Top Scoops

Book Reviews | Gordon Campbell | Scoop News | Wellington Scoop | Community Scoop | Search


NZ's 2007 Budget and the Overvalued Dollar

NZ's 2007 Budget and the Overvalued Dollar

by Keith Rankin
17 May 2007

One of the biggest questions that arises from this budget is what impact, if any, will it have on our number one economic problem in 2007, the chronically overvalued exchange rate. The Budget had no impact on the exchange rate on Budget Day (17 May). In the longer run there may be a substantial impact, although it probably won't be seen to be a result of the increased savings rates mandated by this Budget.

Given that the exchange rate is substantially determined by monetary policy (by the Reserve Bank's interest rate settings), a part of the question posed is "what effect will the 2007 Budget have on monetary policy?". But that effect, if any, is only a partial answer to my question.

The key point of this Budget is its "tight" stance on aggregate expenditure. Any new "handouts" will be locked up, as contributions to the new quasi-compulsory retirement savings scheme. For all practical purposes, Kiwi Saver is a tax increase. The Kiwi Saver scheme is being set up so that most people will feel morally obliged to participate (much like the War Bonds of the early 1940s, which were essentially an anti-inflation measure and not really about paying for World War 2).

The tight stance of the Budget is an invitation to Reserve Bank Governor Dr Alan Bollard to reduce interest rates. The problem is that there are other forces which will make it hard for Dr Bollard to ease monetary policy; forces such as ongoing growth of retail spending, and house price appreciation. The exchange rate has got itself into a new cyclical pattern that actually seems quite stable, and Dr Bollards tinkering with interest rates may not matter much.

This new pattern, which dates back to 2004, is that the trade-weighted index (TWI, the main measure of the exchange rate) tends to sit in the 70-73 range (roughly equivalent to ($US 0.72), but dives every 18-months or so, down to a TWI of about 60. This dive can be regarded as a "market correction". Following such corrections, which are driven by the fear of an exchange rate fall, the logic of higher interest rates in New Zealand takes over, bringing the exchange rate back to around 73 before the fear of another correction takes hold.

The reasons for this pattern of chronic currency overvaluation are fourfold: (i) high monetarypolicy- determined interest rates in New Zealand that seduce international investors (including the swelling compulsory retirement savings funds of other developed economies), (ii) low monetarypolicy- determined interest rates in many other countries (especially Asian countries), (iii) high savings rates in these low interest countries, (iv) the overwhelmingly favourable experiences that international investors have had (for over two decades now) from supping in New Zealand's debt and real estate markets.

In other words, the tendency for substantial capital inflows to come into New Zealand is something that our Reserve Bank may not be able to do much about, other than to spark one of these temporary "corrections" that I've noted.

The key relationship, that must be true because it’s a law of mathematics, is that a net capital inflow into a country must be matched by an equal current account deficit.

So, if foreign investors (speculators, pension funds, carry traders, banks, Belgian dentists etc) decide to send their savings here, then (unless an equal amount of New Zealand money is used to purchase overseas assets) there must an excess of spending from New Zealand (a current account deficit exactly equal to the capital account surplus) to balance that capital inflow.

The rising $NZ exchange rate is simply the mechanism through which this "balancing" takes place. That balance, in the 2000s' decade, has taken place at an exchange rate of around 73. If the balance of payments is disturbed by an additional capital inflow (eg from China), the $NZ will rise until an equal but opposite fall in the current account balance is achieved. New Zealand's balance of payments relationship, driven by capital inflows, requires that our exchange rate be set at levels that render uncompetitive New Zealand's tradeable sector while sucking in imports.

So what would happen if New Zealand households take the savings message of this Budget to heart, and reduce their expenditure on imports by saving more? It would mean just one thing: that at an exchange rate of 73 there would be excess demand for the $NZ. That means the $NZ would rise further (eg to a rate of 80) until the further cheapening of imports persuades us to return to 2007 levels of spending on imports, or until further export carnage brings about the required current account deficit. It might seem hard to believe, but spending on imports keeps the dollar lower than it would otherwise be, and thereby helps our exporters.

There is a way out of our exchange rate problems that does not involve a risky cut in interest rates. The Reserve Bank can actively build up New Zealand's official overseas reserves by buying foreign assets (preferably low-risk items such as foreign government debt) to the extent that the net capital inflow falls within an acceptable range (eg 3-4 percent of GDP). In other words New Zealand's gross capital inflow could be offset by a substantial Reserve Bank initiated capital outflow, funded by newly created New Zealand dollars.

This "exchange-rate targeting" approach to monetary policy would not be a perfect solution, because the interest yields on the foreign assets that Reserve Bank acquires will be lower than the interest rates we will be paying to those who "invest" in us. But, by raising New Zealand's official overseas reserves, it would give us the means to manage our way through any financial crisis that we might find ourselves involved in the future.

To summarise, the Budget's emphasis on increased savings is, in the medium term, likely to aggravate New Zealand's exchange rate problem. Increased savings will reduce imports and thereby raise the exchange rate to higher levels than it would normally be at today's levels of imports.

So long as central banks across the world prevent convergence of countries' interest rates, then destabilising capital flows from low interest rate countries to high interest rate countries will create huge imbalances in the global economy. Low interest rate countries for the most part will experience tight monetary conditions, domestic deflation (combined with inflation in the tradeable sector), falling exchange rates, and substantial and rising current account surpluses. High interest rate counties for the most part will experience easy monetary conditions, high domestic inflation (combined with deflation in the tradeable sector), rising exchange rates, and substantial and rising current account deficits. New Zealand is at one end of this spectrum of countries; Japan is at the opposite end.

The irony is that countries trying to create easy monetary conditions are, as capital exporters, achieving the very opposite. Likewise countries like New Zealand that are trying to create tight monetary conditions are, as capital importers, achieving the very opposite of what they are seeking. The 2007 New Zealand Budget seeks to soak up excess liquidity as quasi-compulsory savings. Instead it will aggravate existing imbalances within New Zealand, and between New Zealand and Asia.


( krankin @ )

© Scoop Media

Top Scoops Headlines


Eric Zuesse: U.S. Empire: Biden And Kerry Gave Orders To Ukraine’s President

Eric Zuesse, originally posted at Strategic Culture On May 19th, an implicit international political warning was issued, but it wasn’t issued between countries; it was issued between allied versus opposed factions within each of two countries: U.S. and Ukraine. ... More>>

Binoy Kampmark: Budget Cockups In The Time Of Coronavirus: Reporting Errors And Australia’s JobKeeper Scheme

Hell has, in its raging fires, ringside seats for those who like their spreadsheets. The seating, already peopled by those from human resources, white collar criminals and accountants, becomes toastier for those who make errors with those spreadsheets. ... More>>

The Dig - COVID-19: Just Recovery

The COVID-19 crisis is compelling us to kick-start investment in a regenerative and zero-carbon future. We were bold enough to act quickly to stop the virus - can we now chart a course for a just recovery? More>>

The Conversation: Are New Zealand's New COVID-19 Laws And Powers Really A Step Towards A Police State?

Reaction to the New Zealand government’s handling of the COVID-19 pandemic and resultant lockdown has ranged from high praise to criticism that its actions were illegal and its management chaotic. More>>

Keith Rankin: Universal Versus Targeted Assistance, A Muddled Dichotomy

The Commentariat There is a regular commentariat who appear on places such as 'The Panel' on Radio New Zealand (4pm on weekdays), and on panels on television shows such as Newshub Nation (TV3, weekends) and Q+A (TV1, Mondays). Generally, these panellists ... More>>

Binoy Kampmark: Welcome Deaths: Coronavirus And The Open Plan Office

For anybody familiar with that gruesome manifestation of the modern work place, namely the open plan office, the advent of coronavirus might be something of a relief. The prospects for infection in such spaces is simply too great. You are at risk from ... More>>

Caitlin Johnstone: Do You Consent To The New Cold War?

The world's worst Putin puppet is escalating tensions with Russia even further, with the Trump administration looking at withdrawal from more nuclear treaties in the near future. In addition to planning on withdrawing from the Open Skies Treaty ... More>>

Binoy Kampmark: Why Thinking Makes It So: Donald Trump’s Obamagate Fixation

The “gate” suffix has been wearing thin since the break-in scandal that gave it its birth. Since Watergate, virtually anything dubious and suggestive, and much more besides, is suffixed. Which brings us to the issue of President Donald Trump’s ... More>>

Gordon Campbell: On The Ethics (and Some Of The Economics) Of Lifting The Lockdown

As New Zealand passes the half-way mark towards moving out of Level Four lockdown, the trade-offs involved in life-after-lockdown are starting to come into view. All very well for National’s finance spokesperson Paul Goldsmith to claim that “The number one priority we have is to get out of the lockdown as soon as we can”…Yet as PM Jacinda Ardern pointed out a few days ago, any crude trade-off between public health and economic well-being would be a false choice... More>>

Binoy Kampmark: Brutal Choices: Anders Tegnell And Sweden’s Herd Immunity Goal

If the title of epidemiological czar were to be created, its first occupant would have to be Sweden’s Anders Tegnell. He has held sway in the face of sceptics and concern that his “herd immunity” approach to COVID-19 is a dangerous, and breathtakingly ... More>>


  • PublicAddress
  • Pundit
  • Kiwiblog