THE PRESS SATURDAY, AUGUST 13, 1988. An overvalued $NZ

Press, 13 August 1988, Page 20

THE PRESS SATURDAY, AUGUST 13, 1988. An overvalued $NZ

The argument for a devaluation of the New Zealand dollar to save export industries was advanced by Professor Allan Catt to a council meeting of the Manufacturers’ Federation. This was but the latest contribution to a series of views that the high value of the New Zealand dollar is harming the country’s exports. The free float of the New Zealand dollar since March, 1985, has been a hallmark of the Government’s economic policy and there has been a clear reluctance to change that stance as the Government has fought inflation with outstanding political daring. It has achieved a great deal in that fight, bringing inflation itself down to slightly more than 3 per cent, doing much to eliminate inflationary expectations, and rooting out a great deal of the cost-plus mentality that had bedevilled rational economic development in New Zealand. Fearsome as inflation has been, sooner or later other factors have to be given priority in consideration of the economy. It is not enough for the Government to rely on the view that lower inflation will automatically bring about lower interest rates and a lower exchange rate; or that achieving these will in turn bring about investment and a creation of employment.

The dilemma in the New Zealand economy at the moment is that it is showing few positive signs of growth; yet some of the main conditions for economic expansion would seem to have been created. In the United States and Britain strong economic growth followed a fierce fight against inflation; in some countries low inflation has been accompanied by a stagnant economy. Mr Paul Volcker, the former chairman of the Federal Reserve Board in the United States, made the comment in Christchurch on Wednesday evening that New Zealand was one of the few developed economies not sharing in the economic boom being experienced elsewhere. Although he did not cite them, the Australian and Chilean economies are among those doing much better than New Zealand’s.

Although the Australian economy in particular has a mining base that New Zealand does not, both those countries export many of the same agricultural products as does New Zealand; and they export them to the same markets. Mr Volcker declined to comment on the management of the New Zealand economy directly. He nevertheless made the comment that, at one time, the United States dollar had been handicapping American exports and he left his audience to draw a parallel between that situation and New Zealand’s.

New Zealand, as Mr Volcker said, came late to the economic changes that many countries in the West adopted. These changes included deregulation, increased competition, the privatisation of some Government activities, a tight control of monetary policy, and the holding or cutting of Government expenditure. The floating of exchange rates was usually another feature of the changes. Mr Volcker believes that it is sound to fight against inflation. He also believes that there should be much more stability in international exchange rates. He acknowledged that although New Zealand had started late in the economic changes, the pace here had been rapid. In his optimistic comments (he had both an optimistic scenario and a more pessimistic scenario for the world economy) he believed that expansion could continue for the indefinite future. It would be splendid if Mr Volcker is right about expansion continuing indefinitely; but if he is wrong (or if his other predictions are right) the possibility exists that New Zealand might be ready to take advantage of a good world situation only when the times of plenty have passed. Added to that gloomy possibility is the consideration that the New Zealand economy has always depended heavily on exports and, because of its small population, and the nature of its physical resoures, New Zealand will continue to do so. Any sound growth in the New Zealand economy has to be driven by exports. The instability in the exchange rate and the high value of the New Zealand

dollar are both of prime concern to exporters and the Government must be concerned about the exchange rate. Failure to pay attention would, in the end, be downright negligent. A relatively high exchange rate was once taken as a reflection of a very sound economy. In the absence of foreign-exchange controls, it is possible for great pools of money to whirl around the world seeking the best short-term or long-term advantage. The amount of money a country is paying in interest rates has an immense impact on the value of its currency. If one country is paying interest rates far in excess of other countries, it is likely to find large amounts of money pouring in to take advantage of those rates. Investors have to take the stability of the country, its indebtedness, and the possibility of loss through devaluations into account; but if these risks seem reasonable, the high interest rates will attract a demand for that country’s currency and the demand will drive up the value of the currency. Conversely, a decline in interest rates will encourage investors to move away. This process has very little indeed to do with the general soundness of a country’s economy or its ability to pay for its imports with exports. In New Zealand, high short-term interest rates have been attracting huge amounts of foreign investment and as New Zealand dollars have been in demand, their price has risen. The Government has not deliberately driven up the value of the New Zealand dollar; but its reliance on short-term interest rates as a key element of its monetary policy has had the unfortunate effect of increasing the value of the dollar to levels that have badly hurt many exporters. Further, because imports become more affordable, manufacturing for the domestic market also comes under strain.

Few would argue that the Government should abandon the general thrust of its economic policies. There is, however, reason to believe that the policy mix should now be altered. The very great gains made in the internal economy should be given an opportunity to produce dramatic gains in exports. A more-market economy does, after all, need markets. The improved trade balance apparent in recent statistics cannot be taken to mean that all is well with New Zealand exporting. Commodities such as aluminium exported and petroleum imported contributed heavily to that improvement. Declining farm stock numbers, particularly of sheep breeding stock, lower returns for meat, and a drop in the value of exports in some of the industries with high labour content produce a much less cheerful picture. Various techniques are available to the Government to bring about a lower exchange rate. Professor Catt offered one. This consisted of deliberately selling dollars until the price fell to what the Government wanted. The potential inflationary effect of this would be overcome by the creation of long-term debt within New Zealand. Another technique would be for the Government to sell its short-term bills at lower interest rates. This would mean that investment would flow out of New Zealand and the dollar would fall. Export industries should then start to flourish and the economy should begin to boom. There are difficulties with all approaches. The creation of more long-term debt might mean greater demands on the pool of money available for productive investment, drive up interest rates, attract more money to the country and drive up the exchange rate. Selling short-term Government bills at lower interest rates might mean that the investment money would flow elsewhere, making it impossible for the Government to fund its internal deficit. The danger would always be a return to inflationary pressures. Increasing the country’s liquidity before the completion of the next wage round might be to set the country on an inflationary spiral again and all that has been won would be lost. Any new mix would have to be carefully monitored and controlled and the timing has to be right. Taking such factors into account and getting the right mix at the right time should be one of the functions of a central bank and of the Government.