Unpaid debts

More than a decade ago now, I got interested in the sovereign debt defaults in the 1930s. Debt was in the wind, between the severe economic recession and financial crisis and the Reinhart and Rogoff book. And so it was while I was working at The Treasury that I first became aware of New Zealand’s sovereign default in the 1930s. A couple of years later that story ended up written up here and our (quite limited) default joined the published lists of sovereign defaults.

The biggest defaults globally weren’t, and often still aren’t, in such lists. I wrote here a few years ago about the US government’s abrogation of gold clauses in debt instruments, in effect depriving bondholders of a big chunk of their real purchasing power, all as written up in UCLA economist Sebastian Edwards’s accessible book.

But on a global scale the most important series of defaults in the 1930s were those on liabilities arising from World War One. There was German war reparations of course: by the depths of the Great Depression there was little appetite to keep claiming them, and rather less willingness on the German government’s part to keep paying them.

But there were also big debts among the governments of the World War One allies. Once the US entered the war in 1917, Britain and France in particular had borrowed large sums from the US government, and Britain in particular (France to a much lesser extent) throughout the war had lent large amounts to her allies (including New Zealand). Britain had made substantially more intergovernmental loans than she had received (and was a net lender even once the large loans to Russia, never likely to be repaid after the revolution, were set to one side). For the UK, intergovernmental debts alone were about 20 per cent of nominal GDP (the war had also given rise to a lot of market debt, offshore and domestic)

In his new book, University of Nottingham political science and international relations professor David Gill writes about The Long Shadow of Default: Britain’s Unpaid War Debts to the United States 1917-2020. The “long shadow” is, in part, an allusion to the literature which suggests that in practical terms memories of sovereign default often seem quite short, with defaulters often relatively rapid able to re-enter the market.

After World War One there was a considerable strand of thought in Europe – and some in the US – that the intergovernmental war debts should simply be cancelled. The war had, after all, from 1917 become a common project, and if the US had been the net lender to its allies, those allies themselves had paid a much higher prices in lives and physical destruction. To the extent it was not going to be cancelled, pressure for substantial reparations from Germany would be increased (particularly from France, whose combined debts to Britain and the United States, with few offsets, exceeded Britain’s gross debts to the US).

The cost of cancellation would of course have fallen primarily and substantially on the US, and its taxpayers (Britain would have borne some costs, while France and Belgium would have been significant beneficiaries). Gill never points out that the total debts owed to the US government were equal to perhaps only 10 per cent of US GDP (although note that the US federal government share of GDP itself at the time was very small), but he is a political scientist primarily, and anyway what mattered was (much) less the economics and much more the politics. There was little or no appetite in the US, and specifically in Congress, for the Europeans to do anything other than repay the debts their governments had voluntarily taken on. US opinion seemed particularly reluctant to accept any connection between the intergovernmental debts and German reparations.

During the 1920s each European sovereign borrower reached its own agreement with the US government on servicing and repayment terms for the war debts. The main focus here is the UK, and in 1923 Chancellor of the Exchequer Stanley Baldwin had settled with the US on terms that involved payment of the following 62 years (and an effective discount on the debt of 28 per cent of the original total), and provisions which prevented the US government marketising the debt, selling it off to retail and wholesale investors. Signing was controversial (sign now or wait: many states that waited secured more generous US terms a few years later) but was regarded by officials as broadly satisfactory, since the UK negotiated in parallel in respect of its own wartime loans to allies and was left expecting its outgoing would be broadly met by receipts on those loans to allies). At prevailing exchange rates, servicing the US (USD) debt was costing the UK (gross) less than 1 per cent of GDP per annum.

Most European countries that had borrowed from the US during the war defaulted in 1932. European countries had largely agreed among themselves, although the agreement was never ratified, to end both reparations payments and the service of intergovernmental war debts among themselves. After making token payments in 1932 and 1933 (accepted by the US as not formally defaulting), the UK government chose to default in 1934. (Of all the sovereign borrowers, only Finland maintained an unbroken record of payment, making a final payment in 1975 eight years ahead of schedule (to a toast from President Ford at a state banquet in Helsinki)).

As Gill makes clear, the issue for the UK itself was never primarily about ability to pay. Yes, the Great Depression had happened – but it was much less severe in the UK than in the US (or Germany, or New Zealand/Australia) – and going off gold in 1931, and the subsequent exchange rate depreciation, had raised the sterling servicing costs of the US war debt. But even by 1933, UK real GDP is estimated to have been only about 2.5 per cent below the 1929 peak, and by 1934, when the final default decision was made, UK real GDP was hitting new highs. The issue was primarily one of willingness to pay, a willingness that was no longer there (amid a European desire – which would not have benefited the UK financially – to have wiped the war debts/reparations slate clean). From Gill’s account there was little appetite in political circles, government or opposition, or in the wider public to keep on paying (though of course by 1934 impressions will have been influenced by other countries having defaulted in 1932).

The US was another matter, even though it had been President Hoover who had in 1931 initiated a one-year moratorium of all intergovernmental war-related payments. There were attempts to negotiate with the US but they were ultimately futile. Even though there were some prominent figures in the Hoover administration who favoured a more generous settlement, Congress was the main obstacle and in the depths of Depression there was no public mood sympathetic to writing down the debts. In fact, in early 1934, Congress passed, and Roosevelt signed, the Johnson Act, under which no government in default to the US would in future be able to borrow in the United States (enforced via heavy criminal penalties on anyone in the US involved in buying or selling such bonds). Gill notes that there are suggestions that Roosevelt may have been sympathetic to this measure, but whether he was or not, he had other fights he chose to spend his political capital on. The Johnson Act was in place when the UK made the final decision to default.

Much of the book is about the aftermath of default. As Gill notes, the defaults (not just Britain’s) appear to have reinforced the aversion to involvement in European affairs that resulted in the Neutrality Acts. But the most tangible effect, that came increasingly into focus, was the inability of the UK to borrow in US markets, something it would not normally do in peacetime anyway, but which would be likely to be necessary in the event of a new general European war (there had been considerable UK government on-market borrowing in the first couple of years of World War One, while the US was still neutral). Gill cites documentary evidence that in 1938 and 1939 senior British officials, and presumably ministers, were well aware of this emerging constraint (he isn’t writing about France, but it would be interesting to know if French officials were equally well aware). The issue wasn’t likely to arise in the very short-term (foreign reserves and existing holdings of marketable securities could be used to generate USD) but could easily became a binding constraint in any protracted (and British preparations assumed any new conflict with Germany would be protracted).

The issue came to a head by late 1940, as the British had placed defence orders in the US (and taken over some of those placed by France before the fall in June 1940). Its own sharply declining export receipts exacerbated the intensifying pressure on the available foreign reserves (USD and gold holdings) and it was increasingly apparent to both British and American officials in late 1940 that by some point in 1941 Britain would no longer be able to pay for the orders that were being placed.

By this point Roosevelt – whether he envisaged the US eventually entering the war or not – had concluded that Britain’s successful resistance was in the best defence interests of the United States.

And thus the genesis of the Lend-Lease programme under which aid could be granted to other countries, when doing so was judged to be in the defence interests of the US. Huge amounts were to go to the UK and the USSR in particular without any real expectations of post-war repayment (the idea of returning equipment after the war was there at the start). There was, by this time, a real aversion on all sides to a repeat of the entanglement of debts, and tensions post-war, of World War One (although the British – with survival at stake, the continued ability to fight the war – would have borrowed if they could, and did borrow heavily from within the sterling area).

But even with Lend-Lease well underway, and the US itself entering the war in December 1941, as Gill documents the memory of the 1934 default still hang over financial dealings between the UK and the US. In a decision he later regretted (describing it as his worst mistake in office) Truman cut off Lend-Lease assistance as soon as the war ended. The UK’s own export industries were not going to fully rebound overnight, and the UK still had significant foreign currency commitments (including occupation forces in Europe), and without a significant decline in living standards and/or a deep depreciation of the exchange rate (which finally came in 1949), the UK needed a gift or a loan (a large amount either way) from the US. People debate whether the US should have been more generous, but Gill’s book documents the way in which the memory of the past default shaped public and congressional opinion in finally agreeing the onerous terms of the loan (some of which quickly proved unsustainable,and were not sustained). This approach in turn jeopardised Britain’s willingness to proceed to join the IMF and World Bank (the very late British vote to finally proceed – mid-December, less than 3 weeks before the deadline – may have further reduced the prospects of New Zealand joining at the foundation).

You might have supposed to surely by this point, a whole new war having flowed under the bridge, the old debts – and memory of the default(s) would have passed into history, with no ongoing significance. And I think a fair reading of the book would be that that was largely so in the end in substance. But not in law, and – Gill has a book to sell – there have been surprising returns of the issue in the decades since, which have kept officials (and lawyers) busy, even apprehensive, from time to time. The US has never written off the World War One debts and has continued to record them with accrued interest in their own government accounts (Gill reproduces a US Treasury table from 2009, showing US$37.2 billion of debt outstanding, $16.7bn of which is owed by the British government. The British government accepts that the debt has not been written off – although since World War Two got fully underway they have not received six-monthly demands for payment – and has also long had the position that its own loans to World War One allies (including New Zealand) have not been written off either (of the New Zealand loan, Condliffe’s 1959 economic history records that after 1952 New Zealand no longer included its debt – 24.1 million pounds remaining, before any accrued interest – in our public debt statistics, but still recognised it then as a contingent liability). Gill even recounts the story of a court case arising out of a decades-old (1920s) will where, after the death of the life-interest beneficiaries the proceeds (by this time the 1990s) were to go towards Britain’s war debt to the US, in which officials in both countries had to decide what signals might be sent by their stance towards the litigation (to change the terms of the bequest). US courts ruled that there was a valid outstanding debt, which was legally enforceable.

But still the legacy of the default was not exhausted. When the UK first sought sovereign credit ratings in the late 1970s there appears to have been considerable discussion around whether and what to disclose regarding the 1934 default (which did not stop the UK getting AAA ratings.

There was talk in the 1960s, when France had accumulated large reserves, and was threatening to convert them to gold, of suggesting an offset with the French war debt. In the early 70s, a hundred US congressmen signed a resolution on collecting the old debts (at the time, the US was successfully pursuing debt arrears with several other sovereign borrowers). As recently as 25 years ago, then US Treasury Deputy Secretary Lawrence Summers was involved in a controversy within the US government regarding the accounting treatment of these debts and the signals that might be sent by particular choices. In this century there have been occasional questions in the UK Parliament regarding these debts. They sit, it seems, in a limbo in which it is in nobody’s interests to seek to press for payment (no one wants to reawaken the entire chain on other debts and claims, including German reparations) but no mileage in seeking to get the debts formally written off either. Perhaps they will forever.

In case you are wondering, the Johnson Act is still on the statute books – I have a hard copy of this very short piece of legislation in front of me as I type – but it was amended in 1948 to state that the provisions do not apply to any country that was a member of the IMF and World Bank (the UK has done some occasional borrowing in the US). New Zealand, of course, did not join the IMF until 1961, but then we had neither borrowed from the US government nor defaulted to them.

It is a fascinating and well-written book, drawing fairly extensively on archival material. New Zealand pops up surprisingly often: that outstanding debt to the UK still (apparently) not legally written off. There is absolutely no doubt that the default and the Johnson Act constraints mattered a lot over 1939-41, although I can imagine some other scholars perhaps mounting an argument that the post-war story, curious and interesting as it is, is a little over-egged (and I didn’t find his account of NZ’s debt difficulties in 1939 particularly convincing). Gill often raises the “what might have been” (but impossible to answer) questions. That could have been from both sides – whether more courageous political leadership in the mid-late 20s might have lead to a cancellation of all inter-government war debts, or whether (since it was able to pay) the UK continuing to service the debt after 1934, perhaps easing the grounds for finance in the early years of World War Two. It is impossible to tell but, intriguing factoids aside, perhaps what I took away most was the astonishing and courageous nature of the British decision to push towards confronting Hitler in a war knowing that the only international credit market where they might otherwise have raised funds was firmly closed to them. (If you wonder how Hitler got on, having no borrowing markets open to him, think pillage and plunder (“occupation levies”) of three of the most advanced industrial countries under Germany occupation by mid 1940.)

How much debt defaults really matter – especially for on-market debt raising – is primarily an empirical questions. But some years ago at a function I was talking to someone senior in local government finance in New Zealand. Somehow NZ’s credit record came up and I mentioned that in the article (linked to in the first paragraph) about New Zealand’s 1933 default I had noted in passing a couple of NZ local government debt defaults in the 1930s. My interlocutor was somewhat rattled as apparently information memoranda to potential latter day investors in local government securities had reported that no local government in New Zealand had ever defaulted. The defaults of a couple of small local authorities 80 years earlier probably had little useful information on probability of default now, but it still seemed to attract a little attention.

Now I’m almost curious as to what would happen if I sent $50 to the Minister of Finance or Treasury towards settling New Zealand’s outstanding World War One debt to the UK.


In the Sunday Star-Times yesterday there was a double-page spread in which various moderately prominent people (all apparently “leading speakers” at some “annual University of Waikato economic forum” this week were given 100 to 150 words to tell us “How can NZ build back following a string of serious economic and social setbacks”.

Most of the contributions were pretty underwhelming to say the least. To be fair, 150 words isn’t a lot, but real insight tends to shine through and there wasn’t much on offer in this selection. But then, who really cares much what the chief executive of the Criminal Cases Review Commission or the co-founder of an advertising agency think on such issues.

By contrast, Paul Conway is a statutory office-holder in an economic field. He is the (relatively new) chief economist of the Reserve Bank of New Zealand and in that capacity has been appointed by the Minister of Finance as an internal member of the decision-making Monetary Policy Committee. This was his contribution.

It was pretty bad. It is hard to argue with the first sentence, although the previous decades had not been an unbroken record of success and low inflation (check out core inflation measures over 2007 and 2008). But it was when I read the second sentence that I started to get concerned. What possible analytical or empirical basis is there for that claim?

For decades the Reserve Bank has told us (and rightly so) that there are no material long-run trade-offs between inflation and activity/unemployment/”prosperity”. That is so on the upside – you can’t buy sustained prosperity or lower unemployment by pursuing or settling for a higher inflation rate – but it is also largely true on the other side. Not only does lower inflation not create permanent adverse economic outcomes, but it is not a magic path towards materially better economic outcomes either. At best, and this is a line the Bank has also run for years, sustained and predictable low inflation, or price stability, may be conducive to the wider economy functioning a little better than otherwise, but any such effect is typically viewed as very small, and difficult to isolate statistically.

Unfortunately, Conway’s line has the feel of political spin, the sort of thing we might here these days from Luxon or Hipkins amid talk of a “cost of living crisis”. But, as the Reserve Bank MPC members should know only too well, real hits to economywide material living standards are not a consequence of general inflation but of supply shocks that (a) central bank can do nothing about, and (b) which would have been a thing, with adverse consequences for average living standards, even if the central bank’s MPC had done its job better over the last few years (Conway himself was not there when the mistakes were being made). As it happens, the process of actually getting inflation back down again will – on the Bank’s own forecasts – actually, and necessarily, involve some temporary losses of output and “prosperity”.

It was pretty poor from the chief economist of the central bank who (unlike his boss, the deputy chief executive responsible for macro matters and monetary policy) is a qualified and experienced economist.

Then we get the curious claim that monetary policy “is only part of the solution to reducing inflation”. Except that it isn’t. The way things are set, the Reserve Bank Monetary Policy Committee is responsible for keeping (core) inflation at or near the target midpoint, after taking into account all the other stuff that is going on, all the other policy initiatives here or abroad. Monetary policy isn’t the only influence on inflation, but it is given the job of delivering low inflation having factored in all those other influences. Thus, when the Canterbury earthquakes happened and there was a huge stimulus to demand over the next few years, it was still monetary policy (and monetary policy alone) that was responsible for delivering inflation near to target. We wouldn’t have wanted the repair and rebuild process slowed down just to have made the Reserve Bank’s job a bit easier. Same will go, on a smaller scale, for the repairs etc after the recent storms. Perhaps Conway or his colleagues think the government should be running a different fiscal policy, but as monetary policymakers it is really none of their business: fiscal policy and the central bank should normally each do their own jobs. As it is, Conway’s line gives aid and comfort to people talking up things like temporary petrol excise tax cuts as a way of helping ease inflation.

But bad as some of that stuff was it was the last three sentences that really struck me, including because Conway likes to talk about productivity (he was head of research at the Productivity Commission in that agency’s better day, and produced a range of interesting papers). We should all be able to agree that, in general, higher economywide productivity growth would be a good thing. People would be better off and individuals and governments would have more real choices.

But it isn’t a path to lower inflation, let alone lower interest rates, whether in the short or long run. And it isn’t clear why Conway appears to think otherwise.

In the short run, perhaps he has in his mind a model in which the Reserve Bank determines nominal GDP growth. If it did then, all else equal, the higher real economic activity was in any particular period then, mechanically, the lower inflation would be in that period. If higher productivity was an element in that higher real economic activity, and nothing else changed as a result, then higher productivity might be part of such a story. But the Reserve Bank does not control nominal GDP growth in that sort of mechanical sense, and if firms suddenly stumble on paths to higher productivity it is very likely nothing else will change as a result. Over the longer-term, higher rates of real GDP growth – and productivity growth – tend to be associated with higher, not lower, interest rates (a “good thing” in that context, as not only is there typically strong investment demand to take advantage of the productivity shocks and the opportunities they create, but also expected future incomes will be stronger and people will rationally want to lift consumption now in anticipation of those future gains). And if, as it appears may be the case, Conway is more focused on the short-term (“without the need for ongoing interest rate increases”) then it is really just magic fairy stuff, distracting from the (hard) choices the Reserve Bank has been having to make. Productivity growth isn’t just conjured out of the air at short notice to suit the cyclical preferences of central bankers.

It might have been better if Conway had declined to participate in this elite vox pop (after all, monetary policy really hasn’t much to offer, and we shouldn’t want to hear a central banker’s personal views on other policies) but if he was going to participate he really should have produced something better than what actually appeared. Yes, he didn’t have many words to play with, but the basic points aren’t hard to make quite simply. Whatever shocks, positive or negative, the economy experiences the Reserve Bank should be looking to provide a stable macroeconomic backdrop, and nothing monetary policy does can do more than take some of the rough edges off the worst of booms and busts while delivering a stable and predictable general level of prices. After the failures of recent years, that wouldn’t be nothing.

A couple of MPS thoughts

I don’t have very much I want to say about yesterday’s Reserve Bank Monetary Policy Statement – although “welcome back from the long holiday” might be in order. Oh, and I noticed a nice photo from my own neighbourhood on page 6 of the pdf.

As so often, I continue to be a bit surprised by the fairly superficial analysis of inflation itself. Thus, they include a chart of various core inflation measures, but all as annual rates. Surely, surely, surely, a central bank Monetary Policy Committee, ostensibly forward looking, would want to be focused as much as possible on the very latest quarterly data. For example, this chart from my own post last month on inflation data.

It isn’t impossible that the “true” story is less encouraging than this quarterly series might appear to suggest, but I’d have hoped to hear/see the analysis why or why not from the Bank. As just one example, the data aren’t seasonally adjusted, but the RB is big enough and has enough clout with SNZ that they could either redo the series using seasonally adjusted data or get it done for them (or having looked into it concluded any difference was small enough it didn’t matter). As it is, even if there are some seasonality issues the Q4 numbers for both series were lower than for Q4 in 2021. It looks to be a somewhat encouraging story – still some way to go to get back to annual rates around 2 per cent – but better than it was, better than it might have been.

There is still no sign either – in the MPS or any of the other material the Bank has published in recent months – that the Bank has thought any deeper about what and why they (like many other people) got the inflation (and, thus, monetary policy) story so badly wrong over 2020 to 2022. The Governor was reported this morning as telling MPC that he didn’t think the inflation outcomes represented a “failure”. With hindsight, things might be partly understandable, perhaps even somewhat excusable, but against (a) the targets the government set for the Bank, and (b) the promises of central bankers over recent decades as to what they could deliver, it does not help the advancement of knowledge or understanding (although perhaps it helps MPC members sleep at night) to pretend what has happened has been anything other than a failure. I

I’m not taking a strong view on what the inflation outlook is, or even how much additional monetary policy restraint may (or may not) be needed, but the second point from the MPS that struck me was around their own story and how well it held together.

On their numbers, the output gap was estimated to have been 2.1 per cent of (potential) GDP in the June quarter last year, rising to a new peak of 3.2 per cent in the September quarter. Here are the estimates and forecasts

Their forecasts show that they expect the output gap to have averaged 2.7 per cent of (potential) GDP for the Dec and March quarters too. In other words, the period of maximum pressure on resources and of upward pressure on core domestic inflation includes right now (around the middle of the March quarter).

If so, core inflation (quarterly) should have been continuing to rise, something there is no sign of in the data. And a great deal turns on the June quarter, when they expect a sharp fall in the output gap as GDP growth itself turns negative. That is a fairly big call in itself (and of course, actual events will be messed up by post-cyclone repair activity).

But what of inflation? The Bank forecasts that by the December quarter of this year, headline quarterly CPI inflation will be down to only 0.6 per cent. There is some seasonality in the headline CPI numbers, and December inflation tends to be a bit lower as a result. But the difference looks fairly consistently to be only about 0.1 per cent, so that a seasonally adjusted forecast for the December quarter (measured as at mid November, nine months from now) is probably 0.7 per cent. That would be the least bad outcome since 2020, and in annualised terms back inside the target range. (And the December quarter numbers won’t have been thrown around by the end of the petrol excise tax cut or temporary fruit and veg effects of the cyclone). If they deliver that it will be a good, and welcome, outcome. If we apply the eyeballed seasonal factors to their remaining CPI forecasts, by the September quarter of next year, quarterly seasonally adjusted inflation is right back down to 0.5 per cent – slap bang in the middle of the target range.

But I’m left puzzled about two things. The first is that the Bank usually tells us that monetary policy takes 12-24 months to have its full effects on inflation. If so, then why on their story do we need further OCR increases from here when inflation 18 months hence is already back at target midpoint. And then, given that inflation is at the target midpoint 18 months from now, why is policy projected to be set in ways that deliver deeply negative output gaps (not narrowing rapidly at all) all the way out to March 2026? Perhaps there is a good and coherent story, but I can’t see what it is (and I don’t see it articulated in the document). Entrenched inflation expectations can’t really be the story, because as the Bank has often noticed medium to long term expectations have stayed reasonably subdued and shorter term surveys of inflation always tend to move a lot with headline inflation which is expected to be rapidly falling by this time next year.

(My own story would probably put more emphasis on the unemployment rate as an indicator of resource pressures. On the Bank’s (and SNZ”s) numbers, the unemployment rate troughed a year ago.)

The final aspect of the MPS I wanted to comment on was the brief section (4 pages from p30) on “The international dimension of non-tradables inflation”. It is good that they are attempting to include some background analysis in the document, although sometimes one can’t help thinking it might better have been put out first in an Analytical Note where all the i’s could dotted and t’s crossed, and the argumentation tested. We might reasonably wonder what the non-expert members of the MPC make of chapters like this, which they nonetheless own.

The centrepiece of the discussion is this chart, which looks quite eye-catching.

Count me a bit sceptical for three reasons. The first is that I am wary of a picture that starts at the absolute depth of a severe recession and would be interested to know what it would have looked like taken back another three or five years. Perhaps they didn’t do so because the treatment of housing changed (very materially) in 1999, when the dataset they used starts from, but one is left wondering. Second, end-point revisions are a significant issue with the techniques used to derive the global CPI component, and might be particularly so over the last year when headline inflation has been thrown around so differentially depending on (a) exposure to European wholesale gas prices and mitigating government measures. And then there is the question of the countries in the sample. Of the 24, 12 are part of the euro-area (or in Denmark’s case, tightly pegged to the euro) for which there is a single monetary policy. For these purposes, it is like using as half your sample individual US states or Japanese prefectures. I don’t understand why they chose those countries, or why (for example) Hungary is in but the Czech Republic and Poland (all with their own monetary policies) are out. Or why you’d include Luxumbourg – which has the euro as its currency – and not (similar-sized) Iceland with its own monetary policy. And since this is just using headline CPI inflation data why you’d use only these countries anyway and not a range of non-OECD countries with market economies and their own monetary policies. Perhaps it would make little difference, but we don’t know, and the Bank makes no effort to tell us or to explain their choices.

Now, to be honest, if you had asked me before seeing this section I would probably have said ‘yes, well given that a whole bunch of advanced economy central banks made similar mistakes I might expect to see a stronger than usual correlation between New Zealand non-tradables inflation and some sense of “advanced world core inflation”. And thus I wasn’t overly surprised by the right hand side of the chart above.

The Bank attempts to address that question, summarised in this chart, using the same period and same 24 countries as in the earlier one.

But count me a little sceptical. Almost every OECD country – including their 24 (with all the same issues around selection of countries) – had unemployment rates late last year at or very close to cyclical lows. As New Zealand did as well. But whereas the Reserve Bank estimates our output gap late last year was +2.7 per cent of potential GDP (and, by deduction, the Bank must be using their own estimate in this calculation) OECD output gap estimates have 12 of the Bank’s 24 countries running negative output gaps last year (they don’t even think New Zealand’s output gap was positive last year, despite abundant evidence of resource stresses here). Given the choice between fairly hard unemployment rate indicators and output gap estimates which are notorous for revisions, personally I’d be putting a lot more weight on the labour market indicators where (as the Governor himself has emphasised in the past) all his peers say they have the same issue of “labour shortages”. (The OECD no longer publishes “unemployment gap” estimates but they do publish “employment gap” estimates, and of the Bank’s 24 countries only a handful had (small) estimated negative employment gaps in 2022).

They end the special section with a paragraph “What does this mean for monetary policy?”. I didn’t find their story persuasive – that it would mean monetary policy was harder – but given how little confidence we can have in the charts, it isn’t worth spending more time on that discussion.

Harry White, and reconstructing the international financial system

Harry White and the American Creed: How a Federal Bureaucrat Created the Modern Global Economy (and Failed to Get the Credit), a new book by James Boughton, was my weekend reading.

Boughton, now retired, was formerly the official in-house historian of the International Monetary Fund (IMF).   White was a fairly senior official in the US Treasury, a key adviser to Secretary Henry Morgenthau, from the late 1930s to 1945, and has a fair claim to have been the technocratic father of the IMF (and was then for a short time the first US Executive Director of the IMF).  It was a short official career and he died quite young, but has an interesting – and contested – story nonetheless.

What of the book?   Well, ignore most of the title.  I’m still not at all sure what the “American Creed” is supposed to mean in this context, and the bit about “created the modern global economy” is simply laughably wrong (and seriously misleading to the casual bookshop browser).  It is a full biography, but two-thirds of the book is about the last 7 years of White’s life (1941-48), including extensive discussion of the allegations which have dogged his reputation ever since that White may have been a Soviet spy.

By the time White became even moderately senior in the US Treasury, pretty much every country had moved off the Gold Standard (the European “gold bloc” countries not until 1936) and most major exchange rates floated.  In the diminishing number of democratic countries, private capital movements were mostly still free (although in the US for example private holdings of gold were simply outlawed).  Views differed on whether the new exchange rate regimes were a “good thing” or otherwise (in another book on my shelves there is a record of White on an official trip to London in the mid 1930s talking to prominent business figures who had embraced an era of floating exchange rates, but officialdom was often less enthusiastic).  In some circles then – and still today (Boughton seems guided by this story) – there was a narrative that non-fixed exchange rates were a material element causing a backing away from globalisation and multilateral trade in the 1930s (a story that I don’t think stands much scrutiny). It is certainly true that floating exchange rates in peace time were something of a novelty.

Then came the war (the US eventually joining in late 1941) with the attendant debt, disruption, and extensive controls over all manner of aspects in life in pretty every combatant country (and even many neutrals).

White wasn’t heavily involved in the creation of lend-lease, that innovative form of cross-country support initiated by the US (although they too were recipients of lend-lease assistance, New Zealand (for example) being a net provider of assistance to the US) but eventually had oversight responsibility for the administration of the scheme.  The real focus of his efforts as described in the book was on post-war planning, which absorbed a huge amount of resource among (in particular) US and UK officials even as the physical conflict raged.

As is fairly well known, there were rival conceptions of the details of what the post-war international monetary order should look like, exemplified by the ideas of White (for the US) and Keynes (a key adviser to the British).   But what no one seems to have been in much doubt about was that a regime of fixed (but adjustable) exchange rates should be established, and that if current account convertibility (ability to buy, sell and pay for goods and services freely from abroad) was over time to be a goal for many/most, private capital mobility was (at best) looked on with considerable suspicion (neither White nor Keynes were keen).  If you weren’t going to allow private capital mobility, not only were fixed exchange rates were more or less unavoidable but governments had to be sure of their own access to foreign reserves to manage fluctuations in the demand for their respective currencies.  There was no appetite for a return to a classical Gold Standard, but also a surprising attachment to the idea that gold should still have a place in the international monetary system (one presumption being that countries would be reluctant to accumulate substantial foreign reserves simply in the currency of another country without the ability to convert to gold).

If there were different conceptions there were also different interests and contexts.  The US, for example, had been a net provider of assistance to the rest of the world during the war, and so although it would emerge from the war with large domestic debts it had not accumulated an adverse international position.    The US under Roosevelt also came and went a bit on to what extent they sought to undermine the future of the British Empire and British Commonwealth relationships (notably the imperial preference trade arrangements, and the “sterling area” which had developed after Britain went off gold in 1931).  The UK, by contrast, had suffered a real large deterioration in its external financial position (as well as having lots of domestic debt) as a result of the war, and had accumulated huge volumes of blocked sterling liabilities to Commonwealth and Empire countries (goods had been sold to Britain, sellers had been paid in sterling, and the resulting central bank balances were not readily convertible into other currencies –  notably dollars).  New Zealand was among the countries that had accumulated such large claims on the UK.  The overhang of sterling liabilities was to be an issue for decades.   The US was keen on a fairly early move to convertibility, while the UK was wary, to say the least.   (There were, of course, many other countries, including the exiled governments of occupied countries like the Netherlands and Norway, but the bulk of the discussion and negotiation was between US and UK officials –  often led by White and Keynes (both of whom seem to have been awkward characters in different ways).

In institutional terms the US conception won the day. It was almost always going to. The US was by the biggest economy, was not itself dependent on external finance (although had a clear interest in a general post-war economic revival), and of course whatever was agreed between governments had to get through a US Congress that –  as ever – was not generally under the control of the executive.   And, in truth, the basic IMF structure (my focus here although the World Bank –  International Bank for Reconstruction and Development – also emerged, less controversially from this process) was an elegant one.   Countries would fix an exchange rate to the USD, while the USD itself would be convertible (for governments/central banks) into gold at a fixed rate.  Each member country would deposit some portion of their gold or USD reserves with the Fund, which in turn would establish rights for countries to “borrow” from the Fund in times of temporary balance of payments pressures.  Countries could make modest exchange rate adjustments themselves, but larger adjustments – to address structural imbalances – would require the approval of the Fund, itself governed by Executive Directors appointed or elected according to the quotas negotiated for each country.  I put “borrow” in quote marks, as formally the IMF did not do loans, but things that were more like currency swaps –  and obscure currency swaps (partly modelled on what had been done with the US’s own Exchange Stabilisation Fund in the 1930s) were thought easier to get through Congress than loans.  In economic substance there was no difference.

Boughton was, as I noted earlier, the official in-house historian of the IMF. Since the IMF still exists today, it is a perspective that leans him to seeing what was created in 1944/45 as an unquestionably good thing.   I’m much more sceptical.  One could wind up the IMF today and the world would not be worse off.   And one could mount an argument that if negotiated arrangements were almost inevitable in 1945, there is still little reason to suppose that the creation of the Fund was a net positive even then.

It didn’t –  couldn’t –  deal with the really big overhanging issues (including, but not limited to, those blocked sterling balances) and was part of state-led arrangements that enabled for a time some deeply unrealistic post-war exchange rates.  Britain, for example, went through a period of seeking further US financial assistance, was then forced by the US in exchange to allow early convertibility which went badly wrong very quickly, and only finally took the deep exchange rate depreciation that was always needed under pressure in 1949.   It is not hard to think that restoring floating exchange rates pretty much as soon as the war ended might have been a better way (also reducing the pressure later for the Marshall Plan – a point some US sceptics made even at the time).

But whether or not the creation was a good thing, there is little doubt that White was the technocratic father of the Fund – which exists today even if the world it was created for almost wholly doesn’t – and Boughton has written a useful and interesting account of aspects of that period, complementing the range of other books (many on the Bretton Woods conference in 1944 where the final details were negotiated with 40+ allied countries in attendance).

There is lots of other interesting detail in the book (occasionally too much – even as a former Washington resident I did not need every single street address White lived at), including White’s involvement in helping flesh out the madcap Morgenthau Plan that envisaged turning post-war Germany into primarily an agricultural economy. White owed his position to Morgenthau who in in turn owed his position and influence to his friend and neighbour Roosevelt. Once Roosevelt died, White’s hour in the US government system had passed,

One is left with the impression of an influential, extremely hardworking, smart individual, but also an abrasive and not altogether pleasant one.  In an age of great figures –  good and evil – my sense is that no one would today be writing biographies of him if (a) the IMF no longer existed, and (b) it were not for the espionage allegations (the two aren’t unrelated since it was uncomfortable for the Fund to have such allegations about one of its “founders”).

The espionage allegations were not my main interest in buying the book. Not being American I’m probably less interested in any case against White than in, say, the truth about Bill Sutch.   Boughton goes to great lengths to review and rebut in detail many of the claims that have been made ever since the 1940s.  In some cases, he seems very persuasive, and in others a bit less so.   What is now unquestionable is that some of White’s good friends and colleagues were Soviet agents in one form or another (in some cases very active), and even Boughton concedes that at times White may have been indiscreet in his ties with people who, while Soviet officials, were still wartime allies and official interlocutors.  But if Boughton’s is the pro-White case, other serious people (without IMF ties) still seem equally certain of White’s guilt.  Perhaps we will never really know.

New Zealand participated in the Bretton Woods conference where the new international monetary arrangements were settled.  Our key delegate was Walter Nash then (simultaneously) Deputy Prime Minister, Minister of Finance, and resident NZ Ambassador to the United States.  His small delegation including the Secretary to the Treasury, Ashwin, the then Deputy Governor (later Governor) of the Reserve Bank, Fussell, and the highly regarded economist AGB Fisher.   There were two main working groups at the conference –  one on the Fund chaired by White, and another on the World Bank chaired by Keynes.  Nash chaired a less important working group.

Bretton Woods was, in many respects, not a matter of great moment in New Zealand (and it is interesting that neither the war economy  nor political and external affairs volumes of the NZ official history of World War Two seem to have any mention of the conference or the issue).   New Zealand was firmly in the sterling area –  our pound pegged to sterling –  and Nash had a strong aversion to overseas debt.  But there was still an important defensive interest, since Labour has put in place pre-war extensive exchange controls and import licensing restrictions and had no intention of removing those restrictions in peacetime.

Digging around various other books on my shelves, it seems clear that Nash and the NZ delegation did not make a great impression.  Ed Conway’s book, The Summit, has a few comments.  Introducing Marriner Eccles, the then chair of the Fed, he suggests that Eccles’ oratory “would give New Zealand’s dreary Walter Nash a run for his money as the most self-important and tedious delegate”.  The relative size of each country’s quota in the Fund was then, as now, a matter of politicking dressed up behind an apparent technical façade.  New Zealand was among those objecting to the US proposal (not helped by the fact that Nash apparently confused sterling and dollar amounts) “in a ten-minute sermon from the country’s dreary lead negotiator, the Hon Walter Nash”.  Conway quotes from the contemporary diary of UK delegate/economist Lionel Robbins “throughout the conference {Nash] has shown a tendency to be about three bars behind the band”. 

A more recent history of New Zealand diplomacy during the war, by Gerald Hensley, has a more substantive discussion.  He notes that the delegation had a good grasp of the basic New Zealand needs “But not one had been able to do any deeper thinking about the implications of the Fund and on this occasion it showed”.  He goes to quote from a contemporary British delegation report back home which concluded that Nash was simply out of his depth (“He understood comparatively little of the technicalities, but could not restrain himself from intervening in an embarrassing manner on many complicated points which were, moreover, not the least concern to his country”).  The Australian delegation also recorded complaints.

As Hensley notes, however, the government’s (and Nash’s) main focus was on ensuring that nothing in the agreement would interfere with the government’s ability to maintain exchange and import restrictions.   Nash’s official biographer, Keith Sinclair records that “according to the notes he made at this time, he asked the chairman Harry D White whether exchange controls were permissible, provided that exchange was used to pay for all current transactions.  White replied that this was his understanding, and he asked the meeting if there was any dissent. There was none.”

(Which is all very well but it was not be until the early 1980s that New Zealand finally removed all restrictions on even current account transactions)

If Nash himself was content with the final form of the agreement, there was still a significant amount of angst back home.  Instructions came from the Prime Minister that New Zealand was not to sign adhesion to the Final Act from the conference, and in the end the two most junior officials in our delegation were allowed merely to sign a document that certified that it was a true record of the conference proceedings. That Nash himself was persuaded is reflected in a letter to Harry White that was read to the conference by a senior US delegate as the conference was winding up (Nash had had to leave early)

“Owing to the urgency to make a train last night it was not possible to say goodbye before leaving for New Zealand.  In congratulating you and those working with you on the foundation work in connection with the Fund and the Bank I affirm that it can easily be the greatest step in world history with possibilities of removing one of the major causes of war, if not the major cause.”

Talk about overblown political rhetoric.

New Zealand was one of a very small handful of countries that participated in Bretton Woods that did not join the Fund early on (the most prominent of course was the Soviet Union, but even Australia did not join until 1947).  There is an entire article to be written on this strange history one day (I have a big folder of papers I collected a few years ago but cannot immediately find it).  There was significant unease on both sides of parliamentary politics with talk of free votes. It seems to have been one of those issues that few cared much about (either way) but a minority (against) felt very strongly about.   The Labour government failed to take any lead (there was significant dissent in their own caucus), and by the 1946 election campaign the leader of the National Party was openly opposed to joining.   There seem to have been a range of concerns, some reasonable, some not, and it is not as if there was no sensible dissent in other places either (I read one speech from a senior former UK minister in the House of Commons ratification debate expressing concern that the IMF would allow the UK less exchange rate flexibility than the UK had needed in 1931).  Between close ties to the UK, some unease about an emerging US-led system, a commitment to the sterling area and UK trade preferences, all combined with on the one hand the NZ regime of controls and, in the late 40s, New Zealand’s strong external position (we revalued our currency in 1948) there wasn’t much momentum, before the undertones of Social Credit type concerns were mentioned.  When New Zealand did finally sign up in 1961, Hansard still records unease from Labour members that IMF membership might threaten New Zealand’s full employment record.

New Zealand did join.  New Zealand has borrowed from the IMF on a few occasions ( a former colleague recently described to me the gaming of the rules of one particular facility in the 1970s).  It isn’t clear that joining or not really made very much difference then or now – these days we get only not-very-useful advice and a few job opportunities for officials – although it would these days look odd not to be a member.

(Personally I’m quite glad NZ finally did join as four years on the IMF payroll –  two resident in Zambia, two as Alternative Executive Director in Washington – were by far the highest paid of my career, and the only technical assistance mission I ever did for them, in China, was conveniently timed to pay the bills for our wedding.)

UPDATE: Someone inquired about my observation that NZ was a net provider of lend-lease assistance to the US. On checking, I’m reminded that in accounting terms the two sets of flows were roughly even (we received about as much as we provided), however Hensley’s book (p250) notes that this somewhat misrepresented the flow of real value, since much of what New Zealand provided was valued at pre-war prices, while material received from the US was typically accounted for in contemporary price terms. To the extent this was so, NZ was a net provider to the US.

Reappointing Orr – some documents

Yesterday’s Herald had an interesting article on the reappointment late last year of Adrian Orr as Governor of the Reserve Bank. The article appeared to have been prompted by the Bank’s response to an OIA I lodged last year asking for background material on the reappointment. A link to that OIA response is now on the Bank website.

The key quote was this, from the letter from the Board chair Neil Quigley to the Minister of Finance recommending Orr’s reappointment.

“The governor will also model the highest standards of behaviour in promoting a safe environment for debate and in treating with respect those people with different views from their own, consistent with Public Service Commission guidelines,” 

The best that might be said for that claim is that it may represent wishful thinking that somehow their leopard once reappointed might change his spots. So many people who have interacted with Orr was Governor, or observed him interacting with others, could testify that he has modelled none of that sort of behaviour (and there are specific accounts on record from people for Victoria University’s Martien Lubberink and the NZ Initiative’s Roger Partridge, as well as the story that Quigley himself one day felt obliged to pull Orr out of a Bank Board meeting over concerns about Orr’s conduct in the meeting). Watch any Orr appearance at FEC and much of time his response to challenge and questioning has been pretty testy. There must have been a recent Damascene conversion for Quigley’s assertion to the Minister to be anything other than wishful thinking at best. More likely it is just outright spin.

There was another interesting quote in the Herald article itself, from Chris Eichbaum a Labour-affiliated member of the outgoing board (both the outgoing board and the new Robertson board recommended the reappointment). Eichbaum is quoted as claiming that

An outgoing board member, Chris Eichbaum, confirmed to the Herald the old board went through a “robust and exhaustive”, “backward and forward-looking” process before coming to its decision to endorse Orr.

However, the Bank released summary minutes of the relevant meeting of the non-executive old-Board directors on 12 May last year (which, incidentally, was attended by Rodger Finlay, at the time chair of the majority owner of Kiwibank, the subject of Reserve Bank prudential supervision). The entire meeting lasted only an hour, with five items on the agenda, including the Annual Review for the then Deputy Governor.

“Perfunctory” looks like a more accurate description than “robust and exhaustive” – which isn’t surprising since the old Board had no formal responsibility any more and most of the members were by then probably more interested in their own next opportunities beyond 30 June (I recall one telling us at about that time of the next role he was going to take on once he left the Bank Board). You get the impression that the new Board – on average even less fit for office – must have been even more perfunctory in its deliberations because the Bank neither released nor withheld minutes recording their deliberations on the matter (at their very first meeting on their first day in office, 1 July). Note that not even the Bank’s own self-review of monetary policy was yet available to either Board.

The Reserve Bank OIA response was not, however, the only relevant one. When Orr was reappointed I lodged requests with the Bank, The Treasury, and with the Minister of Finance. They all obviously coordinated their responses since all three were late and all three finally arrived on the same day.

What was interesting in these releases is what wasn’t there (not what was done but withheld, but what appears never to have been done). Thus one of the better aspects of the amended Reserve Bank legislation was supposed to be a heightened and more formalised role for The Treasury in monitoring the Bank on behalf of the Minister of Finance. But there is no advice at all from The Treasury to the Minister of Finance on the substantive pros and cons of reappointing the Governor even though (a) Treasury had just taken on a new heightened role and responsibility, and (b) the question of reappointment was arising amid the biggest monetary policy failure for decades. They drafted the Cabinet paper for the Minister of Finance to reflect the Minister’s own views, but that seems to have been all. There is no sign Treasury was even made aware, let alone asked for advice, when the two Opposition parties raised concerns about the proposed reappointment, even though this was the first time such consultation provisions had existed for a Governor appointment.

As often seems to be the case, the Minister of Finance’s response was fullest, although there were these documents withheld

Intriguing, since there is no sign in any of the other documents of any legal doubts about the ability to reappoint (and all these documents pre-date the letter from Quigley cotaining the Board’s recommendation to reappoint Orr).

The statutory provisions the Minister had inserted require the Minister of Finance to consult other parties in Parliament before recommended to the Governor-General the (re)appointment of a Governor. It was an interesting addition to the legislation (and arguably there is a stronger case for such a provision for the Governor than for Board members, where the record indicates that the Minister had already treated the consultation provision as no more than a cosmetic hoop to jump through on the way to doing whatever he wanted) and certainly suggested an intent that anyone appointed as Governor should at least command the grudging acceptance of other political parties (perhaps especially the major ones) given the huge discretionary power the Governor, Bank and Governor-dominated MPC wield.

Here is the body of the letter sent to the other parties on 19 September

Interestingly, the letter makes no substantive case for the proposed reappointment, addresses nothing (good or ill) about his record etc. I guess parties might be presumed to know Orr, but it still seems a little curious to make not even a one sentence case. But that is the Minister’s choice.

Three of the four non-Labour parties in Parliament responded (the Maori Party did not). This was the response from Genter/Shaw for the Greens

Being an unserious party, they supported reappointment because of things the Bank and Governor have no statutory responsibility for.

Both National and ACT expressed opposition to the reappointment. The letter from Nicola Willis has been released previously and so I won’t clutter the post by reproducing it all here. Their opposition was on the (deeply flawed) ground that they believed no five year appointment should be made for a term starting in election year (even though the starting date for the second term was in March 2023 and the election then seemed likely to be in October or November). However, Willis ended her letter this way.

Willis has since described the reappointment as “appalling”, but seems to continue to rely on the argument about a five-year term even though (as I’ve pointed out previously) their 2017 comparison is flawed and the legislation has always been designed deliberately not to make it easy for new governments, of whatever stripe, to come in and appoint their own person.

We had known that ACT was opposed to the reappointment but had not seen the body of Seymour’s letter back to Robertson. It is a couple of pages long and raises substantive concerns about both style and policy substance (but rightly not questioning the ability of the government to make a five year appointment). It has a distinctive Seymour style to it (and so even as an Orr sceptic some lines jar with me) but it is an undeniably serious document, in response to the first ever statutorily-required political party consultation over the appointment of a Governor.

But it was all just ignored. This is what little the Minister of Finance told Cabinet

so not even a hint as to the nature of the concerns the Opposition parties had expressed, or any reflection on what expectations (around multi-party acceptance, if not endorsement) the government’s own legislation might have given rise to.

After the Cabinet paper had been lodged, Robertson did write back to Nicola Willis in a fairly substantive letter (the full text of this and other documents is in here)

Robertson OIA on Orr reappointment 2022

The Minister rightly pushes back on the argument about pre-election appointments, highlighting the substantial differences to the 2017 case (and actually makes the interesting point, that I had not noticed, that the law provides for only a single reappointment, so any one year term for Orr would have to have been his final term).

Perhaps of more substantive interest are the comments from the Minister on the Governor’s monetary policy stewardship

A lot more spin than substance, that fails (completely but no doubt deliberately) to distinguish things central banks are responsible for and those they aren’t really, chooses not to distinguish shocks that New Zealand did not face (eg global gas prices), and in the end is simply complacent about the serious core inflation outbreaks here and everywhere else. There is no sense of any accountability.

The Minister’s letter ends this way

Not only has the entire legislative structure long been built around a model in which the Minister of Finance has always been free to reject a nominee (but cannot impose his or her own favourite) but it was Robertson’s own government that added the political party consultation provisions. Rejecting an Orr nomination – especially after both Opposition parties had expressed serious concerns – would not to have been to politicise the process, but would simply have been the Minister of Finance doing his job. As it is, the risk now is that the consultation provisions will come to be regarded just as an empty shell.

Those paragraphs above from the Minister’s letter to Willis are nonetheless of some interest because they are the only material, across three separate OIA responses, even mentioning the conduct of monetary policy on the Governor’s watch. In the Board minutes (see above) there was no sign of any consideration or analytical input (not that none of the Board members really had the capability to provide such an assessment themselves. In the Quigley letter to Robertson there is this

which is not only input-focused (rather than outcomes), focused on March 2020 (rather than the aftermath), but shows no sign of any critical reflection or evaluation. And in the Minister’s paper to Cabinet monetary policy and inflation – let alone $9bn of avoidable losses to the taxpayer – get no mention at all, just burble about Orr as a change manager (leading decline and fall perhaps?)

It was a poor appointment (my long list of reasons was in this post) even if one that was always to have been expected, since Robertson had never displayed any serious interest in accountability or performance, or much in the substance of the Bank’s role at all (and failure to reappoint might have risked raising questions about the government itself). But it is still a little surprising how short on substance, around the key failings of the Governor in recent years (style and substance), the documented parts of the process leading to reappointment seem to have been.

There are, of course, some levers open to a new National/ACT government were they to win the election, but it would be a little surprising if they do much at all. More likely, the decline and fall of a now bloated and unfocused institution will continue through Orr’s second (and apparently final) term.