“To be, or not to be, that is the question,

Whether ’tis nobler in the mind to suffer

The slings and arrows of outrageous fortune,

Or to take arms against a sea of troubles,

And by opposing end them.”  Hamlet, Act III, Scene 1.

It seems, after nearly 30 years of deregulated markets, that we face a sea of troubles ourselves. An extreme global debt deleveraging is upon us, the numbers too outrageous to even consider. Not only have we consumed beyond our means, we have mortgaged our future. Whereas once credit was difficult to come by and banks conservative in their lending (can you pay this back?), the brave new world brought us access to unlimited treasures, all paid for on a credit system, which had limited restraint.

As financial models became more complex and debt could be packaged, securitised and sold off, all sense of restraint was lost. Who owed whom was lost in a parallel universe of metaphor: swap, hedge, collateral, obligation, repurchase. Repaying principal and interest, in the old fashioned sense was put to one side. Can you afford the interest? Don’t worry about the principal, that will pay itself off as the price rises! Can’t afford the interest? Don’t worry, we’ll lend that to you as well, or have a holiday (from interest that is….keeps charging but pay it some other time). Tick, tock, tick, tock.

Maybe Hamlet wasn’t as crazy as he sounded.

As I explained in a previous post on the Euro, deleveraging debt is a painful process. As debts are written off, the money supply contracts, causing a contraction in the general economy. This creates a spiral where demand for new credit drops and this causes further losses to business, resulting in more job losses and so on. Traditionally, this has been dealt with by the lowering of interest rates, which hopefully stimulate demand for credit and reduce interest burdens. Sadly, this doesn’t work until the overhanging debt has been cleared out, by which time unemployment has risen and economic output has contracted to severe levels.

The road to austerity is a self-fulfilling process. Clearing the debt mountain will take many years and, perhaps, like Japan, it could be a decade or more. During that time people will be unemployed, machines will sit idle and resources will be untouched. In the 1930s governments stood back, waiting for the miracle of the market. None came. That is not a road we want to travel down.

As the shadow banking system starts to fall apart, it is time to plan and look forward to building a stable and local supply of money to see us through the hard times. Continuing to rely on overseas capital and ever increasing borrowing is a road to ruin. Our gross debt will hit $90 billion  by 2016, according to Treasury forecasts. The government talks of returning to surplus by 2015 but that is very optimistic. Even then we will still carry this debt for many years to come.

So is printing new money and spending it directly into the economy a better idea? I talked about this in a recent interview with Kim Hill and Radio NZ National, which you can catch here.

RadioNZ National Kim Hill interview

I have had an incredible amount of positive feedback since the interview and, interestingly, from a very wide range of people. There were a few comments about “funny money”, including a little pop from Nevil Gibson at the NBR. My answer to that is if you think this is funny money, try explaining the nearly $4 trillion that’s been used to buy debt off US banks! The feedback has confirmed the following: that there needs to be a clearer explanation on how the money creation process actually works (even though the RB has published on this here), that inflation needs to be better understood and that people are extremely concerned about the way the financial system is structured. We will be working on producing a simpler explanation to those issues.

In the meantime, around the world, there is a lot of new work being undertaken around the quantitative easing process and how that is not really working. Sushil Wadhwani (Goldman Sachs and MPC member in the UK) and economist (and former colleague of mine) Michael Dicks have looked at more direct interventions into the economy, noting that QE is a very roundabout way of trying to stimulate an economy. They look at directing lending to companies from the central bank and, more interestingly, at simply giving households a voucher to spend. You can read the brief paper here. Their proposals are in the right direction but do not go far enough. Nouriel Roubini recently wrote that direct spending on new infrastructure in the US would be much more useful than simply buying toxic bonds off failing banks.

What’s clear is that more and more economists and policy analysts are realising that QE is a sop to the banks, boosting their balance sheets and stock prices, at the expense of the taxpayer. Clearly this is a misallocation (and perhaps misappropriation) of taxpayer funds. Furthermore, even with trillions of $ of QE, there has been no inflationary effects at all. This is important to note when considering the direct injection of new money, as we have proposed, for the Christchurch rebuild.

As I noted in this recent piece for ChangeNZ, as long as there is surplus labour and resources, there will be no inflationary effects from new money. This has been confirmed from business sources, who note the economy is limping along at between 33-50% of capacity. So there is little concern over the direct effects of the new money in raising prices. The indirect effects through the banking system are also likely to be minimal, given a very low demand for credit across the economy. Indeed, with debt deleveraging in full swing, we are likely to see further reductions in debt, offsetting any new potential demand for credit. Still, credit numbers will need to be watched carefully and, at the same time, it’s important to note that the amount we are suggesting is only $5 billion. Ultimately the goal is a strong and locally managed financial system with price stability. That is something we have not had, despite the continuing myth of a central bank induced low inflationary environment. The time is right to consider an alternative way forward.

Perhaps we should leave the final words to Hamlet, as we ponder the road ahead:

“The undiscovered country, from whose bourn

No traveller returns, puzzles the will,

And makes us rather bear those ills we have,

Than fly to others that we know not of?

Thus conscience does make cowards of us all,

And thus the native hue of resolution

Is sicklied o’er, with the pale cast of thought,

And enterprises of great pitch and moment

With this regard their currents turn awry,

And lose the name of action..…”

 

 

 

 

 

 

 

Slowly but surely mainstream commentators, economists and policy analysts are all starting to realise that exponential debt is the core of our current economic malaise. This is great news to those of us who have been banging on about this for many years.

But still there is confusion around what to do about it. “Saving” has become the new buzzword, sitting squarely alongside “austerity”, as private individuals are urged to save more and governments are urged to spend less. That sounds like a sensible way forward. But watch the economy tank when that happens. Why?

Simply because when debt is paid down (and no corresponding new loans made) the money supply contracts as the debt is destroyed. The debt never existed as “money” in the sense of notes and coin but as an asset and liability for the bank. The interest is collected and the debt destroyed, leaving the profit for the bank. A monetary system based on debt will always lead to booms and busts as the interest charged overwhelms the ability of the productive sector to pay it. Ironically the system always needs infusions of new debt to stay afloat as the amount of money in the system declines.

Of course, when companies start to lay off workers (their first cost saving option) this creates uncertainty and an unwillingness for new borrowing to take place. This creates a self-reinforcing cycle which in some cases leads to recessions and occasionally to depressions. So what’s the best way out of this?

Austerity? No. Austerity will keep some investors happy but generally this will simply lead to slower growth and higher unemployment. But austerity is also a fact of life. When you have borrowed money and spent it, you know one day you have to pay it back. If you haven’t saved for that day then you will have to forego consumption for repayment. If you are in that position, which many governments are, you have, in fact, over consumed your income and eaten into your future. That’s not a pleasant space to be.

Is there an alternative?

Yes there is. I’d like to propose what i term “Monetary Dialysis”. This process seeks to replace debt money with real money (let’s assume for the moment that fiat money is real). The difference between debt money and real money is two fold: firstly, real money is permanent and once it enters the banking system it remains there; secondly, real money enters the banking system without interest, with no charge for its creation.

This two key differences will lead to new outcomes: a more stable money base and a less inflationary one.

How will this process take place?

The government, instead of issuing new bonds to raise money (primarily from overseas investors), will directly spend the money into the economy. In other words public spending will be funded by new money, not new debt. Immediately there will be a saving in interest costs, with current funding costing 5-6% per annum. The current annual bill (previous to the recent enlarged debt issuance) has been running at close to $4billion a year which is a hefty sum (I am only talking government borrowing here).

I use the term dialysis as a representation of a monetary system that is malfunctioning, not just here but globally. I propose a slow transfusion with the goal to end government borrowing completely by 2017.

Where’s the catch? Ok clearly there needs to be some balancing on the other side of the equation. As well as issuing new money instead of new debt, another part of the monetary dialysis approach is to create stronger limits on the abilities of banks to increase the money supply through the issuance of new debt. This can be done in many ways, using a variety of macro prudential tools, whether it’s increasing capital requirements or other similar actions.

Monetary Dialysis is the first step to cleaning up our monetary system. It will lead to a more stable money supply, lower inflation and clear savings in interest costs. The reduction in public debt will be highly beneficial for the economy and the country as a whole. The cost savings from this clean up will be in the order of $20billion over 6 years.

Now that’s something to really think about.

I was at University when the quake struck, eating my lunch and reading a paper on “Native Rights”. I didn’t hang about and immediately dived under the table as I didn’t like the look of the walls and ceiling lights flailing about like paper decorations. When the first shake had finished I headed outside quickly and sat down whilst the two big after shocks rocked the surrounding buildings. The University seemed reasonably unscathed……nothing like the CBD which is 5 kms to the East.

The damage of the Feb 22nd 6.3 shake is way worse than the Sep 4th 7.1 quake. No doubt this is due to the depth and the proximity of the epicenter. But this post is not about the earthquake, it’s about the economic impact and the re-building to come.

The cost of this disaster is only guessable at the moment. Numbers from $10 to 16bln have been thrown out but it could be anything. There is no doubt that this is a complete rebuild of the city’s infrastructure and central business district. Added to that is the viability of the eastern suburbs. They were affected badly and there will be questions over ground issues when it comes to re-building.

I want to go back to 1936 and the First Labour government which introduced low interest loans as part of a system of public finance to rebuild the country’s post-war economy. Think of it as New Zealand’s New Deal. The Reserve Bank governor can direct this at any time. This is certainly one possibility.

What I would like to see is fresh new money being injected directly into the economy by the government. The Treasury can action this at any time. The New Zealand economy has been struggling for a few years now since the GFC hit and deleveraging started. Business is struggling and cash is constantly tight. This latest quake will have finished off many business hanging by a thread.

I am proposing the Treasury create $5bln of new interest free money and credit it to the Government Earthquake Department for use in the rebuilding of public infrastructure. This is real money (not debt) and it will flow through into the economy thus giving it a boost as well as providing liquidity to the economy.

The money supply will increase by $5bln but I don’t believe there will be any inflationary risk. We are currently in a period of deflation and deleveraging with falling house prices and economic stagnation. NZ needs all the help it can get and there has never been a greater need nor a better time for this proposal.

It’s time for a New Deal. Please pass this on if you can.

2 years seems a long time but feels like yesterday. In that period the NZ$ fell from 0.82 to 0.49 and now is back trading just below 0.68. Wow…talk about currency whiplash.

So back then I suggested the RBNZ should think about selling as much NZ$ as they could. Why? Why go against prevailing market sentiment which is that intervention doesn’t really work and simply provides a target for the speculating hordes which incidentally account for 95% of the volume of daily trades.

That’s a fair sentiment when your currency is falling but when it’s rising? And when you have an eye popping foreign debt of almost 140% of GDP……that’s foreign debt not overall debt.

And yet the punters keep buying the NZ$. Perhaps they know something I don’t. Maybe 50 years worth of oil has been discovered in the Southern Basin. Who knows?

The point is that at some point that money has to be paid back and at the moment, due to the sneaky monster that is compound interest, we can’t even get close to reducing it.

But now is the time to strike.

Again I would like to suggest that the RBNZ starts selling NZ$. When you have a lot of something to sell it’s always best to do it when others are keen to buy. Now is that chance.

By selling NZ$ now and paying back, or at least holding for that same purpose, it will take the pressure off the very precarious dependency we have on overseas lenders.

This doesn’t eliminate the debt but simply transfers it to a domestic situation where it can be managed at lower rates and where there is no threat of having to suddenly repay.

How can the RBNZ do this? Again this is very simple. Print NZ$ and buy US$. There is no change to the actual money supply just how the debt is denominated.

Considering the implosion Iceland experienced and the unfolding disaster that is Ireland (surviving only due to its membership of the Euro), it makes complete sense just to get on with this now.

To allow foreign debt to be run at such a level is financial mismanagement of the highest level.

It also shows a willingness to be dictated to and dependent on overseas interests. This makes no sense at all when the country’s economy security is at stake.