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.

Comments (12)

by James Green on November 08, 2018
James Green

I don't think capitalism is the base issue driving boom-bust cycles, rather it is the private control of the money supply that is the root cause. If the Reserve Bank directly controlled the quantity of money the impact of financial crashes would be great reduced, if not eliminated.

The US, China, and India are the only three countries big enough to be able to get away with not supporting free-trade. Thankfully at least China is at the moment, but we shouldn't count on any of these three to maintain open markets forever. Hopefully India opens up soon to replace the US's backsliding.

Reforming the WTO without the US is what I'd like to see, I don't see the US rehabilitating itself any time soon, even after Trump is gone.

by KJT on November 09, 2018

Amazing that anyone still supports, so called, "free trade" , after the manifest harm, and costs in unemployment, negative trade balances and hemorrhaging finances that have been the result. Our idealogical, and self immoliating, unilateral abandonment of protections and rules, has not caused others to voluntarily follow suit. Funny that.

China is booming, and to some extent pulling us along in their coat tails, with policies protecting their own industries. And the Keynesian policies and exchange controls we abandoned.

As Ha Joon Chang states, "all succesful economies protect their own balance of payments, and domestic industries.(We have our own proof with the success of, subsidised, and mollycoddled, agriculture) Now they are determined to prevent others from doing the same". "Every country thinks they will win the trade wars by out exporting their nieghbours". Only fools, you would think, expect countries like China or USA will let us win long term. In China locals know they are re-fighting the boxer wars, with trade. This time the West will lose, because no one in the West can think beyound the next quarterly report.

by Pat on November 09, 2018

6 billion p.a. in oil imports would be a good place to start.

by Brian Easton on November 11, 2018
Brian Easton

James Green: I’m afraid the US has a veto in the WTO. That is why countries are looking for a framework outside it which provides a new disputes resolution procedure.

KJT :The issue arises as soon as we want to trade. Since we cannot produce all we want nor consume those products in export surplus we do not have much choice. Once you start trading with another nation you are going to have to make compromises. The things you object to are a part of those compromises.
Instructively, and painfully, foodstuffs have long been outside the standard free trade framework, and New Zealand has been screwed as a result.

Pat: Yes, self-supply has its attractions to reduce vulnerability. Liquid fuels are an obvious area but it will be difficult to reduce our dependency quickly. Personally, I favour making (restrained) interventions to reduce our use of imported oil. Not all economists agree with me; the profession is scarred by the memory of trying to do so in the 1970s when we went down the ‘Think Big’ path with disastrous consequences from the subsided interventions.

by Pat on November 11, 2018

I have grown up with the descriptor "Think Big" as a denigration but Im increasingly of the opinion that it was a victim of timing, and as we know timing is everything. The 'horrendous debt' that resulted was lower than our current (considered low, perhaps excessively so) debt to GDP ratio and curiously many of the projects are precisely what have been identified in the pathway to carbon neutrality by 2050. The killer was inflation and although that risk remains it is not current as it was then...and the alternative energy technology has already been largely developed and consequently dosnt carry the development risks/costs.

I wonder how NZs economy would now be positioned if the original vision of Think Big had been presented by a more likeable proponent and we had had 40 years of its development with all the technical and employment opportunities it may have presented.....I suspect that the Treasury foil, the MOW would likely still be with us and all the expertise that was lost with its demise.

Hindsight is a wonderful thing.

by James Green on November 11, 2018
James Green

The Organisation of American States managed to solve their USA problem, they simply formed a new organisation, CELAC, and didn't allow the US to join it.

by KJT on November 12, 2018

Pat. Muldoon was not to know that the USA was shortly to go to war to bring oil prices down. If they had stayed high, he would be a hero, today.

One of them, Marsden point, the oil companies made enough money on it, a few years after privitisation, to more than cover the debt. Unfortunately after Labours ill judged fire sale, we were left with the debt. The oil companies got the profits.


by KJT on November 12, 2018

Brian. New Zealands idealogical abandonment of almost all trade protections, left us with nothing to bargain with for agriculture access.

BTW. The failure to diversify our exports from agriculture is a major crime of successive Governments. Muldoons killing our nascent boat building industry, being just one example.

Sacrificing other industry, and our balance of payments, on the alter of dairy, seems to be a constant theme. I wonder if farming, now, even covers the finance costs going to the Ozzie banks? In other words the costs of dairy, if you add all the direct and indirect subsidies, are likely exceeding its export income.

by Brian Easton on November 14, 2018
Brian Easton

Pat: I was one of the earliest critics of ‘Thank Big and I do not resile from that critique. However almost everyone failed to recognise that imbalance in the risk. It was classic National Socialism, the private sector took the profits, the public sector the losses. (The exception, by the way, was a Canadian economist visiting Otago University. I never met him, and we did not pick up his warning.)

Fair enough, James. We can expect a proliferation of international organisations in which the US is not involved.

I agree KJT. At the time I said our abandoning protection was like taking all you clothes off at a picnic with the expectation that everyone else would follow (birthday) suit. They took one look and put on an extra jersey.

by Pat on November 14, 2018

National Socailist is a somewhat loaded term Brian and im not sure that the it equates with private sector profit and public sector loss , indeed that could be more accurately attributed to the following administration that sold those state assets at firesale prices...for all their perceived faults the "Think Big" were at least publically owned albeit until the advent of Douglas and many of them had a export goal.

What and who was the exceptional Canadian?

by Brian Easton on November 19, 2018
Brian Easton

Apologies Pat did not mean to offend. its' an old joke from my student days. Focus oon its serious message. 

The underlying problem was that by the time the major projects came online, oil prices had plunged to levels below which no one expected. The Muldoon Government had guaranteed the private investors' return so the loss was borne by the public in various ways. (For instance, the oil refinery extension was funded by New Zealanders paying a high price of petrol.) The fire sale prices you cite were a consequence of the market return on the assets given the low price of oil. (The NZ Steel story details are a little different but the same thing happened.) 

The Canadian economist at the University of Otago, who we did not listen to properly, was Robert Mansell currently at the University of Calgary. 





by Pat on November 20, 2018

No offence taken. The old joke was lost on me though on reflection is is the underlying implication, something that our current politicians could be paying more heed to.

The unforeseen oil price plunge may well have caused problems,as did the delays and cost overrruns at Marsden but the Refinery Levy was in effect no different to the existing and current excise which ostensibly funds (partially) our transport infrastructure. You may be surprised to note (or not) the relationship with fuel prices to CPI post the expansion in the attached

My hunt for R Mansell's analysis continues

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