Should the NZ dollar be dumped in favour of the Australian currency? BRIAN FALLOW wonders whether desperate times really call for such drastic measures.
The New Zealand dollar is unloved these days, and not just on the foreign exchange market.
A significant number of business people are at least ready to entertain the idea of dumping it in favour of the Australian currency.
The Employers and Manufacturers Association is staging a panel discussion on the issue in Auckland this Tuesday, with Reserve Bank Governor Don Brash, HSBC economist Grant Fitzner and Arthur Grimes, co-author (with Sir Frank Holmes) of a recent and influential book on the subject, An Anzac Dollar?
The Treasury has just released a review of the book which it commissioned from Andrew Coleman, a former Treasury and Reserve Bank official now teaching economics at the University of Michigan.
Coleman concluded that the authors had convincingly established that "had New Zealand entered a currency union with Australia in 1984, the economy would not have been worse off, and could well have been better off."
They had also shown there was little evidence that the floating New Zealand dollar had buffered the economy against terms-of-trade shocks (when it suddenly takes a lot more butter to pay for an imported truck, or the fuel to run it).
The Holmes-Grimes study also reported the results of a survey a year ago, which piggy-backed on the National Bank's monthly business opinion survey.
It found that 58 per cent of respondents thought currency union would be positive for their business and 14 per cent said it would be negative. The rest did not think it would make any difference.
Support for a single currency was strongest among firms with between 11 and 20 staff. For firms with under 20 staff, exports represent only 6 or 7 per cent of sales; over 20 staff the ratio jumps to 14 per cent.
This is perhaps the strongest argument for a single currency, that it would help small firms over the initial hump into exporting, by giving them one less thing to worry about (assuming Australia was the first export market they tried).
"Up to 20 employees, exporting is hard work. Beyond there it starts getting easier," Dr Grimes said. "If we can help firms which are on that growth path to make that big step, it could be a big advantage for New Zealand."
Big swings in the exchange rate, which made life difficult for exporters at times during the 1990s, are not just a New Zealand phenomenon, as Dr Brash has pointed out.
The trough-to-peak appreciation of the kiwi dollar during the decade (on an inflation-adjusted, trade-weighted basis) was 29 per cent, larger than Australia's 20 per cent, but similar to the 27 per cent recorded by both the US dollar and the German mark, and dwarfed by the 62 per cent appreciation experienced by the Japanese yen, he said.
Maybe so, but a much larger proportion of New Zealand's small and open economy is exposed to the exchange rate than in, say, the euro zone, which is the most ambitious experiment in currency union so far.
On the other hand, only around 22 per cent of New Zealand trade is with Australia, so the extent to which the traded goods sector as a whole would escape currency volatility under a single transtasman currency is correspondingly limited.
Two main arguments are advanced against a single currency:
*That having our own floating exchange rate provides a buffer against adverse New Zealand-specific changes, spreading the costs of economic adjustment across the whole community and over time.
*That a common currency would mean that monetary policy in New Zealand would be determined by what was good for Australia.
In a speech in May, Dr Brash put the first argument like this:
Suppose there is a sharp fall in New Zealand export prices.
With our own currency, this is likely to lead to a fall in the New Zealand dollar, as it did in the wake of the Asian crisis.
"This fall cushions NZ exporters to some extent from the adverse impact of the fall in world commodity prices, effectively by spreading the pain of that fall across the rest of us, who find that our New Zealand dollars can now buy fewer imports than before," he said.
"Without our own currency, on the other hand, there is an increased risk that a fall in New Zealand export prices leads to no fall in our new currency; our exporters have to suffer the full pain of the fall in international prices and may well be forced to lay off staff and reduce output."
The problem with this theory is that the Grimes-Holmes study found that between 1986 and 1999 (almost the whole period since the New Zealand dollar was floated), movements in the exchange rate did not offset movements in the terms of trade at all. There was almost no correlation between the two; the cushion had no filling. But that may reflect the peculiarities of that period, and provide a shaky guide to the future.
First there was massive structural change to the economy, including opening up protected industries to international competition and privatising state assets.
Then the mid-1990s saw a rapid expansion of internal demand, propelled by households doubling their debt burden, which had the Reserve Bank stomping on the brake.
Given the magnitude of those forces it is little wonder they had more influence on the exchange rate than the terms of trade did.
Mr Coleman says that capital flows, which are ultimately based on the relative desirability of owning assets in New Zealand versus overseas, drive the exchange rate as much as trade flows do.
He points to major swings in confidence since the currency floated. First came a period of hubris, "when the New Zealand financial sector believed they were the best in the world and the New Zealand dollar was destined to replace the yen as the third most heavily traded currency in the world." That crashed in October 1987.
The second cycle, which peaked in 1997, was driven by worldwide interest in the deregulation of the economy, leading to widespread purchases of New Zealand assets.
"In both cases the flexible exchange rate increased sharply, forcing the external sector to downsize to make room for the industries of the future. In both cases the future disappointed and the exchange rate depreciated rapidly to help the remnants of the external sector adjust back to their earlier size."
While New Zealand will presumably experience such surges in confidence again, they are unlikely to be so extreme, Mr Coleman believes.
"In which case external shocks will be a more important influence than internal ones, and you would expect to see a better correlation between the terms of trade and the exchange rate."
In contrast to the New Zealand experience, the Grimes-Holmes study found a fairly strong (77 per cent) correlation between Australia's exchange rate and its terms of trade cycle over the same period.
The second major argument against a single currency is that it would involve renouncing control of short-term interest rates, including those which drive floating mortgage rates, to the Reserve Bank of Australia. (Even if a new, Australasian central bank were set up, the Australians would still be entitled to about 90 per cent of the say).
The Grimes-Holmes study said there was about a 70 per cent fit between New Zealand's gross domestic product cycle and Australia's.
Reserve Bank economists also found that both economies have been in sync about 70 per cent of the time since 1960.
But that suggests that at least some of the time New Zealand, under a single currency, would have ill-fitting monetary conditions, perhaps interest rates too low to constrain local inflationary pressures, or an exchange rate uncomfortably high because minerals prices are high.
Big risks in riding Oz currency piggy-back
AdvertisementAdvertise with NZME.