Tuesday, June 12, 2007

Kiwi nincompoop

This may come as a surprise, but I don’t think that the Bush Administration has the corner on incompetence in government. Many other countries have incompetent officials, too. In fact, we have one in New Zealand who veers awfully close to deserving that description.

His name is Alan Bollard and he’s Governor of the Reserve Bank of New Zealand, which is responsible for monetary policy. Its mission is to keep inflation within a 1 to 3 percent target. And therein lies the problem.

The only weapon Bollard has at his disposal is raising the official cash rate (OCR), which affects the percentage rates charged on all loans in New Zealand. So far this year, he’s raised interest rates three times so now New Zealand has the highest OCR in the developed world.

His goal is to cool the hot housing market by driving up mortgage rates, but most mortgages in New Zealand are fixed for between two and five years. So, it won’t affect the majority of people for quite some time. When it does, it’ll put the brakes on consumer spending as people face higher mortgage payments when their fixed-term rate expires.

That’s in a perfect world. In the real world, investors continue to buy investment properties because house values keep rising and so do rents. But the real effect is that foreign investors are attracted to New Zealand because of the high interest rate, and our exchange rate against the US dollar goes up. That makes imported goods cheaper, so people buy more stuff, often on credit—all of which is the opposite of what Bollard wants to have happen. Clearly, constantly raising interest rates isn’t the best idea.

The Kiwi dollar has reached its highest levels since it was floated two decades ago. So last night, Bollard used taxpayer money to buy US dollars, which drove down the value of the NZ dollar by about two percent—back to what it was last week. This was a colossally stupid move as it has now interested currency speculators in the NZ dollar, which has already started rising again.

Bollard intervened to sell Kiwi dollars—the first time in 22 years it’s been done—because, he said:
We regard current levels of the exchange rate as exceptional and unjustified in terms of the economic fundamentals.
He’s wrong. Prices for agriculture commodities are at 33-year highs, the US dollar continues to be weak and we have the highest interest rates in the developed world. The Holy Free Market they all seem to worship so much has raised the value of the NZ dollar exactly as could be expected—exactly as Bollard should have expected.

Experts say Bollard is playing a game of high stakes poker with taxpayer money, that he’s sending mixed messages on monetary policy, and that he’s raised a red flag to currency speculators—gamblers who have nearly destroyed currencies in the past. All of which is true.

Even though there clearly need to be tools to control inflation other than raising interest rates, I don’t believe Bollard’s the right man for the job. The people who lose out in this gamble are ordinary Kiwis, and twice: First, as they are forced to pay higher mortgage payments, and again as Kiwi jobs pack up and move overseas as several large manufacturers have recently announced because the Kiwi dollar has been high for quite awhile.

Today, one bank in New Zealand was offering mortgages fixed for 21 months at a whopping 9.25%, or 8.99% fixed for 33 months. The current floating rate is around 10.25%. The Kiwi dollar, meanwhile is now expected to be above 70 US cents for around two years and to hit or exceed 80 US cents before it peaks.

Where will this end? When the real estate market crashes and mortgagee sales are common? When there are no manufacturing jobs left in New Zealand? Will Bollard be happy once his policies cause a recession? I don’t know, but I don’t see how it can end well.

The worst thing is that we ordinary folk have no way to get rid of Bollard because the Reserve Bank is independent. It doesn’t matter who we elect to Parliament, Bollard will continue. I hope politicians can come up with more creative ways to kerb inflation without sticking it to ordinary folk.


d said...

Well, raising interest rates and dumping currency are common economic measures used to slow down an economy. For some reason, it doesn't work here. In the US, Greenspan raised interest rates a quarter point several times in one year before the housing market stabilized and came down a bit.

Selfishly, I'd like to see the Kiwi dollar weaken against the US dollar so that I can bring the rest of my money over here!

However, as the US dollar is weak in general right now, perhaps buying US dollars was not the way to go...as an accountant (not an economist), I have no bright ideas. The Kiwi dollar and the housing market do need to weaken at some point, though.

Arthur Schenck said...

D: You're absolutely right that the Kiwi dollar needs to weaken at some stage, but Bollard's policies won't do it. The main problem, in my non-expert opinion, is that there's a strong incentive to invest in residential property. Part of that is the lack of a capital gains tax, along with many tax deductions. Then there's the fact there's no incentive to invest in so-called "productive" investments (shares--but that's another matter). All of which is part of why Greenspan's methods don't work here.