Orrsomely Shite

I knew Adrian Orr slightly at Waikato University where he had a reputation for loving the Chunder Mile and doing funny, crazy things like ploughing an old motorbike into one of the varsity duck ponds during some midnight drunken madness. He was an outsized character.

I had no idea what degree he’d done so was a bit surprised when he turned up running the NZ Super Fund (Cullen Fund) and even more surprised when he got appointed to be the Governor of the Reserve Bank given his lack of qualifications for either job, especially compared to previous Reserve Bank Governors.

He’s been a disaster, although that’s been aided by a spendthrift Labour government. But aside from inflation getting away on him, there’s also the news that he’s now the $9 billion dollar man – $9 billion in losses that is. Michael Reddell at Croaking Cassandra has the story:

August was not a good month for the government bond market: yields rose further and the market value of anyone’s bond holdings fell. And thus the Reserve Bank’s claim on the government, under the indemnity the Minister of Finance provided them in respect of the LSAP programme, mounted.

Presumably all the numbers will eventually turn up in the Crown accounts, but for now it seems safe to assume that Orr and his colleagues (facilitated by the Minister of Finance) have cost taxpayers around $9.5 billion dollars – getting on for 2.5% of New Zealand’s annual GDP (or about 7 per cent of this year’s government spending).

Basically what happened was that back in early 2020 there were the usual worries about liquidity in the economy because of all the businesses being shut down by the government with their lockdown policy. It’s what happens in a typical recession and what happened big time during the GFC (Global Financial Crisis) of 2008-2009 – except those situations happened because of internal changes in the private sector, even if government policy has a hand in them (which it especially did in leading up to the GFC).

Global government bond markets were in a mess in April 2020 – a reflection of primarily US-sourced extreme illiquidity and the flight to cash (at the time stock markets were falling very sharply too). The interest rates on Government bonds were rising (even as policy rates had been cut). There were worries that private banks and investors would not be able to or would be unwilling to buy these bonds.

So the Reserve Bank decided that even more pump-priming of the economy was needed and to that effect they created the LSAP programme (Large Scale Asset Purchase) in March 2020. They would buy up to $30 billion of government bonds – and their bet was that inflation (and hence interest rates) would stay low, just as they had after the GFC, despite massive amounts of credit creation by central banks back then (the infamous Quantitative Easing (QE) approach). In fact the US Federal Reserve back in 2011 even called one of their efforts the same name, although QE is the better known name and it purchased a lot more than just government bonds.

In the late 2010’s central banks began to offload those bonds from their books, selling them back into the market and they didn’t lose money because inflation and interest rates remained as low as when the bonds had been issued. Private banks were happy to buy them as a good investment.

But not this time. As inflation and interest rates have risen so have bond yields (because otherwise they don’t sell), and so those old bonds with their low yields don’t look so hot as an investment and thus have to be sold at a discount or not at all. This sort of thing happens in bond markets all the time and old bond holders lose when it does.

Central banks should be (modest) profit centres for the Crown. Between their positions as monopoly issuers of zero-interest notes and coins and as residual liquidity supplier to the financial system there is never a good excuse for a central bank to lose money, and certainly not on the scale we’ve seen here (and in other countries) in the last couple of years – punting massively on an implicit view that bond yields would never go up much or for long (as they hadn’t much in the previous decade when other central banks were engaging in QE).

If you’re wondering why this matters this time it’s because there was an indemnity clause put into the LSAP that would allow the RB to call on the government to replace its losses. The RB has to pay much higher interest payments to the private sector on the vastly increased settlement cash liability relative to the yields on the bonds. It amounts to about $1800 per person in NZ – and that’s money that won’t be spent on things like education and healthcare.

And as Riddell points out there was never much upside to the programme in the first place – although Orr is now trying to argue that there was, but as has become usual with the RB, has no quantifiable argument to back up that assertion:

As it is, the 10 page note does not even provide a serious attempt at a rigorous framework for evaluating costs, benefits, and risks – there is more handwaving, and attempts to blur any analysis, than serious reasoning.

Did the RB really think NZ yields would stay at 4% or more while US, UK, Europe. Canada, and Australia all fell to 0.50% or under? The LSAP really was not needed – and Orr may well be re-appointed in the next few months.