New Zealand’s monetary policy decision today was presented as a “line call” (RNZ news) between a cut of 0.25 or 0.50 percentage points. In that context, the correct decision was made; 0.50%. In the context of the understood policy narrative, it was a binary choice.

In the mainstream expert and pundit commentaries, there was as usual a confused mix of comments about should-expectations (what the Reserve Bank should do, within the constraint of the options ‘on the table’) and would-expectations (what the Reserve Bank would actually do). Outside of that mainstream groupthink, there are of course potentially other could-expectations; about what else the Reserve Bank could do, if allowed and/or encouraged.

(See my comments on Modern Monetary Theory to get a sense of how monetary policies and governments’ fiscal policies represent two sides of the same metaphorical coin. And how the easing only of monetary policy during a structural recession is equivalent to another metaphor: pushing a string. Aotearoa should and could have more money spent into circulation as more government debt.)

The recent commentary we have been getting was that the Reserve Bank was facing contradictory ‘stagflationary’ pressures; a recession which would require a greater fall of interest rates, and rising inflation which – the groupthink alleges – requires a lesser fall (or even no decrease) of the OCR. Would the Reserve Bank prioritise an anti-recession or an anti-inflation policy position? We held our breath until 2pm!

The reality is, given that this was a binary contest – ‘matchplay’ to use the sporting metaphor – the bigger interest rate decrease represented a win (albeit a small win) on both the growth front and on the inflation front; a win-win decision. That’s at least something. History is littered with well-meaning (and, sometimes, not-so-well-meaning) lose-lose policy decisions.

The Interest Rate and the other two prices of money

For our purposes, the Official Cash Rate (OCR) is the interest rate.

In my historical review of monetary policy – I noted that there were three prices of money: the internal price (which is the inverse of pure inflation), the external price (the exchange rate between one kind of money – such as the New Zealand dollar – and a weighted-average of other kinds of money), and the interest rate (which is the price of inter-temporal trade, or what economists more commonly call the price that balances saving and investment).

Note that, in a simple economy, saving is the withdrawal of money from circulation and investment is the injection of money into circulation. (That’s not the way most pundits use the word ‘investment’, however.) Saving is a withdrawal from today’s economy with the underlying presumption that it will be invested into the future economy; or, as in the case of loan repayments today, they were invested in the past. Investment is either the injection of past saving into the present economy, or (through borrowing) the injection of future saving into the present economy.

Today, withdrawals from circulation are too great; and injections too little. (The Reserve Bank might want to switch on the Moniac machine in its museum, to see a simulation of this.)

Trickle-Up and Compound Interest

As noted in my earlier writing, the principal monetary objective of the socio-political elites is to have, on an indefinite basis, an interest rate that’s higher than the inflation rate, thereby creating a positive real rate of interest. This policy objective applies to both of the three elite ‘tribes’; the centre-right tribe (think National), the centre-left tribe (think Labour), and the tribe of economic liberals (think ACT).

Another name for this implicit but underlying policy objective is ‘trickle-up’; a policy to facilitate the accumulation of compound interest. Compound interest may be broadly defined as any financial situation whereby financial wealth appreciates over time, meaning that a dollar saved today buys more tomorrow than it will buy today. Under trickle-up, there is an unrequited flow – tribute, in reality – from debtors to creditors, from poorer to richer.

Real interest rates are positive when nominal interest rates (eg the OCR; or term deposit rates) are higher than the rate of inflation. We note that this definition applies also when inflation rates and/or interest rates are negative. Otherwise, real interest rates are zero or negative. Compound interest is a state of affairs whereby unspent money appreciates exponentially, as if by magic. Every dollar of compound interest gained by A is funded by B.

When real interest rates are positive, A is ‘creditors’ and B is ‘debtors’. Conversely, however, compound interest works the other way when real interest rates are negative. Further, the predominant story since say 1935, at least in New Zealand, is one of negative real interest rates. Our parents actually became rich (as if by magic) because they were debtors for much of their lives, and because compound interest flowed from creditors to debtors. That was trickle-down.

But the elites, most of whom benefitted from trickle-down in their younger lives, now want trickle-up. New Zealand Historian David Thomson documented this in 1989; it was called Selfish Generations? How Welfare States Grow Old (revised edition 1996).

Real Interest Rates are determined by the market, not by edict

The nominal rate of interest is now set by edict. But the other two prices of money are set by markets. The end result will be a positive real rate of interest if ‘investment demand’ exceeds ‘saving supply’. And the end result will be a negative real rate of interest if ‘investment demand’ falls short of ‘saving supply’. The later situation is very much the truth of the present structural recession in New Zealand, and to which much of the capitalist world is veering into. This means that inflation rates will be higher than ‘risk-free’ interest rates, such as the OCR.

It means that a reduction in the rate of interest will ease pressure on the rate of inflation. Under present conditions, the lower the interest rate the more room there is for price inflation to ease. The bigger the reduction in the OCR, the more present ‘investment’ will be enabled (leading to a greater positive or smaller negative rate of economic growth) and the less pressure there is for prices to rise in order to achieve balance between investment and saving.

The Open-Economy Complication: The External Price of Money

Under floating exchange rates, market adjustment in the price of money may take place through the exchange rate (external price) as well as through inflation (the internal price).

New Zealand’s OCR is now significantly lower than the equivalent rates in the United Kingdom, United States, and Australia; it’s the same as Canada and South Korea. It’s still a bit higher than in the European Union, Taiwan, Sweden, and Denmark. It’s still much higher than in Japan and Switzerland which, by not indulging in high post-covid interest rates, never had high post-covid inflation.

By all our conventional understandings, there should be a run on the New Zealand dollar, given that there are so many other-nation options where interest rates are higher and economic activity is less depressed. Two things are propping-up the New Zealand exchange rate; record high commodity export prices, and a history of giving good returns in the past to foreign creditors. Many foreign creditors remain loyal to their historic ‘golden goose’. How long can these circumstances last?

Finally

Historically, the migration of capital has often matched the migration of labour. Just think of flows of money and people within the British Empire over 100 years ago.

I recently took a look at the year-to-August international migration data for New Zealand. Out of 31 countries listed by Statistics New Zealand, only Samoa, Japan, Sri Lanka, Pakistan, had more citizens migrate to New Zealand on average in the last two years compared to the previous year. And the only ones with significant immigration into New Zealand after 2023 were Pacific countries, India, China, Philippines, Nepal, Sri Lanka and Japan. Japan has seen the recent return of those who left during covid. There has been a substantial increase in migrant departures by passport-holders of all of these 31 nations in Asia, Europe, South America, and Africa; and that’s despite the fact that some people who entered New Zealand on one of those passports have exited with a New Zealand passport.

New Zealand is crashing and burning economically, and still its best monetary policy options remain ‘off-the-table’. New Zealand’s recession-recovery policy is tantamount to ‘pushing on a string’. How long will it be before capital emigration matches the net emigration of people with New Zealand passports and the incipient net emigration of New Zealand residents with passports from high and highish income countries? How soon will it be before financial crisis follows economic crisis?

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

Last week I looked at how, for modern day purposes, monetary policy started around 1750. It began with the departure from the presumption that money is wealth to the idea that money is a veil and that therefore wealth is something else. That was, in a sense, the beginning of political economy as a branch of philosophy, morphing into economics as a social science. In the then new (now ‘classical’) utilitarian view, wealth came to be seen as useful ‘product’ and money as a ‘veil’.

The liberal view arose that the best monetary policy was no-policy; that is, no policy beyond the steady coin production of each sovereign’s Royal Mint. While no longer the definition of wealth, across the capitalist world, money was understood as central (as a lubricant or a catalyst) to the workings of a self-regulating productive super-machine. Money came to be understood (correctly) as a technology – a flow technology – rather than as wealth itself. The mercantilist idea of money as wealth – and of gold or silver as money ‘to be made’ – never disappeared, however.

With that view of money as a lubricant in mind, we today can understand that a shortage of money is always going to be a bigger problem than a surfeit of money. (A car with an oil leak will eventually grind to a halt. A car with an overfilled sump, on the other hand, will still function; it will function near-to-perfectly if there is a place within the car to park the excess oil.)

This new laissez-faire view of monetary policy changed once it was realised that the mechanism didn’t work in practice as it did in theory. While it didn’t work for multiple reasons, there was a continuation of the pretence that it did work. In order to maintain that pretence, senior bankers and political leaders – the emerging ‘lords of finance’ – turned to interest-rate manipulation within the context of the ‘gold standard’.

Ultimately, what societies’ elites wanted was to have a form of ‘liquid’ wealth that they could store over time, and which would maintain (or even increase, through the ‘magic’ of compound interest) its purchasing power across time. The merchant capitalist mindset came to prevail over the realisations of progressive bankers and economists. The elite-classes still wanted a monetary policy which would operate as if mercantilism was true.

The elite-classes wanted money to come at a cost, so that they could be sure money would remain scarce. Gold and silver mining (and latterly crypto-currency mining) have been the primordial costs of commodity money. Interest rates would have to serve as the entry costs of modern ‘as if’ money.

Modern Monetary Theory

There is a known and substantially correct story in academia – albeit ‘heterodox’ academia – about money, monetary policy, and the relationship between public finance (fiscal policy) and money. It’s called Modern Monetary Theory or MMT. The conceptual relationship between OMT (orthodox monetary theory, though a better name might be PMT ‘prevalent monetary theory’, or even better LMN ‘liberal-mercantilist monetary narrative’) and MMT is akin to the relationship in the 1850s between miasma-theory and germ-theory in epidemiology. (Many people died of cholera in Europe and the Americas because the scientific establishment clung onto the miasma theory, despite the overwhelming and increasing weight of evidence to the contrary.) MMT dispenses with the requirement that money must enter into circulation at a cost; and disposes of the argument that the public and private sectors are each-other’s rivals.

I was fortunate to meet Randall Wray at an economics’ conference in Sydney in 2011, and found that he and his academic collaborators already had a well-developed theoretical framework which matched some statistical work I was doing at the time. I had been exposed to the work of Japanese/Taiwanese macroeconomist Richard Koo, and his studies of the Japanese structural recession of the 1990s and Japan’s recovery from that event. Of importance was Koo’s concept of a balance-sheet recession.

The central idea is that core money is public debt; a set of promises spent into circulation and backed by sovereign governments. A simple example of this is traditional coin money, made from bronze or silver or gold. In MMT, what gives the coin its value as a token of circulation is the depiction of the sovereign’s head, and not the amount of precious metal in the coin. A second example lies in the history of central banking, whereby the original three central banks (in Stockholm, Amsterdam, London – all in the seventeenth century) pioneered central banking through their roles as bankers to their governments; in particular, they managed their governments’ historical war debts. Those debts became private assets; and the core assets on these banks’ balance sheets.

These banks evolved to become bankers to the other banks as well as bankers to the state. Almost all the world’s central banks – ie Reserve Banks – are now publicly owned; they are very much part of the apparatus of the state. While governments sub-contract monetary policy to semi-independent central banks, MMT suggests that monetary policy is in reality undertaken by nations’ Treasuries. As a result of Treasuries’ monetary misunderstandings, modern capitalism risks becoming like an under-lubricated car with leaks.

Public debt(s) are private assets, just as a bar of gold is an asset. The world’s effectual money supply is the ‘liquid’ – ie flowing or circulating – component of (or derivative of) any monetizable asset; the core monetizable asset being public debt. This chart (from my Governments run financial deficits; it’s their role to do so, Evening Report, 17 October 2023) shows that, this century, public debt – the monetary base – increased each year from 2008 to 2022 by an average of about four percent of global GDP. That’s about how it should be, and with significantly larger injections of money required whenever a financial or economic crisis threatens to undermine the circulation of money in the real economy, as occurred in 2008 and 2020.

The real economy is the purchases of goods and services. The ‘unreal economy’, into which much money leaks, is the ‘casino economy’ whereby money is spent on financial assets; non-money circulating promises such as shares, bonds, and property titles. The ‘upstairs’ casino economy acts as a dynamic treasure hoard, fuelled by leaks from the real economy, with players buying and selling assets at mostly increasing prices.

While according to MMT, public debt (not gold or silver) is the foundation rather than the pariah of capitalism, that is not to say that more public debt is always better than less public debt; just as, in the classical schema, more gold is not necessarily better than less gold. Though in 2025 Aotearoa New Zealand, more public debt would certainly be better than the present constricted amount. The growth of public debt is always limited by tax revenue arising from the circulation of money; as they say, nothing is more certain than taxes. One efficient way to increase public debt – and thereby enhance the liquidity of the economic machine – is through ‘negative income taxes’; for example, universal tax credits (which should act like the credits received in the game Monopoly whenever a player passes ‘Go’).

The prices of money

There are three important prices associated with money: the internal price (which wavers with pure inflation and pure deflation, and does reflect the idea of money ‘as if’ it’s a commodity like silver); the external price (the exchange rate between one form of money and another, eg $NZ vis-à-vis £UK); and the interest rate which is best understood as the price of ‘inter-temporal trade’ (although OMT treats it as the ‘necessary cost of money’).

Inter-temporal trade simply means exchanges when, unlike direct barter, selling and buying do not occur simultaneously. Wage workers effectively sell their labour on pay-day, and buy stuff (say at the supermarket) on another day. When they ‘save’, then it may be months or years before they spend that saved money; that is, months or years before they use it to buy stuff. Alternatively, workers may spend some of their wages in advance; for example, with a payday loan or a credit card. Interest rates are a market-clearing price which – if correctly set in the money market – ensures the balancing of income spent late with income spent early.

People who tend to spend their money before payday are usually net payers of interest. Likewise, people who spend most of their money after payday are net receivers of interest. Thus, interest rates should be high when few people want to spend late and many want to spend early; and low when many people want to save and few want to borrow. There is no reason why interest rates cannot be very low; that is, negative.

Negative real interest rates are indeed commonplace; they occur when the rate of inflation is higher than the interest rate. For example, if the internal price of money is falling by five percent a year (ie annual inflation is five percent) and the interest rate is three percent, then the real interest rate is minus two percent. Under such conditions, interest effectively flows from savers to borrowers; rewarding early spenders over late spenders.

(For a while in the late 2010s, Switzerland had a published interest rate of minus three-quarters of a percent and inflation at minus one-and-a-quarter percent, meaning that the real rate of interest was plushalf a percent. Everything worked fine; interest effectively flowed from borrowers to savers. Switzerland then needed negative interest rates in order to limit the appreciation of its currency the Swiss Franc; otherwise, the external price of Swiss money would have been rising too much. In that episode, all three prices of money came into play.)

Looking at the three prices of money dispassionately, we see that they all play a role in free market capitalism, and that the inflation rate is itself a part of the price mechanism. This indeed has been grudgingly accepted by the mainstream, with today’s monetary policy proposing the optimum annual inflation rate as two percent rather than zero; and there are advocates today for higher inflation targets. The internal price of money should fall, policymakers agree, albeit in a predictable manner. Australia indeed has a higher inflation target than New Zealand.

(If inflation is 2.1% every year for 100 years, two $20 notes put under the mattress today should buy one loaf of bread in the year 2125; $40 would become equivalent to today’s $5.)

One important benefit of inflation is that it encourages the circulation rather than the hoarding of money. The biggest danger arising from large caches of non-circulating money is that such money may reactivate at short notice, creating substantial ‘excess-demand’. Just as we are used to seeing money regularly leaking into the casino, money in the casino can be injected into the real economy at short notice.

Bimetallism as a way of favouring Inflation over Deflation

An early attempt at monetary reform during the gold-standard period was the advocacy of bimetallism.

The United States election of 1896 was fought, in effect, on the issue of inflation versus deflation. At that time, due to gold scarcity, the gold to silver exchange rate was high (16:1) and rising. There was a substantial world depression in the early 1890s; an event that hit Australia very hard, causing New Zealand to resist overtures to join the incipient Australian federation.

In the world of the gold standard, prices were at an all-time-low and many small businesses had become distressed; especially farmers who were selling their produce at prices which were falling even faster. In the United States the free silver movement was prominent, and the Democrat Party chose a candidate – William Jennings Bryan – who favoured that political position. He failed to get elected because there was an effective party split, with many urban voters in opposition to the policy to shift from the gold standard. (As a result of the Democrat split, many Gold Democrats aka Bourbon Democrats voted Republican. The new Republican president was the recently hyped imperialist William McKinley. The gold-silver exchange-rate issue largely dissipated following the 1897 Alaska gold rush.)

The anticipated effect of a switch to a silver or bimetallic standard was that prices and wages would go up, and the highly indebted small businesses would be able to service their debts in an environment of inflation rather than deflation. City workers in 1896 tended to favour deflation; many were unable to make the connection between their future standard of living and the retention of a thriving small-business sector.

As we have seen, this position of favouring inflation over deflation is now mandatory in most capitalist jurisdictions. The largely successful monetary policy attempts in the 2010s to ward-off deflation ensured that there was no general depression in that decade. The policy, strictly, was largely unsuccessful in achieving its inflation target. That’s because of one of the fundamental flaws in orthodox monetary policy; low interest rates generate lower rather than higher costs, and therefore low rates of CPI-inflation.

Examples of ineffective and effective monetary policy from (mainly) New Zealand history

There were antecedents of MMT (and other pragmatic initiatives) in New Zealand and elsewhere during the recovery from the Great Depression which peaked in the early 1930s.

In the 1920s New Zealand had no Reserve Bank. New Zealand’s (mainly Australian-owned) banks did their banking in London, the world’s pre-eminent financial sector. From 1926 until 1928, New Zealand’s Minister of Finance was William Downie Stewart, an economic liberal and a monetary conservative. Gordon Coates – more of a pragmatist, but largely untested – had been endorsed as Prime Minister in the 1925 election months after the death of William Massey.

1927 was a disaster year for New Zealand, exacerbated by Stewart’s unresponsiveness in his role. Australia had its economic meltdown a year after New Zealand, reversing the trans-Tasman migration flow. This made the government even less popular, as unemployment in 1928 was blamed on immigrants. Coates’ Reform Party – the principal precursor of today’s National Party – went from 48% of the vote in 1925 to 35% in 1928, losing power as a result. In 1929 there was a United minority government, initially facilitated by Labour. The winning policy of United – the former Liberal Party – was increased government borrowing. The result was 20 months, in 1929 and 1930, of relatively good times despite the unfolding international crisis.

Reform went into the December 1931 election as junior partner in a United-Reform Coalition (a formal coalition which formed that September). While gaining many more votes and seats that election than United, Reform remained the junior partner. Stewart was restored to Minister of Finance at the worst possible time; going into 1932, the most difficult year of the Great Depression. Labour’s doctrinaire socialism was unappealing to voters, despite the growing unpopularity of the United government in the months following the retirement and death of Prime Minister and Finance Minister Joseph Ward.

As a ‘sound-money’ man, Stewart had been a stickler for the revised gold-standard rules. However, before the 1931 election, Britain’s government collapsed due to the financial crisis. Britain had to suddenly withdraw from the Gold Standard. The ensuing rapid depreciation of the British pound (largely reversing deflation in that country) kick-started the British economy, and also brought the New Zealand economy out of its 1931 ‘free-fall’. But New Zealand, being an agricultural commodity economy facing severe terms-of-trade issues, needed an even bigger (and longer-lasting) currency reset. Eventually, in January 1933, Stewart did the right thing and resigned on a matter of monetary principle. Coates – Stewart’s replacement – now pragmatic and worldly-wise, immediately devalued the New Zealand pound against the British pound, in line with the recommendations of the young generation of economists.

New Zealand’s recovery remained slow, but at least it was under way. The management of New Zealand’s financial reserves in London remained too conservative. Nevertheless, many subsequently iconic new businesses began their lives in 1934 and 1935 (for example Wattie’s, Fisher and Paykel, Sleepyhead).

Coates did two more things of great importance. First, he established a reform-minded Brains Trust made up of three young economists – Campbell, Sutch, Belshaw – who would argue for monetary pragmatism. And Coates established the Reserve Bank of New Zealand in 1934. Though created with conservative monetary principles in mind, the means had become available to introduce heterodox monetary policy in the event of a future government willing to flirt with an alternative narrative.

Another important development was the rise in the United Kingdom in the 1920s of Social Credit, then known as Douglas Credit, a ‘lay’ movement (counter to the political economy traditions of Marshall and Marx) reminiscent of the previously-mentioned American ‘free silver’ movement. Social Credit largely antagonised academic economists, by making anti-orthodoxy generalisations which were simplistic and too broad. Nevertheless, Social Credit gained a substantial political influence, not least in New Zealand; and it did have policy prescriptions helpful for extracting economies from a state of structural recession and inequality.

In the Labour Government elected in 1935, there was a substantial Social Credit faction; and there were a range of other monetary reformers with varying degrees of sympathy towards Social Credit. Social Credit’s central argument was that the orthodox monetary system had a permanent and structural deflationary bias, and that a public institution – such as an appropriately modified central bank – would be required to offset this bias. In effect, Social Credit argued for quantitative easing, and a national dividend (and food price subsidies, called ‘compensated prices’) as means to inject new money into circulation while addressing monetary poverty and inequality. (See A National Dividend vs. a Basic Income – Similarities and Differences, by Oliver Heydorn, 2016.)

Unlike the quasi-Marxian form of socialism advocated by New Zealand Labour from the 1910s until 1933, the party under the leadership of Michael Joseph Savage became infused with monetary radicalism and a desire to unite rather than divide diverse economic interests.

A commitment to monetary reform within Labour in 1935 led many rural voters to vote Labour for the first time ever (including voting for my great-aunt’s husband in Kaiapoi). Those voters remained loyal to Labour in 1938, in light of Labour’s subsequent monetary achievements. Particularly effective was the State Housing programme, politically managed by John A Lee, a working-class monetary reformer. Labour made full use of the new Reserve Bank to create-through-spending the money required. Economic growth boomed (about 25% in two years) while inflation remained low; a big recovery from a big depression.

In New Zealand, Social Credit split from Labour in the 1940s, and formed its own political party. While often polling highly, it could not break the two-party system, and was eventually broken as a political force – in 1984 losing two-thirds of its 1981 vote – after having been lampooned by Bob Jones. Jones was leader of the one-election-wonder New Zealand Party; an ‘unsuccessful’ party which successfully acted as a political catalyst for the return of economic liberalism and the floating-currency version of classical monetary orthodoxy.

While much of what Social Credit claimed as chronic weaknesses of the orthodox monetary narrative has turned out to be true, the successful albeit piecemeal monetary reforms which took place in the middle-third of the twentieth century eventually undermined Social Credit’s critique of monetary orthodoxy. Social Credit had indeed contributed to its own seeming redundancy as an economic force in New Zealand. (There was a Royal Commission on Money in 1954, in which Social Credit had a chance to make a substantial case. Although there had been a near-recession around 1953, after the Korean War, and Social Credit gained 10% of the vote in 1954, there was little evidence then of structurally unsound monetary arrangements.)

A third important development was the publication in 1936 of The General Theory of Employment, Interest and Money by John Maynard Keynes, an already famous British economist. This was a largely technical book which extended and reconsidered Keynes’ earlier views on money and monetary policy (1930 A Treatise on Money), while emphasising the critical roles of public debt and government spending in getting a country out of structural recession. Keynes also recognised in 1933 that import protection through tariffs would help with national economic recoveries, and that national economic recoveries would enable the restoration of the international capitalist economy. Keynes criticised international capitalism in order to save it.

Keynesian analysis led to the pushing a string critique of monetary policy.

It was the Keynesian critique which created the post-war international expansion; underpinned by an emphasis on government spending as a curative for the kinds of unemployment which widely prevailed in the 1930s. But Keynes believed that the problem of the 1930s was more cyclical than structural; hence he argued – in contrast to the MMT argument – that governments should run budget surpluses during periods of full-employment.

Keynes was the architect for the post-war monetary system that might have been. But the alternative American-led version won out, with politics prevailing over good argument, and with Keynes’ premature death.

Keynesian and other insights from the Great Depression of the 1930s informed monetary policy during the global decolonisation period from 1946 to 1976. Newly independent countries emerged, all with central banks. Central banks became, more explicitly than before, an arm of government. In New Zealand, with its substantial historical national debt (a result of imports exceeding exports for around 100 years) the development of import-substituting and export industries became central to economic policy. Interest rates remained below the rate of inflation through sufficient costless money creation. Organisations close to government – especially the producer boards such as the Dairy Board, forerunner of Fonterra; also, the State Advances Corporation which funded mortgages – gained direct lines to practically costless money through their Reserve Bank accounts.

While those monetary reforms worked in their time, future fiscal-monetary policies will need to be more about sustainability and private-choice than through a single-focus on selling more goods in a stormy world marketplace.

Unfortunately, monetary policy from the 1980s regressed into the spirit of 1920s’ economic liberalism and monetary conservatism. The result has been the nonsense of simultaneous economic growth and deteriorating living standards through stagnant wages, overwork, unaffordable housing, and weak environmental stewardship; the inequality norm of the neoliberal era matches that of the early twentieth century.

Money is inherently public. Unfortunately, there is a ‘groupthink’ in the economics profession; the profession which describes economies with a very limited vision of capitalism’s public sphere. Modern monetary theory straddles capitalism’s public-private interface.

Financial Mercantilism and Labour Mercantilism

In the neoliberal counter-revolution of the 1980s, the Reserve Bank of New Zealand was mandated to use interest rates as a weapon to suppress inflation by creating a recession. Although government debt was costless to create, governments were obliged to pay high ‘market’ rates to borrow. A new ‘expensive-money’ era of neoliberal-mercantilism was born, in which money was required to have innate scarcity value. Money reverted to its former status as a commodity to be made and stored.

The neoliberal era is best characterised as a new period of financial mercantilism; an era in which money is king, and the objective of economic life is – through capital or through toil – to ‘make money’.

This neoliberalisation took an unusual path in New Zealand, in that the figure after whom these changes were identified – called ‘Rogernomics’, after Labour Minister of Finance, Roger Douglas – had a deeply set philosophy which can best be described as ‘labour mercantilism’. The philosophy dates to conservative working-class practices in the Victorian era, the Fabian era, and which gave a nod to Marxian class consciousness. In that era of working-class self-help, worker welfare came through worker-funded contributory societies in which all contributors had an equal stake and expected equal benefits, though spread out over time. To be a beneficiary, you had to be a contributor to the fund from which you and your family expected to benefit. Money earned in one period would be paid out much later. Pension-fund benefits, for example, paid out of saved money, needed to purchase new goods and services. While this idea presumes economic growth through the accumulation of physical capital, the initial withdrawal of money from circulation could inhibit such growth.

This funding idea forms the basis of ‘savings-funded’ pension schemes, as distinct from ‘pay-as-you-go’ taxation-based schemes. The savings-funded schemes create huge financial liabilities which must be liquidated in an inherently uncertain future; the fiction is that wealth is stored in the past to be consumed in the future. The current-tax-funded schemes, on the other hand operate entirely in the present tense; a person’s pension is determined by today’s economic conditions, not yesterday’s conditions.

Financial mercantilism is a ‘store-money-today’, spend it decades later perspective. Labour mercantilism is the variation applied to the savings of wage and salary earners.

In the late-1930s’ Labour Government there were three factions, which Michael Joseph Savage (Prime Minister) had to manage. There were the monetary radicals – the radical centre – which included Social Credit. There were the left-wing redistributors, who wanted to ‘tax the rich’ and ‘pay pensions and tax concessions’ to workers. And there were the ‘right-of-the-party’ labour mercantilists who wanted to withdraw money today to build sovereign wealth funds from which future retirement and other benefits would be paid to workers’ families. These last two groups squabbled intensively behind the scenes. (A very useful source is the 1980 book, The Politics of Social Security, by Elizabeth Hanson; another is A Civilised Community, 1998, by Margaret McClure).

That first Labour caucus included Bill Anderton, Roger Douglas’s maternal grandfather (MP for Eden and then Auckland Central from 1935 to 1960; no relation to Jim Anderton, whose father’s surname was Byrne and mother’s birth-surname was Savage, though no relation to Michael Joseph Savage). From 1960 to 1975, Norman Douglas succeeded his father-in-law Bill Anderton as MP for Auckland Central. Norman and Roger Douglas were in Parliament together from 1969 to 1975.

In 1937 there was a push from Labour’s right to abandon the 1935 policy pledge of universal pensions (and other benefits) in favour of an actuarial scheme – what we would today call a sovereign wealth fund – that was conceived-of as a kind of ‘magic money tree’ based on the ‘principal of compound interest’. Minister of Finance Walter Nash, returning from the United Kingdom in 1937, was accompanied by accomplished British actuary George Henry Maddex. Much time was spent with Maddex – some would say wasted – trying to supplant the promised ‘pay-as-you-go’ universal pension with this scheme which promised some people – mainly men – with large benefits in the distant twilights of their lives. Further, because the people who financially contributed the most would get the most, the scheme in essence promised an avalanche of future-spending by people other than those with the most needs. In the end the left and right factions cancelled out, resulting in a universal welfare state funded for current beneficiaries with current money.

Compound interest only works if interest is less than inflation over the medium-long term. In practice such ‘pension funds’ play about for decades in the casino economy, trying to replicate the promise of compound interest. Further, they represent capitalism’s greatest financial risk; the possibility that financial assets, dynamically-parked in the casino of capital gains, will sometime in the future return at scale and at short notice to the real economy. Flooding the future economy with excess demand. Or eventually providing deferred benefits which would buy much less than promised.

Fast forward to 1974, Roger Douglas devised and established such a sovereign wealth fund, which commenced operation in 1975, and was cancelled months later. In the midst of high inflation and a global economic crisis, the greater monetary priority was addressing the issues of that time, not stashing away stocks of money for the never-never. The National Party under Robert Muldoon fully exploited that misplaced priority.

When in power again in 1985, Douglas turned to the redistributive face of Labour, means-testing the ‘universal superannuation’ which had existed in one form or other since 1940.

Nevertheless, still alive and well at 88 – and long-after he established New Zealand’s most right-wing party, ACT – Roger Douglas is still pushing for the same sovereign wealth fund that his grandfather wanted in 1937 and that briefly operated fifty years ago. This time he has University of Auckland Economics’ Professor Robert MacCulloch at his side, claiming this pension fund as a magic bullet solution to New Zealand’s present stagnation (refer GDP drop sparks calls for Willis to step aside, RNZ, 19 Sep 2025). One-again, withdrawals from the ‘circular-flow of money’ will not rejuvenate an economy which desperately needs injections of ‘money-in-circulation’.

Kwasi-nomics

An interesting recent episode was the Fall 2022 rise and fall of Liz Truss as United Kingdom Prime Minister, and her hapless Chancellor of the Exchequer Kwasi Kwarteng. Truss and Kwarteng were right-wing monetary mavericks, willing to expand the United Kingdom’s public debt through ‘unfunded’ tax cuts. Yet the structure of those tax cuts was principally to allow the already rich to become richer, rather than to inject the money into where it was most needed. Subsequent to her effective dismissal, she went on to laud Argentina’s hatchet (aka chainsaw) President Javier Milei whose modus operandi is to drain money from those sections of Argentine society which most need it. Kwarteng and Truss were co-authors of Britannia Unchained, which argued ‘for a radical shrinking of the welfare state in order “to return it to the contributory principle … that you get benefits in return for contributions”. That’s the same quasi-economic principle which underpins labour mercantilism.

Ricardian Equivalence

Ricardian Equivalence is an idea gleaned from classical macroeconomics which became fashionable within neoconservative economics in the 1980s. It claims that fiscal policy is futile; that increases in government spending are ‘internalised’ in such a way that private spenders adjust by spending less. It has been widely used as an argument for the futility (rather than the centrality) of government spending as an engine to establish a healthy full-employment market economy.

Neoconservatives push the liberal-mercantilist monetary narrative as the only valid macroeconomic policy programme. Ricardian Equivalence, much-touted by economic liberals to justify fiscal conservatism, puts all their policy eggs into monetary policy. Meaning the monetary policy, based on innate money scarcity, of using interest rates to recreate the primordial costs previously associated with gold and silver mining.

Ricardian Equivalence is a ‘straw man’ argument. In as much as the data supports it, that conservative characterisation of government spending does not apply to economies stuck in depressions or structural recessions. Only programmes of active government spending – or waiting for too long – can resolve a structural recession.

And the monetary system always requires enough public debt to act as the banking-system’s ‘modern gold’.

Finally

Modern Monetary Theory is a valid description of money as it actually is (and was), and a policy recipe for economic growth. There are important twenty-first century stories which require money to be something more; in particular, a means to generate higher living standards and productivity without requiring economic growth. This is partly an issue of work-life balance, better enabling those who wish to choose more leisure and less work. And a prosperous future without economic expansion will be a requirement of a future of demographic contraction, as is forecast for the end of this century.

To achieve these ends, we have to go beyond public-debt-induced peoples’ money to achieve ways in which ordinary people – households of people who consume goods and services among other things – can choose their own balances between consumption and other facets of good living.

It can be done. Public equity dividends – dividends arising from public domain capital, equal and unconditional, complementing private incomes – can enable the overworked to work less and the underworked to work more. That could be the future direction of modern money.

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

On Monday (Pushing a String; Ineffective Monetary Policy, 22 September 2025) I wrote about how, in circumstances of economic depression or structural recession, monetary policy is ineffective as the sole policy to induce a country’s economic recovery.  Here I look at the historical antecedents of today’s monetary policy narrative.

Understandings of Money

Human understandings of money go back to the prehistoric development of accountancy, the world’s first profession. (Other professions, by definition, require at least some basic method of accounting.)

There are three broad historical concepts of money: money as wealth, money as a veil, and money as circulating promises. (If we think of coins as a promise, it is the sovereign whose head is on the coin who gives value to that coin, and not the amount of silver or gold that the coin contains. If we think of banknotes, the promise is made by the senior banker whose signature is on the note.)

For the first two concepts, money is a commodity with innate value (such as gold or silver) which is co-opted to act as (among other things) a medium of exchange. For the third (correct) conceptualisation of money, it’s a social technology which arose out of the practice of accountancy and its derivative, banking.

In the intellectual history of money, the important decades were those either side of the year 1700. The two most important names are the English philosopher John Locke (advocate of commodity money) and the Scottish radical banker John Law ( advocate of bank money). Discussion of events in those times is beyond the scope of what I’m writing here; but I recommend the book Money, the Unauthorised Biography (2013), by Felix Martin.

(I would also like to mention here John Law’s banking rival, Richard Cantillon, of  Irish Catholic upbringing and living his professional life in Paris and London. He made his money through the financial crisis of 1720 by pioneering the practice of short-selling, made famous to lay-audiences by the movie The Big Short; this made Cantillon very unpopular with his many rivals who lost their money only to watch Cantillon become very rich. Cantillon went on to write the most important economic treatise of the first half of the eighteenth century – Essay on the Nature of Commerce in General – in English; it is a book that particularly plays up the importance in the new capitalism of entrepreneurship. The book was written in English, but only the French translation survived; Cantillon was murdered – a crime believed to have been instigated by one of his many enemies – in a fire in his London home, with the fire consuming the original manuscript. The French translation was able to be published, however, and eventually the book was retranslated into English. When I was reading Cantillon’s retranslated book many years ago, I was struck by the frequent use of the word ‘undertaker’ to mean ‘entrepreneur’. Later, in the 2000s, US President Bush apparently claimed that “the trouble with the French is that they have no word for ‘entrepreneur’.” I could not help but think of Cantillon.)

The differences in conceptions of money can be summed up as the philosophers versus the bankers. The philosophers, and their economist ‘descendants’, prevailed in a misframed and misadjudicated debate. The bankers, in reality, were more correct. Misunderstandings about money are as prevalent today as they ever were.

It is true that even modern money can be construed as a commodity; a ‘silver’ florin – still in circulation in New Zealand as a 20c coin – buys much less today than it did in the past. Using CPI inflation as a proxy for monetary inflation, the Reserve Bank’s inflation calculator tells me that a florin’s purchasing power was 120 times greater 125 years ago than it is today, a result of an average annual inflation rate of 3.9%. (In New Zealand we also have a crown still in circulation; it’s the 50c coin. In the 1950s and 1960s New Zealand did not then have a crown coin, but it did have a half-crown coin [25c today] in circulation alongside the florin [20c] and the shilling [10c]; these still-existing New Zealand coins reference the principal coins used by the merchants of Sweden, Netherlands, and Austria – all ‘G10’ nations in the 1750s.

Nevertheless, that is despite its superficial history as a commodity, money is in its essence a technology, not a commodity. While money is a technology of trust, hence the explicit or implicit signature, it is a technology whose power is based on its circulation. ‘Currency’ is like an electric current; it must flow in order for it to perform its function.

Money as Gold or Silver or modern equivalents such as Bitcoin and Real Estate

The idea that money is wealth is known as ‘mercantilism’. Belief in merchant capitalism – the mercantile system, mercantilism – drove the European global commercial expansion from around 1490 (Columbus) to 1790 (French Revolution). Nevertheless, mercantilism is to economics what alchemy is to chemistry; hence most economists know nothing about mercantilism, just as most chemists know nothing about alchemy, and as most doctors know nothing about humoral medicine. Both belief in alchemy and in belief in humoral medicine represent critical pathways in the evolution of those modern scientific disciplines.

The present United States president is an unreconstructed mercantilist, in that he believes – by fair means or foul – his country becomes wealthy (aka ‘great’) by ‘making money’ through the exploitation of land and labour and foreigners. In particular, unreconstructed mercantilists want their countries – as presiders, or through their identification with their national ruling class – to make money at the expense of their rivals.

In this crude understanding, money is conceived not as a circulating medium but as a stash of wealth. Monetary policy, as such, is simply to augment that hoard. Modern ‘assets’ such as real estate (land considered as a financial commodity) and cryptocurrencies represent modern developments in the ‘money as wealth’ paradigm; hence the ‘mining’ of cryptocurrencies is an exploitation of nature (through its wasteful use of electricity) just as is gold and silver mining. For our monetary system – connected to silver and gold only in the abstract – those metals may as well still be under the ground as in bank vaults.

Money as a Veil

The (incomplete) debunking of mercantilism was performed most notably by two Scotsmen: David Hume around 1750 and Adam Smith in 1776. Smith pointed out that nations could best accumulate money through free market mechanisms (rather than through extortionary mechanisms), relying in part on capitalists’ innate patriotism as a determinant of their enlightened self-interest.

It’s Hume to whom I wish to turn. He was the first to fully conceive of commodity money as a ‘veil’. The idea was that money is simply a scarce and durable commodity, such as silver or gold; silver was the more important monetary commodity in his time. (Anyone visiting Fremantle, Australia, should not miss the Shipwrecks Museum, which features many silver coins recovered from the Batavia and other ships of the Dutch East India Company.)

The idea, today known as the crude quantity theory of money, was that the price of silver (as a commodity) was effectively the price of circulating money. So, when silver was scarce, the price of silver would be high, the price of silver coins would be high, and therefore the prices of all goods and services (and of labour) would be low (ie low relative to highly-valued silver coins). Cabbages and carriages and personal services would be cheap; wages would be low. And, when silver was relatively abundant, the price of silver would be low, and therefore the prices of all goods and services would be high. Cabbages and carriages and personal services would be dear; nominal wages would be high. It didn’t really matter if prices were high or low; the economy would work just the same. Hence the notion of money as a veil.

When the price of silver was falling there would be inflation. When the price of silver was rising, there would be deflation. While neither inflation nor deflation were huge problems, both were destabilising; the biggest concern was that, with inflation, the purchasing power of hoarded money would decline. Thus, it was seen as preferable that prices were either low or high, but not rising too much. (The ruling classes – the owners of private and royal treasure hoards – clearly quite liked deflation, while hating inflation.) Royal hoards of silver and gold belonged in the sovereign’s ‘Treasury’.

Hume developed the veil idea into a theory of monetary economics as applied to international trade. (While the modern concept of a nation as a territory defined by its borders was only just emerging in Hume’s time, the G10 of the 1750s were: Great Britain, France, Spain, Austria, Netherlands, Sweden, Ottoman Turkey, Russia, Mughal India, Qing China; all imperial powers, some waxing others waning.) Hume also noted that money had some real value; not as absolute wealth, but as circulating oil, as lubricant.

Countries with balance of trade surpluses would accrue silver ‘reserves’, whereas countries with trade deficits would deplete their silver reserves. The quantities of money in circulation – especially silver coins or ‘specie’ – were assumed to be a constant proportion of those reserves. (And, as a more tacit assumption, private stashes of silver were presumed to be at a stable proportion to public reserves.) Hence, there would be predictably more money circulating in a country following an inflow of silver; and less money in a country when there had been an outflow of silver. The mechanism, as stated by Hume, came to be known as the price-specie flow mechanism.

Based on earlier mercantilist habits of thought, all countries’ ruling classes wanted inflows of silver and wanted to avoid outflows. In effect, Hume claimed, it wasn’t such a big deal. The international monetary system would self-regulate. Countries with inflows of silver would experience rising prices; countries with outflows of silver would experience falling prices.

The world economy would self-regulate as if it was under ‘thermostatic’ control. Costs of production would fall in deficit countries, and would rise in surplus countries. Hence deficit countries would increase their exports and decrease their imports; surplus countries would decrease their exports and increase their imports. Money flows would reverse, until those cost discrepancies were eliminated; it’s an elegant mechanism.

There were three problems. At an increasing rate, and especially after 1750, un-understood bank money was growing rapidly, so – for that reason and others – the money supply in the growing G10 countries (especially Great Britain) had become increasingly detached from the silver supply. Second, price levels never varied proportionately with the quantity of money; the velocity of circulation (ie turnover) of money varied substantially in the short-and-medium term, with new forms of un-understood money making up for long-term shortages.

But, at the time, the main issue was the resistance to inflation (rising prices) on the part of the nations’ ruling classes. In particular, in the eighteenth century, the G10 economies were highly protectionist; Great Britain became the worst offender, mercantilist trade barriers morphed into open warfare. Later, in the nineteenth century, silver (and gold) flows between nations were minimised through the use of international credit arrangements; the unbelievers in bank money allowed full use of the banks so as to shore-up their countries’ ‘wealth’. Indeed, at the end of the nineteenth century in Great Britain (now the United Kingdom), prices in 1900 were half of what they were in 1800 despite massive increases in the actual money supply.

The more people believed in commodity money the less important it became. I remember learning from a lecturer of mine (indeed a recent persona in New Zealand’s monetary policy governance) that the most sophisticated treatise on money in the whole of the nineteenth century was An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, by banker Henry Thornton, written in 1802. Meanwhile, ‘monetarism’ became the intellectual weak link of the Ricardian classical system (reflecting the tradition of the philosophers rather than the bankers). And the huge disputes about money in the 1840s, between the currency school and the banking school, were settled by the elites in favour of their favoured philosophical narrative rather than through truthful observation.

There was also elite resistance to deflation (falling prices) on the part of nations with depleted reserves of silver and gold. While deflation boosted the (largely unrealised) purchasing power of the treasure hoards of the small numbers of rich people, falling incomes to peasants and other workers diminished the local demand for goods and services, leading more to business failures and the concentration of ownership of economic assets in favour of the already rich.

The International Financial Game

In the second half of the nineteenth century, the formal gold standard emerged; although most money was neither silver nor gold, then bank money (especially paper money and bank deposits) in the Euro-capitalist would be treated as if it was gold. In principle, countries’ gold reserves would be shuffled across the floors of the bank of England’s vaults in accordance with countries’ trade deficits and surpluses; with the Bank of England being tantamount to a global central bank.

But short-term finance – much like inter-bank finance today – would stabilise countries’ money supplies; meaning that countries with trade surpluses would not experience monetary inflation, and countries with trade deficits would not experience monetary deflation; so those patterns of destabilising surpluses and deficits would not be resolved. Money as a thermostatic veil had become completely ineffective. Further, international money flows were increasingly divorced from imports and exports; much more they had become cross-border flows of ‘investments’, profits, interest, rents, and royalties.

This process was not well understood at the time; today we understand it by focussing on ‘current account’ balances rather than ‘trade balances’. Indebted countries today are countries with repeated large current account deficits. (Thus, New Zealand is easily one of the most indebted countries in the world; although the New Zealand government has low indebtedness by international standards. One of the puzzles of our time is why professional and media commentators focus so much on government indebtedness and so little on national indebtedness.)

To make up for the by-now irrelevance of the price-specie-flow mechanism, the leading lords of finance – especially those who became governors of the emerging central (Reserve) banks – developed the first international-rules-based order.

Countries experiencing more inflation (rising prices becoming more common after around 1905) saw themselves as becoming ‘less competitive’, so – rather than addressing root causes – the rule for them was to instigate a price deflation by placing downward pressure on their money supplies. The principal means to do this monetary deflation was to jack-up interest rates; to raise the rate of interest at which the leading banks or central bank would lend to other banks, thereby reducing banks’ willingness to make new loans and in turn diminishing the amount of money in circulation.

The deflation mechanism, a response to the implicit overvaluation of the problem country’s exchange rate, was expected to force a downward adjustment of prices and wages in such countries. We saw exactly this mechanism of internal devaluation at work in Greece in the mid-2010s as it’s bearing the burden of the Euro-crisis. The Euro currency is an effective system of fixed exchange rates between member nations; therefore the only solution to an overvalued exchange rate is a costly internal devaluation. We note that nations such as Germany and Netherlands try not to follow the same rules by having an internal revaluation; this means that the Euro-zone as a whole has uncorrected current account surpluses.

Monetary policy as we know it today, through interest rate manipulation, was born. A major problem was that the whole capitalist free-market economy depends on prices – including interest rates – adjusting freely in accordance with market forces; interest rate manipulation is contrary to capitalist freedom. The hijacking of interest rates for an interventionist purpose disabled a central feature of self-adjusting liberal market economies.

The rules of the game that applied in the early twentieth century created a powerful ‘deflationary force’, interrupted for a while by World War One during which those rules were suspended. The financial lords did generally raise interest rates in accordance with the rules, but were often reluctant to lower interest rates when those same rules required them to do so. When inflation was relatively low, however, rather than ‘reflate’ or ‘inflate’ their nations economies the lords of finance and their political masters saw this as an opportunity to run trade surpluses and to thereby augment their national gold hoards; in the 1920s, France and the United States were the biggest culprits. This one-sided adherence to the rules led directly to the Great Depression, the suspension of the gold standard, and the return to war. But the rules could never have worked; they were predicated on a stable relationship between money in circulation within each country and that country’s prices.

Post World War Two

After WW2, the gold standard was revived under American leadership as a gold-exchange standard, with the value of the US dollar pegged to gold, the other ‘hard currencies’ pegged to the $US, and the other currencies (such as the £NZ) pegged to hard currencies (eg the £NZ was pegged to the £UK). There would be periodic devaluations (mostly) or revaluations (occasionally, as in New Zealand in 1948 and 1973); although the $US could neither devalue nor revalue. This last issue led to the end of the gold-exchange standard in 1971, when Richard Nixon suspended the convertibility of the $US to gold; this enabled the $US to devalue, a monetary matter necessitated by the Vietnam War and the associated American current account deficits. What happened next was a mix of a US-dollar standard (whereby, the $US was treated ‘as if’ it was gold) and a floating exchange rate mechanism, meaning that the free (or free-ish) foreign exchange market would set the price of participating countries’ currencies. New Zealand became a participant in 1985.

The New International Financial Game

A world of free-market currencies represented a new international financial game, with rules in the same spirit as the price-specie-flow mechanism (as described in the 1750s by David Hume) and the gold-standard interest-rate rules developed in the years just before 1900.

The idea was that trade flows (or at least ‘current’ flows, distinct from ‘capital’ flows) would be the principal determinant of currencies’ exchange rates, and that countries with current account deficits would see depreciating exchange rates (albeit with some inflation) and thereby increases in ‘competitiveness’, and that countries with trade surpluses would see appreciating exchange rates (albeit with some deflation, or at least disinflation) and thereby face decreases in ‘competitiveness’.

From the late-1970s, the world of monetary policy and finance saw a return to the ‘economic liberalism’ which peaked in the 1920s; this time under the misleading names of ‘monetarism’, ‘neoliberalism’, ‘public choice’, ‘rational expectations’, ‘economic rationalism’ and ‘free-market economics’. The momentum for this financial coup-d’etat had been gathering in the 1960s, through the work of Milton Friedman and other members of the ‘Chicago School’; indeed, the revival of monetarism probably go back to Friedrich Hayek (also at Chicago, though not a direct colleague of Friedman), author of the popular 1944 anti-Keynesian book The Road to Serfdom. The Chicago School went on to manage the economic program of the neofascist Pinochet regime in Chile; more the politics of serfdom than the economics of freedom.

The name ‘monetarism’ harks back to David Hume, though misleadingly. Milton Friedman’s monetarists treated money as a veil when it suited them. For example, in the inflationary 1970s, Friedman offered a simple solution based on the crude quantity theory of money. Whatever the causes of a bout of inflation, restricting the growth of the quantity of money in circulation to say 5% per annum would bring the inflation rate down to 2%, he argued. Friedman was offering a counter-deflation, a cover-up rather than a solution. Yet, in his simplistic narrative of the 1930s’ Great Depression, A Monetary History of the United States, 1867–1960, he claimed that the quantity of money was anything but a veil. Money, for Friedman, became simultaneously everything and nothing.

Friedman, and Hayek too, favoured ‘quantitative tightening’ over the more overtly interventionist jacking-up of interest rates.

Neoliberalism – the ‘new right’, commonly called ‘neoconservatism’ in the United States – was the revival of 1920s’-style ‘economic liberalism’ under post-Nixon conditions. Its stated mantras were ‘free-market’, ‘more-market’, ‘private-good public-bad’. The neoliberal microeconomists readily joined forces with the monetarist macroeconomists in the advocacy of authoritarian mandates to suppress the market ‘signals’ that were interest rates and inflation.

The opposite of the economics of ‘freedom’ is the economics of ‘intervention’. Yet neoliberalism in its various guises is very much the politics of economic intervention; just certain types of intervention, such as asset privatisation, monetary policy with a high interest-rate bias, and the minimisation of public goods’ provision.

‘Public choice’ became a name for ‘private preference’. And ‘rational expectations’ became the underpinning of ‘credible’ – ie unnuanced and unforgiving – monetary policy to override allegedly irrational expectations; we had to believe that the awful monetary medicine prescribed for us was good for us, regardless of the evidence or the ethics. Rational expectations were imposed because the mandated public authorities were required to tell us what our expectations should be and why they had to be ‘corrected’. ‘Economic rationalism’ meant authoritarian dogmatism rather than democratic pragmatism, especially in relation to matters of money, inflation, interest rates, private ownership; and, increasingly, in relation to public debt. Economic rationalism was idealism in the philosophical and utopian meaning of that word.

Just as the rules of the gold-standard game were perverted – both because they were based on false premises, and because they were corrupted by mercantilists seeking perpetual trade surpluses – so the rules of the floating exchange-rate game have been perverted. There are two ways to manipulate the original trade-based rules. The first manipulation is for countries to defend their exchange rates by central banks using foreign reserves to buy domestic currency when the market price of the domestic currency is falling. This is called a ‘dirty float’, meaning a nation’s authorities acting to prevent the depreciation that was intended to be a central aspect of the mechanism. This has been generally a biassed form of intervention; the converse policy to inhibit an appreciation was used much less often (though was used to great effect by the Bank of England in 1932 after the pound was floated in 1931).

The more familiar intervention to pervert the rules has been the use of jacked-up interest rates to attract foreign money, thereby maintaining the living standards of the monied classes through an overvalued exchange rate (meaning cheaper imports and overseas travel). This is the policy that has created massive private debt in Aotearoa New Zealand, and some other countries; while also containing the growth of government debt. Lots of spending on imports by New Zealanders has increased GST revenue as well as creating income tax revenue in, for example, retailing and wholesaling. Such huge blowouts of private debt are the flipside of what has been euphemistically called ‘foreign investment’; money inflows not arising from exports, many of which – known as the carry trade – amounted to ‘speculation’ or ‘arbitrage’. The interested authorities and commentators have effectively covered-up these increases in national debt by relentlessly focussing on government debt; indeed to the point of labelling government debt as ‘national debt’.

This kind of monetary policy intervention – a perversion of the floating exchange-rate game – is tantamount to a Ponzi scheme whereby new national debt is required to service existing debt. The scheme has changed since 2023, with New Zealand relying on non-trade money inflows other than the ‘carry trade’; an important example is that of money brought in by immigrants.

While the likes of New Zealand hijacked ‘the game’ by trying to maintain an overvalued exchange rate, other countries – especially the modern mercantilists like Germany, Netherlands, Sweden, China – sought to maintain undervalued exchange rates. Sweden did it in the 2010s by having zero and negative interest rates. Germany and Netherlands play a game within the rules of the Eurozone. And China moved from a low fixed exchange rate against the US dollar to a dirty float of the renminbi. These countries, less so China since the global financial crisis, accumulate money hoards through current account surpluses, just as France and the United States ‘played’ their trade surplus game by undermining the gold standard rules of the 1920s.

Important Change in Understanding of Monetary Policy since the 1980s

In the late 1980s, banking and other retail financial services changed far more than is commonly realised. While this is true worldwide, changes in New Zealand, well illustrate the key points.

Back in the day – the early 1980s and before – term loans, including mortgages, were contracted at a certain interest rate for the life of the loan. When the focus of monetary policy turned to interest rates and away from quantitative policy levers, the understanding was that higher interest rates would deter new debt; and lower interest rates would increase new debt, including new mortgage debt. The understated presumption was that lower interest rates would increase the uptake of new loans in all sectors, yet there was a second (also understated) presumption that governments would not be responsive to changes in monetary policy; thus, monetary policy was perceived as only applying to the business and household sectors. Yet a rational government should be at least as price-sensitive when undertaking debt as a rational business.

Something else happened in the late 1980s. As the big trading banks absorbed the various retail non-banks (such as building societies, savings banks, and then finance companies) mortgage finance underwent a fundamental change. As well as the majority of mortgages now being issued by the increasingly powerful bank oligopoly – the one-stop shops – the interest rates would only be contracted for short periods; time durations well short of the maturity date of the loan. Long-term finance was now being priced as if it was a series of short-term loans.

An important but rarely stated implication of this change was that the average interest rate of a 30-year mortgage would be the average of the short-term interest rates over those thirty years. So in a world of economic cycles through which short term mortgage interest rates fluctuate between say 3% and 7%, then the average interest rate would be 5% regardless of what the interest rate is at the time the loan is issued. On the basis of the ‘rational expectations’ mode of thinking (which also took-off in the mid-1980s) the interest rate should not have any impact on the quantity of new mortgage lending, because the expected average interest rate would be 5% regardless.

We still chatter in the media and academia as if high interest rates do discourage new mortgage lending, and low interest rates do encourage more. For example, there is a widespread supposition that new mortgages issued in 2021 were substantially facilitated by the low interest rates prevalent then; and that, therefore, if interest rates had been significantly higher in 2021 then the short-lived housing bubble that year would not have happened. But this does not survive the ‘rational expectations’ test; if the critical factor in 2021 really was unusually low short-term interest rates, then the bubble will have been caused by irrational expectations of average interest rates over the duration of the mortgage.

This century, the perception of tight money policy as a deterrent to new lending has gradually given way to the perception that mortgagors have become the ‘meat in the monetary policy sandwich’; the perception that monetary policy works through targeting the discretionary day-to-day spending of this narrowing cluster of middle class and upper-working-class households.

Though less discussed in mainstream media, there also remains the widespread perception that tight monetary policy works through restricting the growth of business lending, especially small-business lending; lending which was always based on short term debt. One irony here is that reduced small-business lending encourages more mortgage lending by banks, especially given that under the one-stop banking-shops the same institutions are now doing both types of lending. We saw that particularly in the years 2004 to 2008, when increased mortgage lending stimulated a real estate bubble despite a tightening monetary policy implemented through the Reserve Bank imposing higher interest rates. It is likely that something similar happened in 2021; banks pushing new mortgages (regardless of the interest rate at the time) because of the huge risks then-associated with small business lending.

New Zealand Exceptionalism

New Zealand central bankers gloried in being at the vanguard of these changes in global monetary policy intervention. In the late 1980s, the monetarists – very much in control in New Zealand as a result of the financial reforms of the mid-1980s – pushed the ‘money-as-a-veil’ idea, that CPI-inflation was a simple derivative of the increasing quantity of money, that inflation could therefore be made ‘illegal’, and that the Reserve Bank would become the monetary police. In the absence of evidence of its efficacy – inflation in New Zealand was lower in the 1990s than in the 1980s, though there was no evidence that the new framework for monetary policy had caused inflation to be lower (there was a general decline in global inflation in the 1990s) – ‘direct inflation targeting’ became prevalent practice internationally. New Zealand features in American macroeconomics’ textbooks for that reason.

While the notion that underpinned New Zealand’s 1989 Reserve Bank Act was precisely the naïve presumption that underpinned Hume’s price-specie-flow mechanism in 1750, in the world of the 1980s the only way to implement such policy was through the creation of an independent monetary police-force. And the only way those police in most countries could (at that time) contemplate performing their task was through the interest-rate lever. The transition from free-market monetary economics to manipulative monetary oversight was now complete, undertaken by interventionists who claimed to be free-market ideologues. (Alan Greenspan, Federal Reserve Bank chairman in the United States, was indeed a member of Ayn Rand’s ‘objectivist‘ inner sanctum.)

Next Week

My next article looks at good monetary policy in the last 100 years, especially New Zealand in the 1930s (NZ after 1933 and 1934 and 1935), Keynes’ monetary and fiscal balance, Social Credit, reserve asset ratios, Japan’s recovery from crisis, and Modern Monetary Theory. I will mention the recent ‘labour mercantilist’ idea of Roger Douglas and Robert MacCulloch. And will mention that idea’s Australasian precursors; and the  associated problems with wealth funds, especially Sovereign Wealth Funds. And I’ll mention Ricardian equivalence, with its much-touted reason given by economic liberals to justify fiscal conservatism, thereby putting all their policy eggs into monetary policy.

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

Back in the day, Economics 101 students learned that trying to recover from a depressed economy using monetary policy alone was like ‘pushing on a string’.

Easy monetary policy is supposed to work by getting people – households, businesses, and governments – to incur more debt; in a phrase, to borrow and spend. Easy money alone sometimes works; for example, in an ordinary downturn of the trade cycle. It does not work in a depression or a structural recession (see my Chart Analysis – Structural Recession, Evening Report 21 September 2025); because – for most parties – the overwhelming priority is to get out of debt rather than to recover through debt. The carrot of cheap loans does not appeal to overextended and technically insolvent borrowers.

Recovery through easy monetary policy depends on there being enough potential borrowers willing and able to respond to the monetary carrot.

The central government is such a potential borrower. When the government responds to the incentive, the policy is called easy fiscal policy. It’s a game-changer. Easy monetary policy may mean there’s plenty of money sitting in banks’ balance sheets; sitting waiting to be borrowed and spent. For the economy to recover, that money has to move; money – to be money – must circulate. It requires a spending agent able to take on the risk of more debt in a recession to get money moving once again. The government is generally best-placed to be such an agent, though not necessarily the only one; larger domestic corporates should also be motivated to help with the recovery of the economy which represents their home base.

In a structurally recessed economy, the banks need to create the extra money and the spending agents with deepest pockets need to borrow and spend. It’s not rocket science. Banks will almost always create the money when good customers come to borrow; that’s a central feature of profitable banking.

Will governments which borrow more end up with more debt; with too much debt? The answer is, generally no. By spending, governments generate income and therefore income tax. There’s a multiplier that is particularly powerful during a structural recession. (In 1937, the New Zealand economy had double-digit annual growth, as state-housing funded by new money created the necessary stimulus to get New Zealand out of the Depression.) Customers of governments generate income and therefore income tax. And customers of those customers also generate income and therefore income tax. And so on.

It’s widely known that income tax grows faster than income in an expanding economy, especially a growing economy with two-to-three percent inflation. (And it’s known that income tax shrinks faster than incomes in a contracting and/or deflating economy.) That’s why the Australian government has a Budget surplus (0.6% of GDP) at present and New Zealand has a deficit (-3.1% of GDP); as well as why Australia has less government debt as a percent of GDP (data from Trading Economics; though data users should be critical, that source gives the latest United States quarterly economic growth data at four times what it really is – note the presence or absence of the word ‘annualized’). Australia has a Treasurer who’s not afraid to spend (and despite Australia having higher interest rates, tighter monetary policy); hence the healthy revenue of the Australian Treasury.

In a depressed economy, fiscal policy is the answer. Monetary policy helps of course. But relying on monetary policy alone is like pushing a string. The economy just goes slack. This is not a revelation. It’s basic Economic Principles, as it was once taught.

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

This last week I watched Push: The Global Housing Crisis on Al Jazeera, featuring Leilani Farha, Canadian lawyer and former United Nations special rapporteur on adequate housing. She is now leader of The Shift (the global movement to secure the human right to housing).

The central takeaway from this ‘Witness’ documentary is that the housing crisis is a global financial crisis (as opposed to the Global Financial Crisis of 2008).

The problem is essentially the concept of housing (and the real estate that it sits on) as more a form of financial wealth (‘financial wealth’ is an oxymoron, by the way; it means ‘wealth comprised of claims on wealth’) than a human right; as such, whether housing is occupied or not – or whether it is occupied by sojourners rather than residents – is incidental. In this financial view, all that matters is the dollar value attributed to assets, and that wealth is somehow generated through a bidding process that raises that dollar values of financial assets.

Managed Funds, especially Government (or government-mandated) Pension Funds

While we may emphasise the self-perceived entitlement culture of individual speculators in financial assets, the point of emphasised by Leilani Farha was the role of managed funds, which means that – indirectly – many of us, with savings ‘invested’ in these funds, are financial speculators without thinking of ourselves as such.

A particularly important class of managed funds is government funds, including and especially government pension funds. The worst kind of these funds would be the kind such as the New Zealand Superannuation Fund created by Roger Douglas in 1974 and thankfully disestablished by Robert Muldoon in 1976. The Canadian government pension fund is notorious in this regard. And New Zealand does have a smaller-scale government fund of this sort; it came to be known after its establishment in the 2000s as the ‘Cullen Fund’.

We can generalise here, by thinking of Sovereign Wealth Funds, many of which are classed as ‘pension funds’; and we can think of private managed funds – the mainstay of the financial industry – many of which (like KiwiSaver) are government partnerships with that industry. Governments, around the world, have a deep stake in the financialisation of real estate assets; both as governments, and in the private capacity (as speculators) of finance industry and technocratic and bureaucratic and elected elites. In the formal sense, as citizen holders of public equity, we are all speculators when government-directed funds are deployed in the speculative financial marketplace.

Yes, including the homeless and the underhoused among us; the deprivileged among us can still feel good that our unrealisable public equity increases as our housing and other material rights deteriorate. We own notional shares in the lands we are evicted from.

The way around this financialisation approach to ‘wealth management’ is the ‘pay-as-you go’ approach, which was last championed – in New Zealand – by Sir Robert Muldoon. New Zealand Superannuation is still largely funded – as it must be – out of current economic product; and not through the sale of financial assets that we hope can be converted by retirees into goods and services of a certain value. Further, pay-as-you-go is the essence of the Basic Universal Income, an income distribution mechanism based on democratic accounting standards (ie based on basic human rights); a mechanism that can form the basis for the re-engagement of the rapidly marginalising populations of each country in the world.

(The scandal of Covid19 is how the entitled minority of the world’s population has spread this virus to the disentitled – including the disengaged poor – infecting them, and killing them in numbers on a World War scale.)

Pandora Papers

Other stories this week underscore the conjoint problems of financialisation, inequality, and impoverishment. One such story is the release of the Pandora Papers’ leak to global media organisations.

These papers reveal a comprehensive story, not of illegality, but of uber-elite entitlement; of legal theft.

Control of price-appreciating financial assets, as revealed by these papers, is more than ‘mere’ tax avoidance. It is theft in the fullest sense of the word, in that it is increasing the claims of the entitled on the world’s finite economic output, thereby diminishing the claims of the disentitled, and pushing them into unsustainable survival practices. Financialisation is an entitlement mechanism, and it applies to both the demanders and the suppliers of financial products.

Entitlement is not only a problem of the uber-elite. Indeed, through our KiwiSaver accounts and the like, we all come to align ourselves to some degree with the highly entitled. Further, the highly entitled go well beyond the ‘one-percenters’; rather the top nine percent (or even the top nineteen percent) of the ’99-percenters’ tend to have an entitlement mindset towards property values and interest rates, even while blaming the conspicuous ‘one-percent’ for the world’s woes.

One test of entitlement culture is a person’s attitude to interest payments. People who believe that they are entitled to an interest ‘return’ on saved income over and above the inflation rate are people who believe that they are entitled, as a form of self-congratulation, to an increased share of the world’s goods and services. It was in medieval times clearly (and correctly) understood that it was sinful to ‘make money from money’. This is distinct from making a profit from investments, such as planting a crop, irrigating a field, retaining livestock for breeding, or learning a trade.

In reality, the ‘real rate of interest’ is sometimes positive; that’s when lenders (ie savers) are scarce and borrowers (including investors and willing governments) are abundant. Under those conditions – rare in the lifetimes of people alive today – a legitimate premium is payable to people holding rather than spending money. The reverse conditions are much more familiar – an abundance of unspent money, and an aversion to deficit financing – in which, naturally, the real rate of interest should be negative.

Indeed, it was the negative real rates of interest during the global Great Inflation of the 1970s and early 1980s, that rumbled the uber-entitled, and led to the global financialisation coup of the late 1970s and (in New Zealand) the 1980s; the world event that is commonly called the neoliberal revolution. Theft through financial chicanery has prospered ever since.

New Zealand’s Official Cash Rate (OCR)

The first raising of the OCR in New Zealand for several years is indicative of this entitled view that real interest rates (as an indicator of real financial returns) should always be above zero. As such, the management of interest rates is the illiberal intervention in the marketplace that is most used to support economic liberalism.

By and large, the New Zealand public falls for the argument that higher interest rates are needed to slow down the rate of increase of financial asset prices (eg of house prices). There is little evidence for this, and indeed the 2004-08 house price inflation was in large part a result of rising interest rates.

The problem is that genuine economic borrowers are discouraged by high or rising interest rates, and that rising interest rates make very little difference to speculative borrowers. Thus, when interest rates increase, increasing proportions of all borrowed funds are lent to acquire financial assets with a view to making returns through capital gain. (Capital gains’ taxes are rarely sufficient to offset this reality; the main driving force pushing money into speculation is reduced lending to the real economy.) This truth is clearly evident by a cursory inquiry into the behaviour of house prices during periods of rising real interest rates.

In addition to rising interest rates ‘inadvertently’ stimulating financialised markets, the countries which intervene to raise their interest rates the most find that their exchange rates increase, as foreign money increasingly treats domestic money as a speculative asset. While this currency appreciation may dampen inflation in these countries – while exacerbating inflation pressures in the countries with falling exchange rates – it also does much harm to the export industries of these countries. Export industries suffer the double whammy of higher borrowing costs and an appreciating exchange rate. Indeed, the aggressive raising of interest rates to engineer an appreciating exchange rate has all the entitlement hallmarks of a Ponzi scheme. (Just look at New Zealand in years such as 1987, 1995-97, and 2004-08. If you don’t believe me, look at Iceland in the years before 2008.)

We should note that if rising interest rates make any difference at all to the global rate of inflation, they indeed exacerbate rather than diminish inflation. The only proviso to this is that rising global interest rates also create global economic crises, such as 1929-31, 1979-82, 1989-93, 2000-01, 2005-08, and 2010-12. While rising global interest rates are inflationary – they raise business costs, including higher required rates of profit – global recessions are clearly deflationary. Higher interest rates only reduce inflation by creating recessions, an even worse problem.

Basic Principle

Consumption entitlements should be distributed as human rights, and not as greed premiums. They should be paid as we go, and not divvied out from greed funds. As it is, most entitlements are of the greedy, by the greedy, for the greedy. Inasmuch as we are incentivised to contribute to government-sponsored greed funds, most of us are a little bit greedy. We live in a greedocracy, not an economic democracy. A true democracy distributes public equity dividends – as the economy goes – as a human right.

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