Bernard Hickey looks at how Labour's monetary policy plan backed the Government into the politically awkward corner of favouring a high NZ dollar and interest rates

Bernard Hickey looks at how Labour's monetary policy plan backed the Government into the politically awkward corner of favouring a high NZ dollar and interest rates
"This is where the political rubber hits the economic road." Image sourced from

By Bernard Hickey

Prime Minister John Key was put in a slightly uncomfortable position this week, and it wasn't just over Maurice Williamson's resignation.

Labour's monetary policy announcement put the Government into the awkward position of having to argue in favour of higher interest rates and a high New Zealand dollar.

David Parker's idea of increasing the savings rate in a universal KiwiSaver scheme to take pressure off interest rates and the New Zealand dollar certainly backed the Prime Minister and Finance Minister Bill English into a corner.

The Government's immediate reaction was to oppose such an idea, but that opposition only served to expose and reinforce the political calculations behind our currency and interest rates.

It also meant the Government had to argue against an expansion of a popular savings scheme that it has supported, albeit reluctantly.

Key called Labour's Variable Savings Rate of an Australian-style compulsory KiwiSaver scheme "wacky" and compared it to "pixie dust," but when asked about the prospects for lower interest rates and a lower New Zealand dollar, he explained his conflicted view.

"You've just got to be careful what you wish for because a substantial reduction in the exchange rate would certainly see a lot of consumer goods that consumers in New Zealand buy go up in price," Key was quoted as saying.

This certainly contrasted with the Government and the Reserve Bank's drumbeat of comments in recent months about how the currency was over-valued and unsustainable.

Mr English has been saying since last year he expected the currency to come down and has admitted the Government's long-term target of lifting exports from 30% to 40% of GDP by 2025 would be difficult with an over-valued currency.

That over-valuation has become even more acute since February because dairy commodity prices have fallen 20% since then, but the currency has remained stubbornly over 85 USc.

So which is it?

Does the Government want a lower currency to encourage exporters to create more jobs in a productive economy that drags New Zealand back towards a current account surplus?

Or does it want a stronger currency to increase the purchasing power of stressed consumers who have had to cope with low nominal wages growth and rising domestic costs of electricity, housing, insurance and rates over the last five years?

This is where the political rubber hits the economic road.

The Government can talk all it likes about the economic necessity of a more fairly valued currency that helps exporters in general and farmers in particular, but there are far more consumers and workers than there are farmers and exporters.

The short term interests of the many will trump the short term interests of the few every time, even if a lower currency is in the long term interests of the many and the few.

The Government's reaction exposed this uncomfortable truth.

New Zealanders love cheap imports and overseas holidays, and the cheaper the better.

That pressure becomes acute as the economy picks up and employment starts growing.

As wages and costs for locally made goods and services rise, consumers and businesses naturally look for cheaper alternatives overseas. Anything that threatens that escape valve is unwelcome.

English's brief comments about how term depositers would be losers if interest rates fell under Labour's plan also exposed the Government's discomfort.

But it also exposed a somewhat surprising truth for often-indebted headline writers and journalists - some people love high interest rates.

There are now many more term depositers and many, many more term deposits than there were the last time interest rates were rising in the months before a Government was trying to win a third term.

Back in mid-2005, household term deposits totalled NZ$57 billion. They were worth NZ$127 billion in March this year.

Former Reserve Bank Governor Alan Bollard used to say only partly in jest that he received more letters of complaint when he cut interest rates than when he raised them.

It may be depressing for business leaders and those with a long term view, but politicians and voters respond to incentives and those short term incentives are currently in favour of high interest rates and a high New Zealand dollar.


A version of this article was published in the Herald on Sunday. This version is here with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Why is it that elderly people with savings are seen as less worthy than borrowers with good jobs?
The vote buyers and bossy types of the world seem to favour low interest rates, rising house prices, a low exchange rate and higher taxes and a dependency culture throughout society. That way they can been seen as useful people.
Artificially low interest rates take money from unsophisticated savers who have money in the bank and give it to people who have borrowed too much, whether as individuals, businesses or central or local government bodies.
A 15% cut in the exchange rate is a 15% pay cut.
Life just is not that simple. The dependency culture is the worst bit. Where is the independence, the resilience, in our society if we are all dependent on the current rate of interest set by the RBNZ? Or on government funding for businesses? These people are the hand of death on a business as you start to focus on the secondary issues.

Agree. Agree a cut in the exchange rate is the same as having your wages cut, while a increase in the exchange rate means your wages have gone up .

Get inflation down by putting government into surplus.  Reward savers over borrowers.
How about a tax on interest paid rather than interest earned.  Easy to do under the current witholding system.

GST is supposed to be a Goods and Services Tax. Interest is a service but is exempt from GST, veggies are not exempt. Banker friendly or what?
I did ask Bill English if they had considered widening GST to include interest paid rather than putting the GST rate up. He said no one had suggested it. To be fair to Bill I think he does a good job but his civil servants are derelict in their duty. The GST exemption is just the sort that thing that has accrued over time because governments have been dependent on the bankers. This dependency stuff is bad news.

how does one reward savers over borrowers?  Obviously not with cash, since the money to pay the savers comes from the interest paid by the borrowers (less expenses and taxes)

Encouraging internal saving cuts the need for foreign capital inflows.

Judging by the headlines of late, discouraging foreigners investing or coming here would close of a lucrative avenue of income for at least one major political party. Hence the lack of interest in exporters  who as said elsewhere  are already in  a minority with govt scared of the import consuming majority. 
Personaly I was severely discouraged through the 90s when every time we seemed to be getting some momentum in farming the RB deliberately squashed it.
Déjà voodoo all over again.

Ahhhhh - the 90's. 
Remembering how difficult it was to find suitable factory space when I started out in the 70's - I decided to 'do-my-thing-for-others' by investing in factory space.
The Fool-on-the-hill was - me

and you would have got all those love letters from your local council.... as in "I love your money, give it to me"

""You've just got to be careful what you wish for because a substantial reduction in the exchange rate would certainly see a lot of consumer goods that consumers in New Zealand buy go up in price," Key was quoted as saying."

Well Mr Key perhaps that means we should improve our own manufacturing sector, and if it's luxury items he's talking about...whats the problem??

Surely jobs (improvement of exports) is more beneficial than cheaper consumer items and overseas holidays. You can live without the latter items but try living without a job...

But a lower exchange rate doesn't just magically apply only to them awful consumer trinkets.  
It applies to each and every import which is an input for any onshore economic activity:

  • electronic items of all descriptions
  • many foods (guavas, coffee, tea)
  • medicines and drugs
  • software
  • every transport vehicle/tractor/loader/excavator/grader etc

careful wotcha wish for...

Keep in mind that for the medicines, software (and some transport options) because the producers lock down who can sell their products they often scale their prices to the amount of money in the economy they are selling to. Anything with region supply restrictions and the question "how much can we extract from the market" is not operating in the same currency sensitive way that some of the raw commodity foods on the list are.

Indeed, in effect its a rentier/monopoly pricing, ie set at the maximum the punter will pay.  Anyone who thinks this isnt the case in their economics models, is well blind.
So really if the exchange rate changes the price may go up, or actually might just stick where it is, or even drop as the raw commodity foods are emptying the wallet faster.  If the margins then are too small, the good disappears from the shelf.  

The other shoe for the rentier monopoly (or any monopoly) is they _rapidly_ lose efficiency.  The operators build in extra rules and safety guards for interests beyond the task at hand, because their market dominance lets them pass on the cost of the inefficiency.   They become bigger, often incorporating massive information overheads, as they can force payment of the data collection costs without worrying about whether it creates a value return to collect the information.  And SIG's and personal projects spring up, again, because the free money is there and the price setter effect means the public have no choice in payment.

the other effect is the "woolies" effect, that they can put undue or excessive pressure on their supply chain,  as the can reliably pass their costs/risk from one part of the market, to the trapped target market.  eg dominance selling baby clothing for a fortune, but not paying the garment and wool producers for 3 to 6 months in the hope that the supplier goes out of business (and gets their business "recycled" to a new hopeful )

UM, yes and no.  Say Dewalt, in the USA and I'd assume EU they have to be way more price competitive and have to, to keep their edge.  In NZ they can be lazy? well the local dewalt subsidary could be, indeed some vendor importers I suspect are.  However because we are so small the main office could sell the NZ office goods at MRRP - a % and hence not pay NZ tax in effect keeping the tax offshore. Being such a small market why would main office care if they sold a few hundred units or not? might as well make a fat margin or not bother.
RInse and repeat IMHO.
Hence Im all for Internet shopping, the more the merrier, not just because of savings but because I can see the huge choice and quality available.  eg Im about to buy 60sterling worth of chisels from the UK from a speciaslits store.  I'll get 6 chisels of a good brand V 4 crappy chinese ones here for $120NZ for the same money more or less landed.
Or dewalt planner blades, $40US v $180NZ, except I cant get them shipped in...blah...

Agreed, and the Free Market (vs Globalists)  would say that such situation would represent an excellent opportunity to set up 'top of line chisel'/DeWalt competitor locally.... yet for some reason it can't happen in NZ...   and that's why we're getting screwed, the dominant markets can therefore set price or quality with monopolistic abandon.

not just exports, but local produced and consumed

The correct answer to the question "what should the exchange rate be?" seems to me to be that it should be at a level where the current account is roughly in balance. In fact, given we have had 40 years of wealth destroying deficits, a few years of modest surplus would be a good change. Realistically though from where we are now, being in balance would be a good start.
Otherwise the high wages that a high currency give you in terms of buying power of foreign goods and services, are provided by borrowing from future generations. Worse, they are somewhat dooming future generations to not have any national wealth to speak of. Being wage slaves in a future crowded New Zealand (where our newer residents own the majority of the wealth) is a very real future that we are headed towards unless we address the current account. There is only one way to do so and that is to have the exchange rate at a level that sends pricing signals to buy more local goods and services, and less foreign ones.
Most of the pain would be felt by foreign suppliers, and given their scale relative to NZ, they would barely notice.
Arguably the election is now about this issue as much as anything. Those who want to spend now and have someone else hopefully pay later should vote National; especially if they are in the favoured few whom their policies favour.  Those who would prefer a country where their children and grandchildren have real national wealth to share in, and relative control over their country's direction, should consider other parties.

Excellent summation. You would not run a business or a household like the guvmint run the economy.

“If the recent currency weakness signals a change in China’s policy away from allowing adjustment and moving toward a market-determined exchange rate, that would raise serious concerns,” said a senior Treasury official ahead of this week’s IMF, World Bank and G20 meetings in Washington.

well said.  As other indigenous residents have found in the past, once those new migrants position their wealth in the country ,the real danger is you can't get parity/back on your feet.

That's why I'm thinking the OIO who were tasked with the exact job of preventing that need to be auditted and the quislings _hung_

I agree with your analysis but not your conclusion. The sad truth is that many of the polticians and officials such as the RBNZ do not have a clue about how to get the current account into surplus. I think Bill English does understand the difficulty however, but recognises it is a very delicate task.
Back in 2009 I went to the inaugural Economic Summit in Nelson put on by the local Economic Development Association. By far and away the best presentation was the one by Nick Smith about the current account deficit. It was a brilliant overview of the problem. I was impressed and extremely surprised that a politician should have such a good grasp of the magnitude of the task. My general opinion of politicians is not good, and Nick is a bit unstable at times, but he is intellectualy able to explore a problem from different sides which is unusual in his profession.
Anyway, as far as I can understand it National took a very conscious decision not to crash the housing market by cutting government spending as vigourously as some of us might have liked. They came to the view that they would deserve to be booted out of power for causing unnessary hardship if they had done so.
So they decided to focus their attention on improving the thousand tiny details that make society work rather than looking for the "big fix" like people such as Gareth Morgan or opposition MPs advocate. So, a philosophy of continual reform. Interestingly the story is they took a long time to accept that they deserved to be booted out at the start of the Clark administration and this more humble approach came from that realisation. Labour have still not accepted they deserved to be booted out.
The problem as I see it in the National approach is that you never actually make the hard reforms. They had a window of opportunity in the depths of the crisis that is now closed. They are therefore seen as defenders of the status quo. My own business experience is that you absolutely must act decisively in a crisis, there will be blood spilled and you will need to do things you would rather not have to. If you don't the business will not survive. Crises are hard and you have to be ruthless with your pet projects in order to protect the core.
Half hearted reform at a pace New Zealanders can go along with will get you re-elected but eventually the unresolved issue of the excessive debt load will destroy you. If you are in debt you have to pay it off out of income, sell assets or go bust. There is no get out of jail free card.

All fair enough. I think though if you read your own note again, you will see you make a pretty good case to turf the Nats out. Being as nice as I can be, they are at best too conservative with a small c to make any significant changes, especially now they have their own 6 year history that they have their egos invested in. 
In terms of a solution to the exchange rate and the current account, simplistically there is a NZ money supply factor of NZD sloshing around in NZ (forget the pretend currency foreign traders play with offshore every day); and that affects buying power, inflation and asset prices here in NZD terms.
Then there are capital flows in and out; from importers and exporters, but more notably, from those buying our assets, or financing our debt- either government or private. This bit netted off must more or less equal the current account deficit.
Between the government and the Treasury, it should be relatively easy to ensure the NZD money supply is at a level where pricing and assets are within acceptable bands. This will break a few eggs with the commercial banks, although they would still have plenty of space to manage their core functions. There seem to be a range of options including:
Finance government debt directly through the Reserve Bank.
Finance commercial banks' funding needs directly from the Reserve Bank (Similar to the Martin Wolf piece in the FT last week).
Somewhat tighter controls on overseas buying of assets.
Don't kick stupid own goals like selling government assets offshore.
Manage some or all the above- plus others?- until you have an optimal exchange rate, and or until inflation is at risk of breaking out. ( I can accept a sudden shock of say 10-15% down in a hurry may threaten inflation, although worth a go in my view). 
A key point is you would not need to choke off the NZ money supply to achieve a much better current account result, albeit the sudden upheaval to a differently balanced economy would no doubt cause some pain to some, and take a bit of adjusting to.

In general I agree with the thrust of your argument. Politically I think we are better with the current lot than the ragged alternative. National have a small number of highly competent people, the other lot have a very small number. Take your pick.
That said, there is the view that what matters is that debt to GDP comes down over time. The glide path idea, that if nominal GDP rises faster than debt it will all sort itself out over time. This seems to me to be valid, if you can pull it off.

Mostly agreed again. Both parties have focussed on government debt to GDP (and on this Labour were actually very good) but have ignored as too hard the current account for forty years. Asset prices also have been largely ignored by both (in fact nudge nudge wink wink, encouraged up, as high house prices have the feel good factor you talk of in your first note).
From an NZ Inc point of view, the current account is the debt to concern ourselves with. If that is the debt (or loss of asset ownership) you mean, then we are totally agreed- apart from the minor matter of who's best to deal with it.

Exactly, when I said debt I meant Total Debt, the whole lot, household plus government plus business (farming is business) plus other (stuff that hasn't been noticed, yet). Cullen thought he was being clever when he swapped a significant government debt for a household debt twice the size. He had me fooled too.
Having said that it is clearly better for the debt to be household debt rather than the other two. Government debt can't be got out of easily, all taxpayers are on the hook. Too much business debt usually leads to a destruction of productive capacity - ie the economic engine gets smaller. Household debt can be cleared by selling to cashed up people fresh off the boat.