We may have just stumbled over the tripwire that has underpinned our economy for many years. Our exchange rate is starting to tumble. For over a decade we have been protected from the harsh reality that we have been living beyond our means as a nation, and the main buffer against this reality has been the high New Zealand dollar, particularly against the greenback. This is starting to change.
Our economy has been oddly out of sync with the United States for over a decade.
The American economy struggled to overcome the legacy of the global financial crisis. As a result, the Federal reserve kept interest rates at extraordinary lows and used quantitative easing to pump liquidity into its financial sector to keep it afloat.
During this period the NZ economy experienced the stimulatory effects of the Christchurch rebuild, a dairy and tourism boom, housing inflation and massive immigration.
There may have been some substance to our rock star economy but there was also a large element of substance abuse, particularly debt.
The American economy is now showing signs of vigorous growth — the Fed is raising interest rates to reverse its potentially inflationary quantitative easing of the past decade.
But the NZ economy appears to be stumbling. Our Reserve bank has recently signalled it intends keeping interest rates on hold for a lengthy period.
This has sent a very clear message to financial markets.
This has the potential to create a large sucking sound as hot money flows out of here towards the United States seeking higher yields.
There is also a self-reinforcing mechanism to this process. As investors anticipate a declining NZ dollar and appreciating greenback this becomes a reality.
A common feature of this trend is overshoot giving potential to a large decline in the value of the NZ dollar.
A significantly lower NZ dollar against the greenback could create an ugly cost-of-living vice here. It would rudely expose that we have been living beyond our means for a long time.
The evidence for this has been our continued current account deficit which measures our national income and expenditure with the rest of the world. It also reveals how much we are borrowing to stay afloat.
If our dollar falls, the prices of most tradable items will rise.
Tradeables include both exports and imports.
They include items such as meat, milk, cheese, butter, electronics, clothing, cars, petrol, diesel, whitewhare. Anything that is bought or sold internationally.
Brace yourselves.
But there is a plus side to this scenario.
Businesses that are exporters will benefit from a lower NZ dollar. The long-awaited rebalancing of our economy towards export-oriented industries could slowly occur — though it is likely to be a slow, painful process.
Our reserve bank also has the capacity to cut interest rates further if the economy slows due to a decline in discretionary spending as people are forced to tighten their belts. But this would likely further depreciate our dollar, particularly if central banks elsewhere are doing the opposite.
We may be about to experience a nasty hangover after a hell of a long party.
Peter Lyons teaches economics at Saint Peter's College in Epsom and has written several economics texts.
