Posts Tagged ‘trade’

August 8th, 2012

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The Currency Conundrum

A story in this weekend’s NBR outlined how the exchange rate was still the major concern for NZ exporters. With the NZ$ at 52p and 0.65 Euros, it’s not hard to see why that is the case. On the other hand, strong commodity prices over the last few years have helped the trade balance into positive territory on occasions, negating the effects of the strong currency. So on balance, although the currency is clearly too high, it is not so out of whack that our trade balance is deeply negative.

Currencies are primarily a method for exchanging goods and services between different nations and, therefore, an important component of international trade. When countries have a surplus or deficit in their trade accounts, they need to deal with the foreign currency surplus or deficit. Theoretically, the exchange rate should adjust to rebalance any surplus/deficit and so restore an overall balance. That’s the general idea behind floating exchange rates. It was certainly the crux of the plan that Keynes proposed at Bretton Woods back in 1944, as he knew that trade imbalances had contributed to general global political instability in the previous world wars. However, the US, with its tail up, insisted on the US$ as the centre of global trade, and thus we have seen the global imbalances continue for the last 70 years.

Prior to the 1980s deregulation bonanza, a serious balance of payments deficit could see a country on its knees, going cap in hand to the IMF to borrow the deficit, as was the case with the UK in the 1970s. There was some form of censure and limit to imbalances, with draconian lending measures, added to a sharp devaluation in the currency, bringing about the appropriate rebalancing. Fast forward to 2012 and we see many countries running persistent current account deficits (ultimately accumulated balance of payments deficits plus borrowings to fund them) without a care in the world. New Zealand is a prime example of this. So why is NZ not being called in to see the IMF to explain its large overseas debts and why is the NZ$ not 15-25% lower?

Therein lies the modern conundrum. As the financial system has been flooded with surplus currency, the demand for safe ports has increased. This has seen deficits overlooked as surplus countries have sought to keep funds out of their domestic systems, this keeping their currencies weaker than they should be and actually reinforcing the imbalance in trade. In effect, they have lent back the surplus to the deficit countries, in return for a nice yield. The obvious problem is that surplus countries have amassed too great a surplus and so created instability in what is, at best, a volatile international system. At some point, one would reason, there must be some major adjustment as we saw in the late 1980s with the Plaza and Louvre Accords, but instead, a dependency is created, where deficit countries become addicted to debt…debt they have been fed by surplus countries. This metaphor of addiction is all too real. In the end, when repayment in demanded, what can deficit countries offer? They cannot sell their goods, as the currency is too high. All they can offer is their assets….land, companies and other resources. That’s generally not too popular, as we have seen here with the Crafar Farm sales debacle but in the end the piper must be paid.

Added to this is the new headache of currency reserve diversification. The Euro and the $, not to mention the Pound, are not in favour at the moment. The SFr has a line underneath it as well, and this leaves few options for liquid currency investments for major holders of cash, namely sovereign countries and major corporates. An example of this is the A$, another major deficit country, which has seen major inflows in recent times from all manner of investors, including Apple and Google. This really is madness: Major US corporates having to store cash outside the US because of a loss in faith in their domestic currency. This is set to continue and cause serious problems for Australia, a country where growth is slowing and commodity prices, which normally support the currency, falling. Thus, the capital account has overwhelmed the trading account, with investment flows having more impact on currencies than the simple price of goods and services. Foreign direct investment is lauded as both necessary and positive for an economy to prosper, yet it indicates that countries are not in a position to finance their own activities. The irony of this contradiction seems to be lost on policymakers, who have clearly drunk too much of the global capital kool-aid.

At some point, and when is anyone’s guess, these flows will reverse. Recent and past history tells us that this is not likely to be an orderly event. For the foreseeable future, the real economy will continue to struggle as currencies are priced on a non-production related basis. More and more,  we will see jobs being exported from deficit countries, rather than goods and services. Some central bankers, the RBA and RBNZ in particular, seem to believe they can do nothing about this problem. This is primarily due to the over earnest and somewhat naive adherence to strict inflation targeting and singular focus on monetary policy to the detriment of the real economy. The world of global finance has shifted considerably in the last 20 years and a fresh look at the problem of a persistent current account deficit is warranted. To simply ignore this is a recipe for further financial disaster, as Keynes clearly predicted back in 1944, and with every possibility that the wheels of the global financial system will completely fall off.





February 20th, 2011


Savings (Working Group): There aren’t any.

I’ve finally finished wading through the paperweight (as is the norm) aka the Savings Working Group report. Having read the initial commentary, I wasn’t that excited about the prospect but often in these reports there are useful nuggets of information. The main noise is around saving more and adjusting savings incentives especially to promote Kiwisaver.

What is not clear though is to what extent we have an actual savings problem. Our gross saving is at the low end of the OECD with Portugal and Greece below us along with two nations that might surprise: The US and the UK (page 121). There is also difficulty in analysing the differences between household and business saving. NZ is a country of small businesses and often business and household financials are closely interlinked. There is no definite conclusion around this issue and the report asks for further research into this topic, especially around data collection.

The macro level is really where the problem can be seen. When looking at the growth in national wealth, it’s clear to see that housing revaluations are the key driver (page 127) of growth since 1999. In fact “property revaluations explain nearly all changes in household net worth since 2001 (page 130). This is another way of demonstrating that we haven’t actually created any productive wealth: we’ve simply revalued our housing base and used that to fund increased consumption. That consumption has been funded by debt and that is why we have a serious debt problem.

So can we save our way out of this problem? Looking at the data on household incomes one would have to say “no chance”. Market incomes have fallen (yes fallen) for the bottom half of the population between 1988 and 2007 (page 140). That is simply astounding. This at a time when house prices have risen 490%. This is the cause of the deepening inequality between the owners of property and the renters. Even with benefits added in income for the first four deciles has remained largely the same (page 141).

Poor choices? Or simply no income with which to save. I think we must face the fact that half of our population is existing on meagre income. They cannot save and are likely to be in debt simply by virtue of not having enough cash to afford purchases or expenses outside of the simple basics of living. Those who have managed to get on the property ladder have prospered primarily because their asset has risen substantially in value. That is where their  savings lie. It should be noted though that, for many, this increased wealth is purely on paper.

At this point it might be worth looking across to data from Australia (page 128. Aussies actually have more of their wealth in residential property than Kiwis do (50% vs 46%). Investment in shares in much the same (8% vs 9%). The big difference is in long term assets. Aussies have 19% in Pensions and Superannuation whereas Kiwis have 2%. To balance that out Kiwis have 22% in business and farm assets against Aussies holding just 9%. So for Kiwis businesses and farms are their pensions. This is not an exact comparison but it’s clear that there is not much to separate the two countries other than Aussies invest in public companies and Kiwis keep it private. It also shows that Australia may have the same debt problem we do though they have benefitted more from the commodities bubble than NZ.

The oft quoted statement (from Ministers, the RB and other officials) that Kiwis should save more is somewhat optimistic. Save more from what exactly?

So what can we do? Well we can look at the other side of the savings coin and that is our expenditure. As a country we have essentially borrowed our GDP for the last 20 years. This is reflected in our current account position which has left us with a Net Foreign Liability (NFL) of 85% of GDP. Poor investment and low labour productivity (not sure where the NZBR gets its numbers from) has left is with nearly 40 years of negative current account balances (pages 20-24). The simple explanation is that we have consumed more than we have sold (plus all that accumulated and compounding interest). This consistent deficit should have seen NZ with a consistently weak currency (to allow the balance of payments to correct) but this has not been the case. NZ’s high real interest rates have been attracting overseas investment looking for a high yielding home (page 26). NZ is seen as a safe place to invest and, in an era of low global rates, has seen major inward flows which have not just funded the current account deficit but also the major revaluation in house prices.

The accumulated current account deficit has pushed interest rates thus forcing up the currency . This in turn has made imports even cheaper fueling the spending boom and embedding the circularity of higher prices in the economy (page 39). The bottom line here is that our currency is too high. This has been noted for some time but successive governments have chosen to ignore the problem, hoping that regular comments will help keep a lid on its appreciation. A 2010 IMF study estimated “that stabilising NFL would require the real effective exchange rate to depreciate by 20%”….that’s to just keep NFl where it is now. To reduce “NFL to 75% of GDP over 15 years would require the real effective exchange rate to depreciate by 25%” (page 36).

That would put the NZ$ at between $0.55-0.60. Ouch!

That is the real story to come out of this report. To summarise:

– We don’t save much because half the population has had no increase in income for 20 years.

– The other half have increased wealth due to large revaluations in house prices.

– The top 2 deciles have seen increases in wages and this is where most of the real saving is coming from (if any).

– Debt funded consumption has seen interest rates rise thereby sucking in more investment flows and boosting the currency.

– We have borrowed to live and really have no spare cash to save.

– The best form of saving is paying down debt, both private and public.

– The only way to improve our position is to export more and import less.

– The primary way to export more and import less is to engineer a significant and lasting depreciation in the currency.

– The second option is to develop and invest further in export based industries.

Adjusting tax incentives and boosting Kiwisaver are not going to help us out of this malaise. Only strong and decisive action can help us from here. So what would I recommend? That’s too much for this post but at a high level some of the following (most of which I have written about previously).

– Lower the exchange rate by direct intervention.

– Cut interest rates as well as bringing down the cost of mortgages which are still very high.

– Restrict bank credit by raising asset requirements.

– Build a self-sustaining energy sector.

– Introduce a basic income to replace welfare and superannuation.

– Liquidate the overseas portion of the Cullen Fund (now whilst markets are at 30 month highs).

– Invest more in the productive export sector.

– Oh and let’s have a land tax whilst we’re at it (this was ruled out by the government in the terms of reference!).

Next week: The Welfare Working Group reports…..can’t wait!

February 16th, 2011

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ANZAC$: Back on the Parade Ground

Yesterday Julia Gillard became the first foreign leader to give a speech in Parliament. It was full of mateship and the usual joshing that is a theme for Australian-New Zealand relations. Beneath the jovial tone lay the theme of integration. This has been around for a long time, probably since the CER was first implemented back in 1983. It’s been somewhat on the backburner over the last 12 months as Australia has gone through a political shift but now the same theme is back on the table.

Is complete economic union likely? I addressed this back in September 2009 when it was last on the table. What has changed since then?

There has been a major shift in global political alignments. As the shift of economic power has moved from West to East, so has the political spotlight. Back in 2008 I noted cross border acquisitions from the East and that these signaled a major shift to a post-imperial world. That shift has continued apace with China rising to the fore, now the second largest economy in the world. For the ANZAC brothers that has major implications.

Being connected to the ASEAN has helped both Australia and New Zealand define its geo-political position in a post-Empire world, specifically post European Community integration. Asia is quite clearly the major focus in terms of trade and this has seen some interesting reaction from the old allies. This year we had a visit from William Hague, the British Foreign Secretary, along with his Defence colleague, Liam Fox. It was the first visit in almost 20 years and indicated that the UK was taking this shift East a little bit more seriously. Suddenly old friends were very much worth getting to know again. Previous to this we had a semi-royal visit from Hilary Clinton, the US Secretary of State, down under to sign the Wellington Declaration which put NZ back in the very, very good friends corner. And today we see the Treasury heads of the UK and Australia in town to meet with their NZ counterpart. This is of note as it is the first time they have met together.

So what does this all mean? Simply it’s a jostling for position and a reaffirming of old ties in  a very new world. This puts Australia and New Zealand in a very strong strategic position. We are friends of the old and the new world. We are well located geographically…out of the way but close enough. For the ANZAC buddies that poses some interesting questions. Stronger together, weaker alone or carry on as is?

We can see that the CER is being re-negotiated to allow of higher levels of non-reviewed investment which could mean a lift for corporate activity as well as a loss of company control. And this is really the crux of the matter. Do we want to control our own destiny? Lessons from Europe are all too stark in this regard. Sinking economies have no room to lower their currencies and so swing in the wind, completely reliant on bailouts.

Ultimately the people will decide on this, though its clear that further integration around common borders, regulations and practices is likely to continue. At what point does having separate currencies become a pain? Well ask anyone trying to transfer money between the two countries. You would imagine you could shift cash at minor spreads but actually you pay through the nose. Travelex is one the worst players in this market. Even market spreads are quite wide. So there is definitely a cost to doing business which might add up to 1-2% of overall activity.

A nation’s currency is ultimately a reflection of its sovereignty. The ability to issue your own coin is one the the most recognised symbols of nationhood and has often been as an economic weapon in the colonisation process. If you lose that ability then you lose control. It’s as simple as that. The way to overcome that is to just recognise that you are part of something bigger (in this case Australasia) and take the good with the bad. Personally I think it’s a tough decision to make. History tells me that having control over your own affairs is a good thing. But perhaps the mateship bond will swing views the other way. Perhaps it’s already happened. I’ll leave the final word to Peter Costello, the former Australian Treasurer, at the second Australia New Zealand Leadership Forum in April 2005 (“Crisis”, Bollard, 2010, 26):

“You guys in New Zealand have to get real. If you want to be part of a single economic market with us you can forget having your own banking system. Remember, you sold your banks to us: you don’t own your financial system any more. Leave the regulation to us”.


October 6th, 2010

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The Art of Currency War

It’s been 3 years since the G7 made a serious call for the Yuan to appreciate. But not much has happened since then (apart from a complete meltdown in the global financial system) except for the global trade imbalances to worsen. We are now faced with the distinct possibility of more currency mayhem as markets reach another tipping point.

We are starting to hear more overt language from both officials and the general media about the potential for currency way, namely competitive devaluations, capital controls and other measures to shift currencies to where they should be or where officials would like them to be. Sovereign states have always messed with their currencies whether to screw their own people or other nations. It’s always about self-interest. But at some point the beggar they neighbour approach fails and we race to the bottom. There is no doubt that China is the key here but it’s played a very smart hand and has the US over a barrel. The geo-political arm wrestle is at full bore here and we don’t get to see much of it in the news. At some point though the surplus nations must adjust their currencies to bring the trading world back into equilibrium otherwise the whole system will fall apart. Keynes predicted this would happen and its been a 70 year work in progress. Kondratiev would be impressed.

The question is why hasn’t that happened already. You would imagine that a country with a trade deficit and an ongoing current account deficit (swollen by interest on borrowings to cover the trade deficit) would see its currency weaken and surplus countries would see the opposite. THis change in currency rates would, other things being equal, reverse the flow of trade and all would be rebalanced. On paper maybe but in the real “free market” that doesn’t happen. Why? Because deficit countries tend to have higher interest rates (in order to attract the capital it needs to pay off its debts) and those higher yields attract more and more capital looking for a home. So we have the ludicrous situation of one country lending another country the money to buy its goods…….that is not a recipe for long term success….unless you happen to be running a criminal organisation where your goal is to get your clients hooked on the product…..

It’s also known as debt slavery. And it must stop.

So does this mean we are headed for a new Plaza/Louvre Accord? I think that will be very difficult to achieve at the moment. It’s unlikely the Chinese would accept a single focus on the Yuan. It would almost be better to completely realign the whole global currency system where all surplus/deficit currency rates were realigned to new levels. The obvious problem (other than agreeing new rates) is that there would be nothing to stop markets moving rates right back. This suggests capital controls may come into play (Brazil is already trying something here with its bond market) perhaps in the manner of Malaysia.

More over steps such as currency intervention can be a problem unless the stars are aligned in your favour. Trying to weaken a surplus currency is next to impossible as the SNB found to their chagrin when buying huge amounts of Eur/Chf at a time when the market was actually desperate for Chf. The Japanese are repeating the same mistake as the Swiss by intervening, cutting rates, increasing liquidity and generally flapping about in the Yen. At this point in time they have made no progress at all. Why? Because the market wants to own surplus currencies and not the $. At some point $/Yen will collapse which will suit the US though probably not the Japanese.

For deficit countries with an appreciating and overvalued currency like New Zealand there may be better opportunities for influence. More on that net time.

For now though begun the currency wars have.

November 9th, 2008

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Pump up the Volume: China Stimulates

Not wanting to bve left out of the party, China announced a huge stimulus package over the weekend. $600bln or thereabouts is not be to sneezed at. The Chinese are taking no chances with collapsing global trade and economic activity. They have an large domestic economy and plenty of headroom to generate homegrown action.

They also have the money to do it.

As Yves notes the sums involved are getting to the point where a trillion doesn’t raise eyebrows. The Fed’s balance sheet is expanding quicker than a fast food muncher’s waistline. $2trln or will it be 3? Who knows? Who cares anymore? It’s like the end of a Monopoly game where the deals come thick and fast and the rent for landing on Mayfair (or Park Avenue) breaks your bank.

At the same time one continues to hear, in the background, that ecosystem stress is alive and well. As I noted last week there are some major concerns about the level of ecological debt. In a report by the WWF, called The Living Planet, they estimate some $4-5trln worth of ecological damage is occuring on an annual basis.

Deflation, stagflation, hyperinflation, ecological breakdown and over population.

Your cash losing its value every day as the printing presses run wild.

Time for a pause and a lie down.

May 5th, 2008

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Begun the trade wars have

Do you ever feel like life is an endless re-run of Star Wars? Maybe not but news comes that Thailand has floated the idea of a rice cartel along the lines if OPEC.

Not surprisingly the Phillipines, the world’s biggest importer of rice, expressed strong reservations saying almost 3 billion people are rice eaters and calling it inhumane. Oh dear.

One can see his point. But the rise in agricultural commodities is giving producers a great opportunity to flex their muscles for a change and they may see it as one to grasp, especially if they happen to be major importers of oil.

This type of proposal will have many importers worried especially if those imports include oil and rice. We know the impact that the formation of OPEC had on the world economy and coming at at time of global financial instability, this proposal can only add to the uncertainty.

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"I’m a Londoner who moved to Christchurch, New Zealand in 2002. After studying economics and finance at Manchester University and a couple of years of backpacking, I ended up working in the financial markets in London. I traded the global financial markets on behalf of investment banks for 11 years. Since moving to NZ, I have been an angel investor, budget advisor, director, trustee, mentor and business consultant. I'm currently a Councillor at Christchurch City Council and a Trustee of the Volunteer Army Foundation and the Christchurch Arts Festival Trust. I write about the intersection of economic, social and environmental issues."

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