By Peter Redward*
Since March 1985, the New Zealand dollar has floated freely in foreign exchange markets. The Reserve Bank of New Zealand has, from time to time, guided the NZD stronger or weaker in line with its management of overall monetary conditions, but with the exception of a brief period in mid 2007, the RBNZ has not physically intervened to alter the level of the currency.
In March 2005 the RBNZ published a list of four criteria for considering FX market intervention: 1) the exchange rate must be exceptionally high, or exceptionally low; 2) the exchange rate must be unjustified by economic fundamentals; 3) intervention must be consistent with the Policy Targets Agreement; and 4) conditions in markets must be opportune and allow intervention a reasonable chance of success.
The Reserve Bank’s reticence to intervene in the FX market has been understandable. Over much of the past 25 years, the RBNZ’s primary focus has been to lean against strong credit creation and rising asset prices, and their associated inflationary pressures.
Keeping short-term interest rates well above the country’s trading partners helped wring inflation from the economy and at the same time provided a strong rationale for steering clear of FX market intervention.
Intervention to bring down the value of the NZD would run counter to the Reserve Bank’s monetary policy objectives while simultaneously eroding the bank’s profitability, potentially leading to significant capital losses and the need for capital injection from the Treasury.
In this environment, intervention was not credible, nor was it consistent with the PTA (Policy Targets Agreement). It simply would have provided speculators with more attractive levels at which to buy the NZD, meaning intervention would have had little chance of success.
The situation confronting the country today is quite different. New Zealand is experiencing a shallow, long-lasting recession in economic activity. GDP growth, which averaged 3.4%p.a. in the decade to 2005, but has averaged a mere 0.9%p.a. since. Significant underutilised resources need to be put to work. Unemployment has risen by 25,000 (since 2008), with the unemployment rate now standing at 6.8% of the labour force.
The Reserve Bank estimates that the economy is operating around 2.6% below its rate of potential GDP while the New Zealand Institute of Economic Research highlighted in its March survey of business opinion that sales are the key constraint in the economy.
Credit growth is anaemic, as households and businesses, notably farmers, attempt to pay down debt. This is proving a slow process, hampered by asset price deflation, as businesses and households faced with cash flow problems are forced to liquidate investments in a depressed market.
'Inflation under control'
Headline CPI inflation rose to 4.0% y/y in Q4 2010, but much of the acceleration in inflation can be attributed to the 2.5% increase in the GST, and higher administrative charges and petrol prices, with the Reserve Bank forecasting inflation dropping to 2.1% in 2012. Given the weak state of the domestic economy, workers have limited wage bargaining power and firms have limited pricing power.
Against this backdrop, and given the recent earthquake in Christchurch, the RBNZ chose to cut lower official cash rate by 50bp, to 2.5%, at its March Monetary Policy meeting. While the rate cut will provide some welcome relief to the mortgage belt, we wonder whether households and businesses will chose to spend the modest extra income they receive, or whether it will simply get swallowed up in debt repayment.
In our opinion, the current environment is such that FX market intervention can be contemplated in a manner that is credible, consistent with the RBNZ’s monetary policy objectives and not injurious to the central bank’s balance sheet. Given the weak state of the New Zealand economy, intervention that suppresses the value of the NZD can temporarily lower both the nominal and real (ie, inflation-adjusted) exchange rates. In other words, an artificial weakening of the NZD via FX market intervention would result in only a modest pass-through to domestic prices, at least until the economy recovers.
'Bigger bang than a rate cut'
This weakening of the exchange rate would support exports, assisting both the aggregate growth rate of the economy and employment, especially in manufacturing and tourism, sectors that have not benefitted from improving commodity prices. It should also boost government tax revenues through higher PAYE and company taxation. In the current environment, this form of monetary stimulus is likely to have a higher money-multiplier effect than simply cutting interest rates.
We believe FX intervention would assist in rebalancing New Zealand’s economy away from domestic consumption, providing a boost to tourism and manufacturing exports, two sectors that have not benefitted from the surge in global commodity prices but are significant employers. A weaker NZD would help to narrow the current account deficit and reduce New Zealand’s large net external debt/GDP ratio. Moreover, at a time when international credit rating agencies are increasingly concerned about New Zealand’s fiscal outlook, rising foreign reserves should assist by improving the country’s external solvency.
Higher FX reserves would raise the import-cover ratio (the number of days imports that can be paid for by FX reserves), as well as our short-term debt cover ratio (the ratio of FX reserves to short-term debt). Both of these indicators typically have a significant effect on sovereign credit ratings, and may act to hold off a potential downgrade of New Zealand’s international debt ratings.
A key factor determining whether FX intervention will have a reasonable chance of success is its impact on the central bank’s balance sheet.
This will be determined by three factors: 1) the yield on foreign securities purchased; 2) the yield on bonds issued in the domestic money market to sterilise the intervention; and 3) the degree to which the intervention is sterilised in the domestic money market.
'Affordable for RBNZ'
Historically, intervention would have proven non-credible on this count because of New Zealand’s high short-term interest rates relative to foreign interest rates and because FX intervention would have required complete sterilisation. Speculators would correctly surmise that the RBNZ could not sustain losses and consequently they would happily use any temporary weakness in the NZD to buy.
These dynamics do not apply today. Assuming that the Reserve Bank buys 2 year government bonds weighted by the five currencies in our trade-weighted exchange rate index, the yield on these assets would be 1.94%, compared with a domestic 90-day bill rate of 2.64% (returns could be raised to 2.63% by reducing Japanese government bond purchases and increasing purchases of Australian government bonds).
This implies a net loss of 69bp assuming complete sterilisation. However, given the current macroeconomic environment, the Reserve Bank does not need to completely sterilise intervention, instead it can allow the money supply to expand. A sterilisation ratio of 74% would be enough to cover the cost of intervention, with a lower sterilisation ratio likely to assist in boosting base money, providing somewhat of an offset to the contractionary forces associated with the current de-leveraging.
We recently talked with global foreign exchange traders to gauge their reaction to the possibility of FX market intervention in New Zealand. To our surprise, the arguments outlined above were unanimously supported. Intervention in the FX market to weaken the exchange rate is clearly not sustainable on a longer-term basis, as many central banks in Emerging Asia are discovering, but under the right conditions, intervention it can be a powerful tool.
We believe the time is right for the RBNZ to contemplate this policy.
* Peter Redward is a New Zealand expatriate living in Singapore who is the Head of Emerging Asia Research at Barclays Capital.
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46 Comments
It sounds so much better if Barclays Capital first suggests we start printing money than if Bill English had mentioned it. I am sure the idea had never crossed his or the RBNZ's mind before this article.
But now the suggestion has been made, what a good idea - as is dressing it up as currency intervention.
This sound advice from the failed Barclays Bank which had to be bailed out by the British taxpayer to the tune of Billions, and is supposedly too big to fail ?
In whose interest is a devalued currency, when much of our debt is denominted in other currencies ? It encourages speculators in to buy our assets up on the cheap , on the back of a weak currency.
Its certainly not in our interests .
Food is already too expensive for some families. Petrol , Diesel, buidling materials and all imports will skyrocket, leaving us much poorer than we already are.
Sorry Mr Barclay, but even though we are really battling with this recession , we will sort ourselves out in the long run.
Government needs to cut expenditure , big time , and we all need to cut our cloth accordingly
We run an open honest economy based on free market principles, and while we are being punished for our profligate ways over the past decade, the free market always balances things out in the long run.
We need to get people off the benefit and into work, we need to introduce drug screening for people on the benefit , only clean, drug free people should receive taxpayer funded handouts.
We need to exploit our resources like oil and natrual gas , and we need to maximise the value of our SOE's
Boatman. Businesses don't buy assets on the cheap / they invest where the profit is. Fontera for instance sells commodities in US$ and the higher the NZ$ the less real hard cash gets paid as tax and as profit to their suppliers.
I point to your example of food - does NZ really have to import food? Yes and what makes this possible? - Our high dollar means it is often cheaper for Australians to dump apples on our market than to supply their own. Also what business will invest here in the means of food manufacture pasta, noodles, pastry ext.. when on the back of our high dollar it is cheaper to ship from there current factory.
As for running an honest open economy, so does America and Europe and look at the mess they are all in by following the free market ideology that is enslaving their people to the banks socialized loss scheme.
Boatman
Think you might have the wrong British bank there.
Barclays didn't take bailout money directly. That was Royal Bank of Scotland and Lloyds HBOS.
Although there might be some argument about whether Barclays was given a leg up or two by the Fed indirectly.
cheers
Bernard
I stand corrected Bernard , Barclays did not receive a direct handout , although they seem to have received liquidity support between March and October 2008 .
It does not detract however from the fact Barclays along with all the Multi National Banks should not be trusted.
I would suspect that Barclays took a punt on the Kiwi Dollar going south , and it has turned around and bitten them .
I dont see any logic in trying to manipulate the Currrency up or down . Fiddling the currency is a quick fix that often fails along the line . Let the market do its job.
In spite of the recession ,we are actually doing quite well as a county with a national population the size of a small Asian city.
It was never going to be easy , and the earthquakes will have unforseen consequances (such as AMI's problems ) .
There can be no more instant solutions , we need patience , fortitude , hard work and a bit of luck
I don't think readers will understand what needs to happen and what the implications are from reading this article in order to right the wrongs of our passed discrepancies.
Firstly we don't want to have a low dollar value for the sake of making tourism and our other assets more attractive to overseas buyers, we want more dollars trickling down to the people in our economy — more dollars equals increased profitability, higher pay rates, increased tax and more ability to save for our own future.
Increasing money supply by printing is also by far a better long term solution to our over valued property prices in relation to wages than the sitting game of waiting around till the prices correct themselves by further stagnation and deflation.
The negatives of increasing the monetary supply are inflation of foreign goods and a lower value of exchange when traveling abroad and as far as I can see these are both positives as they both increase home investment and spending.
Over both the medium and longer term the effects of increasing the money supply in relation to the value of a devalued NZ dollar will disappear because if we get our internal economy profitable again, if we get our wages on par with Australia - overseas people will want to work here and overseas business will once again decide to invest here.
Linked from omo.co.nz
Morgan Stanley Feb 2010
Here’s our key point: If the way to covertly default is to pay an interest rate below the nominal growth rate, we think it’s possible that policy makers will aim to lower the interest rate rather than lift the inflation rate. In a sense, central banks buying government debt are already a small step down that path. A medium-term approach, however, could be to compel private financial institutions to purchase government debt. Such holdings were often mandated (as prudential measures) prior to the deregulation of financial systems in the 1980s
What a stupid idea, bash the savers again.
What really needs to happen is for NZ to get back to only spending what it earns.
The only way to do that is stop the banks bringing in cheap money from oversea, stop all this covered gonds rubbish, and get back to lending exactly the same amount as what we save as a country.
Why is this Bashing savers? If we print money businesses become more profitable, more profit equals a greater return on investment.
The real crime would be to maintain the status quo of low interest rates and there-fore a low rate of return.
I agree with you that there is no need to borrow money from overseas and that is what the article to me is about, we can print all the money we need to grow our tax base and businesses and then catch up with Australia and other countries when our businesses are profitable and represent a good investment to overseas countries.
Yes it's about spending what we earn and to do this we need to print more money and devalue our dollar. A lower dollar value means we import less because goods become more expensive and the goods we export stay the same to explain this our goods don't actually become cheaper because we sell in American dollars, it's just that we get more NZ$ when we do the currency exchange our goods actually increase in NZ value.
This is a sound solution.
ctnz, to answer your good questions, you grow your sales through inflation a business doesn't have to expand their production at all. By printing money to expand the money supply all you are doing is increasing the money supply.
Looking at oil because it is traded in US$ you could say that the price of oil has increased to US$112 and this is inflation / you could also correctly say that oil has not increased and there is no inflation at all because the US has increased their monetary supply and as a % of that monetary supply increase the oil price has stayed largely the same.
Now if you want to increase production which is the outcome from having a correctly priced NZ$ then you do need to buy specialist machinery from overseas so you do your maths and work out if there is profit in the investment - nothing changes.
I should also mention that if you are selling your goods in US$ then you can buy the machinery with those dollars and not worry about the NZ$ situation.
Roadhouse
If I think your conclusions further, the Reserve Bank should just print HEAPS of money (like Bernanke) and disperse it to all and sundry, then we all would be sooo rich (like the Americans, particularly those with food stamps).
Reminds me of my grandmother, who was very rich, she had 2 Millions to buy a loaf of bread back in the twenties.
Gertraud, the same people writing here against deflation will also be writing on Bernards other blog 'green lights rise in currency' against inflation.
It's funny when you think of all the people running around in circles wanting better this and fairer that but who really just want to maintain the status quo of going nowhere.
The Swiss National Bank just tried and made the heaviest losses in its history - without creating much of an impact.
This Barclays kid just does not know what he is talking about. Manipulating markets is all he knows about coz - as mentioned by another contributor before - his job would no longer exist, had the UK government not bailed out him and his smart colleagues.
I understand that the idea is buying the USD to bring down the exchange rate. It makes sense if you buy it ahead of the interest rate hike in the US. But if they continue with the "low rates for an extended period" the RBNZ will be toast and it will cost them ouch ammounts of money. The SNB burned 24 B $ trying to prop up the Euro and made a big loss.. It is a good idea if the timing is right.
Formally, we are living in a capitalist society where badly managed companies - such as Barclays - are sorted out by the markets.
As it happens, our governments are constantly intervening in markets to an extent that we are living in an era of near complete distortions.
Had Alan simply left his silly fingers off the situation, e.g. the distorted property markets would have fallen to where they belong i.e some 20 or 30% lower, and as a consequence speculation in NZD would have lessened.
This is a case of one intervention chasing the next, trying to undo some it its distoring effect. The solution would be to simply let good old capitalism takes its course.
The guy from Barclays obviously does not understand that the increase in the value of the NZD is caused by the USD devaluing not the NZD increasing. That situation is not going to change anytime soon, while the Federal Reserve keeps printing money. If they do halt printing US interest rates will soar, their deficit will go though the roof.
The riots following forced budget costs in that situation will be like we have seen nothing yet!!
When will these guts learn, devalutaion will make NZer's poorer, will increase inflation and further pressure on the ecomomy from increasing imports. After all we import more than we sell, even when the dollar has been 50-60c/ USD range.
The best thing that could happen would be for the government to cut spending, get rid of the regulations that make running a business so costly and uncompetitive and focus on regulating monolpoy situation, insider trading in the stock market, make directors and business owner liable for there failuresr that might help give those with saving, have confidence to take it their savings out of property and into other investments..
If the government cuts spending that will leave more money for private investment.
There are no countries with a real free market economy, all are distored with tariffs, import duties, subsidies and company bailouts dating back decades. Politicians love to play god dishing out taxpayer monies to get themselves elected, regardless of the handouts affordability.
Shrink the goverment should be our mantra!!! Lets get responsable for our own lives without nanny state in the background. Politicians rate poorly in the trust stakes so why do we expect them to solve anything!!
And just how much cash does the RBNZ have to pitch in against the hedge funds and currency speculators of the world? We've forgotten how sterling was forced out of the EMS in 1992 against he efforts of the BoE?
Didn't Gareth Morgan say that NZ is a pimple on the world's backside?
What this Barclay mouth is saying is that his bosses have bet on the Kiwi$ falling and right now they are facing heavy losses...QED we get this public blast of BS aimed at saving the bank's arse. Bugger Barclays.
The public need to see through the likes of Barclay's bullshit...they are sprooking the market for their own ends....remember...the "B" in bank stands for bullshitters.
You know Wally you just might fess up occassionally and state that you also have self interest here...you also have an axe to grind.....and you are always banking on the destruction of the USD which helps the shiny stuff increase in value.
You are a habitual quoter of Market Oracle ....who are about as an impartial observer as I am.
QE3...you got wrong.....where the Feds broader outlook is going ...you got wrong...gold at $5000.00....you got wrong....as a matter of "fact" we are about even on wrong calls.
You don't always get it right Wally ....nor do I........... but try to be a little more ok with it.
For what it's worth I still think the NZD is way over value.....but appreciate the gasoline trap we are in....so it's a lose lose.....which is a pretty fair reflection of how the feeling is out there on the ground.
A high NZ dollar hurts our exporters, those who raise overseas earnings. It also provides us with cheap imports and discourages NZ manufacturing - look at the cheap flood of Chinese imports. loan money is cheap and encourages further borrowing, and it doesn't help us to realise we are living beyond our means. A high dollar discourages tourism, one of NZs leading revenue earners and is also employer and created of jobs. A high dollar means petrol is cheaper and therefore discourages us at looking at alternatives such as electric cars which are a fraction of the cost to run. A high dollar discourages overseas investment as our labour and business costs are high. A high dollar encourages us to travel overseas instead of holidaying at home and further strengthening our economy. A high dollar is hurting the average kiwi but possibly is hurting the currency traders who also believed it is 20% overvalued and gambled against it's fall. while I hate the greedy speculation of our currency, I also want what's best for our country in the long term.
Electric cars.........economically I dont think they stack up....the difference in the exchange rate makes little difference....first thing is look at the TCO, total cost of ownership....not petrol costs.
A 1500cc petrol car costs about $22k, a prius, miev or similar about $46k over double the cost....the next big kicker is the lifespan of the car....A conventional car lasts at least 15 years and 20 years is quite common....mine is 15 years old and has another 5 easily...
Personally I think his arguments are specious for the most part.
I think there is an argument for the RBNZ to buy gold (or other physical commodity, but gold is convenient) when the dollar is high, but not with the intention of controlling the currency as such.
My recommendation is the RBNZ just buy a tonne of gold a day when the NZD is above 75 USD.
This has a number of effects:
1 It puts a gradual pressure on the currency when it is high
2 It builds up an emergency gold fund for the future
3 It has an inflationary effect to counter the deflationary effect of a high currency
4 It allows the RBNZ to run slightly higher interest rates, so gently encouraging saving over borrowing.
5 It reduces the pressure to blow borrowed money into the economy by creating asset bubbles.
Essentially it allows the RBNZ to increase the money supply when needed without the consequence of asset price bubbles as the transmission mechanism.
This country needs residents with equity to invest in viable businesses, not money borrowed from overseas. Its called savings.
Thank you Kunst.
Its such a simple easy thing to do. No great brow beating required on the part of the RBNZ..
Its simplicity is really important. No "74% sterilised intervention" here. Really these bankers are just selling their wares and doing a wonderful job of making unfamiliar things sound complicated.
In their jargon I suppose this is 100% pure unsterilised intervention.
This stuff is not really that difficult but it does deal with unfamiliar concepts that took me a while to get to grips with. The vested interests in any field always try to make themselves look clever by using long latinised words, it's always a giveaway.
The Carry Traders won't appreciate that kind of talk. I expect we would get spanked by a downgrade and subsequent debt rate hikes. Imports would rise to the moon too. It would help our tourist industry some, especially during the Rugby World Cup.
It seems there are few options left but to reduce our exchange rate, to try and get some stimulus. When is the next RBNZ meeting?
Bollard's latest blather...just released by the RBNZ.
“If households and firms use the income boost from higher commodity prices and exchange rates to bring forward consumption and investment, or increase borrowing, then pressure on resources in New Zealand would lead to more inflationary pressure. Monetary policy would need to counteract any rise in inflation expectations.” doh
So how come Bolly cut the ocr..was this not to increase consumption...to pork the market...what the hell is going on?
The concise upshot of this article is one of complete contradictions of the usual mumbo-jumbo .
Its a fantastic approach the ruling elites employ, confounding the cotton pickers, easy to see tactics when you follow the money down the rabbit hole.
So anyway in the meantime cotton pickers ya better jump down turna round and pick a bail cotton jump down turn around pick a bail a day!
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