Borrowing to save

Radio NZ reports:

ACT Party leader Don Brash is dismayed that Labour wants to borrow a lot more than National, saying it’s imprudent.

“This makes no sense at all. Why would any householder with a large debt borrow more money to invest in shares? No prudent householder would do that – the Government shouldn’t be doing that either.

“Personally, I think the Government should be selling the assets in the Super Fund and using it to pay off debt. Why the Government should borrow money to invest in shares is simply beyond me.”

The Green Party is also critical of Labour’s plans to borrow to feed the Super Fund, also known as the Cullen Fund. Co-leader Russel Norman believes such a move is economically irrational.

“The Cullen Fund is a repository for surpluses, so when the Government’s running surpluses it makes sense to stash money away for the future and we really applauded Labour for that.

“Whereas, when you’re running a deficit, the logic of borrowing to put into your savings doesn’t make so much sense to us.”

I’m pleased to see some economic sanity from Russel Norman on the issue of Labour’s plans to borrow to save. Norman is correct to call it irrational.

Readers should be aware that Labour’s promise to borrow for the fund perverts its original intentions, as set up by Michael Cullen. I blogged what Cullen said when it was launched:

How will the government pre-fund future New Zealand Superannuation costs if there are insufficient surpluses?

The government will make contributions to the Fund from available surpluses. Where these are insufficient for making the required contribution a reduced contribution would be made.

So what Labour are proposing with their goofynomics is not what Cullen said would happen. He never proposed borrowing money to stick into the Cullen Fund. It was explicitly a fund whose contributions would come out of surpluses.

Now Labour are proposing to borrow an additional $6.1b off China over the next three or four years and to give it to the NZ Super Fund, who will promptly invest it mainly in international sharemarkets (that is where 58% of the Fund is).

Now Europe remains on the brink of a debt crisis. If Greece goes under, this will snowball. French banks especially will be massively hit and may go under. That in term will push some US banks under, and what happened in 2008 could look mild. If this happens, expect global sharemarkets to plummet.

And the economic geniuses in Labour say this is the perfect time to borrow $6.1b and invest it mainly in international equities!!!

As Russel Norman, said it is irrational.

Yes, in theory sharemarket investments will get you a higher return than sticking money in the bank. But do you know why that is? Because they are riskier. And as individuals we may choose to take those risks, but it is not the role of the Government to borrow money on our behalf and risk it on overseas (or domestic) investments. The world’s financial markets are fragile, and there is no guarantee that the returns of the past will ever be achieved again.

The fund has now been going for eight years. That is more than a quarter of the time set aside for it to gain so much money, that it can start to subsidise superannuation from 2031. It has lost a whopping $2.8b in just five months. Over the entire eight years, it’s return has been just 0.5% higher than the average Treasury bill rate (the cost of borrowing). It’s not quite as simple as this calculation, but this means that the actual extra money available for superannuation in 2031 onwards is $2b (annual cont approx) x 0.5% = $10m/year or $80/m over 8 years. Allow some compounding and let us round that up to $100m.

Yes $100m is what eight years of the Cullen Fund has achieved, compared to the alternative of just paying off debt. Not going to make a fuck of a lot of difference to the sustainability of superannuation in 2031, will it?

National, the Greens and ACT all agree. Say no to borrowing to save under Goofynomics. We need less debt, not more.

UPDATE: The NZ Super Fund has e-mailed me to comment:

It is correct that the return on the Fund is 0.50% above Treasury Bills since inception to 30 September 2011 (or as you say about eight years).

But you have confused two calculations to arrive at your $100 million figure. The 0.50% p.a relates to the Fund’s return relative to Treasury Bills (which you do say), not to the contributions made by the Government and so should not be used to calculate the return on the Government’s contributions (which ceased in July 2009 and so did not cover the whole eight-year period in any event).

Yes the Super Fund overall has increased its contributions by more than $100m. But the point I was making was a comparison to if the contributions had been used to pay off debt.

Total contributions since inception are 14.88 billion. Our return since inception is actually 3.92 billion. Both of those figures are on our website. The 3.92 billion includes just over $2 billion in NZ tax (again, as on our website), which the Governments that received it over the life of the Fund (the bulk of which was in the last two financial years) would not have gotten otherwise. Clearly, we don’t know what the return on that $2 billion might have been had we invested it instead. The point though is that it’s a bit more than $100 million.

There is a debate about whether you include the tax returns, as the argument is that if the money was (for example) used to subsidise KiwiSaver more, then those funds would also have generated more tax.

Additionally, we believe that in taking a strongly commercial approach to investing locally we produce social and economic returns for NZ over and above the financial returns on those investments (e.g. the 50% investment in Shell, the 40% investment in Kaingaroa Forest, the millions committed to locallthy-managed funds providing growth capital to small and medium size NZ businesses, the investments in high-quality dairy land etc etc.) Now of course that’s not directly relevant to meeting the future cost of NZ Superannuation – but hopefully you agree it’s more broadly positive for NZ.

I should point out that in no way am I critical of the job the Guardians have done. My own superannuation funds have taken a beating also – every month I stick $1,000 in and they lose more than that, so my fund is dropping. My argument is around whether it is sensible to borrow to invest in the Fund.

Finally, a big part of the value of the Fund is that it exists at all. It is a part of the Crown balance sheet that has one specified purpose and one only – assisting future Governments to meet the rising cost of New Zealand Superannuation. We believe that does make a difference to the sustainability of superannuation from 2031 onward.

It does, but so does paying off debt. As I said in my original post, it is a balancing of returns vs risk. The events of the last three years have reminded us that the risk is real.