A step too far: The case against pursuing direct capital/trade/currency controls

To start off with I have to admit I like Bernard Hickey.  I like the fact he has got out there, written about New Zealand economic issues, and pushed to add an open debate type platform to the discussion regarding the New Zealand economy.  As a result, I may have not been critical enough when I read his posts in the past – as I did not see this coming.  In truth, the calls for exchange rate, trade, and capital controls is a massive step too far in what could well be the wrong direction.  Let me talk about the points Hickey has raised:

Description of the world

Do I disagree that there were incentive problems and imperfections in the global economy.  Not at all.  However, I would hardly blame this on the “orthodox thought”.

The very fact that the losses could be socialised was part of the institutional setting that was provided by government – there was a trade-off between the moral hazard associated with such bail outs and the risk of a systematic bank run.  Helping to drive such problems were a host of other issues in the market – namely asymmetric information, a problem that may have actually been exacerbated by ratings agencies rather than helped.

However, none of this suggests massive socialist style capital controls – it simply suggests that policy makers have to be aware of the potential for government and market failure with regards to the finance industry.

Better information and education are the solutions – not enforcement of arbitrary central controls.

I would also note that the term Great Moderation was termed in 2002 to describe the 1990s – it wasn’t initially about the period 2002-2007 as Hickey suggests.  I would also note that it has not been invalidated, and was not a fiction – inflation expectations remain remarkably anchored, growth around the world responded amazingly rapidly to changes in the economic situation.

We experienced one hell of a shock in 2007 for sure – but that doesn’t invalidate the fact that we had 20 years of amazingly stable growth and inflation going on around the world.  The key lesson is to understand what happened now – not to rail against the good things that did occur!

Back to New Zealand

However, Hickey’s discussion on the world is simply a primer for his policy suggestions for New Zealand.  As a result, this must be the main focus.

We increased our foreign debt by NZ$97.5 billion inside the last six years, but all that happened is our per capita GDP actually fell over that period.We borrowed from the free and easy and low interest rate global capital flows to pump up asset prices and go on a spending spree. All we have left for it now is some leaky homes, a big debt and a hollowed out workforce.

Ok, lets think about these statistics a bit.  There are several issues:

The fall in per-capita GDP:

Yar, it has fallen.  Of course RGNDI (Real gross national disposable income eg *) has risen, which for a small open economy that has experienced a large change in the terms of trade and international transfers of income is a better indicator of actual income – but lets ignore that.

The key point here is “what has happened to potential GDP” – we are currently near the bottom of our “cycle” when in 2004 we were well on the way up on an “upswing” in our cycle.  We aren’t comparing like with like here – for example per-capita GDP took until June 1994 to recover to its previous peak from the 1991/2 recession!

As the economy recovers and unemployment falls, per-capita GDP will rise – as a result, looking at the current artificially low figure exaggerates the size of our relative debt position.


Yes, liabilities have risen.  Furthermore the generally more relevant figure of net liabilities has risen, albeit by a smaller amount of $59bn.  Now, given this is an aggregate figure we should compare it to total GDP not per capita GDP.  So our net liability position as a % of a single year’s production is 88% in June, compared to 74% in June 2004.

Remember how I mentioned RGNDI before as well – you might say we should probably compare it to that, since that is a better measure of our underlying current income per year.  That would look a lot worse than the GDP stat, with debt rising from 90% to 128%!  However, this is a mistake as we are comparing a nominal variable (net foreign liabilities) to a real variable – so one is adjusted for the change in prices and one is not.

Working out GNDI manually (but excluding indirect business tax, as I didn’t get around to looking for it) debt rose from 78% of GNDI to 92% by June 2010. [Note:  Nominal GDP already captures the terms of trade impact, so using GNDI helps us capture the result of investment and transfer flows – which we know are a negative thing for NZ.  This is why we are getting out some bigger numbers 😉 ].

Now, these are some big looking numbers – but lets put it in perspective.  We are talking about a STOCK of borrowing that accounts for nearly a year of income (a FLOW).  In essence this doesn’t tell us anything about anything – and without actually digging down and asking what has happened with the money, and why, we can’t say whether this growth in debt makes sense or not.

Have people been investing, have they been consuming on the basis of future growth, or has their been some sort of market or government failure leading to a poor allocation of resources and leading to “over-borrowing”?

We need to answer these questions before we can interpret what is going on – if the high debt level in on the back of good investments that will lead to future growth, arbitrary restrictions are a bad thing.  If it is on the back of the fact that people WANT to borrow now, restrictions are bad.  But if there is an identifiable issue – we should tackle that issue, instead of throwing around random macro-policies and hoping we hit some arbitrary target set by a management consultant.

Of course – this entire debate requires that our statistics are perfect.  Stats NZ does a great job, but in a small economy like New Zealand we often find that it is hard to measure stocks of things, like net debt and wealth.

Liabilities part 2:

We borrowed from the free and easy and low interest rate global capital flows to pump up asset prices and go on a spending spree. All we have left for it now is some leaky homes, a big debt and a hollowed out workforce.

Two things scream out at me when I see this:

  1. Interest rates were low and credit was cheap – so WE GOT A GOOD DEAL.  Surely the person who loses out is the person who is holding the asset with the low rate of return!!!
  2. Is it even true we went on a spending spree?

If we look at the GDP statistics (*, *), we find that nominal consumption as a % of GDP was actually BELOW historic averages over most of the last decade.  It was spending on residential construction that was high.

So we may well have spent too much building houses that are “too big”, or houses where the cost of construction was “too high”.  But if this is the case then we know that there is a single INDUSTRY with an issue – not the whole economy.  It is an issue of POOR INVESTMENT rather than too many non-housing consumer goods.

And what has the government just done?  It has tightened tax rules around investment housing and it has tried to move housing in line with other investments.  It sounds to me like this “issue” has been identified and dealt with – why do we suddenly need to artificially restrict capital flows.

External shifts

We need to recognise that in a world of competitive devaluations, growing trade tensions and nakedly selfish vested interests (governments, multinationals and global investment banks) that we have to defend ourselves and be just as nakedly nationalistic.

We have to assume, just as Marx pointed out, that free markets will eventually overheat and blow up if we allow them free rein.

I would note several things here.  We are a social democracy, not the type of free market Marx discussed.  Furthermore, when there are “competitive devaluations” this increases the New Zealand exchange rate, which reduces inflationary pressure, which leads to lower interest rates from our Reserve Bank – this is part of the system in place.

The dollar has been high compared to history, well at least against the US and Yen.  I would note that commodity prices have been elevated and our terms of trade as a result strong.  Our dollar captures part of these external pressures, it distributes the income gains from higher commodity prices around the economy, it is doing what it is supposed to.

Fundamentally, there is a point here regarding currency – but I reach a different conclusion than Hickey.  Trade, capital, and exchange rate controls are a prisoners dilemma – a prisoners dilemma that helped make the Great Depression much worse.

However, unlike Hickey I can’t see us going down this road again – the monetary policy easings overseas AREN’T begger thy neighbour in the way Paul Krugman is suggesting if all monetary policy agents are responding by printing money.  Given that this response is part of a central banks reaction function, I think we are sufficiently fine here.

Now Paul Krugman is not wrong – he is far too smart to be.  He correctly recognises that, in practical terms, the US would be extremely slow to respond to a change in international monetary surroundings – given that they now have to do it through QE (Quantitative Easing).  NZ can still cut rates, and has the scope to get involved in the earlier, easier, stages of QE should things really deteriorate.

I realise that many people will fear that our Bank will not do enough in the face of lots of monetary easing overseas – that is a legitimate fear, given the observation of what has happened in the US.  However, in this case it STILL just says that we need to watch the issue of Reserve Bank action, not arbitrarily limit trade, currency, and capital flows.

Pure abhorrent 1984 style controls

Income needs to be redistributed to offset the concentration of wealth that naturally occurs in such a globalised, free flowing world of capital. Ownership of assets needs to be monitored and controlled. The growth of foreign debt needs to be restricted.

Consumers and bankers need to be saved from themselves.

Sorry what.

Seriously, this is just saying “I think other people are stupid and we need a central planner to live large portions of their life for them”.  This is abhorrent policy – it is a small step from this to supporting dictatorship.

Suppose there is some issue here – suppose there are legitimate income issues for example, or a belief in the social value of land.  If that is the case introduce redistributory policy or a land tax – don’t control peoples lives.

The state only has a role to take away someones liberty when they impinge on someone else “excessively” – the state SHOULD NOT do this just because the individuals involved in government think someone is borrowing too much.  Talk about an out of proportion response, gosh.


Stop the fudging and have a debate

Here I agree.  We should have an informed debate, with a clear theoretical framework for framing how these things function – and clear data, which we can use to analyse what is going on.

There may be legitimate reasons for introducing macro-policies.  I would personally always prefer it if we found the micro-drivers for any imbalance and dealt with them directly (whether it be the fault of government or elements in the market), but the debate should be had in a fully reasoned environment.

Calling on highly unorthodox trade, currency, and capital restrictions on the basis of how things “feel” is far from this.  So I don’t disagree with actual research – but I do disagree with the extreme policy prescriptions that have been raised, especially given that there is an unclear basis for these policies.

Currency wars

Brazil, like Australia and New Zealand, has a freeish floating currency that is rising as others try to devalue and buy into countries with hard rather than paper assets.

So people are buying things voluntarily off us, that is nice.

I believe I’ve covered this off before – if everyone else is printing money because they believe there is insufficient domestic demand (or they are implicitly defaulting on debt) then we can do the same.  Now, if this leads to inflation then hello … we don’t have a deficient demand problem anymore, and any unemployment is likely to be structural – indicating that we can’t really do anything.

Instead of focusing on relative currency rates I believe Hickey should be looking at the deficiency in aggregate demand – my good man just look at the money supply statistics, the money stock is falling at record rates and private sector borrowing is anemic, if you want a negative story you can take it from right there!


From a cursory look at the figures, it became clear that many of the issues that are being bemoaned can be solved simply by calling on the RBNZ to print more or less money.  Outside of the abhorrent call for central control of our ability to smooth our lifetime spending, this was the sole thing required.

The calls for trade, currency, and exchange rate controls seemed to stem more from fear than any underlying model of the economy.

Now I agree with his conclusion here:

I’d just like to have a debate and start looking for a new way to run our economy.

Although I would rephrase “way to run our economy” to “ways to improve outcomes in the economy” – as after all we aren’t communist.  This fact stopped me from writing immediately – but then these appeared (initial, 2nd, 3rd) and I knew I had to reply.

Hickey has fallen for the fallacy that we can centrally plan an economy and end up with outcomes that make us better off as a society – but when the central planners are imperfect, preferences are unknown, data is imprecise, and the consequences of our actions are unknown does it really make sense to shove our nose into peoples voluntary trade – if there are institutional issues deal with them directly, don’t just chuck in a bunch of macro policies that restrict voluntary trade in the hope of hitting your target.

And this is the key point of it, Hickey discusses the “free market system” – but he is merely bemoaning what occurs because people are voluntarily allowed to trade with each other, and when these people are able to form institutions are arrangements given this.  He is illustrating that the desire for “benevolent philosopher kings” did not die with Plato – or with the totalitarians of the early 20th century for that matter.

12 replies
  1. Paul Walker
    Paul Walker says:

    “Hickey has fallen for the fallacy that we can centrally plan an economy and end up with outcomes that make us better off as a society”

    Did Mr von Mises and Mr Hayek not have something to say about this many years ago? Those who do not read history are doomed to repeat it.

  2. Matt Nolan
    Matt Nolan says:

    @Paul Walker

    And Smith before them – it is an inherent desire inside man, to feel in control, and that is why this fallacy is so common.

    We need not look far beyond the desires of a man to understand where they are coming from – that is why economists are so useful, we have no desires 😉

  3. Eric Crampton
    Eric Crampton says:

    The only thing I’d add is a link to Masonomics. Hickey’s right that markets fail; he’s missed that politics usually fails worse and has crap incentives to fix things.

    Thanks for posting this.

  4. Miguel Sanchez
    Miguel Sanchez says:

    A wasted effort I’m afraid Matt. “Let’s have the debate” is the catchcry of creationists, prohibitionists, protectionists, and any other group that’s interested in hearing dissenting opinions in much the same way that Mao Zedong was interested in “letting 100 flowers bloom”. When Der Economik Revolution comes you economists will be first up against the wall, unless you can learn to be useful idiots rather than just useful.

    Seriously, even I’m (just) old enough to remember the last days of Fortress New Zealand and why it had to come down in a screaming heap. Hickey should surely know better.

  5. Matt Nolan
    Matt Nolan says:

    @Eric Crampton

    Tis true, markets fail, governments fail – all economists can do is try to point to the relevant trade-offs.

    @Miguel Sanchez

    The way I see it this provides a brief outline of a defence – if specific policy recommendations come up I can then do posts on them starting from this point. Even if no-one listens, hopefully the effort isn’t wasted because it “clarifies my own thoughts”.

    “Seriously, even I’m (just) old enough to remember the last days of Fortress New Zealand and why it had to come down in a screaming heap. Hickey should surely know better.”

    I agree – however, this is the sort of thing fear does to opinions.

    My main issue with this sort of thing is not the fact that people want to make things “better” – I agree with that. My main issue is that people seem to want a quick, silver bullet, solution – rather than trying to understand the issues and determine whether a better, consistent, conterfactual exists.

  6. Eric Crampton
    Eric Crampton says:

    I can’t believe he’s going for the “make Kiwisaver mandatory and compensate for the mandatory by forcing it to invest in NZ”. FFS: I’m in Kiwisaver now, managed by University superannuation scheme. They force Kiwisaver to run massive weighting on domestics, I ask the Uni superfund to pull me out of the kiwisaver part – I’d sooner lose the tax advantage and keep international portfolio diversification given my very large overall portfolio stake in New Zealand (paying off the house). But to compensate by making it mandatory? Jeebus.

  7. Matt Nolan
    Matt Nolan says:

    @Eric Crampton

    The whole compulsion argument is a blunt stick for perceived issues. I just can’t believe that all the people pushing this type of scheme refuse to ask “what” the problem is and “why” it is occurring before coming up with a solution.

    We teach kids in school to ask things such as what and why – why is it that so many intelligent people forget it as adults?

  8. Miguel Sanchez
    Miguel Sanchez says:

    “The way I see it this provides a brief outline of a defence”

    Yes, when the show trials begin I’m sure you’ll be allowed to mount a “defence”.

  9. Paul Walker
    Paul Walker says:

    “Why we must abandon the economic orthodoxy”

    One thing I have always wondered when I see headlines like this is, What is “economic orthodoxy”? Is he really saying we should abandon supply and demand? That we should abandon the Coaseian view of firms? That we should abandon the view that printing money causes inflation? These things seem to be part of the economic orthodoxy to me.

    Or does he mean we must abandon things he don’t like and he will define economic orthodoxy to be those things?

  10. Matt Nolan
    Matt Nolan says:

    @Miguel Sanchez

    The best thing I can do is make sure I can understand the defence – so when things go the other why I can clearly whine about it later. It is all about maximising my utility after all.

    @Paul Walker

    It isn’t clear as the “orthodoxy” is never really defined. It is a lovely straw man to beat up – I see it happening all the time.

    I reckon if someone wants to make a policy recommendation they should have to write it in the form:


    And they should be willing to argue the logical nature of each premise, and the equals. I suspect if people did this – even implicitly – they would recognise that some of the stuff that comes out is “poppycock”.

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