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Insights 41: 5 November 2021
Webinar Recording: Walking the path to the next global financial crisis with Rt Hon Sir John Key
NZ Herald: Three Waters need to be on a commercial footing says Matt Burgess
Report: Walking the path to the next global financial crisis by Bryce Wilkinson and Leonard Hong

The next financial crisis?
Leonard Hong | Research Assistant |
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.

Read our new report Walking the path to the next global financial crisis here.

Climate of distraction
Matt Burgess | Senior Economist |
This week’s Financial Stability Report continues the Reserve Bank’s fascination with climate change.

It says rising seas and changing weather patterns will lead to financial losses. More insurance claims. Higher premiums. Asset prices could fall. Some assets could become uninsurable.

All of this is true.

The Reserve Bank Governor, Adrian Orr, says the financial losses from climate change are a “key risk to global financial stability.”

It is not clear how. Economies are not that sensitive to the effects of climate change.

The UN Intergovernmental Panel on Climate Change puts global GDP losses from climate change in 2100 at 2.6%.

By then, the New Zealand economy will be around 9 times its current size if growth over the last three decades continues. Climate change will reduce this to just 8.8 times. The level of GDP which we would have achieved by 2100 will be postponed to 2102.

Also leaning against financial instability is that financial institutions have already had decades to prepare for the effects of climate change. By 2100, they will have had over a century.

The Reserve Bank is not the only central bank that is worried about climate change. But after partnering with other regulators and three years of looking, the Reserve Bank has not found credible evidence of a stability threat.

Between 1997 (the earliest available online records) and March 2018, the Reserve Bank did not once refer to climate change in any Financial Stability Report, Annual Report, or Statement of Intent.

This year’s Annual Report from the Reserve Bank has three times more references to climate change than inflation.

Which makes the Reserve Bank look distracted in the current environment. With elevated asset prices, rocketing public debt, looming inflation, in a country which sits on colliding tectonic plates in the middle of a pandemic, the Reserve Bank is talking about climate change, an issue for which it has no legal or democratic mandate.

The Reserve Bank aims to “foster long term decision-making… for the needs of future generations.” It will take more than virtue signalling and unsupported assertions to deliver this ambitious goal.

What’s needed, Mr Orr, is rigour.

Climate change is many things. But it is not a plausible threat to financial stability. Systemic risk is not the fact that some investors somewhere will lose money some day. As economist John Cochrane says:

'The idea that climate change poses a threat to the financial system is absurd, not least because everyone already knows that global warming is happening'.

We will host a webinar on 2 December with John Cochrane of the Hoover Institution on what centrals banks should – and shouldn’t – be doing.

Circuit-breaker lockdown needed (but not the one you're thinking of)
Roger Partridge | Chair |
Earlier this week, epidemiologist and media personality Professor Michael Baker was reported saying, "It's hard to imagine any justification for lowering the alert level in Auckland."

In case readers in Auckland think they have misread that, Baker didn't say, "It's a tight call, but on balance… ." The Professor said it's "hard to imagine any justification."

Forget the hospitality businesses going to the wall. Or the hairdressers, beauticians and gym-owners defaulting on their mortgages.

And the trifling matter of those with missed medical appointments and mere "elective" surgeries – including at least 133 women who the Breast Cancer Foundation estimates don’t know they have breast cancer because of missed mamograms.

Forget also that when he uttered those words from his ivory tower in Wellington, 80.3 per cent of Aucklanders across three District Health Boards were fully vaccinated. And that 91.2 per cent had received their first dose.

Or that even with record case numbers last weekend, hospitalisations from Covid-19 stood at just 53.

And the reports of rising levels of depression across the region, relationship breakups from households under strain from months in lockdown, and the long-term harm of students missing school.

Not even the growing signs of civil disobedience seem to have registered with New Zealand’s illustrious epidemiologist. He must have missed the 5,000 protestors marching on Saturday. Who knows how many thousands might join the next protest? And this from compliant, non-confrontational Kiwis.

Yet, according to Baker’s pronouncement on Monday, none of this counted. What mattered was that Delta's R was still greater than one. This means Auckland's case numbers are still rising.

But so too are vaccination rates. From a slow start, New Zealand’s vaccination levels will have soon surged into the top quartile in the OECD league table. Auckland is already there.

The rest of the world has realised it must learn to live with Covid-19. Aucklanders must be allowed to do so too.

Fortunately, Cabinet's decision on Monday signalled a slight (but delayed) easing of Auckland's restrictions.

And Baker’s response? Predictably, he promptly changed tune. The step down in restrictions would “probably be OK,” he said.

In their twelfth week of lockdown, Aucklanders could be forgiven for rolling their eyes.

Perhaps, then, we do need a circuit-breaker lockdown. But just for the epidemiologists and modellers. Or, at the very least, can we occasionally put them on mute?

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