Reports — Reserve Bank of New Zealand’s Financial Stability Report, November 2009—Consideration of Report of Finance and Expenditure Committee

I move, That the House take note of the report of the Finance and Expenditure Committee on the Reserve Bank of New Zealand’s financial stability report, November 2009. It is great to have an opportunity to talk on this report, because it contains a quiet revolution in monetary policy in New Zealand—a very quiet revolution that has gone largely unnoticed but is actually changing some of the policy fundamentals in our country. The Reserve Bank is leading that revolution. I will note very briefly some of the key points that came out of the financial stability report before I get into some of the detail.

The Reserve Bank pointed out that the global financial system has stabilised but is still quite fragile. Lending standards for residential borrowers have eased, but the Reserve Bank is encouraging banks not to return to some of the earlier mortgage practices of lending that created some of the instability in house prices. The Reserve Bank also has been urging the large commercial banks not to restrict their business-sector lending unduly. There has been a problem with businesses in New Zealand gaining access to the credit they need, because the banks have really dried up on providing credit to the business sector. The Reserve Bank also pointed to one of the problems we have in New Zealand, which is one of the most dangerous parts currently, and that is the level of indebtedness in farming. If there is a subprime mortgage crisis equivalent in New Zealand it will be in the farming sector. The Reserve Bank also pointed to the need to lift savings in the medium term. New Zealand, obviously, is highly dependent on inflows of foreign capital, and we need to increase savings to reduce that. And it talked about a new prudential liquidity policy, which I will come back to.

This report is interesting in a number of ways, and I want to start with the first one, which is about the New Zealand dollar. The Reserve Bank states very clearly that the ongoing strength of the New Zealand dollar is a major problem for our economy. In the view of the Reserve Bank the dollar is rather overpriced. The reasons for this are multiple, but they are linked to the fact that investors, or speculators, are driving up the value of the New Zealand dollar, in part because they see New Zealand as a safe place to invest money, and partly because we are a commodity producer. A number of commodity producers around the globe have had their exchange rates go up as commodities have recovered and international speculators have bought those currencies. In particular we have seen it in Brazil, another commodity exporter. The problem, of course, with the overvalued New Zealand dollar is that it is extremely damaging for the tradable sector in New Zealand—that is, domestic producers who compete with imports, and the export sector. The higher the value of the New Zealand dollar the harder it is for the tradable sector. If we do not have a healthy tradable sector, we cannot afford to pay our way in the world, and in the long run we will have to borrow money, which is, of course, what New Zealand has been doing for many years.

There is a very interesting discussion within this report about some of the options around how to deal with the overvalued New Zealand dollar, and I want to touch on just a few of them. One of the options Brazil has introduced is a small tax on incoming foreign capital. It is a 2 percent tax. The idea of it is to restrict some of the speculative foreign capital inflow going into the Brazilian currency in order to try to restrict the high level of the Brazilian currency, and there is a discussion of that in this document. It is one of the options on the table for us. Another option on the table is a level of quantitative easing. The quantitative easing in the United States is undoubtedly part of the reason why the US dollar has been falling, as the US Government has effectively been printing money. One of the policy options on the table for New Zealand to bring down the New Zealand dollar is to engage in some quantitative easing. It has risks, in terms of inflationary risks, but it is one of the policy options on the table. Another policy option on the table that we need to discuss, and it is unfortunate that we are not having this debate very widely—it is only within very narrow circles—is the sterilising of capital inflows. As capital inflows come into New Zealand, it is entirely possible to establish a policy that says that 50 percent or more of those foreign capital inflows must be deposited with the Reserve Bank at relatively low interest rates, with the result that it becomes extremely untenable for those foreign capital inflows to come into New Zealand. So that is another one of the policy tools on the table.

I think that perhaps one of the most interesting policy tools on the table with regard to the New Zealand dollar is that which has been promoted by the economic consultancy Business and Economic Research Ltd, which is to announce that the New Zealand Government has a maximum level that it wishes the New Zealand dollar to go towards, and if the New Zealand dollar goes over that level, then the New Zealand Government will simply start printing money and, of course, will devalue the currency. The idea of this is that if it is announced and the New Zealand dollar does then go over the target level, we actually do start printing money and bring down the value of the New Zealand dollar. We will have to do that only once before foreign currency investors get the message that the New Zealand Government is not willing to tolerate the value of the New Zealand dollar going over a certain level. It is a very interesting proposal that Business and Economic Research Ltd has been promoting, and I think it deserves proper discussion and debate within New Zealand policy circles. So far there has been reasonably limited discussion on it.

The other part of this report that I think is quite fascinating and revolutionary in its own way is the discussion of the Reserve Bank policy mechanisms. We are now seeing open acknowledgment by the Reserve Bank that monetary policy does not work. One of the paradoxes is that when Phil Goff came out and said that he was breaking the consensus on monetary policy, the Government reacted with horror, but in fact the Governor of the Reserve Bank has already broken the consensus on monetary policy. One of the extraordinary paradoxes that is not understood within policy circles, and certainly is not understood more broadly within the New Zealand community, is that the Governor of the Reserve Bank has already decided that monetary policy, as it has been exercised for the last 20 years, does not work, so he has changed it. He has done it very quietly, he has done it within the legal framework, and he has done it rather carefully.

What he has done is look at the crossover between monetary and prudential policy objectives. Monetary policy objectives are obviously around the stability of prices. Prudential policy objectives are around the soundness of the banking sector. Basically, what the Reserve Bank has done is say that there is a crossover between these two objectives—monetary and prudential policy objectives—which is around leaning against assets booms. In particular, of course, the asset boom that has been of most concern in New Zealand has been the housing asset boom, but it is only one potential type of asset boom. There can be all sorts of asset booms and we have had many of them over the years. What the Reserve Bank is saying is that we can lean against these asset booms to achieve both objectives. I should explain how that is done. For example, if the housing asset bubble is a driver of inflation, it is a monetary policy concern. The way in which it works is that as households feel richer as their houses become worth more and more, then those people tend to spend more money. Because their houses are worth more they spend more money, so they drive the inflationary cycle. At the same time, the housing asset bubble is a soundness issue. It is a prudential issue because these housing asset bubbles threaten the stability of the financial system.

So the bank is proposing to introduce a series of policies that are basically counter-cyclical, that have both monetary policy objectives and prudential policy objectives. In the time I have here I will not go into them at any length, but they are around bank liquidity policies—that is, making the banks seek longer-term funding. They are around counter-cyclical bad debt provisioning—that is, making the banks provide for bad debts on the up-cycle of the boom, rather than doing it just on the downward cycle. And they are looking at capital adequacy ratios—at varying capital adequacy ratios, or at least setting a capital adequacy ratio that acts in a counter-cyclical way against a housing asset bubble, which would achieve both monetary policy objectives and prudential policy objectives.

These are minor revolutions in the way that monetary policy is being conducted in this country. They are happening in a very quiet way, but for those people who are watching this space they are a very significant change. Of course, the Governor of the Reserve Bank, as usual, talked about how we need to change the tax treatment of investment properties, which is something the Green Party wholeheartedly endorses, in order to send capital into the productive sector rather than the non-productive sector. There is a lot else in this report. I recommend that people read it. It is a fascinating report. Thank you.

I would like to compliment the member who has just resumed his seat, Dr Russel Norman, on a very insightful speech. I remark to the House: who would have guessed that we would be here on a Wednesday evening, almost in the dead of the evening, debating, somewhat uncharacteristically, the presentation of a select committee report to the House because we are a little short of members’ bills.

In this space we just happen to have tripped across something that is actually truly remarkable. My colleague and friend Russel Norman said that there is a quiet revolution going on, and so there is. It is a revolution that has lined up an intriguing cast of characters. We have the Governor of the Reserve Bank and his staff, who are straining at the leash of convention to do what they know to be right in the midst of a world environment that is changing. We have Her Majesty’s loyal Opposition, which has just ended 20 years of consensus on a monetary framework that no longer works. And we have a Minister of Finance and a Prime Minister who have openly declared that nothing can be done even though their loyal civil servants are already busy doing it. That is a truly spectacular turn of events.

For the ladies and gentlemen who might be listening in, I want to unpick a little bit of that background in “plain English” and try to make it understandable, because whether or not we know it, we are actually watching history being made before our eyes in a really fundamental way. Firstly, what are the problems we are seeking to solve? What is wrong with the old consensus? There are basically two things.

The first is that the people who make stuff, sell stuff, and export stuff that allows us to enjoy the standard of living we do, and to which we aspire, are being creamed by the system as it stands. They are being creamed because they cannot plan a business at the start of the year at 50c kiwi against the US dollar, wind up at the end of the year at 80c, and still be running the same business model. It would be somewhat less bad if the exchange rate was steady and high, but for it to be high and volatile is a nightmare combination for Kiwi businesses. It means that New Zealand workers are losing their jobs, it means that New Zealand entrepreneurs are being denied fair profits, it means that our Inland Revenue Department is losing revenue, and it means that the Government’s options are being constrained. We all lose.

All sides of this House ought to be united in saying that this is not good for any of us. If New Zealand, which is a great producer of protein and a few other things, wants to stride the world stage, then we have to fix this, because we have to export to prosper, and we are killing our exporters. We are killing our productive economy with exchange rates that are too high and too volatile.

The second problem is that we have all suffered from the housing bubble, where too much domestic capital is being sucked into the property sector because of preferential tax treatment and because Kiwis look a little bit askance at other forms of personal investment. Some people were burnt in the 1987 stock market crash. Some people invested in Hanover Finance and a few other finance companies—more fool them—and they have been burnt by the non-bank finance sector really badly. People do not know what else to invest in other than their homes. The problem with that is we spend all our money bidding up each other’s house prices and mortgages, and our businesses, our entrepreneurs—and we would expect the National members to be arguing this, but they are not—are starved of the capital they need to grow their businesses so that we can improve our current account.

OK—those are the problems. How do we fix them? Well, the first recognition is that it is bunkum to say that nothing can be done. If nothing can be done, then we may as well join John Key and Bill English and beg for statehood of Australia. If we want to be proud New Zealanders and to have a country in which smart kids can grow up and get good jobs, we need to grasp this issue with both hands, believe in ourselves, and back ourselves.

As my colleague Dr Norman has said, the problem is complex but it is not hopeless. We know that there is a complex feedback effect between high real interest rates that suck in the hot money of the carry trade through the banking system, which has made billions out of it and has forgotten to pay a bit of tax—but, hey, what is a couple of billion between friends? Those banks have essentially funnelled that carry trade money into our property market, accentuating the problem that it is nearly all going on housing. So the first step is recognition of the problem and belief in ourselves. The Financial Stability Report—this eminently conservative document I am holding—has recognised the problem, and the report of the Finance and Expenditure Committee of Parliament, which we are debating tonight, has picked up those problems, front and centre.

The Reserve Bank has gone further. The bank has stuck its neck out and said we need to have a mix of new prudential policy, evolved monetary policy, and new tax policy to fix it. The Governor of the Reserve Bank is saying what the Minister of Finance is not prepared, perhaps not courageous enough, to say. The Governor of the Reserve Bank is saying that we need a capital gains tax. Of course, Labour’s position is that we oppose having a capital gains tax on the family home but we are willing to talk about options to end the preferential treatment of real estate.

The Governor of the Reserve Bank has gone further. He has said that the Reserve Bank will move on broader monetary and prudential policy evolution in concert with the new global consensus—the new global consensus. Post - Basel II, post - global financial crisis, post-Davos, and post-G20, central banks and economic policy makers around the world know what Bill English apparently does not. They know that the old framework is so, so 2007. It is so pre-global financial crisis. You know, it is so pre-Paula Bennett. Bill English has not woken up to smell the coffee, and everybody else around Wellington is wondering why not and asking what is wrong with him.

What is wrong with the Government that it cannot see the obvious when it is in front of its face? I hope that the Government members are just a little bit embarrassed, because it has taken the Leader of the Opposition, along with our colleagues in the Green Party—and, I might say, ACT, whose members have been pretty useful about drawing attention to the shortcomings of the current situation—to take a stand and say that we need to do something. There is no perfect answer. There is no monopoly on truth, but we have to ask the hard questions.

I turn to the report—and, you know, it is wonderful. Let me read a couple of quotes: “The governor briefed us”—“us” being the Finance and Expenditure Committee—“on the introduction of prudential liquidity policy”—a new prudential liquidity policy—“by the Reserve Bank, noting that there is ‘a zone in between prudential policy and monetary policy’.” It talks about the authority of section 68 of the Reserve Bank of New Zealand Act, which allows it to “[lean] against” the housing boom and develop a “monetary policy objective that supports both macro and prudential policy tools.” The Governor of the Reserve Bank is evolving policy that supports both macro and prudential policy tools.

For mum and dad at home, this is probably not the time to go into the detail, but that is about how banks are allowed to re-lend the stuff they borrow, what capital adequacy ratios for different classes of assets there are, and how that changes across the business cycle. To be really crude about it, when a market is running hot, we tighten up the lending constraints so that the banks cannot lend as much so easily, and when the market is down, we loosen them off so that the banks can lend more, providing a buffer for the real economy. The best part is that the buffer also acts against the carry trade—the hot money that provides that complex interaction that kind of makes it really hard in an open, small economy to run a sensible monetary policy.

Why is it that the currency of little old New Zealand, the kiwi dollar, is the second most highly traded currency per capita anywhere in the world? Is it because we are so intelligent? No. Is it because we are so good-looking? No. Is it because we have such a well-run economy? No. It is because we are a speculator’s dream, and it is killing us. We are a speculator’s dream, because we have a Government that is so pure, so hands-off, that our currency is a one-way bet for speculators.

Here is the irony: the last time the Reserve Bank actually played in foreign exchange markets, it made a profit of $600 million, and the cheque could not have come at a better time for Bill English. Here is the ultimate irony: the Reserve Bank is moving, the Opposition is moving, and Treasury is moving. It made nearly $1 billion from the last time it intervened, but the Minister of Finance is wedded to an old orthodoxy that no longer exists. Would someone shake Bill English and tell him it is the 21st century.

Motion agreed to.