Budget Surplus and Current Account Deficits
This post began as a comment on Jordan Carter's post earlier today - it just grew and grew so I think it deserved it's own post on my blog. Jordan was arguing that the Government Surplus was acting as a buffer to the Current Account deficit.
While this is true, the massive surplus is having unintended consequences. With the Government borrowing less interest rates are being kept low. Lower interest rates are fuelling investment in residential property. Investment in residential property is being financed with debt. The amount of debt New Zealanders hold is creating the massive current account deficit.
So, Cullen has to keep increasing the size of the surplus to avoid interest rates spiking on the higher risk of lending in New Zealand Dollars.
By sitting on the huge surplus, Cullen is rewarding in the short-term those that borrow. If he was to reduce taxes, interest rates would rise, and residential property would not provide the rate of return it does now. Investment would diversify into other sectors, providing a more stable economy in the long term.
What Cullen is doing now is the same short-sighted Government intervention that has happened repeatedly over the past century. Following the 1929 Stock Market Crash, the US Treasury should have allowed the US Dollar to lower in value to compensate for the US Economy moving into recession. Imports would have fallen, exports would have risen and the recession would have not become the Great Depression.
The same goes for the Asian Currency Crisis in 1998. Asian Central Banks kept insisting that they had sufficient reserves to cover the outfolw of funds and kept propping up their currencies - then would have to go to the IMF for Emergency Funding as they had simply reduced the losses of foreign investors as they withdrew money from the economies. If they had not intervened, foreign investors would have faced a choice - lose the lot, or leave your funds in and wait for a recovery.
So by buffering us against the effects of the Current Account deficit, Dr Cullen is dooming us to a bigger shock when it eventually comes. If we were facing higher interest rates, a low dollar and slower economic growth - well, would you put $10,000 on the credit card to holiday in Europe? Of course not, and that would begin to even out the deficit.
While this is true, the massive surplus is having unintended consequences. With the Government borrowing less interest rates are being kept low. Lower interest rates are fuelling investment in residential property. Investment in residential property is being financed with debt. The amount of debt New Zealanders hold is creating the massive current account deficit.
So, Cullen has to keep increasing the size of the surplus to avoid interest rates spiking on the higher risk of lending in New Zealand Dollars.
By sitting on the huge surplus, Cullen is rewarding in the short-term those that borrow. If he was to reduce taxes, interest rates would rise, and residential property would not provide the rate of return it does now. Investment would diversify into other sectors, providing a more stable economy in the long term.
What Cullen is doing now is the same short-sighted Government intervention that has happened repeatedly over the past century. Following the 1929 Stock Market Crash, the US Treasury should have allowed the US Dollar to lower in value to compensate for the US Economy moving into recession. Imports would have fallen, exports would have risen and the recession would have not become the Great Depression.
The same goes for the Asian Currency Crisis in 1998. Asian Central Banks kept insisting that they had sufficient reserves to cover the outfolw of funds and kept propping up their currencies - then would have to go to the IMF for Emergency Funding as they had simply reduced the losses of foreign investors as they withdrew money from the economies. If they had not intervened, foreign investors would have faced a choice - lose the lot, or leave your funds in and wait for a recovery.
So by buffering us against the effects of the Current Account deficit, Dr Cullen is dooming us to a bigger shock when it eventually comes. If we were facing higher interest rates, a low dollar and slower economic growth - well, would you put $10,000 on the credit card to holiday in Europe? Of course not, and that would begin to even out the deficit.
posted by Michael at
10:31 PM
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