Zealand, then the country can be said to be running an external (or current account) deficit. When a country such as New Zealand is running an external deficit, then the country’s foreign sector is running a financial surplus.

For New Zealand, in each of the last few years, the private sector (households and businesses combined) has run a deficit, the government sector has run a surplus, and the foreign sector has run a surplus. While this is a common pattern for New Zealand, it is uncommon for most other countries. Most countries run a private sector surplus most of the time; which means that they typically run government sector deficits and/or foreign sector deficits.

(What may be confusing is that a foreign sector surplus is reported in a country’s national accounts as a current account deficit. When foreigners are net savers, then our country is a net spender. Our country runs a deficit with respect to the rest of the world, and the rest of the world runs a surplus with respect to our country.)

This chart shows that, from 2015, New Zealand has run private sector deficits (ie negative surpluses), government surpluses and foreign surpluses. This has meant that our governments (especially the central government) have spent less than they earned, and foreigners (on average) have spent less than they earned. Households and/or businesses have spent more than they earned (by taking on more debt, or by spending past savings).

This New Zealand pattern was much more striking in the 2000s’ decade, and briefly reversed for a few years after the global financial crisis (GFC).

While New Zealand, as a nation, has benefited from a foreign surplus in every year shown – indeed from every year since 1974 – it does not mean that New Zealand Inc has had unsustainable debt with respect to other countries. What is does mean is that New Zealanders (private sector) have incurred substantial debts that have never been repaid; nevertheless New Zealand Inc remains solvent because it has had no difficulty in servicing its historic debt, and has had no difficulty in extending its historic debt.

(Note that no 2019 data have been given for New Zealand, because the IMF estimates the 2019 government balance by averaging the known balance to the year ending June 2019 with the forecast balance for the year ended June 2020. The forecast for the present financial year is muddied by the Covid19 pandemic.)

Unlike New Zealand, we can see that the United Kingdom government sector last had a financial surplus in 2001. However, like New Zealand Inc, United Kingdom Inc enjoys the opportunities it has to spend more than it earns. Like New Zealand Inc, United Kingdom Inc is a substantial debtor nation with respect to its foreign sector, and is quite solvent. United Kingdom Inc has faced no requirement to pay back its debt to the rest of the world.

When we look at the Eurozone, which commenced in 1999, we see a very different picture. The private sector has been running surpluses since 2001, and is an important creditor to Eurozone governments. Increasingly, however, the Eurozone private sector has become an important creditor to the rest of its world, including to the private sectors of New Zealand and United Kingdom.

What would the Eurozone private sector do if the private sectors of New Zealand and United Kingdom attempted to repay this debt? It would create all sorts of problems for the Eurozone private sector, which would first try to solve its problem by relending it to New Zealand Inc and United Kingdom Inc. Failing that, it would have to seek out riskier alternative debtors.

The Eurozone is where it is because it is where it wants to be, running foreign sector deficits. If forced to run foreign sector surpluses (ie accept debt repayment), then the Eurozone’s private sector and/or government sector would be forced into running deficits. That’s precisely what the Eurozone people and governments do not want.

If New Zealand and the United Kingdom and the Eurozone are happy to maintain this financial relationship, then there may be no problem to solve. However, there is a problem, and it mainly relates to the Eurozone’s financial relationship with the world’s developing economies.

Income in an Economy

The chart above shows how income is distributed in an economy. It shows three major sectors: Government, Business and Households. Households are the principal sector; governments and businesses serve households, and are accountable to households. The chart is a pie chart, representing the economic pie. (For now, ignore the outer ring of the pie; the pie is the part divided into sectors.)

In this stylised example of a closed economy (ie no foreign sector), government receives a portion of national income (which is practically the same as gross domestic product). Part of the government income share goes to infrastructure, part goes to collective services like healthcare and education, and part goes on alms and other welfare payments. If the government sector – which includes local governments – saves part of its income, then it runs a surplus. (Repaying debt is a form of saving.)

The business sector both retains income and distributes income to households. The part that it retains – in blue – can be either invested on capital goods and services (eg buildings, machinery, staff training) or saved. If the sector as a whole saves part of its retained income, then the business sector runs a surplus. (Otherwise it runs a deficit, which is simply a negative surplus.)

The same applies to the household sector, represented here by six families: Waititi, Cooper, Patel, Duff, Tan and ‘destitute’. If the household sector saves more than it spends, then it runs a surplus.

By definition, the sum of the sectors’ surpluses adds to zero. So, if any sector is running a surplus then at least one other sector must be running a deficit.

The incomes shown represent entitlements to shares of the goods and services that contribute to the pie. For example, if the Cooper family run a business that makes barrels, then the business sector (or any other sector) may use part of their entitlement by purchasing those barrels. The profits from this cooperage business represent both income to the Cooper business and income to the Cooper household, enabling the Coopers to buy other stuff.

Surpluses and Deficits

If most households save part of their incomes, then the household sector most likely runs a surplus. (In most countries the household sector runs a surplus most of the time.) We generally expect the business sector to run a deficit about equal to the household surplus. That leaves the government sector with a balanced budget. However, if the business sector does not run a large enough deficit, then the government sector must run a deficit too. If, under these circumstances the government sector resists running a deficit, then not all the goods and services in the pie will be purchased, and the whole economy will shrink next year. (Imagine a missing slice from next year’s pie; that slice is called unemployment, or, strictly, ‘involuntary unemployment’.)

In this chart, debt is easily understood. Most likely the Waititi family does not wish to spend its full income entitlement; and maybe this year the Duff family wants to spend more than its income entitlement. So the Waititis can – directly or indirectly – transfer some of their present entitlement to the Duffs. The usual arrangement will be that the Duffs agree to transfer  – directly or indirectly – a slightly greater amount from a future year’s pie to the Waititis.

The Waititis run a surplus this year, and the Duffs run a deficit. The Waititis contract to run a deficit in the future, so that the Duffs can run a surplus in the future. That is what a debt contract is; a commitment on the part of a creditor who runs a present surplus to run a future deficit, a commitment to be repaid. (The Waititis can defer this future obligation if sufficient new debtors can be found, in the future.)

Economic Growth

If next year’s income pie is bigger than this year’s pie (ie it contains more goods and services), we call that economic growth.

Inflation

The market may put a dollar value on this year’s income pie. If we produce essentially the same pie next year, but the market places a higher dollar value on next year’s version, then the economy has experienced inflation.

Relaxation

The ‘relaxation’ ring around the pie represents the extent that our economy is not ‘maxed out’; it’s the reserve capacity of the economy. It represents the ‘life’ part of a society’s work-life balance. (Economists call this ‘voluntary unemployment’; many do not realise that voluntary unemployment is a vital part of our wellbeing.) Our economic happiness is measured by the enjoyment that we get from consuming the goods and services that we buy, plus the opportunity to chill out and enjoy what we have.

We could increase our living standards by increasing the size of the relaxation outer ring, while keeping the economic pie the same size. Or, we could increase the size of the pie while keeping the size of the outer ring unchanged. While both possibilities reflect an increase in both living standards (aka economic happiness) and the productive capacity of the economy, only the second of these options would be measured as economic growth. Thus many economists have a growth bias in favour of that second option.

There are other options that represent increased economic happiness. The ‘relaxation’ option that needs to be mentioned here is to have a smaller income pie, and a bigger outer ring. This is the option that, coming out of the Covid19 pandemic, makes most sense. We will want to spend less – to buy fewer goods and services – while retaining a highly productive market-based economy. The solution to the Covid19 economic crisis is a structural readjustment to our work-life balance, maintaining economic capacity while spending and working less.

The Pie Chart representation has a Weakness

The sixth household – ‘destitute’ – does not appear on the pie chart, but does appear in the chart’s legend; the ‘legend’ is the table of labels to the right of the chart.

‘Destitute’ is statistically invisible, unless made visible by including it in the table. ‘Destitute’ has no income, no work-life balance. In this situation, the destitute household has little choice but to try to run a deficit, but will struggle to find a creditor. Failing that, destitute can only survive by alms, known by economists as income transfers.

Alms are good, but economic rights are better. Surely ‘destitute’ has some economic rights; rights that grant it at least some income from the pie? Yes, but only if society is grown-up enough to acknowledge and properly confer such rights. Otherwise ‘destitute’ remains visible only to those who will see.

“We are borrowing tens of billions of dollars from our children and grandchildren to get us through the Covid crisis…”. (James Shaw in interview on Radio New Zealand’s Nine to Noon, 23 April 2020)

Debtors and Creditors

Literally, for me to be in debt to somebody means that the ‘somebody’ (the creditor, maybe my friend) has incurred a sacrifice so that I (the debtor) can access some want or need today that I am not otherwise entitled to. We accept that people will not normally make such sacrifices without compensation, and that such compensation is called ‘interest’.

A good example would be if both my friend and I wanted to buy a bicycle. He could afford a basic bicycle now, and I cannot. But I claim to have a more immediate need for a bicycle now. So he lends me enough money so that I can buy a basic bicycle now, and, over time, repay him with interest. As a result, a year later he gets to buy a better bicycle – one with bells and whistles – on account of the interest he receives from me. He makes a present sacrifice (a year without a bicycle), and gains a future reward (a bicycle with bells and whistles). I make a future sacrifice (no bells and whistles), and gain a present reward (a bicycle).

In this financial view of debt, my friend both saved (ie did not spend) and invested (gained a yield in return for a sacrifice). A finance professional would say that my friend had invested in me by buying my ‘bond’. An economist might tolerate that view of my friend as an ‘investor’ if I only wanted my bicycle for pleasure. But, if I needed my bicycle to run a courier business, then I would be the investor, not my friend. To a financial analyst, the words ‘saving’ and ‘investing’ are synonyms. To an economic analyst, ‘saving’ and ‘investing’ are antonyms; to an economist ‘investment’ is the process of purchasing goods and services (spending) that help someone to run a business. To a financial analyst, ‘investment’ is the process of purchasing a promise (which is saving, not spending).

This example shows how the language of finance is somewhat murky, and why so many people give up on trying to understand finance, and how they often extend that abstinence by giving up on economics too.

We may also note that, this bicycle example of a debt transaction explains why many people believe that it is impossible to have negative interest rates; this view is that interest is compensation for sacrifice. This is the prevailing view of financial analysis. (We may note that financial analysts extoll the magic of compounded interest; that by making repeated sacrifices ‘investors’ can accumulate rewards at an exponential growth rate. One catch is that investors must abstain from the enjoyment of their rewards. Another catch is something economists call ‘negative real interest rates’.)

Economists, on the other hand, understand my bicycle example as inter-temporal trade (trade between the present and the future) and that interest is the price that balances supply and demand for such trade. Thus, in economics, interest rates can be positive or negative. Further economists like to talk about ‘real interest rates’ (essentially the contracted interest rate minus the rate of inflation), and accept that, for much of history, real interest rates have been negative. (So much for the alchemy of compound interest!)

(As an aside, for much of the 2010s’ decade, Switzerland had both deflation – falling prices, eg annual inflation of minus one percent – and negative interest rates, eg minus half a percent. When those numbers applied, real interest rates were positive; minus half a percent minusminus one percent equals plus half a percent!)

Saving as Insurance

The reality is that finance is not really about savers making sacrifices. For example, most retirement savings are not spent by old people enjoying their bells and whistles in the last years of their lives. Rather, most private retirement savings ends up in the savers’ estates. In many cases it is their adult children who spend what their deceased parents did not; in perhaps more cases, the inherited money is left in the bank and forms part of the inheritors’ estates. (In matters of inheritance, who is the ‘inheritee’?)

By and large it is high-income people who save; people who do not have to make sacrifices and by and large do not make sacrifices. (Traditional misers – such as Dickens’ Scrooge – may appear to make sacrifices by living miserly lives; but those lives represent their choices. Others may stay in basic cabins when they go on holiday, despite the fact that they could easily afford much better accommodation; again, these frugal lifestyles represent preferences, not sacrifices.)

Most savers do not save for a ‘sunny day’; they are rich enough to not need to save for things they really want. The real reason that most people save is for a ‘rainy day’, as a precaution in case something goes wrong in the future. Their sacrifice is akin to an insurance premium; and it’s a very small sacrifice given that most savers do not live noticeably frugal lives.

What they do want is to be sure that they can withdraw some or all of their savings when it rains very hard. As such, they face a general problem that exists with all insurance. My insurance works when it rains on me, but not on other people. My family or myself gain a payout when my rainy day happens (it could be my death).

What happens when it rains on everybody at the same time? In Christchurch in 2011 the insurance industry could not cope. Further, even Christchurch people with mortgage-free houses and lots of money in the bank had to compete for the services of builders and plumbers and the like. The constraint on happiness was the shortage of essential workers and essential equipment; and an unsafe environment where many workers (including essential workers) were unable to ply their trades. There are times when money cannot buy happiness. The insurance industry’s solution is reinsurance; insurance companies ensuring themselves against large claims.

Neither conventional insurance nor lots of money in the bank can guarantee policyholders or savers security in times of war, pestilence or famine. These are cases when it doesn’t just rain on everyone in your city; rather, it rains on everyone everywhere. When the supply chains are broken, attempts by savers to spend their money result in inflation, maybe hyperinflation. A million dollars of savings is worthless when inflation reaches one billion percent.

Saving represents the creditor side of transactions for with the other parties are debtors. The debtors get extra happiness today; the creditors expect to get extra happiness in the future. A particularly important form of happiness is economic security. (When Cinderella married her prince and lived happily ever after, we may assume that she got three meals a day and a roof over her head; her marriage was like a pauper winning lotto; having a sense of economic security is a very important form of happiness.)

When supply chains are broken, government spending to resurrect and recreate supply chains, and to ensure everyone can access those supply chains, becomes all-important. Such government spending is necessarily debt-funded, except perhaps in a few countries where governments (such as Norway or Saudi Arabia) have large sovereign wealth funds. Governments are insurers of last resort; refer David Moss (2002), When All Else Fails.

James Shaw, co-leader of the New Zealand Green Party

What do we make of Shaw’s claim that we are borrowing from our grandchildren? Does it make sense? Will there be some future financial reckoning which might have an adverse impact on our children? If our grandchildren are debtors, will they have to make sacrifices to settle this debt? Or are they creditors who may become victim to a default? A literal interpretation of Shaw’s statement is that our grandchildren are creditors, not debtors. Creditors by definition gain their benefits in the future, having made sacrifices in the present.

Certainly, there is no shortage of economic commentators who suggest that in the future all this ‘borrowed money’ will have to be ‘paid back’. I think Shaw was making the point that we need to spend wisely, equipping our grandchildren so that they will be able to pay the money back rather than default on debt contracts signed by their grandparents. That makes them debtors, not creditors. Who will they pay the money back to?

They will owe the money to themselves. There need be no reckoning after all.

By ‘we’, Shaw means the New Zealand government. The New Zealand government clearly is the debtor, here, the government of course being a proxy for the New Zealand people.

It sounds as if Shaw really means the opposite of what he said, that our grandchildren will be debtors, in the sense that they will inherit government’s debts incurred by their grandparents. I think that Shaw was trying to say that our grandchildren may inherit a government debt to GDP ratio of (say) 100 percent, and that they will have to pay higher taxes in order to get that ratio down to the 20 percent of GDP that this somewhat austere government believes is appropriate.

Government Debt

Government debt comes in four categories; that is, there are four different possible classes of creditor. Some creditors are less benign than others.

In the first case a government borrows directly or indirectly from its Reserve Bank (aka ‘central bank’), creating what some commentators call ‘monetised debt’. The debtors are the economic citizens of New Zealand, who also happen to be the shareholders of the Reserve Bank. So long as the resultant spending is done to ease the problem of a broken supply chain, and to pay benefits to ensure that all the resident population can draw sustenance from that supply chain, then the putative sacrifice (inflation) becomes less likely, not more likely.

In the second case, a national government borrows from that nation’s private savers, either directly (as in the historic cases of war bonds) or indirectly through the commercial banks. Interest rates may be high, low, zero, or negative. In the latter three cases, there is a surfeit of private savings and the government is acting as borrower of last resort. Private savers like this arrangement, because it is an alternative to increased taxation. The government spends while private savers refrain from spending; the savers are not making a sacrifice because they would have been savers anyway. The advantage for the savers – the creditors – is that they can still access their savings when individual savers face individual crises; this they could not do had they paid tax to the government instead of lending to the government. (This is the Japanese solution, where Japanese lend to their own government at minimal interest rates; they do this in preference to paying higher taxes. The massive Japanese government debt to its own middle class has many economic benefits to all concerned, and few detriments. Japan is not constrained by this debt.)

The third case does not apply in New Zealand, but certainly does in the European Union. This in when the governments of some European Union states are in financial debt to middle class savers mainly resident in other European Union states. In a well-functioning Union, such debt would be comparable to Japan’s government debt. But in Europe the north-south schism is such that this has become a huge problem, albeit an artificial problem.

The fourth case is when sovereign governments are in financial debt to unambiguously foreign creditors. In these situations, creditors may to take it upon themselves to throw their weight around; in particular to make unreasonable and unsustainable demands on debtor governments.

Thus, the problem that can arise from government debt is principally a political one, that relates to the creditor-debtor relationship, and the inequalities that reflect an asymmetrical creditor-debtor relationship.

So, what do we make of James Shaw’s statement? Covid19 sacrifices have been made by all the world’s people, in terms of direct or indirect health outcomes, in terms of lost liberty and induced agoraphobia, in terms of public policy mistakes in many countries, in terms of compromised livelihoods, and in terms of lost benefits which were tied to persons’ now-precarious market incomes. The increased public debt is required to offset these sacrifices.

There is no obvious creditor sacrifice. Rather, for those people with the capacity and preference to be creditors (especially in the second case sense above), government as borrower in a time of few viable private debtors may enable interest to be paid at positive interest rates; so there is a clear creditor reward. As for most debt contracts, the outcome is win-win.

A Constructive Rhetoric around Debt

Debt need not be the bogey which it is often portrayed as. The principal return on coming government emergency outlays will of course be the resurrected and reimagined supply chains, and the incomes (including tax revenues) they generate. Our children and grandchildren will be foremost among those beneficiaries. We can credit them.

Instead of invoking the debt bogey, Mr. Shaw, you could say:
“We are investing tens of billions of dollars for the benefit of our children and grandchildren. May their lives be stable, equitable, and sustainable.”