Places: Running NZ like an investment fund
6 February, 2016
Inc has mutated into NZ funds management: the modern way to run an
you make sense of modern economics? Why is the world so worried about
deflation these days? Didn't inflation used to be the big, hairy
monster so far as finance ministers were concerned?
the other week the Reserve Bank was talking about how the New Zealand
inflation rate – down at 0.1 per cent – is languishing
stubbornly below its
target 2 per cent. We've got to get it up somehow.
penny dropped when someone explained that in today's debt-soaked
world, inflation is your newfound friend. Every month it shrinks the
dollar value of what you owe a little more. You get to pay back
yesterday's $1 borrowed, with eventually a dollar worth something
more like 90 cents.
And as a nation, New Zealand now carries
$120 billion in debt. It is paying $6b in interest annually to keep
its credit card lifestyle going. So we really can't afford to drop
into deflationary territory where this ginormous lump of yesterday's
dollars are suddenly going to start costing us a whole lot
It makes sense. In a backward, wrong-end-of-the-telescope, kind of
Public finance and national economic policy do seem the
black arts of modern life. And in fact the experts say New Zealand is
riding a wave of changing practice that is far more radical than most
Former Canterbury University accountancy
lecturer Dr Susan Newberry, now professor of accounting at Sydney
University's business school, still keeps a fascinated eye on the
"New Zealand experiment". And some of what she sees she
finds a little alarming.
In a paper published by Public
Money and Management in January, she fingers the mythical
nature of our Earthquake Recovery Commission's (EQC) Natural Disaster
Fund – which she sees as part of a bigger story about how the
government now freely shuffles its assets around within the national
And in another heavy-hitting paper published
in Critical Perspectives in Accounting last year,
Newberry raised a red flag on New Zealand's financialisation of its
Does the average Kiwi know the country's
balance sheet now has a derivatives exposure of $180b, she asks? That
is rather a lot of those "financial weapons of mass
Sue Newberry of Sydney University: track record for uncovering
Newberry is taking something of a poke at what is happening over
here. However she has a track record for uncovering uncomfortable
truths in the national accounts.
was the 2003 Transpower deal where a majority stake in the South
Island electricity grid was sold to Wachovia Bank as part of an
elaborate tax minimisation scheme.
really, says Newberry, she is posing an open question. How is New
Zealand being run in terms of economic theory? And does the ordinary
voter – being dazzled by rather spurious "back into surplus"
election targets – understand anything well enough anymore?
is a feeling that New Zealand has been through its neoliberal
revolution with Rogernomics. During the late 1980s and early 1990s,
it made a wrenching transition from old school public accounting to
the lean corporate model – the start of a "New Zealand Inc"
approach to politics.
Newberry says we had legislative changes
such as the State Sector Act 1988 which brought in private sector
disciplines like accrual accounting. There were the state-owned
enterprises, public-private partnerships, and other new structures
that put the delivery of state services on a commercial footing.
idea was to run the national economy as if it were a business, with
taxpayers as the shareholders hoping for a general dividend return on
a thriving concern. It caused much angst at the time, but now New
Zealand seems settled into that NZ Inc groove.
Newberry says in fact the past decade has seen the running of the
economy evolve in a way that keeps New Zealand at the forefront of
small country innovation – like maybe Ireland, Iceland, even
goes up ... even the experts can find high finance a puzzle at
a nutshell, NZ Inc has mutated into NZ funds management.
says successive governments have financialised the economy through
the creation of all kinds of notionally ring-fenced public funds –
the Accident Compensation Corporation (ACC) being an example –
matched by galloping international borrowing and an ever increasing
reliance on risk-hedging derivatives.
grand goal is to free up the national balance sheet so it can be
fully leveraged for growth. The government in effect becomes a
portfolio manager, directing taxpayer capital – or rather the
greater capacity for borrowing thus created – into whatever
activities seem the most long-term profitable.
agrees on one level it is absolutely sound. In the Asian century,
with all the opportunities of the Pacific rim, New Zealand can hope
to be a tiger economy. Speculate to accumulate.
is being created at the level of a whole country about the investor
profile it wishes to choose. In the jargon of financial advisors, do
we as a nation want to be a "conservative", "balanced"
or "growth" managed fund?
So the economic theory is
as modern as it can be. But do Kiwis understand the downside risk of
a financialised economy employing all the latest investment bank and
hedge fund tricks, Newberry asks?
"Shareholders in a
business aren't ever going to lose anything more than what they put
in. It is limited liability investing. But the difference with
corporate-style governmental accounting is that it is unlimited
liability. It is New Zealand's taxpayers and residents who are on the
hook if there are any problems."
not a secret change, even if it has gone over most people's heads,
She cites Treasury documents starting 2007
where: "Treasury has begun to represent its role as that of an
investment fund manager, even to the extent of recasting the
government's statement of financial position into an (unaudited)
investment statement, and referring to the assets and liabilities as
an 'investment portfolio'."
And every year, that language
has become more pointed, says Newberry. In 2012: "Treasury has
reported that although the assets in this 'investment portfolio' are
classified into social, commercial and financial assets, the Treasury
as investment manager intends to advise the government 'on the
allocation of capital to its highest value use'."
others are remarking too. In a Budget 2014 commentary, accountants
KPMG noted that increasingly the national balance sheet is being
"monetised" – another way of saying the government is
taking trading positions by owning investment stakes in physical
assets, rather than owning the physical assets themselves.
accountant Cam Preston: derivatives form the economy's "base
says this is most obvious with funds like the EQC, ACC and New
Zealand Superannuation – a portfolio of three Crown entities
representing $60b alone.
KPMG was cautiously positive, noting
that in terms of the "market evaluation" of the government
as an investment entity, New Zealand voters are making known their
shareholders' view every three years. So it must be doing all
However others, like Dr Jane Kelsey, law professor at
Auckland University, have shown more concern. Last year Kelsey
wrote The FIRE Economy, arguing New Zealand was gambling
too much on the neoliberal bets of finance, insurance and real
And internationally, as academics pore over how the
2008 global financial crisis (GFC) caught out European "periphery"
nations like Ireland, Iceland and Greece, the talk is of how they
allowed themselves to be financialised – open to sudden inflows of
Though the counter-argument – the one heard
from New Zealand Treasury – is that New Zealand has made its own
big moves only after the credit crunch. So we should be hitting the
investment cycle at the proper moment, right when money is cheapest
and the rest of the world still rocking on its heels.
are the mechanics of this new investment portfolio
Interest.co.nz commentator and Christchurch
chartered accountant Cameron Preston – who coincidentally was a
student of Newberry's and has now joined her in her analysis –
offers the simple version.
In essence, he says, it comes down
to accrual accounting, balance sheet leveraging, and derivative
hedging. And as Newberry acknowledges, the theory is rational. After
all, it is how the world's most successful investor, Berkshire
Hathaway's Warren Buffett, made his fortune.
Buffett spotted value in the balance sheets of the rather staid world
of insurance. Pots of money were being created and parked by people
paying premiums in advance of misfortune. If you could own those
funds, you could then leverage them to invest more
"He started making his money from
insurance and reinsurance because effectively what you end up
building is large sums of free money that you can then go and use to
do other things."
Buffett of course was unusual both in
the astuteness of his investments and his readiness to pursue the
long-term, Preston says. But the general principle is the same with
the government's current economic philosophy – get the national
balance sheet liquid in ways that today's capital can be used to
purchase tomorrow's best revenue streams, whatever those might happen
to look like.
change started with the shift to accrual accounting right back under
Rogernomics in 1988.
says in simple terms, accrual accounting is about recognising
"economic events" regardless of when the actual cash
transactions occur. So what are recorded are the decisions to incur a
liability matched against the financial assets thus being
In the old days, the country's accounts were run on a
cash basis. Tax-payer revenue came in, the government spent it on
public goods and services. The Auditor General was still very much
also the financial controller.
"In the cash accounting
world, the Auditor General could say you can do whatever you want,
but I'm putting the cheque book in my back pocket now, so you come
and see me when you want to actually do something."
accrual accounting has become the norm for corporations. And with New
Zealand as one of the pioneers, increasingly so for countries.
the theory is good, says Preston. It gives governments the
flexibility to borrow in the name of future growth. The cost of a
debt created today can be matched in the public accounts against its
expected future pay-back.
University's Dr Jane Kelsey: warning of the financialisation of the
brings a certain purity of thought as well, says Preston. Everything
a nation owns is considered in terms of its dollar value.
crown agencies and state enterprises were formed under the
corporatisation model, they had to start accounting for their assets.
So the New Zealand Transport Agency (NZTA), for instance, calculates
the fair market value of the nation's road network.
could hardly sell off the land underneath our highways," Preston
admits. Yet accrual accounting allows our roads to be included in the
national pot of assets.
And Preston says that is great when
the international credit rating agencies come calling and give our
sovereign debt an AA tick of approval, lowering the government's cost
of borrowing – the interest rate that must be paid in the world's
Preston says if in theory everything is up
for sale, then – like the first-time home buyer wanting to borrow
as big as possible to get aboard a growing property market – this
frees New Zealand to pursue its brightest possible future.
as Newberry also says, it does mean the New Zealand tax-payer is on
the hook if it all goes wrong and there is – as with Greece,
Iceland and Ireland – the international equivalent of a
bank-imposed mortgagee sale.
That is accrual
accounting. And so to derivatives.
In her "Critical
Perspectives" paper last year, Newberry asked why the New
Zealand government's use of derivative instruments had increased so
dramatically – what policy did it represent?
Newberry was following up on complaints she made to the Auditor
General in 2013 that the national accounts were not even revealing
the true extent of derivative use.
Newberry says the figures
reported were net positions – a fair value assumption about whether
the individual deals were in profit or loss – not the total amount
of exposure. The Auditor General changed the reporting practices,
given Newberry the full figures to analyse.
Now Newberry notes
their astonishing yet generally unremarked rise. She says New
Zealand's derivatives exposure has gone from $18b in 2002, to $86b in
2007, to – by her reckoning, adjusting for some accounting changes
– today's figure of $180b.
Newberry says of course the
overall economy has grown too. But that is still a change from 14 per
cent of GDP in 2002, to 52 per cent of GDP by 2007, to 90 per cent of
In itself, Newberry says there is nothing wrong in
the use of financial derivatives – futures, options and swaps of
various kinds. But it all depends on whether they are being used to
hedge assets or instead to leverage speculate investment.
of the portfolio strategy: PM John Key and Finance Minister Bill
English on Budget day.
trying to explain it simply, Preston says a derivative is a contract
between two parties. So it relies on each being around long enough –
and having deep enough pockets – to fulfil both sides of the
a balance sheet tool, derivatives can be used to tune investment risk
either way. By betting against the possible downside of an investment
– say a change in exchange rates which makes the future cost of
finishing some national road-building project unexpectedly more
expensive – you can insulate your risks.
you can do the exact opposite, the equivalent of doubling down on
your bets, by applying leveraging that only pays if all your
investment strategies pan out.
says the claim is the New Zealand government only employs derivatives
for hedging – targeting the neutral outcome. And by being such an
active user now – creating a market of $180b – it is deepening
the New Zealand capital markets in a way that is good for the whole
markets in the form of insurance businesses, pension schemes and
derivative instruments, are really a way of protecting against
shocks. So in New Zealand we had the oil shocks and so forth – a
lot of economic upheavals through the 1980s.
a mature capital market is seen as a way of insulating a country from
those external shocks, like the base isolators under a building in an
economic theory is that a financialised economy is self-correcting
because the money represented in a nation's assets becomes divorced
from the physical ownership of those assets themselves.
are smart. So letting the money to flow through complex webs of
derivative transactions is a way to stabilise the economy as a whole.
And Preston says this fits in with the value investing philosophy.
economic storms are brewing one year, the worst will be hedged in
advance – already allowed for in the national accounts. This would
allow New Zealand to hold its nerve, pursue its long-term strategies,
despite passing bouts of financial turbulence.
Preston agrees as usual the theory is fine. The problem though is
derivatives by nature are not transparent. In his work, valuing
derivative positions for companies feels more like alchemy.
government's full derivative exposure is now massive at 90 per cent
of GDP. While those are different positions, all meant to offset each
other, and you would never have a scenario where they all went wrong
at the same time, you still end up with this opaqueness," says
a fund manager, the government is asking the public to take its skill
in managing the nation's trading position mostly on trust.
accrual accounting allows for the financialisation of the economy. It
puts the entire nation on the balance sheet in a way that lets
taxpayer assets find their best investment home.
derivatives provide the base isolators, ensuring these national
investment positions are not derailed by the occasional global
wonder New Zealand has a former derivatives trading star as its prime
minister, quips Preston. Who better to understand such a game?
Likewise Australia now has an investment banker, Malcolm Turnbull, in
charge. The portfolio approach looks to be spreading.
opaqueness itself is an issue. Which brings up the use of various
increasingly notional – indeed Preston would call them mythical –
national investment funds.
says once more the beginnings had the noblest of intentions. Labour
finance minister Michael Cullen's 2001 NZ Superannuation Fund was set
up as a pot of government money that would be invested today to pay
for the pensions of tomorrow.
deal was the government would put in $2b or so every year. An
investment team would place the money wherever it would make the best
returns. Then by 2028, there would be bank of savings the government
could start to draw on to cover its pension promises.
says it was responsible finance – a change from constantly loading
the cost of superannuation onto the next generation. And the super
fund has been making stellar investment returns.
ACC was set up to become eventually self-funding. ACC contributions
were set so they would build up a pot big enough to cover the
expected lifetime costs of looking after the seriously injured. And
again, says Preston, employing sharp traders to play the world
markets, ACC now sits on its own nest egg of $32b.
Natural Disaster Fund is another such rainy day story. Once just a
government promise to cover the cost of any major earthquake, EQC was
eventually set up as a Crown entity that used premiums to buy
reinsurance and also steadily build up a further $6b fighting fund.
on paper, all good. But Preston says just as Buffett likes owning
insurance companies because they have parked assets which could be
doing more exciting things, public funds are tempting for a
government which thinks building a nation may be a better investment
than putting the cash into overseas long-term assets.
says the super fund has survived largely intact. But in 2008, an
incoming National Party did say it wanted to see 40 per cent of the
fund going into "New Zealand investments".
didn't happen. Instead National simply said the fund was doing so
well it could afford to suspend further contributions for a decade.
Preston says it shows how supposedly ring-fenced funds can be tapped
to divert their wealth into buying government stock – a roundabout
way of raising capital for whatever a government thinks the country
ought really to be doing, like paying for irrigation schemes or new
this is exactly what has happened in Ireland, where its Pension
Reserve Fund first helped bail out Irish banks, and now is being
ploughed into "economy-stimulating infrastructure projects"
as part of its own national rescue plan.
ACC, Preston says its investments are being actively used to support
the government's balance sheet.
2008, $820m, or 9 per cent of ACC's portfolio, was placed in New
Zealand government stock. That has soared to about $10b, or 31 per
cent of the $32b.
says it worries him ACC is also now reporting profits from
derivatives trading – $250m last year on a $12b total exposure.
shows ACC must have a crack team to come out on the right side of the
deals. But following on from the Reserve Bank reporting a profit on
shorting the over-valued New Zealand dollar, is the hedging starting
to tip over into bolder trading?
is the problem with derivatives, Preston says. There is a tendency
for people to start getting creative with them unless they are
Newberry has now written about the EQC and how the Canterbury
earthquakes reveal the extent to which there was no real pot of
savings there. The fund in reality consisted of $4b in overseas
reinsurance and $6b which the government had directed EQC to invest
into government stock.
the $6b fund was in fact an IOU on premium income already long spent
on general "nation-building" projects, says Newberry. To
repay actual cash to EQC, the government has had to go out and borrow
that money. Or as some have argued, find ways to trim the cost of
says it is going to be future taxpayers who will repay those loans
gradually through higher EQC premiums for many years. There won't be
much scope for "topping up" EQC ahead of further natural
average person would think that there was a pot of money there, and
if we used up that pot of money, nothing else would be affected. But
that's not the case."
Preston's view, the super fund is still 100 per cent a real fund as
it has so far fended off a government financialisation of its assets.
But ACC is now 30 per cent a myth, and EQC 100 per cent of a myth, as
they are gathering premiums which are being channelled into the
government's general balance sheet rather then earning real money in
then the definition of a fund keeps getting looser, he says. The 2013
sale of state-owned power companies – half shares in Meridian
Energy, Genesis Power and Mighty River Power – was justified by the
setting up of a Future Investment Fund.
says the cash raised was put into a pot meant to be spent on nation
building projects. And it is true, it has.
the projects are such things as education, broadband, roads,
KiwiRail, and a few odds and sods like the $5m to repair roof leaks
in the Beehive – the usual things taxpayers would expect to see
money spent on anyway.
says the $5.5b Canterbury Earthquake Recovery Fund is another such
stroke of an accountant's pen.
was a number plugged into the national balance sheet early on to
suggest the probable cost – signal a level of government
commitment. But Preston says that is not the same as real money –
cash which has been appropriated in a Budget and can't so easily be
Preston adds this is not necessarily any criticism. It largely
reflects the logic of accrual accounting and a move towards a
deliberately fluid investment portfolio approach to the economy.
physical assets that taxpayers thought they owned are being monetised
– converted to pure investment flows. To paint some stability of
public understanding over that requires the kind of social contract
which a "fund" represents.
says at least there is a national investment statement that tells us
in general terms the various good things our taxes and various extra
premiums should eventually be doing.
theory sounds good. No one could mind being compared to Warren
Buffett. But the fear is how hard it is becoming to follow what is
really going on under the covers of the New Zealand economy.
says it gets back to voters being able to understand what they are
really voting for.
don't think anyone should relax and assume they're being taken care
of here. Rather there is a need to engage with these kinds of
financial matters. And it is the ability to engage that's become
difficult," she says.
government's latest audited accounts show that it has total
liabilities (mostly borrowed debt) of $186b, and total assets (half
of them financial stakes) of $279b. So on paper, according to this
annual investment statement, New Zealand's net worth stands at $92b –
safely in the black and healthy sounding.
this is accrual accounting, says Newberry. A claim about borrowings
today and earnings tomorrow, anchored by what is now a very large
all seems to be working out so far. New Zealand's economy has been
performing. It has managed to borrow substantially and invest on the
global financial down swing. It may prove to be among the most nimble
market players in this dawning Asian century.
Newberry says New Zealand is continuing to make deep structural
changes in going beyond its NZ Inc corporate revolution and now
entering the NZ funds management era.
how well is that understood in a world where a positive inflation
rate is still a wee bit baffling to most folk? Which reminds me.
Perhaps explain that one to me just one more time again?