Guest Post: Our high exchange rate

August 3rd, 2012 at 11:00 am by David Farrar

A guest post by :

There is something we could do about our high exchange rate

New Zealand hasn’t paid its way in the world since 1973. Every year since then we have had to take on extra debt and sell off assets to fund the gap between our exports and imports. Yes, the Government had paid off most of its debt before the global financial crisis hit in 2008. This means government borrowing is not high by international standards despite recent increases. However, private sector external debt is worryingly high.

The Reserve Bank recently looked at our net international investment position as a percentage of GDP, and came up with a figure of negative 86% as at 2008. Against a selection of 21 OECD countries New Zealand was 18th with only Portugal, Hungary and Iceland having a worse position. Even Greece appeared to be in a slightly better position than New Zealand in 2008! See http://www.rbnz.govt.nz/research/bulletin/2007_2011/2010dec73_4Steenkamp.pdf

New Zealand has got into this position because we have had a chronically over-valued exchange rate. Year after year our export revenues have failed to cover our imports.

The high exchange has been blamed on the Reserve Bank since it became independent in 1989. Apart from some supervision of financial institutions, the Reserve Bank’s only task has been to keep inflation under control and its only levers for the job have been monetary ones. Relatively high interest rates have been required to tame inflation and a side effect has been a high exchange rate as foreigners have rushed to deposit money in New Zealand.

However, there are other factors that affect the exchange rate. The attractiveness of foreigners lending money to New Zealand financial institutions depends on the whole return and not just the ‘raw’ interest rate. Tax can be withheld from the interest paid. New Zealand’s tax treaties allow for a 10% or 15% interest withholding tax.

However, since 1991 the approved issuer levy (AIL) scheme has allowed financial institutions to pay a 2% fee in return for not having to deduct any withholding tax from the interest on foreign deposits. Recently the Government has gone even further and lowered the levy to 0% in some cases. Meanwhile, New Zealanders have tax deducted from the interest on their savings at their marginal tax rate, which for middle to high income earners is 33%.

It is no wonder we have high capital inflows funding our way in the world when we go out of the way to make it attractive for foreigners to put their savings here but not for New Zealanders to save. Other countries have implemented various measures to discourage passive investment from foreigners because they know it pushes up the exchange rate and harms the productive parts of the economy. Here in New Zealand we don’t seem to care.

I suggest that the solution is to allow the Reserve Bank some control over the level of tax on interest payments, and to give it an objective that incorporates sustaining economic growth for the long term benefit of New Zealanders. If AIL was abolished and we went back to an interest withholding tax of 10 or 15% on foreign deposits then the demand for the $NZ would likely to drop a little and the exchange rate fall. This would make imports more expensive and exports more competitive, helping the balance of payments.

Discouraging the inflow of foreign savings could encourage banks to raise their deposit interest rates to raise more money, which would tighten monetary conditions. However, the Reserve Bank can ease monetary conditions if it thinks they are too tight. It has various tools like the official cash rate which effectively allow the creation of more money.

The global financial crisis did disrupt the power of the usual monetary instruments. In some countries, central banks had to turn to new instruments such as quantitative easing (essentially printing money) to increase the money supply. Quantitative easing definitely creates more money without having to borrow it from foreigners!

Making monetary conditions too loose causes inflation and I am not advocating that. But why borrow overseas when more money can be created internally?

Prior to their entry into the Euro zone the Greeks tended to have high inflation and a depreciating currency, no doubt from loose monetary conditions to grease the wheels of their economy. In recent times the Greeks couldn’t do anything to create extra money internally to help fund their excess consumption so had to borrow externally. That is why they racked up huge debts to foreign banks which they now can’t pay back.

It seems ludicrous that NZ should be getting itself into a similar situation to some European countries like Greece (in having high foreign debt) when we have our own currency, our own central bank and a reasonable tax system! It is simple economics to lower the demand for $NZ to lower the exchange rate to stop the need for foreign borrowing. That could, however, mean a fall in living standards as those big screen TVs become more expensive. I suspect that is the real reason why no one wants to bite the bullet and give the Reserve Bank the powers and responsibilities I am suggesting. Just like the Greeks of several years ago, we like to think the day reckoning will never come!

 

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30 Responses to “Guest Post: Our high exchange rate”

  1. Paulus (2,594 comments) says:

    As a lender to the Banks by way of term deposits on my pension funds built up over many years, the return we currently get disencourages savings.
    So – more overseas holidays, rather than save (except change to SOE partial sales).

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  2. krazykiwi (9,189 comments) says:

    Good post. Key para for me was:

    It is no wonder we have high capital inflows funding our way in the world when we go out of the way to make it attractive for foreigners to put their savings here but not for New Zealanders to save. Other countries have implemented various measures to discourage passive investment from foreigners because they know it pushes up the exchange rate and harms the productive parts of the economy. Here in New Zealand we don’t seem to care.

    .. that and the bit about we, like the Greeks, thinking that our day of reckoning will never come.

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  3. Colville (2,248 comments) says:

    I am all for a NZ$ at around $0.50 US.
    I have 50,000 tonnes of pine logs to sell in a few years time!

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  4. Cunningham (836 comments) says:

    “However, since 1991 the approved issuer levy (AIL) scheme has allowed financial institutions to pay a 2% fee in return for not having to deduct any withholding tax from the interest on foreign deposits. Recently the Government has gone even further and lowered the levy to 0% in some cases. Meanwhile, New Zealanders have tax deducted from the interest on their savings at their marginal tax rate, which for middle to high income earners is 33%.”

    It all makes sense but surely there is a valid reason for the government doing this?? I do not know this kind of stuff in detail but I imagine it has something to do with enouraging foreign investment? Does anyone know?

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  5. Alan Wilkinson (1,866 comments) says:

    The Big Mac index says our exchange rate is not overvalued but in fact slightly undervalued. Always query your assumptions.

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  6. BlairM (2,316 comments) says:

    WTF?!!! So he wants to discourage the flow of foreign capital into New Zealand? What a dumbarse!

    The obsession with import/export balance of payments is ridiculous. If investors really thought the New Zealand dollar was overvalued, they would stop buying it and the rate of exchange would fall.

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  7. Linda Reid (412 comments) says:

    My brother lives in San Francisco – and has bought a rental property (no mortgage) in NZ because he effectively gets a 0% return on money in the bank in the USA. His ROI is still not great, but better than nothing.

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  8. seanmaitland (488 comments) says:

    @Paulus – relying on interest on savings accounts as a way of funding retirement is akin to digging a hole in the ground and burying ones money. You shouldn’t be rewarded for that lazy attitude.

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  9. dime (9,799 comments) says:

    IMHO any lower than .65 and we are in for interesting times.

    As some of you know Dime’s an importer (redbaiter loves it). We have seen huge increases out of China over the last 4 years. Over 50%. One of our top ranges has gone up 70%. Multiply that out – our margin, bigger retail margins and its difficult.

    The only thing offsetting that is the high dollar.

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  10. grumpy (255 comments) says:

    There is a heap of shit spouted about exchange rates. A low exchange rate only gives the illusion of higher income, in real world terms it is a driver of poverty.

    A business that needs to rely on low $NZ should not be trading – it’s obviously a 3rd world industry.

    The $NZ is not high, it’s just less low than other currencies.

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  11. dc (174 comments) says:

    Pet peeve: stop using big-screen TVs as the epitome of luxury living! Even with a saner exchange rate they are so cheap now that they’re a tiny fraction of disposable income. The things that would really hurt our standard of living if the exchange rate fell are petrol prices ($3 a litre anybody?), vehicle prices, food and clothing.

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  12. RRM (9,770 comments) says:

    As some of you know Dime’s an importer (redbaiter loves it).

    “Beautiful 21 year old asian virgins want to meet kiwi men for marriage” is it? Judging by the number of chronic sad arses on this forum, that would be a good business to be in, in NZ :-)

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  13. rolla_fxgt (311 comments) says:

    Or it would just be easier to remove RWT on NZ bank deposits, so as to encourage medium to long term savings within NZ, to allow NZ’ers access to local capital, rather than foreign capital. While still allowing foriegn capital to have easy access to the NZ economy.
    The cost to the govt revenue due to the loss of RWT could be balanced out by removing the incentives for kiwisaver.

    @Alan Wilkonson
    Yes it did, but it also failed to account for size difference between Big Macs in different countries, and it also failed to account for local price variations & conditions for raw ingredients, since Big Macs use local ingredients, which have variations from market to market, and season to season. So McDonalds use average price over the year per market to set its Big Mac prices. We know that NZ has higher input costs than the US, which must follow through into the cost of the burger, meaning you can’t really the Big Mac index as a true representation of Purchasing Power Parity.
    Further the US dollar has tanked, and since everything is compared to the US dollar, if they tank then the comparisons are also put out by a margin.
    There are better versions of PPP comparisions than the Big Mac index, its just the most well known. A bit like Internet Explorer vs Chrome or Firefox, all do a similar job, just some are better than others, and some are more well known that others. Being well known doesn’t equate with being good.

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  14. PaulL (6,019 comments) says:

    Mixed response from me.

    On the one hand, yes there are problems in our system. We have too little savings, therefore logically we should rebalance incentives to get more. And it is a problem that we continue to borrow money from overseas to fund current expenditure, it would be much better if we didn’t do that.

    Having said that, there are some other factors:
    1. I’m never sure the statistics are accurate. I think we have better information on investment inflows than outflows. In short, I reckon quite a few people have investments offshore that they don’t declare to the taxman. If I remember correctly, the whole world on average runs a deficit with itself (i.e. most nations run a balance of trade deficit, which is logically impossible)

    2. Addressing our exchange rate as a way to deal with our uncompetitiveness seems a cop out. Surely the right thing to do is to become competitive, not just to devalue our way to third world status? Having said that, perhaps devaluing instead of borrowing against future generations would be a better wake up call for people so they might vote for sensible government policies.

    3. Scaring away, or driving down, foreign investment seems a bad policy decision. Most countries would see that as being crazy stuff. The fact we borrow too much from offshore shouldn’t be addressed by forcing away that foreign investment – in most cases that would mean that investments don’t occur and therefore our productivity languishes – it doesn’t automatically get replaced with local investment. I guess the key here is whether foreign “investment” is really investment (in productivity or GDP enhancing initiatives), or actually just pushing up house prices, or providing funding for consumption spending.

    This is harder than it looks. The long term answer is to get our productivity right – incentives for people to work, to increase their incomes, and to do things that make them happier (i.e. if people are choosing to work fewer hours and spend more time at home, then that’s actually OK – we shouldn’t try to jig things to force them to work more).

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  15. Alan Wilkinson (1,866 comments) says:

    rolla, you can quibble about the Big Mac index as any other index. It still provides a quick reality check against unsubstantiated assertions and assumptions – which is what this article and many others rely on.

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  16. unaha-closp (1,157 comments) says:

    Making monetary conditions too loose causes inflation and I am not advocating that. But why borrow overseas when more money can be created internally?

    Becuase you are advocating inflation.

    Direct price inflation that will screw over every NZer and put us in a position equivalent to Greece 20 years ago.

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  17. dime (9,799 comments) says:

    RRM – nah something more subtle. Sad thing is a lot of you would have Dime products in your houses :D

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  18. CharlieBrown (987 comments) says:

    It is very narrow minded and one dimentional to blame the high exchange rate on the AIL. Since 1991 the NZ dollar has spent a heck of a lot of the time less than 60 cents american, hell it spent 3 years at less than 50 US cents – the high rate is a recent thing we’ve experienced since socialism fully kicked in around 2003 and has stayed in since. I think addressing the overly complicated tax system would be far better than tinkering with the AIL. To start of with, we need to find out why so many people think its better to go into debt to buy a rental property in auckland than it is to put money into a term deposit (perhaps its the fact that after TAX and inflation you lose real value on your TD)?

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  19. PaulL (6,019 comments) says:

    dime: the reality of chinese economics is that their incomes are growing faster than ours. Over time their comparative advantage will fall, particularly for anything where being close to the end customer and/or offering tailoring and/or shipping costs are material.

    The US is already seeing this – manufacturing is starting to move back onshore in some areas. I recall reading an analysis that said car part manufacturing would be moving back onshore to US within about 4 years. The parts have about 30% labour content by value, Chinese employees get 30% or so of US wages, shipping costs 10%. So the wedge on a $100 part is currently $30 of labour in US which costs only $9 in China, but increase of $10 in shipping – so $11 difference. Once Chinese wages get to $20 to manufacture it, cheaper onshore. Once you include the intangibles of shorter supply chains, higher quality, dealing with someone under US law, the actual cutover point is much earlier, probably more like $15 of labour. At 8% pay rises per year, China gets there pretty quickly.

    A similar article here:
    http://www.accenture.com/us-en/outlook/Pages/outlook-journal-2012-north-america-flexes-industrial-muscle.aspx

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  20. dime (9,799 comments) says:

    paulL – there will always be somewhere. in my lifetime anyway! Vietnam is producing more, Indonesia, India etc etc

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  21. bhudson (4,736 comments) says:

    He might write well, but his ‘solution’ boils down to the following:

    1. Remove access to foreign capital
    2. Print more money

    These are not good long term options for our economy! Watch inflation soar while our economy contracts through a lack of capital. A recipe for stagflation I suspect.

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  22. Mr_Blobby (163 comments) says:

    What we want is a strong currency as it indicates a strong economy.
    Seriously do we want to be in the race to the bottom? Win the devaluation race. Look at what a dollar brought 30 years ago and what it buys today. Remember when petrol was 45 cents (10 cents a liter) a Gallon. Theft by devaluation, Governments have been doing it for ever. At the very least we should be looking at parity with the US Dollar.

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  23. dog_eat_dog (775 comments) says:

    So we should cripple ourselves by making the price of petrol etc artificially high, while ignoring the fact that other markets are weakening and we’ve just been given a stable outlook? Newsflash: They’re the ones with the problem, and not us. Look at Japan: no growth, no productivity, but massively high Yen. Sure, it causes issues, but relative to everyone else, it’s considered a safe haven.

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  24. wiseowl (859 comments) says:

    Well Mr Blobby if we had parity there would be a shit load of businesses wound up.It’s bad enough now.
    On the price of petrol have a look at how much a litre is being extorted by the Government.

    The dollar is overvalued and it is crippling many who are earning income for the country.

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  25. Jimbob (641 comments) says:

    Basically it is the weak US dollar that is causing the problems. They are weakening their currency to get rid of all their debt. This could go in the other direction, and the NZ dollar weaken and the US strengthen if or when the GFC worsens. The system we have is there for a purpose, it is the best the bunch. We are a commodity currency and we can not alter that, the interest rate has plenty to do with a currencies popularity, as well as a safe haven, other than the USD. If it was that easy we would all be millionaires, but you have to pay a premium it you are big spenders of public money.
    Artificially controlling the exchange rate, decreases your standard of living on most consumers, the majority, and you do not win elections that way.

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  26. Anthony (789 comments) says:

    There are obviously other things the country could do to get more competitive, but it is a fact that we haven’t paid our way since 1973 and the quickest way to face reality would be to get the exchange to a level where our exports do pay for our imports.

    Foreigners depositing money in New Zealand is passive investment – doesn’t help us become more competitive in any way, shape or form.

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  27. Paulus (2,594 comments) says:

    Seammaitland

    I previously had my money with a leading now automatic “Preferred Kiwisaver” Manager.
    We were locked into well praised, by the Mary Holmes’s, in a Managed Fund for 5 years, and lost capital (no interest either) considerably over $100,000.
    That’s why we went for safety with Bank Deposits.

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  28. wat dabney (3,755 comments) says:

    The basic premise of the original post appears to be wrong.

    New Zealand hasn’t paid its way in the world since 1973. Every year since then we have had to take on extra debt and sell off assets to fund the gap between our exports and imports

    Yet according to the RBNZ paper cited: “The current account deficit has, on average, largely been the product of a deficit on the investment income account – the trade balance has been in surplus for much of the last two decades”

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  29. Anthony (789 comments) says:

    It’s what is called invisibles Wat – still contributes to the BoP deficit because we are not paying our way- and the invisibles deficit gets worse as we borrow and sell more so more of our earnings head offshore – a bit of a vicious circle.

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  30. Anthony (789 comments) says:

    As well as the negative investment income an example of an invisible import is all the money Kiwis spend on overseas travel.

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