The following letter from the Minister of Finance, Bill English was in reply to questions sent by Iain Parker. Note, English avoids answering the question regarding whether the US Federal Reserve bank is private or not.
Office of Hon Bill English
Deputy Prime Minister Minister of Finance
Minister for Infrastructure
18 JAN 2010
Thank you for your Official Information Act request, received on 27 November 2009. You asked a number of questions about the nature of government bonds; as well as about the nature of money and the banking system.
1. Could you please tell me what a Government Bond is and what role it plays in our economy?
As you point out on page 7 of your submission, New Zealand government bonds are wholesale, New Zealand dollar denominated, fixed-term debt securities. They are secured by a charge upon and are payable out of the revenues of the Crown. Cash received by government bond issuance is used to fund goods and services provided by the government, e.g. roading, hospitals and welfare payments. Government bond yields provide an indication of the “risk free” rate of return in an economy and provide companies and households a benchmark with which to compare returns against those of alternative investments.
2. Could you please tell me who in the world of high finance, as Primary Bond Dealers, has the right to buy or monetise government debt bonds before they decide if they do or don’t on sell them on the secondary bond market?
New Zealand does not have “Primary Bond Dealers.” The term “Primary Bond Dealers” refers to institutions that, for example, trade directly with the United States Federal Reserve, where they are required to participate when the Federal Reserve holds securities auctions. In New Zealand, the nearest equivalent institutions are called registered tender counterparties. The main difference between the US and New Zealand is that registered counterparties are eligible but not required to participate in government securities tenders.
To qualify for registration as a tender counterparty, an institution must have a minimum credit rating of A-/A3, or have their obligations guaranteed by a parent entity with a minimum credit rating of A-/A3, or be a Crown financial institution. Tender counterparties are primarily either New Zealand or Australian incorporated banks.
3. Are the Primary Bond Dealers private or publically owned institutions? That is not those that buy bonds on the secondary bond market, but the Primary Bond Dealers?
Tender counterparties are primarily private sector banks.
4. Could you please tell me what they use to buy our government bonds and if that medium of exchange existed before we pledged to pay it back with attached interest out of the future taxes of the nation or was it an electronic debt book entry, not anyones existing savings, but an electronic book entry that brings into circulation new money?
People purchasing government bonds must do so with New Zealand dollars. Settlement of the transaction between the purchaser and the Crown is by electronic cash transfer rather than physical cash. All else being equal, bond purchases result in a reduction in settlement cash balances of the banking system (either at commercial banks, the Reserve Bank or both) as cash is transferred to the Crown.
An explanation for how this cash may originally be created is included in the answer to question 5 below.
5. Is it true that in excess of 90% of the money supply in circulation in New Zealand entered circulation as interest bearing debt owed to the banking network?
It is correct that most of the money supply in New Zealand has been created by the banking sector. This is done through the process of financial intermediation. Commercial banks, and other financial institutions, take deposits from members of the public and firms who wish to hold cash in the form of bank deposits. They then lend to individuals and firms who want to borrow – in the form of mortgages or business loans. This process serves to channel funds between savers and borrowers. It also shifts the risk of lending from individual savers to the banks, thereby reducing the risk of lending. This process of intermediation involves the commercial banks lending a greater value of funds than the cash they reserve to meet expected deposit withdrawals. This is done because at any one time only a fraction of depositors will want to withdraw their funds. Banks therefore need to keep only a fraction of their deposits in reserve in order to meet those demands. Because the banks lend more than the total amount of cash held in reserve in the system, credit is created – thus increasing the money supply.
The exact proportion depends on the definition of the money supply. Using the most common definition of the money supply as M2 (i.e. currency held by the public + balances in cheque accounts + all other business or personal deposits that are available on demand), the October 2009 data show that the part not accounted for by currency held by the public is 95%.
Data on money aggregates can be found on the RBNZ website at: http://www.rbnz.govt.nzlstatis tics/monfin/cl /data.html.
6. Prime Minister Key, could you please describe your activities as a member of the Advisory Board of the Foreign Exchange Committee of the US Federal Reserve between 1999-2001?
I refer you to the reply from the Office of the Prime Minister.
7. Could all please advise me if the US Federal Reserve and the Bank of England are privately owned institutions that sit within their respective governments or publicly owned institutions within their governments?
I refer you to the following pages on the websites of the Board of Governors of the Federal Reserve and the Bank of England respectively for this information:
8. Could you please explain to me the role and relationship of the American Financial institution – Northern Trust – in regard to it being appointed custodian of our own NZ Debt Management Office?
The New Zealand Debt Management Office (NZDMO) has appointed Northern Trust as global custodian for NZDMO fixed income assets The appointment foflowed a competitive tender exercise which was completed in 2008. Custodian duties provided by Northern Trust for the NZDMO are standard for financial institutions and include: the provision of trade settlement services; safekeeping of assets; and other administrative functions.
9. Could you please tell me if in New Zealand, a “new” mortgage at issuance, before it becomes tradable, is loaned to a borrower by a registered bank, is that mortgage created as a debt book entry account, not anyone’s existing savings, but an electronic debt book entry creating “new money”?
The creation of a new residential mortgage will generally result in new money (bank deposits) being created. The bank grants a new loan to a purchaser, who uses the cash to buy property from a vendor. The vendor then may spend or save the proceeds boosting deposits in the financial system.
You also ask for a list of the names of the officials who contributed to this reply. I am withholding these names in full under s.9(2)(g)(i) of the Official Information Act – to maintain the effective conduct of public affairs through the free and frank expression of opinions.
You have the right to ask the Ombudsman to review my decision.
This fully covers the information you requested. I hope you find this information useful
Minister of Finance
Northern Trust Corporation (Nasdaq: NTRS) is a leading provider of investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide. Northern Trust, a financial holding company based in Chicago, has a growing network of 85 offices in 18 U.S. states and has international offices in 15 locations in North America, Europe, the Middle East and the Asia-Pacific region. As of September 30, 2008, Northern Trust had assets under custody of US$3.5 trillion, and assets under investment management of US$652.4 billion. Northern Trust, founded in 1889, has earned distinction as an industry leader in combining exceptional service and expertise with innovative products and technology. For more information, visit http://www.northerntrust.com.
Northern Trust operates in Australia as a foreign authorised deposit-taking institution (foreign ADI) and is regulated by the Australian Prudential Regulation Authority.
Northern Trust in Hong Kong is a securities company regulated by the Securities and Futures Commission.
Northern Trust in Singapore is a foreign wholesale bank regulated by the Monetary Authority of Singapore.
Where Northern Trust’s UK entities undertake regulated business, they are authorised and regulated in the United Kingdom by the Financial Services Authority.
— Northern Trust (Guernsey) Limited, Northern Trust Fiduciary Services
(Guernsey) Limited, Northern Trust Fiduciary Company (Guernsey) Limited
and Northern Trust International Fund Administration Services
(Guernsey) Limited are licensed by the Guernsey Financial Services
— Northern Trust International Fund Administrators (Jersey) Limited and
Northern Trust Fiduciary Services (Jersey) Limited are regulated by the
Jersey Financial Services Commission
— Northern Trust Ireland is authorised by The Financial Regulator under
the Investment Intermediaries Act 1995
— Northern Trust Global Services is authorised and regulated in the
Netherlands by De Nederlandsche Bank
— Northern Trust Global Services Limited Luxembourg Branch is authorised
and regulated by the Financial Services Authority and in Luxembourg by
the Commission de Surveillance du Secteur Financier (CSSF) and Northern
Trust Luxembourg Management Company S.A. is regulated by the CSSF
— Northern Trust Global Services Limited — Abu Dhabi. Representative
Office, Licence number 13/238/2008 SOURCE: Northern Trust Corporation
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