By Bernard Hickey
New Zealand is facing a horrible bonanza.
The Christchurch earthquake has unleashed a flood of US dollars into New Zealand that is helping to push up our currency. Estimates vary, but most think reinsurance payments from insurers in Switzerland, Bermuda and Britain will total more than US$12 billion over the next couple of years.
Statistics New Zealand has already recorded NZ$11.1 billion worth of reinsurance claims in the September and December quarters.
This may not sound a lot in the context of a NZ$180 billion a year economy, but it is enough to lift the pressure on a currency that also has to handle NZ$50 billion worth of export receipts every year.
Those export receipts are benefiting from record high commodity prices as strong demand from China and India adds to the effects of inflation-causing money printing in America and China.
America's debt crisis is further weakening the US dollar against the New Zealand dollar, which set fresh post-float highs at 88 USc this week. This is a perfect storm for the New Zealand dollar that threatens to wipe out any non-commodity exporters trying to add value.
But this is not the first time this has happened in the world and it's not something we just have to sit here and take. Other countries have thought about and planned for just such currency bonanzas to avoid a phenomenon widely referred to as the 'Dutch Disease'
This situation is named the Dutch Disease after the problems faced by the Netherlands in the 1960s after a flood of foreign currency followed its discovery of natural gas in the North Sea. The sharply rising Dutch guilder slashed jobs in its manufacturing sector, thus turning what should have been an economic positive into a negative.
Norway wanted to avoid the same problem when it discovered oil in the North Sea so it set up a stabilisation fund which parked the US dollars it was earning from the oil in assets held offshore. It is now worth over US$500 and owns 1% of all the world's stocks. The creation of the fund in 1990 prevented a debilitating rise in the Norwegian Krone and helped turn Norway into one of the richest countries in the world.
Elsewhere, Chile has created its own stabilisation fund to deal with a surge of copper revenues in the wake of the Chinese boom. Chile actually used money from the fund to help it rebuild after its own earthquake.
New Zealand needs just such a fund to park the currency bonanza arriving in the wake of the reinsurance funds surge and the commodities price shock. The creation of such a fund was discussed last month at the Treasury's Macro Forum in Wellington.
It would be much harder for New Zealand to create such a fund than it was for Norway and Chile, where the government owns the mines and oil fields that generated the income.
The government doesn't own Fonterra and can't confiscate the funds being transferred to New Zealand's insurers.
But the government does need to look at some way to soften the effects of the milk price bonanza and reinsurance flood. It certainly should be trying to save for a rainy day using the proceeds from such a bonanza. Instead, it is just being spent on yet more imports and living for today.
Meanwhile the job-creating export sectors where value is added and high wages produced are withering on the vine.
What's the point of owning an iPad or going on holiday overseas when there aren't jobs for our young people to stay for?
The old will just end up using their iPads and holidays to videoconference and visit their children and grandchildren living overseas.
Poll results this week showing 1 in 5 young New Zealanders want to migrate should be a sobering message for our policymakers.
Doing nothing is not an option in the long term.
Otherwise we are just sleepwalking to poverty.
15 Comments
I think this is an interesting thought, though the examples provided were relating to countries dealing with an influx of funds without having to rebuild one of the largest cities in the country with those funds. The money for Chch does not flood the economy to the same extent as Norway or the Netherlands, because the funds are earmaked for specific and immediate use, reducing the amount of truly 'hot money' sloshing about in the economy.
I noticed you didn't make any comment on carry trade Bernard. What is the role of carry trade in the Kiwi dollar? Is there a point it becomes a serious risk adding to the general problems?
Tangentially, I think the article adds another dimension to the case for a sovereign wealth fund (which could act as a stabiliser) and this ought to be thought of as a non-partisan strategy. It is pursued by many governments in our region in one way or other.
Great advice for Australia Bernard where the minerals boom is most similar to your examples and the "two ecconomy" problem that they now face. Is our agricultural industry in the same position?
Just thinking through the insurance money coming into the country. We need it now for rebuilding Ch-Ch, so I cant see the sense or how we can capture it as it flows in. It will flow into the ecconomy as it is spent rebuilding the city. May be a mechanism could be developed to remove some of it from the general ecconomy and also tone down the large, temporary stimulasis that will result from the Ch-Ch rebuilt. While we are borrowing $300 million per week I cannot see the Govt investing other money overseas. (e.g. the superanuation fund provisions)
Unlike Norway, UAE etc. the govt. don't currently own the agricultural producers benefiting from the commodity boom therefore I fail to see how we can divert some of the forex to a sovereign wealth fund.
Something's missing here Bernard, I can't see you supporting a tax on foreign receipts earned from agricultural exports as this would obviously be shooting us in the foot. So are you supporting the Cullen approach of running surpluses and explicitly directing a wealth fund to buy forex and invest overseas?
Curious?
There is a simple answer to this problem of a high currency due to high capital inflows and, as a by-product it also solves another major problem. It is appropriately called NIFTE.
NIFTE is the National Imdemnity Fund for Terrestrial Events, and acts as a reinsurer for major catastrophes caused by weather and tectonic events, As a state owned entity it provides a positive influence on the balance of trade as reinsurance no longer has to be purchased offshore, but is purchased from NIFTE for similar, though probably generally slightly lower, premiums.
Funds from premiums will largely be invested offshore, which has a negative effect on capital transfers, depending on accounting methods used, but in either case reduces upward pressure on the Kiwi, much as in the Norwegian model.
If there is a call on NIFTE funds which exceeds those currently available, then NIFTE can issue bonds which are either taken up by the market or, in a worst case scenario, by the RBNZ, a form of Quantitative Easing. The very existence of such an arrangement will cause downwards pressure on the Kiwi.
In summary, we have a lower Kiwi, improved balance of trade, and a reasonably priced reinsurance provider for entities that currently struggle to find any provision.
Thanks for raising such an important issue Bernard; my proposals are not fully worked through, but have evolved from a few recent discussions.
It is typical of Bernard to suggest a wildly impractical solution to a real problem and then blame the Government and the Reserve Bank for not acting on it. This time he has even highlighted the flaw in the arguement while trying the make the case. The cash flowing in belongs to insurers and farmers. The government cant sieze it because the owners need it to pay claims and retire debt. They could invest the reinsurance due to the eqc from offshore and refrain from liquidating eqc assets held offshore now to meet claims. That would mean borrowing the money locally which might increase local interest rates and force up the currency by fuelling the carry trade. Bit of a conundrum really.
No doubt the exchange rate has got out of control but we dont really have a mechanism for controlling it that wont cause more problems than it solves. For some reason we seem to be regarded as some sort of safe haven. Tends to put the lie to some of the doom sayers here but it also does not say much for the state of the rest of the planet.
I seem to remember a couple of weeks ago Bernard advocating a tax on local banks in respect of currency speculation activities. Not sure what happened to that idea. Maybe the local banks are not involved.
Any chance of any research into the source of the purchasing of the NZD? Are they real flows into the economy or is it speculative money chasing our yields or looking for a safe haven? Is it Government borrowing ? Might be a good idea to identify the source of the problem before we implement a solution.
Some good points worthy of consideration Waripori.
I can only offer some opinions.
1. Yes, we are regarded as a safe haven, because our public sovereign debt position is very strong, we produce commodities which are in high demand and likely to stay so, and we are likely to have positive currency flows for the next few years. Most of the western world is a shambles in comparison.
2. It is pretty unlikely that there is much of a 'carry trade' into the Kiwi. Our yields have been quite low for a while now, compared with say Oz and SA. There may be a few traders who have factored in the prospect of a significant rise in NZ interest rates, but they must be declining by the day.
3. It is very likely that the Kiwi is forming part of strategic foreign currency reserves by both sovereign and private funds. Gone are the days when a fund manager, possibly influenced by the continual whining and handwringing of so many NZ commentators, could say 'Why would you?' to Kiwi holding. Now the question is 'Why wouldn't you?'
4. Yes, the Government borrowing doesn't help. Those tax cuts have had a somewhat bizarre effect. Little evidence that one can see of investment in productive activities so far. Increasing public debt to allow paying down of private debt seems pretty cynical.
5. The tax system is broken. The Labour policy of a CGT is too little too late. We need a wealth tax and possibly a Tobin tax to avoid the gradual degradation of our social structure which is being caused in large part by a feeling of disconnect and dispair.
"The government doesn't own Fonterra ... " True, but it owns the legislation that supports their earning ability and the legislative power to apply levies as appropriate. Or, simply modify taxation laws to implement a land tax or similar, that would also damp associated damaging effects on the wider economy.
Or we could just do nothing.
Looks like it's nothing then.
Useful article Bernard.
Cheers, Les.
FYI from a reader via email:
Bernard, Perhaps could you explain to simple souls like me why firing up the presses to produce millions of those apparently desirable " safe haven " NZ $'s ( What have they been drinking ) is going to produce a worse outcome than destroying a nations manufacturing base which is what we are doing right now ? Of course with Government ( Central & Local ) now forecast at well over 55 % of GDP ( before we add in SOE's and Air NZ ) most are not feeling any pain at all. Trust me - out in the real world - manufacturers who don't sell milk products to China or commodities are hemorrhaging.Cheers, John
You don't know what FX hedging the insurance companies have had in place, and therefore you can't know what effect the 12billion coming in is having. Except that we do know, that NZD represents about 1.6% of the 4trillion (with a T) global daily turnover in foreign exchange. So 12billion over 2 years isn't going to make much of a difference.
You're right that this economy, and the young especially, have some issues, but if you think those issues can be solved by pushing the currency down, then you've lost the plot.
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