Many of us will agree that the COVID-19 economy in New Zealand has resulted in record-levels of government borrowing and Reserve Bank lending. Soon it may challenge the idea that we are supposed to keep those two things separate.
The labour-led government were able to introduce stimulus packages and grants to protect jobs and support the economy but did not have the spare $19 billion sitting around. Just like us, the government can borrow too by selling government bonds, also called Kiwi Bonds, which are small packets of debt. And who buys them? Investors, retail banks and the Reserve Bank of New Zealand (RBNZ).
In response to the COVID-19 pandemic, the RBNZ decided to increase the pace of bond purchases and buy a large amount of Kiwi Bonds to effectively transfer billions of dollars to support the government's stimulus spending.
As a result, RBNZ's ownership of the nation's outstanding fixed-term debt has risen steeply from 6% to 37% in seven months, and the current programme is targeting $100 billion of bond purchases by June 2022.
To purchase government bonds in the secondary market from the investors and retail banks, the Reserve Bank can produce 'new' money. This, in turn, puts more money in rotation, and retail banks would be able to lend more. This process is called Quantitative Easing, which was very popular during the 2008 financial crisis.
This easing process has been used and has held up, through numerous economic disasters with central banks around the world buying plenty of public debt. They typically make sure to complete it in a roundabout way; i.e., buying bonds in the secondary market instead of directly purchasing government debt with the new money.
On the other hand, Quantitative Easing has long been seen globally as a slippery slope that starts with politicians ignoring central banks' independence.
According to a report in Bloomberg, our ultra-aggressive quantitative easing program has helped to cushion the New Zealand economy. However, it risks killing bond market volatility, weakening trading interest and compressing bank earnings. A subdued market with depressed yields may also deter overseas investors, limiting foreign capital that is needed to fund the current-account deficit.
A senior rates strategist at TD Securities in Singapore said: "The RBNZ is the 'kiwi whale' from bonds and monetary policy perspective. The risk is that eventually it will crowd out other investors and yields may get to a certain level where investors question whether there's any point in buying the bonds at all."
The Japanese Approach
Japan is a classic case study in modern macroeconomic policy and exemplifies why governments and central banks cannot control the economy in the way that many textbooks suggest. The 553.6 trillion yen ($4.87 trillion) of assets the Bank of Japan (BOJ) holds are worth more than five times the world's most valuable company Apple Inc. and 25 times the market capitalisation of Japan's most valuable company Toyota Motor Corp.
BOJ started amassing government bonds in the 1990s to break the grip of deflation. Now, it has a balance sheet bigger than the economy, owns about 43 per cent of the government's outstanding bonds, and has seen its policy of quantitative easing replicated across the other parts of the world.
It's a progressive shift. We're moving towards overt monetary finance, said Russell Jones who is a partner at London-based research group Llewellyn Consulting.
He says if economies continue to deteriorate because of the pandemic, we will see central banks directly financing governments, and they'll do it explicitly, it's only a matter of time.
In a recent Bloomberg Television interview, Finance Minister Grant Robertson has downplayed the prospect of the RBNZ monetising government debt, saying it’s approach to quantitative easing is working.
While Robertson would "never say never" on other approaches, RBNZ's Governor Adrian Orr said he was "open-minded" on the concept of buying debt directly from the government despite the risks involved.
The longstanding fear among monetary experts has been that handing this kind of money-creating power to politicians with short-term electoral goals will lead to overspending that hurts economies in the longer run by triggering inflation. That's why most developed countries keep those levers in the hands of central banks.
If we can learn anything from the Japanese approach, it is that interest rate manipulation and a mounting huge fiscal deficit have not helped Japan's economy for nearly 30 years.
And investors who want to secure their financial future should recognise that looking for quality financial advice and diversification across global markets is important to navigate the looming negative interest rate environment in New Zealand.
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