NZ Economy- Cheap Money

This article was published by Gareth Morgan in Aug 05, discussing why interest rates remain low despite the RB...

Cullen’s Call to Compound the Global Glut of Savings
3 August 2005

A conundrum puzzling central banks around the world at present is the fact that bond rates today are lower than they were when interest rates started being raised in mid-2004. There are a number of reasons this could come about but the one that has gathered the widest consensus is that there is a global glut of savings and too few investment opportunities to soak up those monies. The result is that the return required on investment is dropping.
Now of course one country’s surplus is another’s deficit so it is interesting that with some of the record balance of payments imbalances around the world today (deficits for the US, New Zealand and Australia and surpluses for Japan, China and the EU) that the net impact is a fall rather than a rise in global bond rates. More conventionally one would expect, if these imbalances balloon to “critical levels” the risks in international investment to rise as investors fret about the deficit countries’ ability to service their debts. And if risks rise then interest rates rise with them.
But the opposite is occurring. Rates are falling (especially in real terms) giving credence to this view that the world is facing a surplus of funds looking for investment rather than the more conventional shortage of funds compared to the opportunities countries have. This new dilemma has flummoxed no less an expert than Federal Reserve Chairman, Alan Greenspan who just last month expressed his take on it.
“The trend reduction worldwide in long-term yields surely reflects an excess of intended saving over intended investment. This configuration is equivalent to an excess of the supply of funds relative to the demand for investment. What is unclear is whether the excess is due to a glut of saving or a shortfall of investment.”
Even in New Zealand, where arguably we’re pushing the envelope once more on just how high we can get this current account deficit, we see the same phenomenon. Long term interest rates today are lower than when the Reserve Bank recommenced its hike of interest rates at the start of 2004. And prospective inflation is higher now, so real rates are a lot lower than then.
So long as China for instance is willing and allowed (are those protectionist drums I hear?) to increase its investments around the world then in its ongoing trading success lies the source of capital for general world growth. Such a benign scenario could mean a deficit country such as New Zealand could merrily continue funding its standard of living on other people’s money – at least until something rudely interrupts. The willingness of the surplus countries to fund investment elsewhere is certainly for now, the dominant force.
And where’s the evidence that New Zealand is “suffering” from this recycling of the surplus countries’ capital? We have record low unemployment, we have inflationary pressures that are hardly “wild”, and we have a government, despite the occasional politically-motivated denial from Dr Cullen, that has money to burn on its social dreams.
Indeed if we just stay with the New Zealand situation for a minute there’s a real opportunity here. By continuing to drop the real interest rates we face the world is sending us a very strong signal – “borrow more, we love what you do”.
Where then is the strange Kiwi Saver idea of Dr Cullen’s coming from? His Budget speech hypothesised that the reason the country has a permanent and currently expanding balance of payments deficit is because Kiwis aren’t saving enough. But as Dr Greenspan whose skills, you’ll appreciate I have a little more respect in these matters, suggests – it is not for this reason the imbalances persist but rather that others (the Chinese, Japanese and Europeans) save too much! And the trend in interest rates is supporting the Greenspan theory rather than the Cullen one.
So from this heaven-sent supply of global capital New Zealand has the opportunity to expand further its balance-of-payments deficit apparently with impunity. And we’re doing it – we’re out to 7% of GDP heading for 9%. And the closer we are to the ceiling of capacity constraints the faster this spillover into imports will flow. Why would we curb our spending as Dr Cullen requests – the cost of borrowing is falling!
It reminds me of those days back in history when debt, any debt was regarded as the beginning of the end. How fallacious that proved to be – world living standards have rocketed since debt became commonplace in the financing of investment and consumption. Now we have a situation where there’s a global glut of savings – an absolute boon to borrowers such as ourselves – and the Minister of Finance is saying we should save more. Pardon.
Spare a moment for the solemnity of the disaster scenario. One day – who knows when – those countries doing “so well” with their big fat surpluses, are going to wake up and decide to deny us access to them. When that day dawns, the prices of what we’ve bought with our borrowings will come crashing down around our ears. Our house prices, our currency and our jobs will bear the burden of our profligacy. Never mind that this outcome will also destroy the investments of our creditors, apparently it is inevitable. Why else implore Kiwis to save more when the return on savings world wide is plunging?
Pull the other one. Even forgetting the OECD’s finding that governments cannot influence the level of private savings, only its pattern, current financial market conditions are signalling that we should borrow more not save more. Until global conditions change Dr Cullen remains strangely out of phase.
Which raises the question of what his real motivation for Kiwi Saver is? Let’s talk about that next week.