Orr on Super Fund

March 5th, 2009 at 8:31 am by David Farrar

CEO has an op ed in the Herald. Interestingly the Herald notes he won’t do an interview with them – only an op ed.

Before I respond, I should make clear that I think the Fund’s “Guardians” have generally done an excellent job. The fact the fund has made less money than we would have got by paying off debt, is because of the global economic recession – not because of bad decisions by the fund managers. All funds have been hit.

They key issue for me is whether one should borrow money to invest in the Fund, when the whole rationale for the Fund was that it would be “surplus” funds that gets invested. Anyway Orr says:

Investing for future retirement income is just one activity the Government does. It is equally valid to talk of government borrowing in order to fund tax cuts, or pay for schools and hospitals. All of these activities are funded through tax revenue and borrowing. This is an everyday practice across households, businesses and governments globally. In fact, the New Zealand Government has done well, with one of the lowest government net debt positions in the OECD.

I think this is somewhat misleading. Investing in the Super Fund is not a core Government activity such as paying for schools. It was set up specifically on the premise that it would be funded out of operating surpluses. It is not just a competing expenditure like schools.

And if you look at th Treasury accounts, the contributions to the Fund are not expenditure. They are shown as the line after the Operating Balance, which is now heaving negative.

The Government has been running a public debt programme throughout the entire life of the fund. The fact that the Government’s operating accounts have gone into deficit makes no difference to the investment proposition of the fund.

I disagree. Borrowing to pay for capital expenditure is very different to borrowing for operating expendiiture. Let’s use a household example.

Household A has income of $100,000 a year and expenses of $60,000. So it has a surplus of $40,000.  It decides to borrow $400,000 to buy a house. So it is taking on debt, but it is running a surplus to allow that debt to be paid back. Hence while not stictly rational, it is quite reasonable that it may stick $10,000 of its surplus into a savings account and $30,000 into debt payments.

Household B has income of $70,000 a year as the husband has lost his job. And their expenses are $80,000 a year. And they still owe $200,000 on their mortgage. So every year they have to borrow $10,000 to just pay the household bills, and borrow $20,000 to meet the interest on the mortgage. Now in this scenario, would you also borrow a further $10,000 to stick into a savings account? Of course not.

The fund is a simple concept. The Government has legislated to invest money today to gain a return over the long term. That return is to be used in the future to smooth the tax burden of the rising cost of superannuation income.

Yes but it is not going to smooth the tax burden anymore. If we have a decade of deficits and debt, then we will still need to massivley increase taxes in the future to pay for it.

One measure of financial success is whether the returns to the fund over decades (not randomly selected days, weeks, months, or year-to-year) are above the cost of government borrowing.

Yes, and sadly the returns over the entire life-time of the Fund are around half the cost of borrowing. Now this is not the fault of the Guardians, but a consequence of the recession. But it is a fact.

When it comes to saving for the future, there is no free lunch. If we don’t save now the retirement payments time bomb in the future simply grows.

Borrowing to save, is not saving. It is like me borrowing $10,000 on the credit cards and claiming I am a saver as I have $5,000 in a low interest savings account.

A government is in a great position to benefit from investing over decades, more so than any individual. It can focus on the long term and, hence, make investment decisions not available to many. It can capture this premium. It has the ability to ride out the tough patches and avoid “fire sales”.

Here I agree. Mind you the Iceland Government might not.

Right now, the earnings prospects for long-term investors have also just improved significantly. This is especially so for a young Super Fund like ours, with the weight of money ahead. The global recession has seen asset prices fall and the rewards for accepting investment risk rise to historical levels.

This is probably right, but have we hit the bottom of the market? I’m not at all sure. I think Europe is looking very vulnerable.

That’s not to say investment opportunities may be better again in 12 or 24 months’ time. But, as long as we are able to buy more as value opportunities arise, and not be forced to sell assets at “fire sale prices”, we will succeed in our task. History also teaches us that the best time for investment returns is after significant downward corrections. We must make sure NZ is positioned to benefit whenever this occurs. Stopping out now would ensure we suffer the downside and miss the inevitable leg up.

And in 24 months or so, maybe contributions could be restarted (if they are ever suspended – who knows what the Govt will do).  But until the Government can start to make inroads on reducing the deficit, so it tracks back to a surplus at some stage, I would rather have lower debt by not making contributions.

UPDATE: Brian Fallow makes similiar arguments to Orr in his column today. I think he is wrong also :-). He also argues that investign in the Fund is just liek any other sort of expenditure and that you not argue it is all being borrowed. Again I disagree – the contributions were designed to be funded out of operating surpluses.

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41 Responses to “Orr on Super Fund”

  1. expat (4,050 comments) says:

    Right now, the earnings prospects for long-term investors have also just improved significantly.
    >> euphamism for the markets look like they may possibly have stopped going down like a $5 hooker. maybe.

    This is especially so for a young Super Fund like ours, with the weight of money ahead.
    >> Say what? As opposed to a large, established, mature, cash rich super fund?

    The global recession has seen asset prices fall and the rewards for accepting investment risk rise to historical levels.
    >> Which rewards are these?

    Cough cough, emotive and misleading bullshit.

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  2. jcuknz (704 comments) says:

    Once upon a time schools were not part of core government activity … everything has to start sometime.
    It is rational if the family believes there is another job in the near future.
    For somebody who has problems with saving it can make good sense to borrow at 20<22% on a credit card for a couple of weeks or even a month than to break into one’s savings and loose interest … less so these days at 3.75% than last year at 8%.

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  3. burt (8,206 comments) says:

    In the lead up to the election the left wing fruit lopps (you know who you are) were going bananas about National increasing debt if they got into power. We suffered endless barrages of the evils of borrowing to pay for infrastructure and the real cost over time etc. See the myopic creatures who hang on every word their master Dr. Cullen said never really understood that funding long term infrastructure from current cash flow was inequitable…. and debt was really really bad right…

    Now they want to borrow to invest – they are mad OR stupid or both.

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  4. expat (4,050 comments) says:

    both. and disengenious lying scum. imho.

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  5. Murray (8,845 comments) says:

    Borrowing to invest and reduce the value of the money borrowed is insane. It would be cheaper to borrow later to pay the retired directly.

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  6. burt (8,206 comments) says:

    Murray

    I have discovered its pointless talking common sense to people with an ideology which is bigger than their intellect.

    Of course borrowing at a higher cost than the earnings from the invested money is foolish… but the Cullen fund is an ideology thing… no common sense will be permitted by the followers of failed ideologies and lovers of corrupt govt.

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  7. jacob van hartog (300 comments) says:

    Orr says ..lowest government net debt positions in the OECD.

    Well well . Who would have screamed for the last 5 years that all the ‘surplus’ should have gone in tax cuts- that would have boosted inflation, increased overseas borrowing.
    So hardly think your economic ‘analysis’ would be worth following now. When you have got it spectacularly wrong for the last 5 years ( in fact you wanted even more borrowing, thinking were werent geared enough!!)

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  8. expat (4,050 comments) says:

    WTF are you talking about commie?

    Are you on the bong at 0930?

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  9. slightlyrighty (2,471 comments) says:

    Why in gods name would you borrow money, pay interest on the money you borrow, and invest that money in a fund that is most likely to lose money, adding a further cost?

    That is the sort of insanity that only a strongly held ideology would support.

    We need to look at what would be the lowest cost to the taxpayer to provide the superannuation needed. Flushing borrowed money down the toilet is not what we need. If we need to borrow money to cover the cost of super, then that is fine. If we need to borrow even more money in an attempt to get enough of a return on investment to cover the costs of super…..well if someone can point out to me how we could do that in these times, I’m listening.

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  10. burt (8,206 comments) says:

    expat

    If I were not working I would probably also be on the bong at 9:30… Give the poor frustrated follower of failed ideology a rest, he’s had a hard decade clapping every time his beloved leaders have pissed my money up against the wall to convince lovers of corruption that they should be re-elected.

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  11. Murray (8,845 comments) says:

    It has all the hallmarks of religious fanaticism.

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  12. expat (4,050 comments) says:

    slightly – its called margin trading, or leveraged invstments. not good when the trend is down on the assets you have borrowed to ‘invest’ in.

    burt – i suppose after being fired for stealing $7 chardonnay there may not be too many job offers rolling in. sorry jacob.

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  13. s.russell (1,603 comments) says:

    Over time, the Fund’s returns should easily exceed the cost of the Govt borrowing. Financial assets rise faster than debt. So the economic effect is neutral or better.

    But the deficit created by continuing payments into the Fund will be an excellent political justification for continued tightfistedness over Govt spending.

    So the Fund acts politically to aid better Govt policy (just as it lessened Labour’s spending in the past seven years).

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  14. jacob van hartog (300 comments) says:

    slightlyrightly you are dead wrong on your first premise. The money for the cullen fund is NOT used to pay for super ( this year) Its invested to provide a return in 10 -20 years to help pay for the the baby boomers super. Wiil the money borrowed now provide a greater return in 15 years . YES. End of economic arguement. Plus if you knew anything about investment not all money goes in shares, theres property and theres cash.

    Looks Key will stump up money for the private commercial property sector like Rudd has promised. And thats a good idea ??. yes if its done through the Cullen fund and the return is satisfactory

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  15. expat (4,050 comments) says:

    Over time>> care to share your estimated break even date?

    But the deficit created by continuing payments into the Fund will be an excellent political justification for continued tightfistedness over Govt spending. >> more likely fiscal justification once NZ Inc gets downgraded by the ratings agencies.

    So the Fund acts politically to aid better Govt policy (just as it lessened Labour’s spending in the past seven years). >> after a bottle of chardonnay a few bong hits maybe.

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  16. jacob van hartog (300 comments) says:

    Still dont know how the US taxpayers stumped up booze for the press gallery end of year function.

    Now THAT is a waste of borrowed money ( deficits during all of the Bush years even before Obamas budget)

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  17. expat (4,050 comments) says:

    bwooce – quoting Buffet circa 1997 out of context and stating that Orr alluded to him is a) bullshit b) slightly embarrassing for you.

    3.5/10 for name dropping.

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  18. JC (942 comments) says:

    A Super scheme like this isn’t isolated from the general economy but often arises from a faulty analysis of it’s need.

    A couple of issues strike me..

    First, we are told that we are poor savers and need a super scheme to force savings.. but lets look at that. When Labour won the 1999 election, the net percentage of household savings over disposable income was a little less than zero. Labour increased taxes and Govt spending and household savings plummeted to minus 17% by 2005/6.. and in a piece of magnificent circular reasoning Cullen said we needed to save more.. hence the Cullen Fund.

    So the first issue is that Govt taxes and activities drive household savings and *create* the need for forced savings.

    The second is the effect of taxes on savings. Household savings have plummeted, but retained earnings in companies and trusts are way up.. trust accounts, for example, had gone from $2 billion in 2000 to $6 billion 5-6 years later. In addition, wives and family have suddenly become trustees and directors for income splitting purposes. The fancy graphs on savings versus disposable income have become very unreliable indicators.

    The third issue for me is incentives. The success of Kiwisaver is due to incentives.. not because people have suddenly developed a saving habit. That same business of incentives could have just as easily been given via tax rebates on national “goods” like insurance, dedicated bank savings or national projects.

    Finally, any forced saving schemes imply a contract between Govt and people. Govt’s part of the deal is that it will restrain taxes and govt spending so as to keep inflation under control and not erode the savings, and to repatriate over taxation or use it only on positive “goods” like infrastructure. Incentives like tax rebates are most likely to stand the test of time and spread investment risks away from housing and shonky finance houses.

    JC

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  19. expat (4,050 comments) says:

    so your mates, jacob, decided to steal it on behalf of the oppressed peoples of Nth America?

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  20. dc (143 comments) says:

    I think the Fund’s “Guardians” have generally done an excellent job.

    I don’t. Last time I looked they had not significantly beaten their benchmark indices. That’s a mediocre effort at best.

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  21. PhilBest (5,120 comments) says:

    Look, DPF and all you other “centre right” guys; how about not forgetting first principles?

    We have a problem with the populace not saving money?

    Why is the only solution on the table, a employer-gouging, tax-break, State-run superfund?

    Why can’t we use our intelligence occasionally and actually look at the underlying structural problems?

    The biggest problem of the lot, was property values consistently going up faster than incomes, to the point where the property market was a Ponzi scheme.

    Now that these bubbles are in the process of bursting all over the world, people might not be sucked in again so readily; however, government attention to the causes of these property bubbles would still be wise.

    Then there are the poor returns, compared to property, and even compared to inflation, of safe interest bearing investments and even of investments in productive activities. It is just absurd, given the role of productive activities in our whole future well-being, that there are so many regulatory and compliance cost and taxation obstacles to it.

    If we lowered or abolished company tax and taxes on interest, the whole savings problem would come right. Freeing up the supply of land to keep property values from bubbling, is also a must.

    I have tended to oppose the idea of capital gains taxes because the cost of these tend to be passed on through the system anyway if there are unaddressed underlying structural problems diverting investment away from productive activities. Note that capital gains taxes did not prevent property bubbles; the severity of these bubbles correlates to land supply issues. World Bank Economist Alain Bertaud said in a recent study that capital gains taxes were merely passed on by property vendors and developers. But if those problems are addressed and capital gains taxes are offered as part of a shift of the taxation burden off productive activity and onto “rentier” activity, I would have no problem with it.

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  22. expat (4,050 comments) says:

    Kiwisaver is fundamentally a good idea and I recall Key saying that.

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  23. PhilBest (5,120 comments) says:

    Politically appointed fund managers are simply never, ever, going to be people that should be trusted with investments. In fact, there are very few fund managers who look trustworthy now, after the current round of wipeouts.

    The few truly astute people are flat out making shitloads of money for themselves. Take George Soros. Does anyone think that anyone like him will be prepared to work for someone like the Cullen Fund? Get real. The kind of people who end up running Cullen Funds are the grist to the mill of Soros et al.

    The crucial difference with these people, is that they correctly pick bubbles and the subsequent downturns, which do occur every few years, and use short selling and derivatives to absolutely clean up the misguided optimists, which includes almost everyone else. While an awful lot of finance market operators work on the same sort of level as kids playing a board game like “Monopoly” or “Careers”, I suspect that Soros et al have studied Ludwig Von Mises’ theories of monetary cycles and actually have got their heads around the underlying fundamentals.

    There are no misguided optimists as misguided as the ones who listen to the politicians and central bankers. And can anyone see a Soros style renegade running a political fund, frantically short selling simultaneously with his political masters assuring everyone that everything is all right or about to come right?

    I heartily recommend THIS gloating little letter from one financial expert to another…….

    http://www.garynorth.com/public/4674.cfm

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  24. NoCash (257 comments) says:

    People seem to forget that money is only a claim on present and future goods and services. Without the capacity to produce, money is worthless. What we need to invest now for the future is to improve our productivity and efficiency, without that there won’t be much point of having a large retirement fund when goods and services are not available.

    Planning for the future retired population needs to be looked at from a macro economic perspective, simply trying to amass more zeros on the Super Fund balance sheet isn’t going to help much if the future generations that will be supporting the retired population aren’t equipped and trained to produce goods and provide services more efficiently from a diminishing pool of workers.

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  25. expat (4,050 comments) says:

    yeah. thats why those boomers are so expensive.

    i paraphrase.

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  26. jacob van hartog (300 comments) says:

    Key was in favour of a lot of things before the election, thats what his pollsters told him to say.

    of course he will get out of national party just before the whole lot implodes on its own contradictions- as he allways has done.

    Elders .. not me I left before that all happened ( but was a lie that was found out)

    merril Lynch – that all happened after I left

    NZ National ….. TBA

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  27. bwooce (10 comments) says:

    Expat: out of context? The argument from DPF is that we shouldn’t invest because we’re not making any money, while at the same time incurring interest charges. I say that one side of that argument is wrong, in that we’re not making money for now but for 20 years away. Investing when prices are falling is exactly what Buffett was talking about, and it is well stated which is why I used it.

    To give an example: No one is suggesting stopping Kiwisaver for the same reasons. I’ve lost money on mine…how about you?

    Orr didn’t quote Buffett, and if you read it then I hope you can see that. But I could well be wrong. The idea that buying stuff while it is irrationally cheap so that you reap future gains is common to both. “Stopping out now would ensure we suffer the downside and miss the inevitable leg up.”

    The debate shouldn’t be if we’ve lost money, but if leveraging is an opportunity or not.

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  28. philu (13,393 comments) says:

    orr just ignored/glossed obver the two elephants in the room..

    ..the madness of borrowing to invest in a failing crapshoot..

    ..and the eyewateringly large amounts of money that have been pissed up against the wall..

    http://whoar.co.nz/2009/comment-whoara-pile-of-dissembling-bullshitfrom-the-head-of-the-cullensuper-fund/

    phil(whoar.co.nz)

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  29. campit (467 comments) says:

    Brian Fallow – linked by DPF’s update – makes the excellent point that now is precisely the time for fund managers to be making regular instalments:

    They can trust their ability to pick the bottom of the cycle and wait until they think it has arrived to climb back into the market.

    Or they can keep making regular instalments, trusting their fund managers to make appropriate asset allocation decisions and consoled by the knowledge that falling markets are reducing their average entry price.

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  30. expat (4,050 comments) says:

    But, perhaps borrowing to invest is a good idea, I’m just not seeing the bigger picture.

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  31. thedavincimode (6,633 comments) says:

    If you are a net borrower, then any expenditure is at the margin and requires consideration in light of marginal cost of funds and associated consequences; such as balance sheet impact and opportunity cost of competing options. The fund return needs to exceed govt’s cost of funds by a margin for acceptable risk. In this case, that risk obviously needs to be low. It might be a little simplistic, especially in the context of an economy as distinct from a business, to evaluate spending/borrowing options on those terms alone, but its a good place to start.

    Orr’s comments are misleading in this regard. His comments about the long term overlook two obvious points. First, what Philu refers to as a “failing crapshoot” and second, why should a Govt net borrower be contemplating investment downside in the expectation of long term gain, or investing in the knowldge of further downside before recovery. Picking the bottom is risky at the best of times, let alone current circumstances, and best left to the punters. Better to not borrow and wait for at least some signs of stability? The only possible basis to invest would be where there is a strategic investment entry opportunity that might not present itself again, for example in infrastructure here or offshore.

    Philu
    Your reference to the dough pissed up against the wall is a bit unfair given the extreme circumstances but the point does highlight the fundamental issue as to whether govt should be investing in equities in the ordinary course of events. I don’t know what the risk and investment profile of the fund is and can’t comment. Maybe its a good time for the ultimate investors to be told this (ie taxpayers).

    Otherwise Phil, I have to confess that I could actually understand what you were saying – there were almost 3 sentences – and I agree with your first point. Good grief. I think I need to go and lie down now.

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  32. burt (8,206 comments) says:

    expat

    Borrowing to invest is a good idea when a) It’s not your money and b) you have no accountability for the value of the thing you are investing into at any given time.

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  33. expat (4,050 comments) says:

    ACC, Kiwisaver, the NZ Super Fund.

    Help me here.

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  34. expat (4,050 comments) says:

    which of these things should the government being running?

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  35. gd (2,286 comments) says:

    Neither Orr nor Fallow nor anyone else knows when the currnet situation is going to turn back up and what the long term future holds.

    The old model has been broken and the old rules no longer apply.

    IMHO in my business and my family situation I am applying the same rules.

    Conserve cash.

    Look for ways to reduce expenditure whilst maintaining quality of purchases/services.

    In both cases there are no borrowings or debt to service but if there was I would be paying it down as fast as possible whilst the interest rates were low.

    Invest cash on hand in short government guarateed investments.

    Now as an absolute opponent of any government guarantee scheme ( and if DPF starts a post on the next phase of this which is about to hit the taxpayer Ill tell you why) of course I am taking advantage of it.

    Watch for new business opportunities coming out of the consquences of the current situation and look for new private investment opportunities.

    Above all take a prudent low risk approach.

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  36. baxter (893 comments) says:

    n fact, the New Zealand Government has done well, with one of the lowest government net debt positions in the OECD……………..Then why are Standard and Poors threatening to cut the Nations Credit Rating………..

    Da VINCI MODE is right the most successful investors in my experience invest only on established upward trends. Fund Managers always argue to average down because that suits their own financial profitability.

    BUFFETT has invested in the downtrend and this time has lost money. He is the worlds best expert and was not investing during the final stages of the Bull Market ,while other funds were,because he realised the value wasn’t there. There is nothing in common anyhow between BUFFETT’s fund and the NZ Super Fund ,one looks for value ,and the other is a diversified fund which makes average gains in Bull Markets and average losses in Bear markets. Diversified Funds in NZ overtime don’t do much better than Fixed Interest. In New Zealand’s case the Super Fund should invest in NZ Infrastructure

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  37. MyNameIsJack (2,415 comments) says:

    baxter (772) Vote: 0 0 Says:

    March 5th, 2009 at 3:12 pm
    n fact, the New Zealand Government has done well, with one of the lowest government net debt positions in the OECD……………..Then why are Standard and Poors threatening to cut the Nations Credit Rating………..

    Let tem. Why should anyone listen to anyting any of these “ratings agencies” says? They’re the fuckups that rated all America’s toxic debts AAA+. Derivatives? great, no risk, buy as many as you can. Citibank? great sound business, AAA+ rating.

    It was their standards that are making the world poor.

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  38. JC (942 comments) says:

    “In fact, the New Zealand Government has done well, with one of the lowest government net debt positions in the OECD……………..Then why are Standard and Poors threatening to cut the Nations Credit Rating………..”

    Presumably because our total foreign debt is $166 billion. $30,000 odd for every person.

    JC

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  39. slijmbal (1,227 comments) says:

    Both articles are complete rubbish and I expect better from Fallow (but not Orr)

    The stated target return from the Cullen folly is 8.6% – the risk free return over the long term (treasury bills) is about 7%. It has a target that barely beats a risk free return – brilliant.

    1) we historically took money out of the economy for Cullen’s folly – the more money a government takes out of an economy the slower it grows – we now have a smaller economy than without Cullen’s folly

    2) we have always had debt – so we have always borrowed to invest with a target return not worth the additional risk (which in this case has to date eventuated) – either don’t take the money in the 1st place or pay off debt.

    3) it was self evident that we were coming to the end of a major bull market and the fund should have changed its mix of allocation types – I did and I did it my spare time and my returns are better than these idiots and I’m not the so called professional – the better (note operative word here) money management types did the same. Orr and his cohorts are incompetent. But, of course, a socialist government would be renowned for its commercial acumen (cough! Kiwifail).

    4) we do not know how much further this market has to fall – prices in almost all asset types were valued very highly above long term trends and when there is a fall prices tend to go under the long term trends. So the drop could have much further to go.

    5) we cannot sell it off now as it truly is fire-sale time and are only hope is to get a recovery and then dump it as yes returns should be greater from our now low base than normal but it’s dubious that this will happen in a time measured in under 5 years. So we are in a dilemma and it is hard to judge whether to hold on grimly or sell – my gut feel is hold on as we might need the money later.

    6) I do not trust the government (any government) with my money – yes – it’s my money until they steal it from me. Give it back and I’ll invest it thank you. We are actually talking thousands of dollars per tax payer here.

    7) borrowing to invest is high risk strategy and should not be applied to say, more than 5-10% of one’s total investments, – we are borrowing to invest every $ we put in both in the past and now if we continue contributions

    8 Governments should only run surplusses to pay off debt – after me – they should only run surplesses to pay off debt – otherwise they are over taxing their food source.

    It was never a sensible, economic idea ever. It is not a sensible idea now. It is immensely stupid to further increase our debt burden to waste money on a monument to bad economics.

    DPF your analogy about borrowing for a capital item does not really match the situation I suggest – we are actually talking about borrowing for a value or income providing item rather than for a capital asset that is required ie a house.

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  40. OECD rank 22 kiwi (2,744 comments) says:

    No more taxpayer money should be “invested” in the sink hole that is the New Zealand Superannuation Fund.

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