Thursday, March 02, 2006

Peter Whitmore: Give governor more muscle to reverse national debt slide

Our record annual trade deficit of $7.1 billion for the year ended January is one more wake-up call that something needs to be done. And urgently.

The steady loss of wealth we have suffered over recent years from routinely importing more than we can afford has now turned into a haemorrhage.

Not only are we losing our assets, our self-sufficiency and financial independence, but we are also moving closer to a crisis.

Since the Reserve Bank Act came into effect in 1990 the Government has basically washed its hands of managing this area and has left everything to the Governor of the Reserve Bank. He, however, has only been given a mandate to control inflation. He has neither the tools nor the authority to deal with the balance of payments situation.

What he can do is to hold inflation down by increasing interest rates. Unfortunately, when he does this, it becomes more attractive for foreigners to invest their funds in New Zealand and the resulting inflow of overseas funds pushes up the value of our dollar. This makes imports less expensive and our exports less competitive. These price signals are diametrically opposite to those needed to reduce the trade deficit.

Out-of-control inflation through failure to properly regulate the money supply is a terrible evil. It is quite different, though, from inflation caused by the price of imports rising when the value of our dollar falls.

If we are importing more than we can afford then, in our relatively open market economy, we need to have this clearly signalled to us through an increase in the price of imported goods. Only then can we make sensible purchasing decisions.

The same goes for our exporters. Holding the New Zealand dollar artificially high to combat trade-related inflation stifles export growth at the very time when we desperately need to earn additional export dollars.

The most obvious way to address this situation is to remove trade-related effects from the Reserve Bank's inflationary targets.

The value of the dollar could then be allowed to fall back to a more natural value. This would cause a significant inflationary bump as imports rose in price, which in turn would lead us to reduce our spending to a more sustainable level.

There would undoubtedly be some short term hardship as we finally allowed for a correction after 15 years of inaction in this area. There would also be the risk of re-introducing ongoing inflation and the Reserve Bank would need assistance from the Government in combating this.

However, whatever problems the adjustment brings are likely to be minor compared to those that await us if we do nothing.

The above would be a first step, but I believe we should be proactive, bring to an end the era of only managing inflation and expand the Reserve Bank's mandate to include responsibility for balance of payments management, as it used to. We then need to develop a policy and give the Reserve Bank the tools to achieve it.

We are living in a fool's paradise, spending more than we earn and funding the difference from borrowing and asset sales. It is time to admit that we have a serious problem and to take prompt and effective action to address it before matters deteriorate further.

* Peter Whitmore has a background in engineering and economics and manages an Auckland-based publishing business.

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