The Reserve Bank Governor Graeme Wheeler has dubbed the strength of our exchange rate “unjustified and unsustainable.” Ultimately the problem lies with his own policies, together with the refusal of the Government to tax the income from capital.
According to the Governor our exchange rate is too high, despite falling from a peak of over 88 US cents to 81 yesterday, and 78 after the this latest open mouth operation. He feels that the fall in dairy prices – around 45% since February – hasn’t been reflected in the exchange rate and is jawboning it down further.
Why is the dollar so high?
Of course, unless they are in a bubble, market prices are usually there for a reason. In New Zealand’s case, our economy and interest rates have been strong relative to other developed nations. This has attracted overseas investors looking for a stable place to stash their cash with a return above inflation (which they can’t get in the US or Europe). And while exporters always complain the dollar is too high, the market makes the judgement not them. We want our dollar to be as high as possible, it helps keep the price of all the stuff we import down. A low dollar is not a path to prosperity, otherwise Bangladesh would have arrived.
What is the bank doing about it?
Wheeler’s words seem to have worked a little bit, but if he wants to really make a difference he will have to back them up with action. The Reserve Bank may have already intervened in the foreign exchange market (by printing NZ dollars and selling them for other currencies), but playing against currency speculators is a dangerous game. Even then there is no guarantee he will win that battle and shift the exchange rate down.
Of course, the obvious thing to do to bring the exchange rate down is to lower interest rates. After all, our high interest rates are why foreign investors are sending their money here, and that is driving up the demand for our currency. But the Reserve Bank bleats it can’t lower rates, because it might ignite another boom in the housing market, particularly Auckland and Christchurch.
So to paraphrase the Bank’s message – our dollar is too high. But we can’t really do much about it, because Aucklanders will buy more houses. Sorry.
Really? I think we have a case of the pot calling the kettle black here.
How many times do we have to say that the reason our interest rates are higher than elsewhere, is that our Reserve Bank and government underpin an ongoing imbalance in our economy by underwriting the overinvestment in housing. So for the RB to then say it can’t cut interest rates as a way to stop stimulating our currency – as other countries would find normal – because it would cause a boom in housing and inflation, really is beyond the pale. Let’s explain.
What is the real problem here?
There are two reasons why our housing market is articifically too hot anyway, and the Reserve Bank is directly responsible for the first:
- The risk weighting directive given to the banks by the Reserve Bank requires them to give priority to lending on mortgage as opposed to business lending. This drives money to those who wish to buy more properties and need a mortgage to do so.
- Successive governments here have refused to fully tax the income from capital, particularly the actual return from home ownership. This is a tax loophole that drives people into house ownership.
The combination of these two is powerful little cocktail that for decades now has seen New Zealanders over-invest in housing. And this has been at the expense of us allocating our capital to business endeavours that generate income and jobs.. The property bubble has been inflated since financial deregulation in the 1980s. If I’m investing in multiple properties I’m not being forced to put my funds to work by investing in businesses that generate income and jobs. And the reason I shun those investments is because the commercial banks make it infinitely easier for me to invest in property and let it lie idle. They are told by the Reserve Bank – the same institution that continually and very publicly bemoans the inflated state of the property market – to regard property as more secure collateral than any other type. Go figure.
The Reserve Bank prudential policy combines with selective tax policy to provide a toxic little no brainer for property investors – to put it bluntly, it is the easiest way in town for people to make money. It means the demand for housing has less and less to do with the demand for accommodation and more and more to do with the demand for a property as an investment proposition. Tenanting the building is of second-order concern if the bulk of the contribution to your profit is the price appreciation. It’s almost like hoarding artworks or rare coins. Certainly in Auckland over the past year or two – again – that has been the game to play.
What should the Reserve Bank do?
First, speak again to the Government about the lack of wisdom in having a mandatory tax only on cash income, but a selective one on income earned from capital, be it capital gain or implicit income that having use of the capital confers. The biggest taxpaying mugs in New Zealand continue to be those subject to income tax. The Government has them under the taxman’s hammer, and Labour and the Green Party only wanted to hammer them more.
But so long as you can increment your wealth via an appreciation in the value of your assets, or live off the non cash benefits of your assets (owning a house means you don’t pay rent), you are free of the burden of tax. That reality is unfair and terribly inefficient when it comes to generating income and employment for New Zealand.
Until the Reserve Bank gets its own hose in order insofar as removing the props that underpin an inflated housing market, it is hypocritical for it to cry wolf over its inability to use interest rates to target inflation, and for the exchange rate to play its full role in effecting that mission. While Graham Wheeler fiddles, our productive industries – especially exporters – will burn a bit more than necessary.
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