Dollar strength a silent killer

The unspoken fear in the economy is that when the Reserve Bank puts up interest rates, the currency will rise higher.

Some say it is holding Reserve Bank Governor Alan Bollard back from hiking rates to slow the housing market.

The theory is that fancy currency traders will borrow in one currency such as the US dollar or Japanese Yen at low to zero interest rates and then lend it to New Zealand at slightly higher interest rates, pushing up the currency.

This is known as the "carry trade" and is viewed as the silent killer of our export sector over the past five years.

But should we fear this silent killer? The Reserve Bank detailed in its September quarter Monetary Policy Statement that international financial markets appear to be ignoring our interest rates.

They seem more interested in pushing our currency up in line with the American stock market, which has virtually nothing to do with our currency or economy.

The Reserve Bank's charts published here show that our currency has been rising faster than our wholesale interest rates.

Even more bizarrely, our currency has strengthened against the Australian dollar despite Australian interest rates being higher than ours, its economy being stronger than ours and its export prices rising more than ours.

"The extent of recent New Zealand dollar strength appears to be a symptom of an almost indiscriminate rush back into risk-taking that has accompanied the recovery in global equity markets," the Reserve Bank says.

"In this regard, the New Zealand dollar has been closely correlated with movements in global equity markets in recent months and appreciated to a greater extent than might have been expected on the basis of movements in interest rate differentials."

The Reserve Bank is saying that foreign investors will put their money anywhere outside the US that seems even remotely stronger, betting the foreign economy will do better and they'll make money as the foreign currency rises.

When they feel like a punt they'll put their money into New Zealand, regardless of exactly where our OCR is, hence they're more likely to take a punt when global stock markets are bubbling along nicely.

I asked Bollard if, therefore, New Zealand could increase its interest rates and not have any effect on our currency. He acknowledged that was possible.

Why doesn't Bollard take the opportunity to put up interest rates to cool the housing market and avoid a repeat of our economic crash of 2003-2007? He doesn't have an excuse not to.

Unless New Zealand breaks its addiction to property investment and foreign investment that goes with it, we are on track to a credit rating downgrade and a harder fall. Maybe that's what he really wants?

It would absolve him of being seen to have pulled the trigger for the crash. He could tell us with a clear conscience afterwards that he told us so and that it was our own fault.

New Zealand needs a smack on the hand but Bollard appears not to want to deliver the tough love New Zealand needs.