Technically Speaking: Monetarism hits the skids while challenges mount around globe

Friday 18th May 2001

Chart 1: Air New Zealand class A

Chart 2: Air New Zealand class B

Chart 3: Tranz Rail Holdings

The role of the state in the economy is being tested as central banks struggle to maintain economic momentum and, closer to home, as Air New Zealand (charts 1 and 2) mulls going cap-in-hand to the government for a rescue bailout.

The European Central Bank (ECB) last week cut its core rate from 4.75% to 4.5% but the markets were not impressed by the sudden reversal of ECB policy. Previously the bank had insisted inflation remained its number one concern and its official interest rate had to sit tight.

Now it has decided that slowdown in Germany, which represents one third of the euro zone economy, is of importance and that M3 money supply growth is of greater significance than price inflation.

At a stroke the European Central Bank has made itself a laughing stock. The euro has turned out to be a garbage currency. At weak exchange rates exacerbated by lower interest rates, it threatens to continue to represent inflationary risk to the euro zone.

The ECB is living in fairyland if it thinks it can bluff the markets into believing everything is under control. It also seems its governor, Wim Duisenberg, fluffed a critical press conference at which the interest rate cut was announced. The ECB lacks transparency and consistency of purpose.

In the US, the Federal Reserve is struggling to make emergency interest rate cuts look like something other than an admission of failure. Japan has given up setting official interest rates and instead is pumping money into the banking system.

Monetarism is on trial in the three biggest economies of the world. It has been an article of faith for some time that independent central banks are capable of underpinning sound economic performance. It is evident that this is not always the case.

Lower interest rates do not seem infallibly able to pick up economies in which confidence has collapsed. The clearest case is Japan, where low interest rates have failed to inspire consumer confidence for some years.

The Americans must be worried they too might go Japan's way, with a deflationary spiral that stifles consumer demand and destroys national wealth. As Japan and America combined make up about half the world economy, the matter is not trivial.

Part of the problem stems from over-expectation of what central banks can achieve.

The essential limitation on central banks is that they can change the incentives for credit by altering interest rates, but they cannot compel any one to borrow or not to borrow money. The critical thing for a central bank to do is maintain credibility. Markets and consumers have got to swallow the propaganda, or at least believe that enough people will do so, to make it less risky to follow the herd than not. The effect is one of mass psychology.

The ECB has tossed its credibility out the window, while the Federal Reserve and the Bank of Japan are battling to keep face. Monetarism is finished at the public policy level as a significant lever on economic behaviour if people stop believing in it.

Closer to home, Air New Zealand has announced it may ask the government to cough up $500-700 million of taxpayers' money to fix its corporate mistake in not letting Singapore Airlines buy half of Ansett Australia. Hard-pressed taxpayers are supposed to get out of bed in the morning and go to work on behalf of Air New Zealand's board. Maybe they will need second jobs.

Had Singapore Airlines bought half of Ansett as it wanted to, instead of being screwed around by Air New Zealand, it would be left holding the baby and putting more of its own money in. The New Zealand taxpayer would not then be insulted by demands for charity.

That Air New Zealand has gone to the government for its salvation suggests the company's board should perhaps be reconstituted. The taxpayer would find it cheaper to finance dole payments for former board members.

Of course, Air New Zealand could be bluffing, reckoning that quantifying the hole in its balance sheet will cause the government to take fright and let Singapore Airlines buy more of Air New Zealand. But maybe not. Desperate people do desperate things.

The government will have to think long and hard about the risks of giving Air New Zealand any money at all. Today it is $500-700 million. But how much could that blow out to if the first donation proves insufficient? Is it the job of the taxpayer to indemnify the private sector against the cost of boardroom mistakes?

If Air New Zealand is such a good proposition, why does the private sector not put up the funding? Why commit the taxpayer to finance what capitalists refuse to touch?

What would a government do in future with any equity in Air New Zealand? Keep it or sell it? What risks are there to the value of any government investment in the struggling airline? It is not just a simple matter of handing over the money and forgetting about it afterward.

Once the government is in for a penny, it could find itself in for a pound. Tranz Rail (chart 3) is another case in point. Deputy Prime Minister Jim Anderton wants to buy out Tranz Rail's unprofitable Gisborne line. If the government bows to Air New Zealand's wishes, why not put money into Tranz Rail? And then why not subsidise another "national interest" business like, say, Contact Energy or one of the airport or seaport companies if it decides life is too tough?

Potentially, there would be no end to bailouts once the first handout happens. Just as well that the treasurer wants to buy the entire sharemarket through his superannuation cost-smoothing device.

The government's own credibility is on the line. Already it has admitted to a spending blowout, so the whole world knows Labour-Alliance budgets do not mean what they say.

This is the same government that could not find $14 million to extend community services card benefits for low-waged workers, although any amount of money is apparently there to throw at an apartheidist dream-scheme like "closing the gaps," the spending priorities of which remain intact even if the branding has been dropped. If the government does bail out Air New Zealand its sought-after reputation for financial probity could suffer.

Business will find its initial negative impression of the coalition was the right one. The Labour-Alliance government could find Air New Zealand's request is a watershed in its chances of survival into a second term. The role of the state in the economy is facing a test case over our national carrier.

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