Not in Denial

This was a note I wrote – ‘Listener’ style – in response to the critics of the 2011 budget.

Keywords: Macroeconomics & Money;

Dealing with addiction is confounded by denial: ‘I’m not a drunk’; ‘One more wont hurt’; ‘I need it to get through the day’; ‘He drinks more than me’. ‘I’ve cut back my drinking (so I can afford the occasional binge)’ ….

Borrowing can be an addiction too: ‘I am not too heavily in debt’; ‘A little more wont hurt’; ‘We need it to keep our life going’; ‘Others are deeper in debt than me’; ‘I am reducing my borrowing (so I can buy that luxury on credit)’ …

A private borrowing addiction is compounded by government borrowing. Perhaps public debt levels would be tolerable if there was not so much private debt. So the addict concludes that the government should borrow more.

We are lucky to have a government which is not in denial. That is how to read the 2011 budget. Sure, it could have used all those justifications to increase borrowing this year: ‘We are not too heavily in debt’; ‘Just a little more’; ‘We need it to stimulate the economy’; ‘Others are deeper in debt’; ‘Its coming down so we can afford another binge’.

Many urged the government to spend-up or tax-down. The temptation in an election year must have been strong – like a recovering alcoholic in a bar. The prudent turn away, because they know the alternative is short term pleasure and long term pain.

The long term pain of borrowing is you have to pay it back, or the country does. One day. Of course the drunk promises to give up drinking, and we can promise to stop borrowing some day in the future. But the crisis usually hits well before we get around to it.

A borrowing crisis? Its when the lenders to whom we have become addicted become nervous. Perhaps we wont pay it back; perhaps we wont be able to pay it back. Shouldn’t they get out now before they lose their investments? Yes, lose their investments: as I write lenders to Greece face that possibility. Its called a ‘haircut’, but it means that you get back less than you put in. One can lose a lot of hair. (Investors in some finance companies went bald.)

That they are talking about haircuts in one country, makes lenders nervous about others. New Zealand is not as badly placed as Greece, but there are enough similarities to make investors nervous. That’s what a credit downgrade means. Its not the ratings agents being mean. Their job is to provide guidance about what lenders think.

Two out of the three major agencies have put us on credit watch. Lenders may soon get nervous. As they do they will want higher interest rates. That will be painful for the borrowing addict. That’s you if you have a mortgage or consumer debt; that may be the business you work for since it certainly owes money and may want to borrow more for expansion; that’s you because you pay taxes, and some of those taxes cover debt servicing. (Can’t we borrow more to cover the extra debt costs? You really are in denial arnt you?)

Couldn’t the government have been a little more expansive borrowing more this year, but restraining itself next? Just like the drunk who is giving up tomorrow. The credit ratings wouldnt have changed this week. (They were too busy downgrading the Australian banks;. Australians are debt addicts? You must be joking.) But they might have later in the year. Just before the election – winning the World Cup wont make the lenders any less nervous.

Choosing restraint was a tough political decision. Full marks for the 2011 budget. I’d have restrained differently, but that reflects different analytic and political judgements.

The weakness of the budget? Of course the year to June 2012 could go wrong. (Who was predicting the Christchurch earthquakes?) But the predictable problem is that there may be less lift in the economy after 2012 than the budget predicts. In which case the ending our over-borrowing will be more difficult. I am betting on a tougher budget in 2012. After the election.