Cheap money, Graeme Wheeler and an exhumed idea

In the big rich world money is ultra-cheap. Here the Reserve Bank kept its official cash rate (OCR) at an emergency low for three years until March. One result has been house price inflation which has been bothering Graeme Wheeler.

Wheeler will make his next pronouncement on Thursday. That comes after financial market players, taking notice of the dizzyingly high exchange rate, lowered their expectations of how far up he will take the OCR through to early 2016. Wheeler even tried to jawbone the dollar down a bit last month.

That came after he forced banks to cut lending to house buyers with deposits below 10 per cent of the price. He did this for “prudential” reasons but has acknowledged it has an effect on the OCR track.

So these LVR (loan-to-value ratio) restrictions have become de facto a monetary tool. Labour’s David Parker seized on this to validate his push for a wider range of monetary tools and for the bank to aim for more economic outcomes than just keeping inflation to 2 per cent.

Parker added another device: adjustments to the KiwiSaver contributions rate. Don’t expect this even if he is Finance Minister. Changing the rate can’t be done overnight and would add an accounting cost and stir anger. Also KiwiSaver is about saving for old age, not saving the economy in the here-and-now.

But Parker has company. Many commentators are groping for new ideas.

That is because the global financial system is not stable and New Zealand is very exposed through: heavy dependence on commodity exports to consumers in foreign countries, some at risk of shocks which could turn off the tap; very high household debt; as a result, very high country indebtedness to foreigners; reliance on banks domiciled in Australia; and a dollar in the top 10 traded currencies, so shocks come here fast.

The rich world has now been running on near-zero official interest rates for six years, trying to get businesses to borrow and invest and consumers to borrow and spend. Low inflation suggests neither is more than tepid.

The big four central banks have also printed money furiously. Their distorted balance sheets range from a quarter to a half of GDP, Financial Times guru Martin Wolf calculates. No one can be sure what “new normal” interest rates might be in, say, 2020. No one knows what the impact will be as money-printing ends and interest rates rise.

What can be said is that there is for now widespread soporific calm (not least among our government politicians who want sweetness till September 20). Stockmarkets are way above company earnings fundamentals. So, Australian Business Spectator Alan Kohler argued on May 28, we should worry: “Historically, complacency always precedes the greatest danger … At some point markets will bump up against the painted sky.”

New York Times columnist Paul Krugman put the case in April for low rates and printing money in current rich-northern-economy conditions by citing the Swedish central bank’s raising of rates in 2010: “… unemployment stopped falling … deflation eventually arrived. The rock star of the recovery has turned itself into Japan” (where there has been a quarter-century of low or no GDP growth).

The current “rock star” economy is ours, according to an HSBC Bank headline-grabber back in January. The parallel doesn’t end there: the Swedish central bank’s rationale for the rise was to ensure it met its 2 per cent inflation target and then to curb a housing bubble, to avert financial instability.

Sound familiar?

Manufacturers and unions, most mortgage holders and most opposition MPs will be on Krugman’s side if/when Wheeler whacks on another 0.25 per cent on Thursday. Shoppers, on the other hand, might like falling prices — which is the “deflation” Krugmanites fear will wreck economies.

Krugman called the Swedish 2010 tightening “sadomonetarism”. He also frequently lambasts those some call “austerians” who push fiscal constraint.

There is a bigger point.

The world is locked by the big rich countries into low interest rates because the financial system went badly wrong from about 1995 to 2007, central banks ran loose monetary policy and regulators were too lax. That poses, not just technical questions about monetary and fiscal settings, but deeper questions about the role of credit, debt and banks in the 2010s.

Wolf in April approvingly wrote of economists who have dusted off 1930s arguments (by Irving Fisher among others) that private banks should not be allowed to create money, as they do now. Instead, those economists say, central banks would finance government spending, make direct payments to citizens, redeem outstanding debts and make new loans through intermediaries.

That sort of idea hasn’t been around here since Social Credit faded in the 1980s (and Parker is not one of them). But that it has been exhumed does pose the question of whether it is time to deeply rethink the financial system.

Don’t hold your breath. Periodic crises are much more exciting.