Liam Dann: Kiwi is top of the pops but trends change fast

Traders shift from one currency to the next just as quickly as teen fans forget about Lady Gaga's last visit when Katy Perry hits town. Photo / APN

This is an idiot's guide to the kiwi dollar, although its not that much different to the expert's guide.

After the dollar rose to a record high against the greenback this week experts predicted that it might rise further - or it might fall.

Really, when it comes to currency the big difference between the expert and idiot is that the idiot claims to know what is going to happen next.

If they have any kind of experience, the economists, analysts and traders have all either come unstuck or seen others come unstuck by putting too much faith in predictions.

Currency dealers make money either by taking positions based on historic patterns and then hedging against the risk that something different happens, or by reacting in a lightning-fast fashion to events of the day and effectively beating the rest of the players in the market.

So being better than the rest isn't about having magic powers of prophecy, it is about weighing odds quickly, being decisive and having clever systems in place to minimise losses.

Those historic economic patterns give us a broad idea of why one currency should be up and another down.

But this week things got really silly. Despite all the economic theory there are times when market traders can't help behaving like teenage girls.

Lady Gaga was cool last week but this week it's Katy Perry. Trends and fads take hold in currency markets and often gather a life of their own.

Suddenly the aussie dollar is too popular to be really cool. So this week it was the kiwi dollar that the traders were scrawling on their school bags and pinning on their bedroom wall.

Real stuff like a country's debt position and its projected economic growth, generally underpin the value of a currency, which is in the end a measure of a nation's wealth.

But it is important to remember just how little effect the New Zealand side of the story has on currency movements.

A currency's value is always relative. The US dollar has been the benchmark for many years, before that it was the British pound and in the future it could be the euro or the yuan.

All of those currencies are traded in much greater volume than the kiwi. So their fortunes are primarily what determine ours.

Clearly the US is not in good shape right now and neither is Europe. So everywhere else has been looking good by comparison.

New Zealand has been fortunate to get thrown in with a basket of Asian economies that includes Australia, all of which have their fortunes tied to the Chinese commodity boom.

But this week the kiwi seemed to suddenly get a life of its own. Why? Aren't we constantly told what bad shape the economy is in?

Well yes, but nobody on a currency desk in New York has time for the long version of the New Zealand story.

To them we are a commodity play and dairy as our biggest traded commodity is a default barometer for our economic health.

That's why Bloomberg News runs so many Fonterra stories and why events like trade data and the ANZ Commodity Index cause the dollar to rise - as they did this week.

The other big part of the kiwi dollar story is interest rates. Investors can make money by buying New Zealand dollars which earn interest at local levels - often higher than elsewhere in the world.

Even at record lows of 2.5 per cent our official cash rate is considerably higher than in Japan and the US.

Right now the market is holding its breath waiting for the New Zealand economy to rebound sharply from the shock of the February quake.

Any sign of good news is being viewed as evidence that rates will rise sooner rather than later - adding further fuel to the kiwi's engine.

The reaction to the National Bank Business Confidence Survey on Tuesday was a good example of how silly the buzz got this week.

After a stronger than expected survey the dollar rose by more than half a US cent. National Bank's survey is an important indicator. It is one that Alan Bollard and the Reserve Bank do pay attention to. But only a bit.

The cold reality is that for most New Zealanders the tough economic times have a long way to run.

We need to remember that at the margins currency markets operate in a hypothetical world which trades on sentiment and always with an eye on the future.

And while bullish currency markets might indicate that our debt levels are not precarious those markets are highly liquid.

Sentiment can change hard and fast and certainly would if the commodity bubble were to burst. If that happens we could see traders drop the kiwi at speeds which would leave teenage pop fans in their wake.

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