The Reserve Bank’s cobbled measures got us through the 2008 crisis

Listener: 23 July, 2011.

Keywords: Globalisation & Trade; Political Economy & History;

1878: While Julius Vogel was on a ship to London, the City Bank of Glasgow crashed. The London money market – the financial centre of the world – plunged. Although we were already over-borrowed, Vogel was going there to raise more capital. He could not borrow much, and New Zealand followed the rest of the world into “the Long Depression”, which lasted about 17 years.

Towards its end, all three non-Australian-based New Zealand banks got into trouble. One reconstructed itself, but the Colonial Bank and the Bank of New Zealand required government support. The biggest debtor of the Colonial Bank was Colonial Treasurer Joseph Ward, who resigned.

1928: Leading the opposition party into the 1928 election, Ward said he would borrow an extra £70 million from the London money market. However, the Government had secretly promised its bankers we would not borrow, because we were too deeply in debt. When Ward became Prime Minister, that promise plus the descent into the Great Depression meant we could hardly borrow at all; the works programme stopped, and men were laid off into unemployment.

1939: Finance Minister Walter Nash was in London trying to borrow, partly to roll over previous loans, partly to pay for imports. The Secretary of the Treasury, Bernard Ashwin, wrote in his private diary: “I attended Cabinet daily while the cables [from London] were considered. Each day as the latest cable was read out, the first comment came from [Public Works Minister and no-nonsense trade unionist Bob] Semple – ‘Tell them to go to Hell’ – and most of the Cabinet were inclined to support that view. Each time I had the job of pointing out that we were not in a position to do that and of persuading them to approve a reasoned reply.”

What Semple had not grasped is that although the Reserve Bank could supply unlimited quantities of New Zealand currency – though that may not be a good idea – the need was for foreign currency.

Elsewhere in the diary Ashwin says that we might have had to “default”. (Today Greece is in a similar situation.) He would be thinking of the fate of Newfoundland, which had avoided default in 1934 by reverting to colonial status governed from London. Fortunately, the UK realised it would soon be at war with Germany and needed our support; the required funds were grudgingly forthcoming.

1984: During the 1984 election, there was a run on the dollar as New Zealand dollars were converted into foreign currency. The Reserve Bank had only a limited supply and tried to borrow more. Credit lines we thought we had proved unwilling. Our overseas missions were instructed to repatriate any spare cash in the local bank accounts – trivial amounts, but we were desperate. Reserve Bank deputy governor Rod Deane later described us as being “on the verge of bankruptcy”. The exchange rate is no longer fixed but a crisis can still happen.

2008: Following the collapse of merchant banker Lehman Brothers, it became virtually impossible to borrow money in international money markets, or even to roll over debt. New Zealand trading banks were turning over up to $25 billion every month. Fortunately, the jamming of the markets did not last long, and the Reserve Bank cobbled together various measures to get us through.

The Reserve Bank has since required trading banks to “lengthen their books”, so that they don’t have to borrow as regularly as they did in 2008. (A three-month loan requires entering the market four times a year, a 12-month loan once.) That raises the cost of borrowing, and hence of bank loans. But better than having a cheap mortgage and no job, which could have happened if the international monetary authorities had cocked up as they did in the 1930s.

There have been other borrowing crises; of the five listed here, two – 1938 and 1984 – were entirely our fault, but in the other three a dire international situation was compounded by our being over-borrowed. The way to reduce the damage from the next one is to reduce offshore borrowing.