Let there be no mistake, New Zealanders want the NZ dollar to be as high as possible. A 65 US cent dollar makes us a hell of a lot poorer than an 88 cent one. So why does the Reserve Bank (RB), cheered on by our Prime Minister (PM) dream of reducing our wealth via the route of degrading the value of our currency? We all know if a cheap dollar were the path to national riches, Bangladesh would have arrived by now.
Why do we want a high dollar? Simple, we can buy more stuff. A high dollar means cheaper imports, cheaper overseas holidays, it makes us richer compared to the rest of the world. If you want to save your pennies a high dollar is good too – it means you can own more overseas assets with the same up front investment. A high dollar is normally a sign of economic success for a country – a sign that the rest of the world wants to buy what we have to sell. We should be cheering the day we have parity with the US dollar.
The question of course is what level should our dollar be now so that we get to the promised land? And on this the RB and the PM have formed the judgement that the market – that infinitely deep pool of decisions made by all investors, speculators and traders of NZ goods and currency – is “temporarily mad” – that the RB and the PM know better, and the currency should be cheaper. Good luck to them both with that.
We have been here before, where institutions and politicians think they know better than the market as to what a price should be. So they exert what influence they can to engineer an outcome that aligns with their preconception. Sometimes they have an affect, sometimes they don’t – it all depends whether they succeed in influencing the expectations of market participants.
In this case the RB and the PM apparently feel that the recent level of our dollar has restricted the ability of the RB to use interest rates to quell inflationary pressures without boosting the dollar further. They also perceive it invites a substantial blow-out in our current account deficit as exporters struggle to earn enough foreign exchange to fund our demand for imports without reliance upon unwelcome accumulation of external debt to fund the gap.
Sine the currency was floated 30 years ago this has been a repeated refrain from the RB and the government – that the exchange rate is overvalued. Of course the data speaks for itself. They have been wrong, soundly wrong on that score. For 30 years the currency has maintained a much higher level than politicians and RB Governors of the day have tended to desire. And of course over that 30 years the external debt position has grown, albeit with a switch from government to private debt.
So what are we to make of these latest outpourings of concern from the RB and PM? Of course with the deflation of dairy prices lately one would have expected the currency to take a bit of a hit anyway. All we’re seeing is the RB and PM seizing the opportunity to try and influence the currency lower than the market alone would engineer. They clearly hope we might gain some perceived temporary advantage in the form of better prices for exporters and more leeway for the RB to use the interest rate to dampen inflationary pressures.
But as soon as the global dairy price cycle reverses (assuming it does once the inventory cycle works through) these efforts will be quickly forgotten and the currency will resume its 30 year track. In other words the currency is a market price and nothing officials do – short of either changing the economic fundamentals or deliberately undermining the credibility of our overall policy mix – will change that. Their efforts then simply add to market volatility – a dream scenario for currency traders but of little additional content.
What’s the “right” value of the NZ dollar? It’s whatever the market is prepared to finance. As we saw when the current account deficit was 8% of GDP, the private capital inflows still funded that deficit. So it’s a very brave – or silly – person who declares that their preconception of what value the currency should be, is anything but a guess. This is what markets do, they set prices. How easily people forget.