Living on the brink

BY TONY ALEXANDER

OPINION: The primary function of the Minister of Finance’s annual Budget is to present the accounts for the core operations of the Crown and reveal to what extent there will be pressure on tax rates to fund planned spending, and the size of deficits which need to be funded, or surpluses which could result in future spending changes.

Somewhere along the line, however, a few decades ago the Budget changed from an accounting exercise into a grab-fest for every group in society who feel money should be transferred to them from others.

Hence we get social groups wanting increased benefits and greater inclusion of services, core state services continually clamouring for more funds to undertake more work, and business lobby groups looking for increased funding for marketing their output, paying for research and so on.

Given the size of the government in the economy and the strong societal desire for central activism it would be wrong to somehow constrain the Budget to being only an accounting exercise – though it would be possible.

However, every year it is somewhat disgusting to see the typical “gimme” attitude of Kiwis reveal itself in such a self-serving manner.

This attitude, however, helps explain why as an economy we will never reach the levels of income enjoyed in the likes of Australia and the United States, and why our ranking in the OECD is more likely to decline than rise in coming decades.

While we have some natural barriers to income growth such as the small population spread over a large area, distance form main markets, and the export product mix of a third world country, our big problem is unwillingness to start the growth drive by living within our means.

Although the household savings rate is undoubtedly rising at the moment it should be noted that it has taken fears surrounding the worst global downturn since WWII to achieve a tiny change.

We probably still have one of the worst savings rates in the OECD.

What this means in simple language is that we fail to pay our way and must borrow someone else’s money to fund our expenses.

These other people live offshore so every year our debt to these people gets larger and larger.

At the moment the difference between what we own offshore and what we collectively owe to foreigners (private and public sector) is about $168 billion.

The difference between what we earn from our offshore investments and what we pay for our borrowings and the assets we have sold adds up to about $14 billion.

This accounts for almost all of our $16 billion annual current account deficit.

This deficit gets added to our negative net overseas investment position each year and the funding costs creep ever higher.

For the past few decades lenders and investors overseas have been willing to give us more rope to fund our unsustainable style of living.

But they keep a close eye on events here and take a guide for whether they are willing or even able to keep lending us money from credit rating agencies and other reports.

Fund managers offshore are restricted in who they can invest in by trust deeds specifying acceptable credit ratings.

This means if our credit rating gets reduced they either will not be able to lend to New Zealand entities (including us banks who borrow offshore 40 percent of the money we have lent you), or they will charge more.

This is why the news from Standard & Poor’s that they have taken their New Zealand credit rating off negative watch is so important.

But this won’t last.

Eventually we will get a credit downgrading because there is no sign that households intend structurally (permanently) lifting their savings level.

This means that apart from the short term cyclical improvement there is little reason for believing our current account deficit and foreign indebtedness position will be trending toward the better.

The upshot is that some year down the track – and it is 100 percent impossible to forecast which decade let alone which year - we will see a currency collapse and soaring interest rates.

Until then, best keep a high proportion of your investments offshore and think seriously about buying fewer consumer goodies and saving more.

*Tony Alexander is BNZ's chief economist

 

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