What If We Are On Our Own?

How prepared are we for the next international economic or financial crisis?

In order to maintain international liquidity during the Global Financial Crisis, the US Federal Reserve and other central banks arranged $US580b of ‘currency swaps’ in which for a limited period they exchanged US dollars for the local currencies. I do not know the extent to which the swaps were used but they gave international markets confidence (and reduced anxieties among central bankers).

The Reserve Bank of New Zealand was one of the 14 central banks favoured by the Fed – the smallest one. Phew! But can we rely on others when the next international crisis happens?

My gloomy answer is no, a conclusion I reached after reading Adam Tooze’s magisterial Crashed: How a Decade of Financial Crises Changed the World. His account of the Greek financial crisis is instructive.

Time and again other European countries deferred to domestic pressures to the cost of Greece. I do not exempt earlier Greek governments from having made some foolish decisions but far too much of the burden of adjustment was carried by ordinary Greek people, while the private banks which advanced the loans to fund them and the Greek elite which benefited got off lightly. (As an aside a related problem is evolving in Italy; we watch the EU response with interest.)

Could the same happen to us, during the next financial crisis? If the Europeans were unwilling to provide support for a larger, nearer country, tied in so closely with their aspirations, the answer is surely that we cannot be certain about whether the world would support us.

Yes, there will be another economic or financial crisis. They are integral to capitalist development – the downside of the upside. As the world economy moves into a new phase dominated by international high-spinning finance, such crises may occur more often.

What should we do about it? Clearly we need to continue with the good government management we were practising in 2008: prudent management, transparent accounts and low debt enabled the Fed to include us on its list. Is there more? Here are some possibilities.

We need to continue being a good citizen of the international world in as many areas as we can. When we are in need, we want to avoid the reaction of ‘Where’s New Zealand?’ to be answered ‘On the map on the wall in the bottom right corner behind the filing cabinet’.

We can probably do more to increase our financial security. A decade ago the Reserve Bank’s foreign currency reserves were increased. Of course they were not enough to deal with the GFC but they gave breathing space. Given that the economy has expanded and so have the international risks, it seems sensible to increase the RBNZ’s reserves.

The under-capitalisation of Kiwibank is a concern. No, you need not worry about your deposits, for there is an implicit government guarantee. But we do not need officials struggling with the peculiarities of Kiwibank during the next financial crisis. (Increasing the bank’s capital base would also put more money into loans for housing and small business.)

More generally, there is a strong case for requiring all our trading banks to have larger capital reserves, the private cushion in a financial crisis.

(I was dismayed to learn from the recent report published by the Financial Markets Authority and the Reserve Bank that trading bank’s incentives for those directly servicing their customers do not align well with the public’s concerns. Aside from morality, such misalignments contributed to the American housing and our finance company busts. As best as I can judge, the current misalignments will not cause a crisis, but it is disturbing that our banks do not seem to understand their dangers.)

An almost fatal defect which became apparent in the GFC was an over-reliance of banks on the wholesale money market. The classic example was the British bank, Northern Rock, which had expanded its loans well beyond what its depositors could provide (that is what is meant by the ‘retail market’). The bank made up the difference by borrowing from other financial sources on the more volatile wholesale market. When those opportunities dried up, Northern Rock shattered.

Our trading banks fund about a third of their lending offshore – in effect from wholesale markets. Measures taken since 2008 have reduced this exposure but we still need to reduce further trading bank borrowing offshore. That involves increasing household savings while public sector savings also have a role to play. Reducing the speculative boil in the housing market will help.

(As an aside, foreign direct investment is not a problem in this context. You cannot pull out of a factory you own overnight in the way that you can from a financial contract.)

It is important not to trap ourselves into a neoliberal frame which reduces our ability to manoeuvre when a more pragmatic approach is needed. Austerity has been too prevalent in Europe (in part because fiscal positions were not robust there.) Fortunately for them and us, the US was more pragmatic – even if some ideologues in its Congress were reluctant – while a less inhibited China pursued a huge public works program on the best Keynesian principles (which has done a lot to underpin subsequent Chinese economic growth). Fortunately, in part because of the stewardship of the Clark-Cullen Government, the Key-English Government was not trapped into austerity policies, even if it made errors which have had long-term consequences.

Are we over-dependent on international trade? Increased autarchy is not really an option, given our demand for things we cannot possibly produce here. But we should not go out of our way to supply offshore at the expense of potentially viable New Zealand industries.

We should aim to diversify – currently we are over-dependent on the East Asian economies centred on China. That means free trade agreements. We have a number in various stages of pending including with the Gulf States and some Latin American countries. My priorities would be the EU (sympathetic) and India (reluctant). I do not think there is much point in putting effort into the US in its current curmudgeonly mood.

Ideally, we should also diversify our exports away from commodities with their volatile prices. We have been talking about this for at least 80 years with not a lot of success

A major concern is the disputes resolution procedures of the WTO. The US is being a proper pain undermining them to the point they soon may not function. The rest of the world may set up an alternative process from which the US will exclude itself. Free Trade Agreements usually include dispute procedures. Following the implementation of the TTP11 ours cover about 64 percent of our trade. The big gaps are the EU and the US (sigh).

New Zealand is not generally in the middle of supply chains so we may not get into the muddles that Brexiting Britain is. (Is there a developing muddle in East Asia as a consequnce of the US-China trade war?). Even so, we need to ensure that we have adequate stocks or alternative sources. For instance, Britain is dependent upon the Continent for its diabetic medicines. If Brexit ends up with the (frightening) ‘no deal’ option it may have difficulties maintaining its insulin and other life-preserving supplies.

There is no need to panic. The next crisis will involve unknown unknowns. It is difficult to plan for them, but it makes sense to review what we can do about the known unknowns in a prudent and commonsense way.