submitted to NZ Herald on 21 July as "The Balance of Payments"
NZ must not go back to capital addiction
by Keith Rankin, published NZ Herald, 3 August 1998, p.A13
Gareth Morgan ("Why I blame coalition for balance of payments", NZ Herald, 21 July) puts the cart before the horse in blaming the present government for a quadrupling of New Zealand's balance of payments deficit from 1993/94 to 1996/97.
In saying "the fall in our dollar is imperfectly linked to the deterioration in our foreign balance", Dr Morgan gives the impression that the balance of payments problem was caused by the fall in New Zealand's currency from 1997, and not by its rise from 1994.
The technical name for what we generally call the "balance of payments deficit" is "the current account deficit of the balance of payments". This is important to note, because of equal importance to the current account is the "capital account", which is a measure of net foreign investment. By definition, the capital account balance is equal but opposite to the current account balance. Thus, if we have a large current account deficit then we must have a large capital account surplus.
The key to understanding New Zealand's present problem is the capital account surplus. Morgan's explanation for the large flows of capital into New Zealand is that we are a profligate nation. In this view, we choose to live beyond our national means by not saving enough. We go to foreign financiers begging them to let us use their clients' savings as means for us to live beyond our means.
Before 1984 we used to look with awe upon banks - at home and overseas - as some kind of paternalist social institution. If a bank manager granted us a mortgage, he was doing us a favour in return for a good savings record. We forgot that the lenders such as banks expected to profit from their largesse.
With respect to the world economy before 1984, whenever our export receipts were down, our politicians would go cap in hand to the stern parents overseas; to the world's financial markets. We were generally but not always successful at getting loans on very good terms - low interest, long duration, flexible repayment terms. We were well-behaved children, who could point to sober financial habits.
In the 1930s it was harder than in the 1970s. In 1939, Walter Nash sailed to motherland Britannia on a mission to get credit to tide us over a balance of payments crisis. Nash was turned away. We were humiliated. The war solved our problem; it guaranteed us high receipts for whatever foodstuffs we could send "home".
The world changed in 1984 and 1985. Banks openly solicit potential borrowers. And foreign moneymen (and increasing numbers of moneywomen) send their clients' money to New Zealand. They sent it to Thailand, Indonesia and South Korea too.
Like the Koreans (not usually regarded as spendthrift), we were happy to accept as much foreign capital as foreigners wanted to send us. Indeed, we rewarded the foreign investors so well that they kept coming back.
The result was that for much of the post-1984 period New Zealand ran capital account surpluses that we didn't need. We could have paid for our imports and serviced our debts from foreign exchange earnings, but we didn't. Exports were not needed, it seemed, when foreign investors were falling over themselves to send us money.
The capital inflow became the "independent variable", and the current account simply adjusted to the capital flow.
From 1994 to 1996, New Zealand received foreign capital at a much greater rate than in the early 1990s. This partly reflected higher rates of economic growth worldwide. More importantly, it reflected an increased relative attractiveness of New Zealand to profit-maximising foreign financiers. An important part of that equation was our high interest rates.
I don't oppose foreign investment in New Zealand. But I do believe that our authorities should have been facilitating outflows of capital to offset the inflows. For example, the government or central bank could have mopped-up excess liquidity by purchasing foreign assets. The rising dollar was an unavoidable consequence of a one-sided foreign investment policy; a catalyst that caused exports to slow down and imports to speed up.
Our policymakers still have the pre-1984 cringe mentality that portrays foreign investors as altruists and New Zealanders investing overseas as traitors. So we think we are doing well when incoming foreign capital exceeds outgoing foreign capital. Indeed "capital flight" (ie capital outflight) is seen as the ultimate economic disaster.
The growing balance of payments problem exposed a responsibility void; a void that was in part a byproduct of the 1989 Reserve Bank Act. The central bank and the government can now blame each other for balance-of-payments outcomes. Nobody is responsible for the nation's chequebook. Since the 1994 Fiscal Responsibility Act, the government has only been interested in balancing its own book.
New Zealand still has a surplus on its capital account, despite the fall of the kiwi dollar. In the first half of 1998, with reduced demand in Asia for our goods and services, the upward effect of foreign investment on our dollar was outweighed by the growing downward effect of reduced export receipts. In July 1998, these two effects on the exchange rate are back in balance. Capital inflows support our currency at its present level, despite the current account deficit.
I do not advocate a "cold turkey" approach to foreign capital. Capital inflow is like a drug. It takes time for addicts to be weaned. Nevertheless, the worst thing that we could do is to succumb to the addiction by reverting to the high exchange rate environment that Gareth Morgan appears to favour.
Sound policy is to ease our capital account surplus towards zero. That probably means that the government will have to legislate to either reduce the independence of the Reserve Bank or to require the Bank to target the balance of payments rather than inflation. The government must take responsibility for ensuring that the nation's accounts are as well managed as its own budget.
© 1998 Keith Rankin