Partying On into the Wee Hours

The Debtor Nation

New Zealand's Current Account figures for the September quarter were released recently. Now the current account statistic is not widely understood, nor popularly followed. Over recent years, while our country has been running an awful deficit, international financial markets have not reacted. It has been largely ignored.

So the party has gone merrily on, into the wee small hours and no-one has cared too much.

Put simply, the current account represents the value of a nation's exports versus imports. If the balance is negative—that is, in deficit—it means that as a nation we are spending more than we are earning. Our imports are costing us more than our exports are earning. And the imports have to be paid for in some way. Over time, if a nation runs persistent current account deficits, they will have to be paid for by “others.” Our imports will need to be funded by borrowing or raising equity capital offshore.

So, the current account is a proxy statistic for whether we as a whole are saving more than we are spending, or whether we are spending more than we can save. New Zealand has been running a balance of payments deficit for decades--which means that we have been living in an increasingly foolish paradise. The Reserve Bank provides a data series going back to 1994. In those “good old days” the account was negative, but it represented only 3.6% of our gross domestic product (that is, all the goods and services which our economy produced in a year). The current account has been in deficit every quarter since 1994. Now it represents 8.6% of our gross domestic product. This is “danger territory.” Yet still the party goes on.

Brian Fallow commented recently that the accumulated current account deficit means that foreign claims (or our national indebtedness) exceed New Zealand investment abroad by $166m, or 92% of GDP—which is very high by international standards. Comparatively, this is like having a mortgage that is equivalent to 92% of your annual income.

Now this may not seem like much. But when you get a persistent structural deficit—such as we now face in New Zealand—each quarter we are increasing our mortgage to fund our lifestyles. This cannot continue indefinitely: in the end the economy will implode in upon itself. New Zealand will be bankrupt.

More concerning is that 93% of the current account deficit ($154 billion) is debt—the majority of which is short term. So, in other words, New Zealanders are borrowing to fund their lifestyles. They borrow from the banks: the banks borrow offshore—and that is how we finance our persistent current account deficit.

Now, there is a justification for borrowing at times. If we are borrowing to invest, so as to increase our productive capacity, the increased production should eventually enable us to pay down the debt. But as a nation New Zealand has borrowed to spend: to buy larger, more luxurious houses, better house fixtures, gardens, holidays, and consumer goods. This they have equated with the "good life". They have used debt (backed by the apparent “certainty” of ever rising house prices) to fund their lifestyles.

While money was freely available overseas, and while interest rates were low, the country could party on. But neither is the case now.

When the government tells you that New Zealand is well placed to navigate its way through the current global economic recession it is either in denial or it is deliberately gilding the lily. We are facing some very difficult times.

What needs to happen? To correct this imbroglio in which we find ourselves, we need to reverse the situation of being in a long term current account deficit. To do this, debt-fueled consumption needs to reduce not just temporarily but permanently. Consumption out of cash surplus is one thing; consumption funded by debt is something entirely different.

Simply put, New Zealanders need to reduce their debt and save more. This will necessarily mean that most need to accept a lower standard of living for a long time to come. Then the import bill will reduce; the current account will move into surplus. As a nation we need to run a structural current surplus for over fifteen years to have any hope of moving out of international indebtedness to international credit.

The likelihood of that occurring, without some very severe dislocation and a full-blooded economic depression, is about zero. We live amidst a pervasive culture of entitlement. People actually believe that they are entitled to a certain standard of living: it is theirs by right. If they don't achieve it, the government is to blame. The recent election was fought and won on this premise: the whole debate was about which party offered the best policies to maintain our living standards. Political power and political survival depends upon it. In our secular hedonistic country, "moving to the centre" politically means adopting an ideology of government responsibility for everyone's standard of living.

Thus, the government of the day will move the earth (“whatever it takes”) to protect the lifestyles of New Zealanders--or face electoral oblivion. This means that lifestyles will not change in any substantial way. Spending to support current living standards will continue apace. Current account deficits will continue to expand exponentially--until . . .

Yes there could well be economic shocks that could force a drop in living standards—at least for a time. Maybe the currency will eventually drop through the floor, going below the US forty cent mark. Sooner or later the world financiers are going to take off their rosy coloured spectacles when they consider things Kiwi. The price of imports would then rise substantially. This would substantially reduce our lifestyles. But can't you just here the swelling torrent of public discontent, as the eyes start to look to Wellington for relief.

Were the price of oil to rise to its alleged market neutral position of around $50 to $70 US dollars per barrel, we would see significantly higher prices for petrol here—this time exacerbated by a lower dollar. Imported rising costs will force lower living standards—which would be a very good thing. However, the government will inevitably respond to this political threat by “taking actions to preserve New Zealanders' standards of living.” To the current account deficit will be added another equally pernicious form of debt: government debt.

We expect that the populist National government, elected on a platform of preserving the living standards of New Zealanders through the politics of entitlement, will blink. Government debt will skyrocket. To the present mountain of private consumption debt is likely to be added another mountain of debt--government debt.

Can we navigate our way through the Scylla of falling world demand for our agricultural products and the Charybdis of debt based consumption? Can we make the necessary adjustments so that we start to produce enough goods and services to pay our way in the world? It is not likely. The habits of debt fueled consumption are too self-gratifying to break easily. We may be able to muddle through—but only to put off the day of reckoning for a time.

In the end, the piper will have to be paid.