New Zealand's Economic Pressure
The $NZ climbed to 76.5 US cents over the weekend. Yet Reserve Bank Governor Alan Bollard remains in denial mode (NZ Herald story Bollard: Don't blame my rate rises for the high-flying dollar).
Comments from the ANZ Bank in another NZ Herald story hint at what might happen if New Zealand consumers actually do heed Dr Bollards "school headmaster" warnings to cut back on spending. "The ANZ bank today said the rise in the NZ currency came as supply completely evaporated and illiquid conditions kicked in" ('Unstoppable' NZ dollar explodes above US76c). Nobody it seems wants to sell the New Zealand dollar.
Our situation is simple. Every time NZ interest rates rise further above Australian interest rates, the $NZ exchange rate rises as ever-more oversees money chases after the ever-better goodies that we offer. This flow is reinforced by "rational expectations" formed in the market place over the last few years. Foreign savers with excess cash have observed and enjoyed the easy gains made at our expense in the past, and are reassured by the assurances the hapless Dr Bollard is giving them. Dr Bollard says that he will tough it out, meaning to foreign investors that he will act to ensure that their gains will be made secure by a commitment to hold our interest rates high for years rather than weeks.
The problem has a deadly twist to it. Let's say that we take heed of Dr Bollard's finger-pointing at New Zealand consumers. Let's imagine that we slash our spending on credit-financed imported consumer goods.
When there is a renewed inflow of foreign money chasing Dr Bollard's interest rates, economists say there's an excess demand for $NZ in the foreign exchange market. So the $NZ rises, making imports cheaper, and reducing the prices received by most of our exporters. New Zealand consumers and producers sensibly follow these market signals; we import more and we export less.
What if we do what Dr Bollard asks of us? He appeals to us to ignore the market signals that he has created.
Well, if we stop buying extra imports, then there will still be excess demand in the foreign exchange market. The $NZ might rise to 80 cents US, and there will still be excess demand if we continue to do as Dr Bollard exhorts. So the $NZ might rise to 90 cents US.
In fact, the only reason the $NZ is not already at 80 cents US is that we have been buying imports; lot's of imports. We've followed the price mechanism so loved by free-market economists. (Indeed New Zealanders, who, unlike foreigners, believe the $NZ will fall soon, are motivated not only by low import prices, but also by the expectation that import prices may soon rise dramatically.) Our buying of imports stops the exchange rate from rising even further, limiting the amount of pain that exporters must suffer.
If, by not buying imports, we let the exchange rate get above 80 cents US, then we will just crucify the non-dairy remnants of our export economy.
There's one further point. Once the demand for consumer credit dries up, who will the banks lend to? The high-flying dairy industry can only borrow so much, and probably doesn't need to borrow much at all. This would mean that an even greater proportion of lending by New Zealand banks would be channelled into housing mortgages, further fuelling the real estate prices that Dr Bollard says he's trying to dowse.
In summary, our consumers are relieving the pressure in our economic pressure cooker, by ameliorating the rise of the $NZ and also by providing avenues for bank lending other than home loans. Dr Bollard's recipe of spending less, taken to its logical conclusion, can only lead to an explosive meltdown of the New Zealand economy.
I have faith that someone will intervene before it's too late. Dr Michael Cullen is the person who should be intervening, by urgently renegotiating the government's Policy Targets Agreement with the Reserve Bank. The Reserve Bank has to cut interest rates.
Alternatively the Reserve Bank may relieve the upward pressure on the $NZ by selling Reserve Bank bills to the banks (at attractive enough interest rates to slow down banks' mortgage lending) and then purchasing large quantities of overseas financial assets; eg European government bonds. (We would not want the Reserve Bank to buy US Treasury Bills; that could be construed as NZ helping to fund the war in Iraq.)
We live in interesting times.