TREASURY BILLS

New Zealand Herald, Volume LXXI, Issue 21855, 18 July 1934, Page 13

TREASURY BILLS

EFFECT OF REPAYMENT POSSIBILITY OF INFLATION INFLUENCE ON EXCHANGE RATE A memorandum concerning the likely effects on the economic position of New Zealand, if the Reserve Bank takes over the Government's exchange liabilities in London, has been prepared for the New Zealand Importers' Federation by Professor B. E. Murphy, professor of economics at Victoria College, Wellington. The memorandum states that at the present time the Government holds approximately £24,000,000 sterling, against which has been issued a roughly equivalent volume of treasury bills in New Zealand, these being taken as an investment by the local trading banks. It is reported that the Government intends to sell these London funds to the .Reserve Bank in exchange" for a local credit and then to repay the treasury bills held by tho banks, thus retiring them. Problem for Banks When this transaction is completed the trading banks will have an unprofitable dead asset that will give them every motive to expand, and, since this additional £24,000,000 will support a credit structure several times as great, an inflation 011 a scale without precedent in tho Dominion appears possible. The trading banks, continues the memorandum, with their wider legal tender basis antl their heavy holdings of unprofitable funds, will be anxious to expand credit, but the general business outlook and the depression psychology still prevalent will incline them to caution and conservation of funds. Therefore it does not seem probable that the openings for inflation will be availed of to any great extent. The greater potential volume of currency and expansion of aggregate currency seem to make some inflation inevitable. Initially this would not bo a bad thing for the country, and, with, a revival of business, the inflationary effect would be quicker and deeper. In time the movement must come up against the effect of business revival on London balances. Trade and Exchange A business revival, states Professor Murphy, would mean increased purchasing power and a higher price level in New Zealand, which would stimulate imports. These imports must be paid for in sterling, and the time would soon come when the pressure- on London funds to meet such payments would harden the rate of exchange and reduce purchasing power. The effect would be to make depreciation of our currency as compared with sterling effective apart from "artificial" exchange control. Adjustments to the present exchange level are going on all the time and will be accelerated by the transactions under consideration. Just at what value the New Zealand pound in relation to sterling would become stabilised would only be manifest after exchange was released from control. Still, it seems inevitable that the general effect will be to make the existing "artificial" ratQ of exchange, or some other depreciated rate, a natural one. The reactions outlined must necessarily depend on psychological factors. Velocity of circulation depends on the estimate taken of the present and future prospects of business, and greater optimism or pessimism will divert events. Broadly, however, to the extent that optimistic views prevail, and particularly if initially sustained by facts, the movement toward inflation will be more marked and immediate, and the trend toward a permanent depreciation of the New Zealand pound in terms of sterling will be surer and more marked. Nobody at the present time can predict with accuracy just at what discount New Zealand currency would settle as compared with sterling in a free market.