Saturday, May 8, 2010

Frank Newman: The sovereign debt crisis

Greece is a worst nightmare scenario for the international financial system, and may be a sign of worse to come as the financial crisis escalates to sovereign debt markets. First it was Iceland, then Dubai, and now Greece. All three (for different reasons) accumulated mountainous government debt that their economies simply could not sustain. Iceland has been bailed out by Russia, and Dubai by its UAE neighbours. Greece has turned to Germany and the International Monetary Fund and secured a 110 billion euro package that will buy it a few years to bring an economy crippled by the spendthrift policies of socialist self interest back into the harsh realities of a balanced budget.

Unfortunately Greece is not going to be the end of the matter. Others within the European community are likely to write new chapters and it is now speculated that Portugal, Spain, Ireland, and even Italy will default on their sovereign debt at some time in the future. The USA and UK too are beginning to set off ever louder alarm bells as their governments try to revive their economies through deficit stimulus programs.

The question is can rich countries like Germany continue bailing out their spendthrift neighbours? The answer is clearly no – the shear scale of the problem is too great, no one will be able to bail out the banks that have lent money to spendthrift countries.

Unlike a mortgagee sale, sovereign debt positions are problematic to enforce and can only be collected with the assistance of the debtor nation government. That inevitably means unsustainable positions endure for years and even decades before economic crisis becomes political reality.

That presents a time window of hope for politicians to make structural reforms to make their economies viable in the long-run, although I have doubts that the short-term political life-cycles are conducive to fronting harsh economic realities.

Time is indeed what the New Zealand government is hoping for to turn around the NZ$1 billion a month deficit being added to our sovereign debt. Should the deficit persist New Zealand too will have debt levels on a par with Greece, and have a savings regime forced upon us by our creditors.


Jens Meder said...

Thanks, Frank, for the realistic assessment.

But what do you suggest should be done?

More libertarian economics with freely consumable income tax reductions and drastic
reduction of Govt. expenditure?

Or converting GST directly into long term (retirement) security and investment wealth creation by using it to resume NZ Super Fund accumulation, under the condition of its immediate investment in NZ infrastructure construction, as a priority at least until excessive unemployment has been defeated?

Wouldn't the latter address budget deficit reduction more effectively than freely consumable tax reductions?

Or - what better alternatives are there?

Frank Newman said...

Hi Jens. To find a solution one needs to agree on the problem. In my view, there is a financial reality that no individual, household, business, or sovereign nation can ignore forever: Income must exceed expenses.

We only need to look at Greece and other European nations to see that the root cause of sovereign default is the pursuit of socialist ideology and a disregard of financial realities. Socialists are primarily concerned with the redistribution of wealth, not its creation.
The answer for New Zealand is in becoming a wealth creation society. I am not hopeful that any of the current parties can achieve that as fundamental to the creation of a wealth society to less government intervention, which is the antithesis of what our socialist politicians believe to be their role.

However, should there be a political will to create wealth one would strategise in the same way that a household or business does. They would begin by asking: how can we grow income, while at the same time putting something away to generate future income?

Should we as a country take this approach then we would see significant improvements in our education system as currently it is failing to provide our economy with the skills it needs to grow the economy, a significant reduction in red tape which strangling initiative, and a significant reduction in taxation which is a disincentive to enterprise.

In my view New Zealand has not even agreed on the problem and under MMP I doubt that it will as there are too many vested interest minorities with a disproportionate influence, so much so that the majority are largely without a voice.

Jens Meder said...

Hi Frank - I agree with you practically in everything, including that none of the political parties at present has the courage of a vision to advocate the will of wealth creation - and forgive me - while the marginal details like less bureaucracy and lower taxation would be helpful, they would not solve the basic problem of inadequate savings to finance maintenance,new investment needed, and debt repayments.
I also agree that income redistribution has gone too far for the health of the economy -but what would be preferable - to stop it "overnight" and declare bankruptcy (ethically and politically impossible, I believe, as we are not that poor yet) - or a concerted, all-inclusive effort towards more widespread wealth creation and ownership, which over time just reduces the clamor (or perceived need) for redistribution, as most easily shown with superannuation.
(If our 1/6 in the Pound had been invested in tangible assets like our NZSF is now, and it had been on Personal NZSF Accounts, then a substantial part (if not all) of my NZ Super would be financed by my own account, with so much less redistribution from current taxpayer income, and no case at all for making NZ Super means tested or surtaxed)

So, I am disappointed with demands for freely consumable tax reductions(which, through persuasive brainwashing by our entertainment industries could lead to widening decay accelerating hedonism rather than the will of wealth creation, limited in this case only to the successful immediate consumption promoters.
Don't you think, Frank, it would be more inspiring to appeal to the personal will and preparedness to participate in direct wealth creation through universal super savings - as could be introduced by channelling a proportion of GST into resuming NZSF accumulation - rather than "demanding" (similar to a welfare "whinger" in the opposite direction) for tax reductions? (Because taxes in NZ are not are not really impossibly high, are they?)

Frank Newman said...

Hi Jens. I agree with you have what could of been had the 1/6 in the pound scheme been retained.

Unlike Greece, things are not dire for NZ (but would be in a decade if the budget is not balanced).

There are never easy solutions to savings but I think Kiiwsver will eventually be morphed into a compulsory savings scheme. Decades into the future that should address the savings issue.

FatBarstedClimbing said...

Hey Frank,

Good article, but I think too upbeat…

I think you will see the issue of Greece come to its head in less than a year, there is another round of debt due for repayment or roll over some time in 2011, and unfortunately with the risk factors being re-assessed by Standard and Poors, the Bond rate has increased on the Greece Sovereign Bonds. That will make it difficult for Greece to pay the interest on the debt, let alone the principle.

Ireland on the other hand has already made good progress toward balancing their budgets, and so long as they are not burdened with the costs of bailing out other nations, they may well succeed.

Spain ...... That is the real problem, makes the Greek issue look like a practice exam. Spain has 20% unemployment, but in the under 30y old group it is 40%.

The big issue for NZ, I see, is this government's lack of vision and forward planning, NZ Inc has been given more time to get the house in order than most, yet the chances are being wasted.

We should look clearly at what got Germany, and other low resource nations too their strong fiscal positions, cut the envy, reward productivity, penalise unproductive behaviour, be it government or private, and get this nation working. It won't be easy, but then often the things worth while have to be earned, or they are unappreciated.

It is time for non productive people in this country to understand that the Government does not have a magical Cash Cow out back, they have a diminishing productive sector, and the burden, both present and future, on that sector is what governs the health of the nation, we borrow at great risk to that future health.

Frank Newman said...

Thanks for the comment FatBarstedClimbing... can't say I disagree with any points raised. As you point out, debt is the key issue. I take the view that government debt is simply deferred taxation.

Jens Meder said...

Hi, All!
There is so much we all seem to agree on on this forum so far, that it seems the natural thing for us to do would be to discuss practical proposals towards solving our - and with this, the Western World's - excessive debt dangers.
Differences of opinions would be discussed on their perceived or demonstrable merits and flaws, with focusing not on WHO (is right or wrong), but on WHAT seems to be more effective for the results to aim for.
I take it we agree, that any wealth creation is physically impossible without someone's sacrifice of (or saving at the expense of) hand-to-mouth consumption (potential).
No rational debate will be possible if we don't agree on that, without a single practical or hypothetical example showing this to be wrong or even just dubious.

On the basis of this it is encouraging to know, that there is at widespread(?) - even though apparently only passive - support for compulsory KiwiSaving.

But would not allocation of the NZ Super Fund - NZSF - to Personal Accounts - PAs - be ethically and economically superior, because:
1. There are no subsidies involved, as there are in KiwiSaving.
2. Collection through the taxation system and investment in bulk through the NZSF achieve the lowest possible cost of administration bureaucracy.
3. As I believe mentioned already, there are quicker, more certain and clearly measurable results in budget deficit reduction
and economic recovery from the moment the NZSF invests consumption tax revenue in needed infrastructure projects as a priority until excessive unemployment has been overcome, and PAs of the NZSF begin financing NZ Super of those reaching their 65th birthday.

There are other advantages, but the above should be enough for a to-the-point discussion.

At this point it might also be worthwhile to discuss the question:
Should we not postpone our desire for freely consumable tax reductions, and concentrate instead on a bit of "belt tightening" for increased investment in productivity and wealth ownership, so the increased taxable income will actually deliver us (at least relative) tax reductions eventually?

Jens Meder said...

Question to Frank Newman:
Why do you see compulsory KiwiSaving as the more likely version of compulsory saving for NZ, than through the 100% participation at a proportionally equal savings rate for all, achievable through NZSF Personal Accounts?

Frank Newman said...

Hi Jens
I think transforming Kiwisaver into a compulsory scheme is easier politically, and more so as more people join Kiwisaver. I suspect the political argument for doing so will run on the lines that most people are already members anyway.

A sweetener could be to divi up (distribute) the "Cullen Fund" by turning it into a unitised fund, and issuing an equal number of units to each Kiwisaver account. That would be a nice boost (approx $3,500) to each Kiwisaver account.

I suspect the deal will eventually be that the National Super will simply be a top-up benefit to cover the shortfall between the value of a Kiwisaver fund annuity at age 65 (or maybe 67 by then) and the value of the pension.

Just my speculation, and as I say based on what I see as political realities.

Jens Meder said...

Thanks, Frank, for substantiated discussion.
Now we even have partial agreement on turning some NZSF capital into KiwiSaving capital, the difference being in that while you suggest turning the whole NZSF into KiwiSaving, I would like to see only the $1000.- incentive as a "sleeping KS Account within the NZSF" extended to all qualifying citizens who are not KiwiSavers yet - at the point when the NZSF is allocated to PAs.
Wouldn't your scenarion leave a substantial proportion of low income receivers out of active KiwiSaving, unless contributions are collected univrsally through the taxation system?
If not the latter, then how would 100% participation be achievable?
And wouldn't there be a case for demanding economically undesirable taxpayer safety guarantees for compulsory KiwiSavings?

As to political achievability, I think the simplicity of allocating the NZSF to PAs, plus the "sweetener" of the $1000.- KS incentive from newborn babies to superannuitants (with rights for them to withdraw after 5 years, regardless whether the account has been activated or not), plus the immediate fiscal relief when PAs start financing NZ Super, and the equal profitability cost to all - (not like in maximum profits chasing personalised KiwiSavings) - when compulsory NZSF savings are invested in low interest infrastructure bonds to keep full emoployment going - will be hard to beat.
Can your proposition match or improve on these prospects, or are the latter unrealistic, or what are their drawbacks?

Please draw attention to what you can see as faulty or undesirable in these "musings".

Frank Newman said...

Hi again Jens

You raise good questions. The scheme would have to be universal, collected through the tax system. Anyone who receives income (including welfare) pays tax, so the kiwisaver contribution would be deducted at source.

Regarding the safety guarantee, my thinking is that a government “kiwisaver watchdog” should put its stamp of approval on schemes that meet a prescribed investment criteria (basically low risk, low or moderate management fees, etc) and any fund carrying that stamp of approval would have a government capital guarantee against default – much like the present government guarantee for finance companies. This would introduce an element of trust that is missing at present.

Regarding accounts for newborns, this is already provided in the kiwisaver scheme. If parents are wise, they would open up a kiwisaver account for every newborn because the government woudl kick the fund off with a $1,000 deposit and as importantly it introduces the child (and its parents) to savings.

Add to that a one-off distribution of the Cullen Fund as I propose and every person would have a meaningful start to savings.

I think this is the only way to return NZ into a savings society.

You will see my scheme is quite simple; adding complexity increase the chances of failure in my view.

Jens Meder said...

Frank - it could be the start of a new era of economic policies in NZ, if you (we) could make the "KiwiSavers of all New Zealanders" principle a political issue widely debated in public.
But some questions:
1. If you stop prefunding NZ Super, then it will become an unsustainable PAYGO (from Peter to Paul) taxation burden, and there is no immediately visible and measurable fiscal relief as there would be through allocating the NZSF to PAs, not even when you start cashing in on your Kiwisavings at age 65.
2. Isn't the NZSF through its widespread diversification much more reliable than any smaller fund can be, and haven't they done a most trustworthy job so far?
3. Aren't NZSF Personal Accounts ethically and economically superior even to 100% compulsory KiwiSaving, because there are no taxpayer nor employer subsidies involved?