What should we be doing about the high NZ dollar?

by Rebecca Macfie / 06 October, 2012
New Zealand’s soaring dollar is punishing exporters and threatening our economy, so what should we be doing about it?
Simon Ward

Simon Ward has been firing off furious emails to the many business lobby groups he pays to represent his interests. His message: the high New Zealand dollar – currently around US82c – is snatching away his profits and wearing him and his staff down. Something must be done about it. Ward manufactures heavy machinery; one of his main products is a clever device that tilts shipping containers up on end, allowing them to be filled with bulk material. The 13-year-old Onehunga company, A-Ward Attachments, sends 95% of its production overseas, and has just become a finalist in the steel industry’s equivalent of the Grammys, the Swedish Steel Awards.

With a staff of just 14, Ward is budgeting to earn $20 million in sales this year. Sales have been doubling every year. It sounds like the business ought to be a roaring success. So, what’s the problem? “I’m not making any money,” he says. “I have always said as an exporter we can survive up to US75c”. Anything above that and the profit margin gets eaten away. With the exchange rate at its current level, business is an “endless grind”. There’s no room to discount to close a deal. He’s been forced to start buying a key component, cylinders, from China, rather than from his preferred supplier in Christchurch. He’s constantly trying to refine his processes and designs to strip out cost. In other words, he’s doing what the Government keeps saying firms should be doing: using their smarts to make their business as lean, competitive and productive as it can be.

But Ward says he holds it all together only by working 70-80 hours a week. “I don’t see my kids. I’m up at six every morning and some days I don’t finish until 11pm. I can only do that for so long and I’ll burn out and there won’t be a company. I have staff who are here at seven in the morning and still here at seven at night, and most of them are salary workers. You can only do that for so long, and we’ve been doing it for too long now.” Despite the company’s strong sales growth, Ward says he hasn’t been able to employ more staff. If the currency was down at around US75c, he’d still be working hard, but there would be enough profit to let him take on extra employees and lighten the load on himself.


At Christchurch’s Wyma Solutions, a company that makes specialist vegetable-cleaning machines for shipment all around the world, the story is similar. The Listener last spoke to Wyma managing director Peter Suckling three years ago, when he was fighting a global slump and a “sky-high” dollar that was eating his profits. Back then the Kiwi dollar was sitting at US71c. Needless to say, with the dollar hovering above US80c for much of this year, the stress is unrelieved. “What the [high] dollar has meant for us as a business is that we haven’t been able to grow in the way that we would have and should have, had the exchange rate not moved the way it has,” says Suckling, speaking on his cellphone while he waits to board a plane for Israel to visit customers.

“It attacks our margin. We could take as many orders as we wanted to provided we didn’t want to make any money. We have walked away from a lot of potential orders where we have said we’re not prepared to do it for that margin.” Suckling describes himself as a passionate exporter, and says the company has fought hard to retain its manufacturing base in Christchurch rather than shift offshore. “But I’m becoming very concerned we are becoming a dumb export nation, putting all our eggs into one basket – agriculture. All we need is an outbreak of foot and mouth and [New Zealand] won’t have an income.”


The battles faced by innovative exporters like Wyma and A-Ward seldom make the news. Their stories don’t carry the high drama and human tragedy of mass layoffs, such as those seen recently at Norske Skog’s Kawerau paper mill, Solid Energy’s West Coast and Huntly coal mines, and Rio Tinto’s Tiwai Point aluminium smelter – all of which blame the soaring New Zealand dollar and falling commodity prices for their woes. But with the currency persistently overvalued and talk that it could go much higher still – Economic Development and Associate Finance Minister Steven Joyce has speculated it could reach parity with the weak US dollar – manufacturers’ pleas for a rethink of exchange rate and monetary policy are gaining traction.

Labour, New Zealand First and the Greens are advocating reform of the Reserve Bank Act to broaden its focus away from purely inflation targeting, and requiring it to consider other factors affecting the economy, including the exchange rate and jobs. They are joined by the voluble boss of the Manufacturers & Exporters Association, John Walley, who has long railed that current policy settings overvalue the dollar, drive investment into real estate instead of productive industry, encourage consumption in imported gadgets and overseas holidays, and harm exporters. Walley claims that every 1% increase in the value of the New Zealand dollar wipes $200 million off exporters’ annual earnings, and that the soaring dollar has cost the export sector $10.4 billion over the past three-and-a-half years.

Joyce has dismissed calls for change as the pleadings of snake-oil merchants and voodoo economists. But lately the challenges to New Zealand’s adherence to orthodox monetary policy, in which the Reserve Bank keeps inflation under control through the official cash rate and largely leaves the exchange rate to find its own level, have become more difficult to shrug off. Last month the New Zealand Institute of Economic Research – an institution not normally known for voodoo thinking – published a short paper on the need for new Reserve Bank Governor Graeme Wheeler to be given additional tools to help ease the effect of inflation-targeting on the exchange rate.


New Reserve Bank Governor Graeme Wheeler

The NZIER says concern about the impact of monetary policy on the dollar has persisted since the early 1990s, with the main complaint being that when the Reserve Bank lifts interest rates to hose down inflation, it causes the currency to rise and “inadvertently strangles the tradable sector”. It points to research by Morgan Stanley showing the New Zealand dollar was the most overvalued currency in the world in 2007, and cites work by the Washington-based Peterson Institute for International Economics that has listed the kiwi among the three most overvalued currencies (given this country’s high rate of indebtedness) for the past three years. The Peterson research also cites the Australian dollar as being seriously overvalued.

In the wake of the global financial crisis, even the International Monetary Fund has questioned the prevailing orthodoxy that the principal concern of central bankers should be to control inflation. Instead, “central banks in small open economies should openly recognise that exchange rate stability is part of their objective function”, wrote a group led by IMF economist Olivier Blanchard in a 2010 paper. The most recent assault on current policy settings has come from the very heart of New Zealand’s financial establishment, with economist and strategist Bernard Doyle of sharebroking firm JBWere arguing the Reserve Bank should “lean against” the high dollar and support industries facing global headwinds. Doyle says he was moved to publish his views following a rush of headlines about major layoffs in the export sector, and news that the US Federal Reserve was to embark on a third round of open-ended quantitative easing – effectively printing money – in a bid to jump-start the American economy (an announcement that immediately pushed up the New Zealand dollar). He argues that in a world where governments are throwing the economic rule book out the window, New Zealand is disadvantaging itself by continuing to follow orthodox monetary policy.


When he was still Reserve Bank Governor last month, Alan Bollard described the Reserve Bank as being in a “reasonably sweet position” – but Doyle feels that’s far from the truth, and suggests there is an attitude of complacency about the risks. He sees dangers in New Zealand’s widening current account deficit, a housing market that’s “bubbling away” and being stimulated by low interest rates, and exporters being hobbled by the high currency. “What’s the plan if the currency gets to US90c or US95c – are we just going to say, ‘We’ve got one lever, there’s no point intervening and we’re just going to tough this out’? “Historically, that’s been fine – you have these cycles where things get a bit out of kilter and the export sector suffers and the housing sector does well, and you know it’s all going to wind down at some point. But I find it a little alarming that we are quite early in the housing cycle, interest rates are low and feeding that cycle, and the currency is already hurting [exporters]. “I worry about the implications for financial stability … With the way the world is right now and all these rinky-dink tricks going on overseas, the prospect of us growing in a stable way from here doesn’t look great to me.”

The “rinky-dink tricks” being deployed by governments and central bankers in the wake of the global financial crisis are many and varied:

  • zero or near-zero interest rates prevail in Europe and the US;

  • the Bank of England is printing money and directing it as cheap loans for households and businesses;

  • the Royal Bank of Canada is trying to hose down an overheating housing market by imposing limits on the length of home mortgages;

  • the European Central Bank is making cheap money available to indebted countries and banks;

  • Chile has twice bought US dollars to depress the value of its peso;

  • Brazil has imposed a financial transactions tax in a bid to peg back its escalating real; and

  • the Swiss National Bank has been intervening in the currency markets for the past year to cap the value of the Swiss franc and help its exporters.

Doyle says before the financial crisis, one of the biggest factors pushing up the New Zealand dollar was the so-called carry trade – stereotyped as Japanese housewives and Belgian dentists buying up Kiwi dollars to take advantage of our high interest rates. Nowadays, in addition to international bond traders seeking the benefit of our interest rates (which are historically low, but high by international standards), he thinks one of the main pressures pushing our dollar higher is coming from other central banks that see it as a safe haven or are trying to hold down their own currencies. The Reserve Bank of Australia recently said the Swiss have been buying Australian dollars as part of their determined campaign to keep the lid on the franc. “That could easily be part of the upward pressure on the New Zealand dollar – other central banks that are intervening in their own currencies and buying our currency.”


Labour’s finance spokesman, David Parker

Labour’s finance spokesman, David Parker, argues that while other countries are engaged in “competitive devaluations” to protect their export sectors, New Zealand is holding doggedly to an inflation-targeting regime at a time when inflation is not the main problem facing the economy. He was recently in Europe and the US, talking to leading economists including the IMF’s Blanchard and Nobel prize-winner Joseph Stiglitz about their views on monetary policy. Parker argues not only should the Reserve Bank Act be amended to remove the primacy of inflation-targeting, but the membership of the central bank’s board should be broadened to include exporters and workers. And, he says, it needs extra tools and levers to influence the currency. But which ones? What could the Reserve Bank do to lower the value of the dollar and help exporters like Ward and Suckling? Here, Parker points to the smorgasbord of exchange rate-targeting options on display around the world. “You could look at the Swiss levers, the Brazilian levers, the Chilean levers.”

Which in particular are best for New Zealand? “For me to go that far would be for me to say I want to manage these things from within government. I think there are trade-offs involved in all these things. We are getting the trade-offs at the moment in the wrong place, which is slaying the export sector and as a consequence the economy is not working for ordinary people … [So] you change the membership of the Reserve Bank, you let them use all the tools that are out there in the world to be used, and they should take that decision, and they should be responsible for good economic outcomes.” But Parker does have some specific suggestions. “You could create a bit more risk in the currency. The New Zealand currency is so predictable that some economists say it means we are a resting place for some of the speculative flows of capital around the world, and those speculative flows are enormous relative to the size of our economy … “And some countries regulate to take heat out of the [property] market. You could do that in Auckland, and say if you want a loan for a house it has to be on repayment terms where it has to be repaid over 20 years.”

Or in a variation on the above, suggested by various commentators, the Reserve Bank could take some of the heat out of the currency by dropping interest rates to reduce their attractiveness to overseas speculators, and at the same time keep a lid on the housing market by imposing loan-to-value ratios that would limit the amount of debt a home buyer can take on.


The NZIER’s paper suggests the rules governing bank funding could be used more actively to weaken the link between the official cash rate and the exchange rate. The Reserve Bank has already brought in new requirements governing trading banks’ core funding, which by early next year will force them to source 75% of their funding from both the retail deposits of mum and dad investors and long-term borrowing from the financial markets. The NZIER thinks the core-funding ratio could be lifted, which would increase the cost of credit and therefore make mortgages and business loans more expensive. It says this would generate “more bang for buck for a given official cash rate … the Reserve Bank can leave the OCR, and consequently wholesale rates, lower, reducing the attractiveness to international investors of parking funds in New Zealand, relieving pressure on the exchange rate”.

But although the Reserve Bank has been actively exploring the use of such measures as loan-to-value limits and changes to the core-funding ratio – which go under the soporific title of macro-prudential tools – there seems little prospect they will be deployed any time soon. The bank is interested in using them as additional tools to help maintain financial stability and cool future housing bubbles, not to provide immediate relief to the exchange rate – and according to Bollard, no such bubble exists right now. And in any case, measures such as loan-to-value rules that limit a mortgage to, say, 80% of the value of the property would have side effects that New Zealanders may not welcome. As the Reserve Bank has noted, they may simply induce householders to “covertly” borrow more than the 80% limit.

Bollard told National Radio’s Nine to Noon programme that loan-to-value limits were possible, but those who were around in the 1970s, “when those sorts of things were attempted, will remember all the distortions that took place from doing that. And people in New Zealand would hate loan-to-value ratios … Remember where finance companies came from – they came from ways to get around restrictions on bank lending in the 1970s.” As for direct intervention in the currency
markets to reduce the value of the dollar, the Reserve Bank tried that in 2007 when the dollar hit US76c – with limited success – “but you never want to be in a situation where you are pouring millions of New Zealand dollars into a [foreign exchange market] that is measured in billions and trillions”, Bollard said.


Finance Minister, Bill English

If Finance Minister Bill English thought the Reserve Bank needed ammunition to fight the high exchange rate, he would no doubt have taken the opportunity when signing up a new Policy Targets Agreement with the incoming governor, Graeme Wheeler. Instead, the focus on inflation has been tightened. The new agreement also requires the bank to monitor asset prices, which Westpac economist Dominick Stephens says gives it a mandate to increase interest rates if house prices boom, even if consumer inflation remains low. “In the short run, this leans in the direction of higher interest rates,” says Stephens – which would no doubt feed into the value of the dollar.

English is dismissive of calls for New Zealand to emulate the likes of the Swiss central bank’s moves to control the value of the franc. “The Swiss started with hundreds of billions of reserves. We don’t. We start with hundreds of billions of debt. And they are taking a very large risk, because if they can’t sustain it, they will have to pay the bill for it. That’s why countries don’t do it.” But as Doyle and Parker point out, other countries are doing all manner of things that would previously have been regarded as heretical economic practices. Why can’t New Zealand join them? “The evidence that it can succeed is very thin,” says English.

“Look at the Bank of Japan [a few] days ago – they committed a trillion yen to shifting the yen for exactly these reasons … They got one hour’s impact and they were back where they started. You’ve got to have enormous firepower, and you have to have the will behind it, which is usually not associated with a democracy. “If you decide to lower the exchange rate, which is a way of lowering the purchasing power of your households, and the world changes and you want to hold your exchange rate, you have to do things like they have done in Singapore in the past and give everyone a 10% wage cut. It’s like Greece – one way or another you have to restore your competitiveness. That’s just the forces of economic gravity.”


Although the exchange rate against the US dollar and euro has been punishing for exporters, English points out trade with New Zealand’s biggest market, Australia, has benefited from a favourable cross rate. And he says it’s not accurate to suggest there’s an array of tools available to pull down the value of the dollar. “The challenge is the reverse. Someone needs to demonstrate that you can pick an exchange rate. And which one it should be – what if it implies a lower rate against the US but higher against Australia, for instance? “And secondly, that there’s a toolkit for executing that in a way that has acceptable risks. I mean, the Reserve Bank could run up an enormous exchange-rate position which accumulates as a large liability on the taxpayer … There’s no great evidence that is sustainable, particularly in countries with no reserves.”

There’s no “free lunch” in all of this, insists English. The answer to exporters’ woes lies in lifting New Zealand’s competitiveness by improving skills, infrastructure, innovation and tax settings. “There isn’t one big thing you can do … There are about 100 things we need to do, all of which have some impact.” For now, it seems, Simon Ward’s regime of 80-hour weeks and missing his children’s bedtime is set to continue.
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