Fiscal Accountability Matters

US President Herbert Hoover once stated, “Blessed are the young, for they shall inherit the national debt.”

Right now, young people have a reason to be concerned. Since Covid-19 arrived 18 months ago, New Zealand’s net public debt has nearly doubled. Government net debt rose from 19% of GDP – Gross Domestic Product – in 2019 to 34% this year.

This is the highest ratio since 1996.

The bulk of debt increase was from the wage subsidies – around $18 billion. Other business support programmes were supplementary. These fiscal responses were intended to enable faster economic recovery.

New Zealanders were seared by the 1984 debt crisis. That experience produced a broad bipartisan consensus in favour of fiscal responsibility rules. Budget surpluses were achieved by the mid-1990s and sustained, albeit with reducing spending discipline, to 2008.

Those surpluses helped New Zealand weather the storms of the 2007-08 GFC and the Christchurch earthquake. But it took seven years of fiscal slog and expenditure restraint to restore fiscal surpluses after the GFC.

Big spending increases from 2017 preceded Covid-19 and now the challenge of turning ongoing fiscal deficits into surpluses has arisen anew.

Are current arrangements up to the task? Not in our opinion. In 2014, the New Zealand Initiative proposed a Parliamentary fiscal council to help Parliament better scrutinise government spending and fiscal prudence.

This was not out of the blue. In 2011, the OECD found that “independent fiscal institutions can buttress a government’s capacity to comply with a numerical rule.” These institutions exist in 28 of the 38 countries in the OECD.

In 2017, the-then opposition parties – Labour and the Greens – endorsed a Fiscal Council of an unclear design. The advent of Covid has stilled work on this, and there are no indications that fiscal discipline and constraint will be the heart of the Government’s priorities.

A global pandemic understandably opens the fiscal taps, but that only heightens the need for a subsequent return to fiscal discipline and accountability. That determination is not yet evident.  

To fail to restore discipline in spending quality and current financing is to do future generations a disservice. It is fine for the young to inherit debt backed by assets of equivalent value, but not otherwise. Herbert Hoover’s remark is best seen as a humorous aside that would be irresponsible if put into practice.

In praise of aspiring ‘influencers’

Content creators are the fastest growing type of small business worldwide. Today, over 50 million people consider themselves ‘influencers’ on social media.

According to YPulse – a youth research organisation in the United States – over 72% of Generation Z wants to become online celebrities.

Nowadays, getting famous on Instagram or TikTok is the ticket to wealth and fame. According to a Harris poll, more kids dream of becoming a YouTuber than an astronaut.

Generation Z kids do not want traditional careers in engineering, medicine, consulting, and teaching. Becoming viral on TikTok through outrageous flamboyance can make you a millionaire.  “Don’t need no education, don’t need no thought control”.

Intellectuals, social conservatives and cultural pessimists commonly decry this trend of ‘superficial consumerism’. “Yet another dissolute younger generation in the making”, they sniff.

Yet, pop culture meets a need. No one is forcing the youthful masses to follow ‘influencers’. Following them takes time, and buying the products they endorse swallows money.

This is not new. Teenagers have been buying ‘brands’ for decades. They having been indulging and experimenting in all sorts of things that affront their elders, probably from time immemorial.

So the followers of the influencers must be getting a benefit. In part, it will be a social group thing. I get that.

Moreover, ‘influencing’ must be a competitive and risky business. Entry is free. Anyone can be outrageous and flambuoyant – until the euphoria fades. One tweak that misses its mark could destroy months or years of assiduous cultivating of one’s followers.

Take Daniel LaBelle for example. He started a physical comedy channel on TikTok last year, and now has over 23 million followers. Podcaster Joe Rogan has to entertain 200 million people monthly on Spotify.

Imagine waking up every morning wondering what you can do next to titivate such followers, without blowing everything. Who wants that pressure?

Many influencers will crash and burn, just as pop musicians have for decades.

But pop music endures because it entertains. So far influencers are passing that test.

The next financial crisis?

Both the global financial crisis (GFC) of 2007-2008 and the Covid-19 pandemic caused disruptions to the world economy.

During the GFC, stock markets plummeted, and millions of people became unemployed. Business and bank failures resulted in financial pain.

Covid-19 did not cause as much economic destruction as experts predicted. So far, at least.

During this recession, bankruptcies declined during the pandemic, while prices of assets such as cryptocurrencies, stocks, and houses reached record levels. The net worth of US households increased by USD$26 trillion in 2020.

These developments are extraordinary and unusual. Usually, recessions mean severe losses rather than wealth gains. Are our current financial circumstances sustainable?

Our new report Walking the path to the next global financial crisis explains how skyrocketing public debt and monetary policy easing threaten global financial stability.

In the wake of the GFC, government bailouts of financial institutions ratcheted up public debt ratios dramatically. That was not reversed before Covid struck.

Governments and central banks in developed economies now face tough choices regarding interest rates and debt.

Raising interest rates or ending quantitative easing could destabilise asset markets and the economy. Governments, meanwhile, struggle to wind down stimulus spending and fear higher interest payments on debt.

By printing money and maintaining low-interest rates, it also fuels consumer price inflation. In New Zealand, consumer price inflation hit 4.9% – the highest level in over a decade. Inflation in the US and the EU is also approaching 6%.

The authorities are not showing a determination to return settings to more normal levels before the next economic shock occurs. They have led investors to believe that the government will underwrite high asset prices such as cryptocurrencies, stocks and housing.

It is now common to hear terms like “too big to fail” and “whatever it takes” in financial market jargon. Such beliefs are dangerous for financial stability.

For the government, it is prudent to repair the roof while the sun is still shining. Financial support packages were necessary during Covid-19. But the government should have a credible plan for reducing net debt to more sustainable levels once the pandemic is over.

The financial well-being of citizens is at greater risk when governments are less financially prudent.

As a small, globally integrated economy, New Zealand cannot prevent the next financial crisis.

We do not know when the next financial crisis will hit. But we can prepare for it when it does.

Amateur hour

If you want to know everything about ancient Egypt, read a magazine article about it. If you want to know a little less, read a book. If you want to know nothing, study Egyptology.

It is a paradox, but it is true.

As Einstein once said, “The more I learn, the less I know.”

Or was it Aristotle? Or Churchill? It’s usually one of the three, and who cares about correct attribution?

But I digress. The problem is not with those people who learn just enough to know they know nothing. The problem is all the others.

These are the people who believe they can land a jumbo jet on an aircraft carrier because they played Microsoft Flight Simulator a few times.

And the millions of sadly ignored All Black coaches who have watched a few tests on TV.

And, not to forget, our team of five million epidemiologists.

We know the issue as the Dunning-Kruger effect. People with low abilities often overestimate their competence. 

Surprisingly, the effect is named after David Dunning and Justin Kruger – although I am sure Einstein could have said it, too.

Dunning and Kruger also gave us a good explanation for their discovered effect. They claim that people are not just incompetent. But people also lack the ability to process enough information to realise how incompetent they are.

Well, I need to think about that.

Unfortunately, modern culture amplifies the Dunning-Kruger effect. Instead of warning people of their inability, it encourages them to live it.

If you have ever watched casting shows or reality TV, you know what I mean.

There are the would-be entrepreneurs going on The Apprentice who could barely calculate the GST on their products.

There are the singers on America’s Got Talent who should not even perform under the shower.

And there are the amateur chefs on Hell’s Kitchen who drive Gordon Ramsay to cascades of expletives.

We can but speculate where this exaggerated belief in one’s own ability comes from.

Is it the schools where every child is a winner? Where there is no failure but only deferred success?

Is it the helicopter parents who stop their children from ever failing – and if they do blame the teachers?

Or is it our general norm of non-offensiveness which makes us call every bent spoon a spade?

Honestly, I have no idea. I guess I am going to write a book about it.

3x4 Tips To Deal With The Dunning Kruger Effect
Dunning-Kruger Effect

Human misjudgement of experts

The process of decision-making is complex. Furthermore, its significance transcends both the private and public sectors, and is crucial not just in politics.

Some believe that if everything were left to the smartest people in the country, things would turn out exactly the way we planned. Experts would be able to handle everything.

But is this always the case?

Not always. American writer David Halberstam explores this hypothesis in his book ‘The Best and the Brightest’. He delves into the foreign policy decisions made by those in the Kennedy and Johnson Administrations.

Harvard’s ‘whiz kids’ were the brains of the government. The list included the brilliant Defence Secretary Robert McNamara, an executive with excellent business credentials, and Air Force Secretary Harold Brown, an expert in nuclear physics who has a PhD.

Members of the Cabinet and Advisory Board possessed outstanding industry experience or were highly regarded academics. They oversaw reshaping US policy in Vietnam. 

Nevertheless, these men ultimately failed. Although they spent over $1 trillion in modern dollars, they didn’t contain Communism.

Since the rise of Mao Zedong in China, they were convinced about the ‘domino theory’ of the spread of Communism. If it spread to one country, it was pervious to others surrounding it.  

It was an oversimplification. Vietnamese national circumstances were ignored – they simply sought independence. Vietnamese retaliation was particularly strong due to the prior experience of French imperialism.

During the period 1965-1975, the US government deployed 2.7 million soldiers. More than 7.5 million tons of bombs were dropped – twice as much as during the Second World War.   

The greater their investment, the lower the return. Mentally, the ‘sunk cost’ fallacy kicked in, increasing military and financial investment in Vietnam. The Kennedy and Johnson administrations wasted a great deal of resources due to the misjudgement of ‘experts’.

Halberstam described their efforts in Vietnam as “brilliant policies that defied common sense”.

On similar grounds, renowned investor Charlie Munger talked about recognising patterns as a way of understanding how humans behave both rationally and irrationally. Perhaps McNamara and Brown would have made a different decision had they considered the alternative.

Confirmation bias of elites leading to the double-downing of the policy that was doomed to fail. As economist Thomas Sowell once quipped, “The road to hell is paved with Ivy League degrees.”

Halberstam concluded that simply featuring ‘the best and brightest’ people on your team does not guarantee success. It’s not an indication that they can make sensible decisions without falling into fallacies. 

How Robert McNamara Came to Write His Memoirs About Vietnam | Time
Robert McNamara and President Johnson

Yes, there is intergenerational inequality on Housing

House prices have risen to all-time highs. According to the Real Estate Institute of New Zealand, prices have risen by 30.6 percent in the last year. We’ve seen record high housing prices for fourteen months in a row.

A housing crisis? It’s more accurate to call this as a “housing catastrophe.” For many young people, attaining the Kiwi Dream is now close to impossible.

Anecdotally, there have been many reports of growing intergenerational inequality between the young and the older generation because of continued price inflation. Is this, however, supported by empirical evidence?

According to Statistics NZ, the average annual income of today’s Generation Z is $45,188. In 1998, the average annual income for Generation X was $22,256. In nominal terms, incomes have merely doubled.

Conversely, national median house prices have risen from $164,167 to $826,000 over the same time period. Prices have soared by fivefold. Prices in Auckland and Wellington are approaching $1 million.

In 1998, house prices were about 7 times the gross income for Gen X, today for Gen Z, it is 18 times. Buying a home today is significantly more difficult for Gen Z than it was for Gen X in 1998.

According to Demographia International, from the late 1950s to the early 1990s, the median property price was only two to three times the average annual household income. This figure is now 8.6.

As far as housing is concerned, the data shows that our parents and grandparents had it far easier than Generation Z today.

Back then, it was possible to buy a home with just a single source of income. Today’s couples and spouses must both work to cover their housing cost, whether that is rent or a mortgage.

It may be true that the older generation had higher mortgage rates due to higher interest rates during the 1980s. But mortgage rates have little bearing on the affordability of a home. Even though new buyers today may face trouble with higher interest rates later.

House prices at all-time highs are detrimental to our economic prosperity. A more affordable housing market with lower rent prices is associated with greater social mobility. So far, this tradition has dwindled.

For a variety of reasons, housing affordability has deteriorated. Restrictive planning laws, poor incentives for local councils, local obstructions to urban development, and the Reserve Bank’s monetary responses to Covid-19 fuelled the fire. However, the main reason for this is a lack of housing supply.

House prices have skyrocketed, preventing young people from realising the Kiwi Dream. It’s time we change that.

Clarke and Dawe in 2021

My article in the week’s Insights newsletter. It is a #3, the third item in the newsletter which is always an attempt at humour. You can sign up to our weekly newsletter here.

One of the finest shows on economic affairs was ‘Clarke and Dawe’. The two satirists collaborated from 1989 until John Clarke’s death 2017. If only this partnership were still around in the era of Covid-19 and quantitative easing. I miss their satire.

So how would Clarke and Dawe explain the current global economic recession today? I wonder…

BD: Thanks for joining, you’re a macroeconomist, correct?

JC: A pleasure to be here. Yes, I am indeed.

BD: As a response to Covid-19, quantitative easing (QE) was used by central banks. How does it work?

JC: Well, it starts at a desk in a central bank. You take the computer out of box, press buttons, click enter. You alert the banking sector and the Treasury, send both an email, and press copy. You buy bonds and send money.

BD: And why did central banks start QE? Isn’t that ‘counterfeit money’? You can’t just print money at will.

JC: They print it digitally. You press buttons with more zeros on the computer – Boom! New dollars, just like that. It’s a free ATM machine, just bigger.

BD: But there is no free lunch, though? What are the financial implications?

JC: Potential inflation, consumer prices could go up. The more money you print like Zimbabwe, the poorer you become.

BD: What do macroeconomists do?

JC: We talk about economics without stories. It’s up, down, left, or right for unemployment, CPI, inflation, GDP etc. Straightforward, really.

BD: Correct, and what about government debt globally?

JC: They’re broke. Particularly the Europeans, the Japanese, and the Americans. Debt levels are above their entire annual economic output.

BD: Right… so what does that mean?

JC: No money. Broke economies were being lent money by other broke economies, but now they are all broke. The only lenders are central banks. It’s a last resort, so to speak.

BD: My goodness. The digital printer machine is out of control, and governments are broke. What’s the next step you think?

JC: Another bail out from central banks, probably. And then a bail-out of the central banks, most likely by themselves.

BD: Correct, an ongoing merry-go-round. Is this sustainable?

JC: Yeah, we might as well be entering clown world.

BD: Correct. That’s a grim end to that story. Thank you for your time.

JC: My pleasure. Oh, I better check the gold price. And where did I leave the key to my safe deposit box?

Mr John Clarke — Clarke & Dawe
Clarke and Dawe

Get rich with Dogecoin

Recently, you have been really responsible with your finances. You stopped buying chicken paninis, cut back on the flat whites, and eating out at KFC. You put more money into a savings account.

Unfortunately, the reward for being financially frugal is a meagre 0.8% per annum of interest. After 2% inflation, you are losing money.

Not very satisfactory.

But, if you cannot build some long-term wealth in the bank, what else can you do?  

Well, let us explore a few options.

You could try housing. However, you’ll need to get a new mortgage and a substantial amount of deposit. It is also costly, with the average house price now exceeding $800,000. And that will only provide you with a 30% return within a few months.

But what if I told you that you could make a 900% return, no a 11,000% return in the same period?*

How about investing in Dogecoin! Yes, that meme dog cryptocurrency.

It started in 2013 as a joke Bitcoin alternative with a caricature of an innocent Japanese Shiba-Inu dog as its symbol.

Then, this year in February, Elon Musk tweeted about it, and Dogecoin took off to the moon.

A dollar invested when Elon tweeted is now worth $17.4 – Oh wow.  

Dogecoin is now worth $80.5 billion – worth more than companies such as Ford Motors, Honda and Adidas. Dogecoin was a joke about cryptocurrencies, but in an ironic twist, it became a wealth-creating digital asset.

In April 2021, a man named Glauber Contessoto gained notoriety for becoming a Dogecoin millionaire. We are supposedly living in a completely new era of unorthodox wealth creation.

Or perhaps it’s just a bubble. During the 1600s in Holland, multicoloured tulips became prized possessions. “Tulipmania” saw prices go crazy until it burst into nothing of substance. 

The folly of human speculation has always been there.

My generation particularly loves bubbles – look at GameStop, for instance. You can profit and still get a decent result on investment by selling at the right time.

No need to be financially responsible. Eat out, buy KFC and spend your remaining funds on the latest Dogecoin.

It will be fine as long as you are the last one out before the bubble bursts. Just short it. Easy peasy.

*Not investment advice

The Theory of Human Stupidity

Humans are complicated. We are intelligent species that dominated the world with our knowledge and brilliance. We built pyramids and skyscrapers, we went to the moon, and we invented Pokémon GO.

Yet, throughout human history, human stupidity has triumphed time and time again – whether it is communism and fascism killing millions of people, recurring asset price bubbles and their eventual bursts, or carelessness leading to environmental degradation. We never cease to stop causing unnecessary harm to ourselves or others.  

Stupidity applies on an individual level, too. We have dozens of cognitive biases, believe our own lies and feel good about it.

But is there something more systematic about human folly?

Italian economic historian Carlo M. Cipolla believes so. In his book ‘The Basic Laws of Human Stupidity’, Cipolla identifies four different kinds of people – stupid people, helpless people, intelligent people, and bandits.

As a group, stupid people are far more powerful than the Mafia and the Military-Industrial Complex because they actually drive and influence social outcomes. 

Cipolla found that the same proportion of people in any group tended to be stupid, even within the group of Nobel laureates or professors, or even blue-collar workers. The reality is that we have to face the same proportion of stupid people, no matter where we go or travel.

Everyone underestimates the effects of stupid people in action because it is not apparent. As a result, non-stupid people underestimate the damaging power of stupid people.

Intelligent people benefit themselves and society; bandits steal from others to benefit themselves; helpless people are exploited for their naivety despite contributing positively to society. However, stupid people are counterproductive to both their own individual and society’s overall interests.

Cipolla says that a stupid person is far more dangerous, especially if the individual was born into the elite class. Their total damage capacity is infinite within their potential position as bureaucrats, generals, and even politicians.

As stated by Yuval Harari, history teaches us that people must never underestimate the role of stupidity in human history. It is one of the most powerful forces around the world.

We cannot trust human decency and supposedly good human leadership to do what is best for humanity. We can only hope that is the case, but stupid humans could win at the end of the day.

The Basic Laws of Human Stupidity by Carlo M. Cipolla - Penguin Books New  Zealand

Kiwi Dream? More like a nightmare

Last week’s Covid cases in Auckland delayed Finance Minister Robertson’s housing policy announcements. The housing shortage has been at crisis levels for a long time, but the delay in this case is not likely to make any difference.

The government has hinted that further tinkering on the demand side is coming, but enabling more building is what is needed.

Demand-side initiatives from both National and Labour-led governments have failed to address the underlying shortage, so house prices continue to rise.

If homeownership is part of the Kiwi Dream, we are deeply into nightmare territory instead.

And the problem is worse than you probably thought.

The Initiative’s new report, The Need to Build, discusses the relationship between population ageing and declining household sizes. Places with older populations require more and different housing than places with younger populations. As New Zealand ages, the housing shortage will worsen. The trend holds both here and across the OECD.

The problem is hardly unknown. Statistics New Zealand and local councils already consider declining household sizes when estimating housing demand. But it is underappreciated elsewhere.

We projected new housing needs for 2038 and 2060 – the numbers are striking.

Even if the the border stayed closed for the next 20 years, we would still need to build at least 20,000 new net dwellings every year to meet demographic changes.   

For the six most realistic scenarios in the report, from 2019, New Zealand will need to build between 26,000 and 35,000 net dwellings – above and beyond the replacement of decrepit houses –  every year until 2038, and between 15,000 and 29,000 per year by 2060.

But we also have a current shortage of some 40,000 homes that also needs to be filled. There has not been nearly enough building for well over a decade. While the current construction boom has brought consenting numbers to the highest level since the 1970s, consenting rates are only a little above long term averages.

Population ageing adds fuel to the fire.

The Kiwi Dream for younger generations – Millennials and Generation Z – is slipping further away. Shortages mean high rent and little disposable income after housing costs. Continuously tinkering with demand policies such as the LVR, bright-line tests, and first home buyer programme will do little to make housing more affordable. 

The government must switch priorities to rapidly free up housing and land supply, or find ways to incentivise councils to be more pro-development.