It's a world of worries for Bollard and Cullen

Alan Bollard is a pingpong ball on an ocean of money. No matter how hard he tries to sink, forces beyond his control keep popping him back up top again. Inflation is now stuck over his 3 per cent limit.

Michael Cullen has a similar problem. Budget surpluses have ballooned up year after year. Even now, when he is trying to spend and spend, not least by shovelling money through Working for Families tax credits, he has another big number to live down.

Yet both must act as if in national control. Bollard will agonise whether to lift the official cash rate next week. Cullen is being propelled, month by cash-rich month, into tax cuts. Neither is happy.

In a sense this is the reverse of 75 years ago, when this economy was powerless in a vortex of world economic depression — farmers and businesses ruined by the hundreds, unemployment at a true rate of one-third of the workforce.

That prompted governments after 1935 to try to build an insulated, shock-proof economy. Fifty years later that fortress crumbled from within, so we went global again.

And that globe is awash with money, reflected in the serious imbalance between debtor United States and creditor Asia.

How come? Start with the United States central bank, the Federal Reserve Board.

The huge productivity improvement of the past decade and a-half — driven by computerisation, particularly in the United States, and the entry of China’s massive and dynamic workforce into the world economy, which cut manufactured goods’ production costs — should have kept prices rising only very slightly and perhaps even falling.

That is what happened when steam and mechanisation transformed the American and western European economies in the second half of the nineteenth century.

Instead, prices kept rising. Federal Reserve Board boss Alan Greenspan was determined not to “take away the punchbowl”, as the saying goes. Price rises were low, he reckoned, and house prices were not his concern. Then after September 11 2001 he crashed interest rates very low.

Compounded by tax cuts, that flooded the United States with money. So there was a consumer boom and house bubble — and a big budget deficit and trade deficit and high debt. A corresponding savings mountain developed in Asia.

That savings mountain fuelled the house bubble and consumer boom here, drove up domestic inflation and stuffed Cullen’s wondrous surpluses.

First institutions, then private investors went looking for high interest rates and found them in a small country which pays an interest rate premium at the best of times and a whopper premium over the past few years.

And that has given us a balance of payments current account deficit of nearly 10 per cent of GDP which is unsustainable.

That unsustainable deficit was a focus of a forum on macroeconomic policy forum the Reserve Bank and the Treasury organised in June with a array of distinguished foreign speakers.

For example, Sebastian Edwards of the University of California, calculated the deficit to be twice the sustainable size, even if you discount it for the fact that we are integrated into the Australian economy.

So it will have to undergo a significant correction, Edwards said. But he thought the adjustment will likely be “benign”. So don’t worry.

Others were not so sanguine: Val Koronzay of the OECD said it is “probably too benign to assume, even for an advanced post-industrial economy like New Zealand, that it is exempt from a ‘brutal adjustment’ scenario”. So prepare for the worst.

It is hard to see how a benign halving of the deficit can come about (except over a very long time), since it can come only through a big drop in imports (implying a consumer recession), a big rise in commodity prices (unlikely from their present high levels) or a big exchange rate fall (which would drive inflation to seriously worrying levels, with interest rates implications — and calls for Bollard’s early retirement).

There is also the supply side. Institutional investors have registered the deficit and largely backed off. If private investors also get uneasy at some point and stop supplying the cash for our house and import binge, that could be nasty.

For Cullen it would probably spell retirement under a cloud.

That would in a sense be unfair, since the gurus at the macroeconomic policy forum generally concluded that he has continued to operate one of the world’s soundest monetary and fiscal frameworks — “among the best thought-out and most far-sighted I have ever come across”, Willem Buiter of the London School of Economics called it. While a number of suggestions were made for changes to monetary and fiscal policy, no one suggested a major shift was in order.

Indeed, Cullen has followed the “prudent, conservative” formula advocated for boom times by Steven Dunaway of the International Monetary Fund at the forum: “under-predict revenue and run surpluses” — in a sense, “hide” the loot from those who would spend it.

But Cullen can’t hide it forever, even if the forward projections from a profit-squeezed economy are for lower operating surpluses and cash deficits. Indeed, he has spent heavily since the election.

Which, of course, brings tax cuts into the focus. A new paper from the Centre for Independent Studies today argues yet again the economic case. Step by step, Cullen is being frogmarched down that road.

He can blame the world.