Bankers Know Little and Care Less
We were assured last week by the Deputy-Governor of the Reserve Bank, Grant Spencer, that New Zealand exporters had “adapted to” the overvalued dollar which, as interest rates climb, will go on rising.
So that’s all right then. Sadly, though, complacent and ill-informed statements like this do nothing to alter the grim reality; the current exchange rate – to say nothing of hikes in the dollar’s value yet to come – is doing, has done and will do great damage to our economy.
Exporters – or at least some of them, if they are lucky – have “adapted to” this circumstance by merely surviving. They have done so either by maintaining their prices in NZ dollar terms, at the risk of foregoing market share because their prices are thereby less competitive, or they have reduced prices in NZ dollar terms, thereby cutting profits and reducing the ability to stay in the market. In either case, this is not the path to successful exporting.
Exporting successfully is an expensive business. Unless margins are good enough to make possible all the spending needed to cover all the additional costs, such as freight and commissions, to develop the overseas market through promotion and after-sales service, and to provide the re-investment needed for product development so as to keep pace with foreign competition, it is not worth the effort. No wonder so many of our potential exporters either don’t try or give up quickly.
Even our most successful exporters pay a price for the dollar’s overvaluation – just ask our dairy farmers. Export profits are by definition lower than they would be if the dollar was at a more competitive level; even our best firms are therefore less able in the long run to keep pace with foreign competitors who don’t have to face the same currency head wind – and that’s to say nothing of those who are struggling at the margin.
And it is not only exporters who suffer. Everyone who looks for customers in the traded goods sector, whether at home or overseas, is at a price disadvantage by comparison with goods made by foreign competitors. New Zealand producers who have never thought of exporting will still be on the back foot because imported goods will be able to undercut them on price in their own home market.
Nor is it the case that the deleterious effects of overvaluation are limited to the traded goods sector. The problems and reduced performance of that sector mean that the whole economy suffers; effective demand for prospective investors is reduced across the economy, profits are lower than they should be, unemployment is higher, investment is discouraged, and the trade balance is weakened and thereby acts as a constraint on growth.
In that more stagnant economy, productivity growth and innovation are held back, and we become more and more dependent on the increasingly narrow sector able to keep its head above water in international terms. In order to maintain the living standards we insist we are entitled to, we find ourselves not only using our overvalued dollars to buy imported consumer goods at the expense of domestic production but we then try to cover the cost by selling off our assets to foreign buyers and borrowing more from foreign pedlars of short-term “hot money” who demand an interest rate premium as their reward.
At the same time, we prepare to enjoy the consumer and import boom that accompanies the huge volume of bank-created credit that is fuelling the rise in house prices in Auckland in particular; as first-time buyers are shut out by those rising prices, those who already own their houses respond to the growing value of their equity by feeling better off and therefore spending more.
As a result of that unsustainable consumer frenzy, the Reserve Bank then takes fright and – focusing solely on its single remit of controlling inflation – finds another reason for raising interest rates. And it is of course the prospect and reality of high interest rates that provokes the overvaluation of our dollar in the first place.
Every step in this vicious circle is foreseeable, yet the Reserve Bank contents itself by advising the productive sector to “adapt” – the equivalent of a doctor telling a patient suffering a wasting illness caused by drinking polluted water that he should go on drinking but “adapt to” the consequences.
The tragedy is that the longer we fail to face the reality of our situation, the faster becomes the trip round the vicious circle and the deeper becomes the downside. Each time we touch the bottom of the orbit, the less chance we have of hauling ourselves back up.
What we need now is some new thinking – not another circuit of a policy proven to fail. The Bank of England, no less, showed last week a willingness to face facts when it published a paper by three of its economists acknowledging for the first time that virtually all the money in our economy is created by bank lending – and that raises the interesting question of what that lending should be for.
Our own Reserve Bank, however, evidently remains stuck in a rut of its own creating.
Bryan Gould
31 March 2014
The Bank of England Owns Up At Last
For those of us who have argued for a long time that orthodox monetary policy is fundamentally misconceived, a significant milestone was achieved this week. In an important paper published in the Bank of England Quarterly Bulletin*, three Bank of England economists have acknowledged that the overwhelmingly greatest proportion of money in the economy is created by the banks out of nothing.
This finding comes as no surprise to that growing number of economists and others who have recognised, as a consequence of simple observation, that this is the case. But it will no doubt be hotly denied, in the face of all common sense and evidence, by those (including bankers themselves) who, for reasons of self-interest or sheer ignorance, continue to adhere to the classical view that banks are simply intermediaries between lenders and borrowers.
The great British public is itself the victim of the confusion and obfuscation that has surrounded this issue for generations. Most people, if asked, will tell you that what the banks do is to lend out to borrowers the money that is deposited with them by savers. On this analysis, there is nothing particularly special about banks; they simply charge for the service they provide in bringing savers and borrowers together.
The truth, however, now conceded by the central bank, is very different. The banks enjoy a most spectacular and surprising monopoly power. They alone are able to create new money – vast quantities of it – by the stroke of a pen or, in modern terms, by pushing a key on a computer keyboard.
When a bank lends you money, it simply makes a book entry that credits you with an agreed sum; that sum represents nothing but the bank’s willingness to lend. The debt you thereby owe the bank does not represent in any sense money that was actually deposited with the bank or the capital held by the bank. Nevertheless, when it arrives in your account, and you use it to spend or invest, the overall money supply is increased by that amount.
The only attempt to regulate the volume of new money created by the banks comes through raising or lowering interest rates – a power exercised not by government but sub-contracted to – you’ve guessed it – another bank.
This means that, in practice, the only limit on bank lending is their willingness to lend to applicant borrowers at whatever the current rate of interest may be. The size of the market which provides the huge profits enjoyed by the banks is, in other words, decided by the banks themselves and their assessment of, and willingness to accept, the degree of risk involved.
There will, in the search for the ever higher profits to be made from lending more and more of the money which they themselves create, always be the temptation to lend more than is prudent in their own interests or desirable in the wider interest – and that is how the global financial crisis came about.
The astonishing feature of this monopoly power enjoyed by private companies seeking profits for their shareholders is that their decisions as to how much and for what purpose money should be created, made with virtually no external control or influence to restrain them, constitute by far the single greatest (and potentially distortional) influence on our economy.
The Bank of England paper has now laid all of this out for public inspection. The authors do not quite have the required courage of their convictions, since they attempt to downplay the significance of their conclusions by using the operations of a single bank to illustrate the process of credit creation, and thereby fail to register the immense scale, when looking at the banking system as a whole, of what they are describing. Even so, the policy implications of what they say are immense.
Our macro-economic policy at present is virtually limited to attempting to control the money supply as a means of regulating inflation. But since the volume of money is a function of bank lending and reflects nothing more than the banks’ search for profits at whatever the current interest rate may be, it follows that the whole thrust of current policy is entirely misplaced.
The banks, in deciding for themselves how much, to whom and for what purpose they will lend, will always give priority to lending for house purchase since it requires by far the least effort, and is the most secure and profitable form of lending. Can we be surprised that, as a result, those wishing to borrow for business investment are at the tail end of the queue while house prices – inflated by the volume of new money going into the housing market – go on rising inexorably?
It is bank-created credit that provides the major stimulus to asset inflation in the housing market, with all of its deleterious economic and social costs, while at the same time diverting essential investment capital away from where it is really needed – in the productive sector of the economy. If we wish to restrain inflation, why do we not target the most obvious cause, rather than burden the whole economy with deflationary interest rate hikes? And if we want a stronger real economy, why allow the banks the exclusive power to decide that the new money should go to housing rather than productive investment?
Our current monetary policy is based, in other words, on a complete misunderstanding of the role of money and its impact on economic activity. Our economy is awash with money, but it is neither the economically neutral phenomenon – interesting only because of its impact on inflation – that classical theory describes, nor does it provide the stimulus to new productive investment in the real economy that it could and should do.
Monetary policy need not be just a rather ineffectual tool for controlling inflation. It has the capacity instead to be a major stimulant and facilitator of real productive investment if we understand and use it properly. The banks’ monopoly of the power to create money prevents us from doing just that.
*Money Creation in the Modern Economy, by Michael McLeay, Amar Radla and Ryland Thomas.
Bryan Gould
22 March 2014
This article was published in the London Progressive Journal on 25 March 2014.
Why Austerity Doesn’t Work
I was honoured to be asked last year to deliver the keynote speech to the Public Services Association’s annual conference which was also the occasion of its 100th anniversary. I have recently discovered that a video recording of that speech is available on YouTube; it can be seen here:
The theme of my speech was the failure of austerity as a response to recession.
Why the Poor Can’t Put Food on the Table
The OECD revelation last week that 17.2% of New Zealanders found it difficult to afford food is a shocking and shameful statistic for any country that claims to be prosperous and developed. It shows how far we have come from the time when it could be said that “here, there is enough for everyone.”
Among all the issues demanding attention from government, this is surely the one that must claim pride of place – that is assuming that pride is an appropriate sentiment concerning such an indictment.
How did we come to this? How does a country that aims to feed the world fail to keep its own citizens well-fed?
The answer is that such deprivation has occurred for two main reasons; one turns on the distribution of wealth in our society, while the other reflects a long-term failure to make the most of our economic opportunities.
The sad truth is that, as we have become wealthier, the greatest proportion of that increased wealth has gone to the better-off; the disadvantaged have stood still – and are now, therefore, comparatively worse off. For the poor, unemployment, low wages, inadequate social benefits, poor health and housing, higher rents and power prices, have all taken their toll.
There has been a different story for the better-off. A renewed housing inflation is in effect a giant mechanism for increasing the wealth of home-owners and penalising those who must rent because they can’t afford to buy. The share of profits in our economy has continued to rise while the share for wages has fallen. Top salaries have risen fast while wages for ordinary workers have been restrained by high levels of unemployment and the failure to pay a living wage.
The untaxed capital gains from property have increased purchasing power for the well-off who have also benefited from tax changes, away from direct taxation (where top rates have in any case fallen) and towards indirect taxation which hits the poor hardest.
It is not the case, in other words, that we have become poorer as a society – merely that the well-off have taken the lion’s share of the economic growth of the past 30 year.
But the second factor has also played its part. Despite all the euphoria occasioned by the long-delayed recovery from recession, the fact is that we have failed over a similarly long period of several decades to do as well as we should with the resources we have – and while the well-off can protect themselves from such failures, the poor bear the brunt.
There can be no better illustration of our long-term failure than another piece of economic news published last week. We were invited to celebrate the fact that record commodity prices, particularly in dairy products, had allowed us to reduce our perennial trade deficit to smaller proportions.
What was remarkable about this was that literally no one bothered to ask why it is that we always run such a deficit. It may sometimes be smaller and is often bigger, but it is always there. It is the best possible evidence that, despite the constant claims of successive governments that they are prudent managers of our affairs, we have simply failed – over a very long period – to pay our way.
We cannot, in other words, sell enough to the rest of the world to pay for the living standards that we – or at least some of us – insist on enjoying. The consequences of this failure are far-reaching.
The gap between what we can sell and what we insist on buying has to be financed in one way or another; the rest of the world will not allow us to enjoy something for nothing.
We must either borrow to fill the gap, or we must sell assets. Our solution? Do both.
But the problem with both solutions is that they carry with them the certainty that they will make matters worse. If we want to borrow, that means higher interest rates, and those interest payments must be paid to foreign lenders. That outflow adds to our current account deficit.
So, we sell assets as well. The problem then is that a greater volume of profit is made from the larger range of assets owned by foreign owners, and those profits must again be repatriated across the exchanges. It is no accident that, at the same time as dairy prices reduced our current account deficit, it was being widened again by the sheer volume of profits being repatriated overseas.
What are we doing about this? Nothing – we simply accept it as a fact of life and continue merrily on our rake’s progress. As the economy resumes growth, we don’t care a jot that the huge increase in bank credit-creation – something that the Bank of England, no less, has at last conceded accounts for virtually all the money and monetary growth in a developed economy* – goes to stimulate housing inflation rather than the increased investment in productive capacity that we desperately need.
It is truly said that “those whom the gods wish to destroy they first make mad.”
Bryan Gould.
21 March 2014
*Money Creation in the Modern Economy” Bank of England Quarterly Bulletin, 2014 Q1
The Thin End of the Corruption Wedge
As an MP in Britain, I offered a free weekly advice service to constituents who needed help. I was occasionally embarrassed by a constituent who seemed to think that any request for help should be accompanied by a gift of some sort. The offerings were usually small in value, and were almost invariably made by a member of the immigrant community. I would gently explain that, while such gifts might be acceptable – even required – in some societies, they would breach the conventions of public service in Britain.
As far as I know, these anti-corruption conventions still apply in Britain and certainly do in New Zealand; indeed, our country regularly comes at or near the top of international surveys showing that we are remarkably corruption-free. So what are we to make of the growing evidence that the culture here is changing and that there is an insidious growth in the belief that politics and business are natural bedfellows?
The Justice Minister’s travails are just the latest piece of evidence. Her failure to recognise a conflict of interest when she went out of her way on a recent ministerial visit to China to visit a company of which her husband was a director shows how far we have relapsed from a proper recognition of the dangers of corruption. Judith Collins’ excuse – that she simply had not thought about the possibility of a conflict of interest – shows how far our standards have slipped.
The revelation that other Chinese businessmen have been able to lobby the government for favours, and have then shown their gratitude for those favours by giving large sums to the National party, demonstrates that a serious line has been breached; in issues involving a conflict of interest, it is the perception that matters.
No one who does business in the international context will be unaware of the fact that different standards apply elsewhere; the temptation – and sometimes, it may seem, the necessity – to pay bribes when expected in order to secure desired outcomes is no doubt ever-present. The slope can be slippery. My constituents in Britain who offered me bottles of whiskey no doubt thought they were acting in a perfectly normal and acceptable fashion; for them, securing my goodwill was the necessary prelude to obtaining my help.
We would be foolish to think that the lower standards in public life that are commonplace in other parts of the globe could not establish themselves here. It is perhaps not entirely an accident that the recent causes for concern have involved Chinese business people. Like many other countries, China – as a country and as a culture – has a view of the law that is quite different from our own. Rules are not so much to be complied with, but rather to be circumvented wherever possible.
With the growing involvement in our economy of Chinese business, we are becoming increasingly familiar with the tendency to disregard the rules – whether they concern minimum wage rates or planning requirements or anything else. One of the most obvious and effective ways of getting round the rules is to secure the support and help of those who make them; and if that support can be made more likely by rewarding the rule-makers with acts of generosity, then who can be surprised?
The danger is, in other words, that along with the undoubted benefits we gain from Chinese investment and business acumen, we may also be invited – almost imperceptibly – to accept somewhat different standards governing the relationship between our rule-makers and the business interests that are increasingly important to our economy.
That danger can be averted and minimised only if the other party to these transactions – the government – is absolutely clear about the standards of ethical behaviour required of those who do business in this country – and it is here that the recent revelations assume a much greater importance.
The impression already given to overseas business interests – and confirmed by many recent instances – is that the way to get things done in this country is to get the ear of the Prime Minister or of his close colleagues and advisers. In that way, private deals can be struck, rules can be changed or bent, tax benefits can be conferred, ministerial interventions to grant citizenship can be arranged – and if, at the end of the day, a generous donation is given to a political party by way of thanks and recognition, then who can complain?
In view of the government’s apparent belief that business advantage trumps all other considerations, and that their role is to serve business interests, we must expect many others to follow in the footsteps of Sky City and Warner Brothers and to find ways of securing government help. Who can blame them if they also conclude that – as is commonplace elsewhere – a discreet donation would not come amiss?
Unless our government is much clearer than it currently is, watch for the New Zealand ranking in the anti-corruption stakes to plummet – and we would have lost one of our most prized virtues.
Bryan Gould
15 March 2014
This article was published in the NZ Herald on 18 March.