The dollar is still too high. Exports and tourism are suffering. Jobs are being lost. Profits are being squeezed. The longer it stays up, the worse the eventual adjustment. What is to be done?
Treasury Secretary John Whitehead and Reserve Bank governor Alan Bollard are due to report to Michael Cullen early next month on possible supplements to monetary policy, which failed to quell the housing boom.
Bollard’s interest rate hikes fed the spiral by encouraging foreign retail investors to buy mountains of Kiwi-dollar-denominated bonds which kept mortgage rates low and fuelled an inflationary consumer binge — and kept the dollar up.
Once upon a time a word from the Beehive could have stopped all this dead by fixing the dollar lower. Exports and tourism could then recover and the balance of payments, now in deficit to a South American level, correct after an initial “J-curve” plunge.
After all, fixed currencies at low rates, promoting exports, were a significant ingredient in the east Asian economic cubs turning into tigers.
Let’s imagine we were still in that long lost world of Beehive fiats and Cullen fixed the exchange rate in the 56-60 United States cents range. That is about the long-term trend rate.
Given that the United States dollar is relatively low at the moment, fixing it in the trend range would be fixing it relatively low. But that might not be out of line with what the market might eventually do. Markets often do overcorrect initially.
Sounds straightforward. Actually, it would probably bring on a hard landing.
Of course, Cullen won’t fix the dollar. He learnt long ago that Beehive fiats have limited effect and often perverse consequences. And, given 20 years of market forces, intervening in the exchange rate would cause a sudden loss of confidence in the regulatory system by most business, which would fear other re-regulation would follow. Investment would go on hold, costing productivity and jobs down the track.
Quite apart from that, there would be series of other consequences.
Foreign retail lenders would recoil, though some funds managers might come back, betting on a rise when Cullen unfixed the dollar or was forced to re-fix it higher. And the price of that would be much higher interest rates — on houses, credit cards and business loans.
With more of households’ disposable income going on interest payments, there would be less for other spending. Retail spending would stall, especially spending on imports, which would become much dearer, which would in turn generate an inflationary headache for Bollard.
Profits would plunge. Businesses would be forced to lay off staff. So total spending power would drop some more.
There would be fright and hardship and that might trigger a change in attitude and behaviour. The love affair with debt would end. We might even develop a love of saving and spread those savings to other things beyond houses, as Americans and Australians do.
And Labour would go out of office in 2008, if not before.
So Cullen knows he can’t intervene much, if at all. But he does want to do something about the imbalances. Hence his request to Whitehead and Bollard to study options other than monetary policy for dampening house prices. Higher short-term interest rates have amounted to not much more than pushing on the end of a piece of string over the past two years.
The options they are to report on are setting a limit on the proportion of a house price banks can lend, requiring a higher capital-lending ratio for banks lending on houses, disallowing company structures which property investors use to reduce their tax liability and other direct interventions by the Reserve Bank.
These options prompted cries of “muldoonism” when announced in November. Not least, some worried that very small businesses, which use owners’ homes as loan collateral, would be constrained and that would cost jobs and slow economic growth.
But the idea that monetary policy should not carry the whole burden alone does have advocates — and not just among “wets”. At the least, there could be better coordination of monetary and other, including fiscal, policies, as for example, Sir Frank Holmes, for 50 years an advocate of freer markets and open trade, argued at the time the Reserve Bank Act was being enacted in 1989.
Cullen has already approved the Reserve Bank buying and selling foreign currency at the troughs and peaks of the currency cycle. So he might well cherry-pick one or two items from the smorgasbord –even if, as seems now increasingly likely, the housing crisis is passing and he doesn’t actually implement any. There is always a next time.
But that leaves him with his exchange rate problem.
He and his officials hope the dollar will gently slide and the economy progressively adjust, without too much pain but at the cost of a long, shallow trough, which some analysts are now forecasting.
But markets often move suddenly. Market forces might do what he must not do — plunge the dollar.
If so, except for the fright to business about regulation, most of the above would happen anyway: a profit plunge, higher inflation, higher interest rates, job losses and households scrambling to get their balance sheets back in order.
Either way, the politics for Cullen don’t look too good.