John Key has a habit of speaking much more bluntly to foreign media than he does to us. In his interview with the Financial Times published this week he stated unequivocally that there will be no stimulus package for New Zealand. He hadn’t told us.
It was this, though, that caught my attention: “he is betting that a falling Kiwi dollar will naturally allow the current account deficit to correct itself over the next one to two years”
Why does John Key think that the dollar will fall as the economy recovers?
Look at some recent news reports on the currency:
“Kiwi slides, NZX falls as world markets tumble”, “the NZ dollar was hit hard as risk appetites retreated and commodities fell sharply. The kiwi had been caught up in growing optimism that global financials”, “Kiwi strengthens as risk appetite recovers”, “NZ dollar falls as investors get jitters”, “NZ dollar slumps with equity markets”
The currency goes down when the news is bad, up when it’s good.
The currency moves not because of the balance between imports and exports, like your high school economics textbook said, but because of investors and speculators moving their money in and out of the country based on confidence and interest rate differentials. We’re in a world economic crisis. Investors are scared. So there has been a ‘flight to quality’, they’ve got out of peripheral economies like New Zealand and put their money in the the safest of safe ports – US government debt. To do that, they’ve had to sell New Zealand dollars and buy USD. Fear about the world economy drives our dollar down.
When things appear to be getting better, our dollar recovers. Investors are less fearful and our relatively high interest rates make us attractive for the ‘carry trade’. They have to buy more New Zealand dollars and that pumps up the exchange rate.
Key’s got it backwards. When (if?) the New Zealand and world economies recover the dollar will rise, not fall, and we’ll be back in the with same problem we had before the world economy went to hell – relatively high interest rates, bringing in speculators, driving our currency too high, making imports cheap and export returns poor, leaving us with a current account deficit that’s too big for comfort.
It’s concerning that Key doesn’t foresee that problem but, then, he does like to look on the bright side. That’s working out great so far, eh?
– the mathemagician