On the Crash of the New Zealand Dollar

Keith Rankin, 10 June 1998


The value of the $NZ has plunged below 50 cents, about the same against all other currencies as it was before the NZ dollar was floated in 1985. It is the turn of New Zealand and Australia to take big hits on the world's currency markets, to the joy of our producers of goods and services that are in competition with similar products from the rest of the world.

One reason foreign currency markets are so unstable is that international currency traders face double jeopardy with unfavoured currencies, and double windfalls with favoured currencies. This results from the way national bond markets work.

In a country with a weak currency, interest rates are on the rise or perceived to be about to rise. That means that bond values are falling or expected to fall. Foreign investors holding NZ dollar denominated bonds fear sharp falls in the NZ dollar value of their investments (a result of rising interest rates in New Zealand) as well as sharp falls in the foreign value of their investments (a result of the falling value of the New Zealand dollar).

(The opposite situation occurs when interest rates are high and the dollar is strong. Perceptions that interest rates are about to fall attract foreign money seeking capital gains in the bond market. In addition to those capital gains, foreign investors secure a gain from the rise in the value of New Zealand currency that their investments cause. These processes have nothing whatsoever to do with savings rates in New Zealand. Foreign money comes here chasing capital gain when interest rates are high and expected to fall.)

Meanwhile, it should be noted that it is a myth that NZ's foreign debt rises as the currency value falls. It is meaningless to value New Zealand's foreign debt in $NZ. Valued in foreign currency - as it should always be - New Zealand's total overseas indebtedness has fallen. The part of that liability denominated in $NZ has fallen in value, while the other part is unchanged in value. Foreign holders of New Zealand bonds (and, to a lesser extent, shares) are among the big losers.

Basically, the present events are good news for ordinary New Zealanders, and they will precipitate a recovery. Not only is the foreign currency value of our debt down, but the ability of our economy to service and repay that debt has been enhanced. There is light at the end of the tunnel; the tunnel of silent recession that New Zealand's provincial economy has been stuck in for over three years; the recession that our manufacturers and farmers were facing while the financiers were telling themselves, the media, and potential foreign investors how well our "miracle economy" was performing.

I received the following email from Germany today:

Dear Sir,
   I am a foreign investor in NZ$ Bond and i am very concerned about the devaluetion of the NZ currency . Do you exspect a correction of this prozess to the levels of last year or do you think that had to be done so that level will continue or fall further? In Europe here a nearly no informations available about New Zealands economy. thank you very much indeed.
   best regards ...

My reply:

Both the NZ and Australian currencies have been falling rapidly in the last week or so. Both may fall a bit further, and will then recover. It is a bit like Great Britain in 1992, when the pound broke away from the European Monetary System.

   Both countries have experienced serious balance of payments problems. From 1994-1997, we had some of the highest interest rates in the world, and money from all over the world flowed into $NZ and $A investments. Returns were very high for a few years, but the NZ economy in particular was being badly damaged by the gross overvaluation of our currency. Export industries - farmers and manufacturers - suffered very badly, while cheap imports flooded into the country. We paid our foreign liabilities by encouraging more foreign money to come into the country, and by selling most of our firms and public assets to foreign (esp. American) companies.

   New Zealand and Australia were also badly affected by the big fall-off in exports to Asian countries, and the reduction in tourism from, especially, South Korea.

   I think that the $NZ will fall to 45 cents to 1 dollar US [it is now at 49 cents]. By the year 2000, it will be back above 50 cents, I believe. Already, our remaining exporters are thrilled by the new exchange rate. Hopefully, we will see the emergence of a new wave of exporting firms, and there will be a boom in tourism from Europe and America.

   There is a big problem, in that the central bank is worried that inflation might get above 3%, and might therefore push interest rates up to very high levels. If so, then the recovery of the NZ economy could take five years or more, as some economists here are saying. I am optimistic that the central bank will be allowed to take a longer term view of inflation than it usually does.

   best regards Keith


© 1998

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