N.Z. EXCHANGE

Southland Times, Issue 21648, 9 March 1932, Page 10

N.Z. EXCHANGE

WORKING OF SYSTEM ECONOMIC COMMITTEE’S REPORT HOW MONEY IS TRANSFERRED Section VIII of the Economic Committee’s report deals with the New Zealandexchange system. The first portion is as follows:— SECTION VIII—EXCHANGE' AND ECONOMIC ADJUSTMENT (A) THE MECHANISM OF EXCHANGE IN NEW ZEALAND AND ITS WORKING. The monetary system of New Zealand Is best described as a sterling exchange standard. This system has evolved over a long period of years in response to the needs of the Dominion’s industry and trade. Under this system exchange has been kept stable in comparison with other exchanges, despite wide fluctuations in the factors that usually determine exchange rates. During the war period, for instance, when many exchange rates fluctuated very widely, New Zealand exchange on London was kept stable. In 1921, despite the heavy unfavourable balance of payments, the exchange moved only about 3 per cent, above par. It dropped about 3 per cent, below par in 1924, when the balance swung in the other direction, but returned to parity again. In 1927, when the balance of trade was against New Zealand, the exchange rate moved by only 4 per cent. Dealings in exchange consist in the provision of money overseas in exchange for money in New Zealand, and vice versa. The exchange-dealer must therefore be In a position to supply money overseas, or, alternatively, money in New Zealand, when called upon to do so. Most of the exchange work is done by the banks, and the operations can best be described by reference to their methods, taking transactions between New Zealand and its chief market — London—for purposes of illustration. All the six banks operating in New Zealand have offices in London and are accustomed to hold there considerable liquid funds for exchange purposes. When New Zealand goods are exported to Britain the proceeds are paid into these London funds and held there. They are transferred to New Zealand not usually by shipping money in any form, but by crediting exporters’ accounts in New Zealand with the amounts due to them. Thus payments for exports will increase bank funds held in London, and increase bank .liabilities to customers, mainly depositors in New Zealand. Generally speaking, the same procedure is followed in regard to all payments from overseas countries to New Zealand. The money is paid into funds held in overseas centres and at the same time is credited to customers’ accounts in New Zealand. When imports are paid for or when money is paid out from New Zealand for any other purpose, the process is reversed. Actually payment is made from the banks’ funds held in London or other overseas centre and the amount of the payment, with adjustment for bank charges, is debited to the customer’s account in New Zealand.

Changes in Bank Funds. It follows, therefore, ’that all payments made to New Zealand will tend to increase bank funds held for exchange purposes overseas, and will at the same time tend to increase the bank’s liabilities’ chiefly customers’ deposits in New Zealand. On the other hand, all payments made by New Zealand will tend to decrease bank funds held overseas and will tend to decrease similarly bank liabilities in New Zealand. If, therefore, over any period payments made by New Zealand exceed payments made to New Zealand, more will be paid out. of overseas exchange funds than is paid in, and more will be debited to customers’ accounts in New Zealand than is credited to them. In these conditions there is a diminution both of bank funds held in London and bank liabilities in New Zealand. On the other hand, if payments made to New Zealand for exports, etc., exceed payments made by New Zealand for imports, etc., the payments into bank funds held overseas will exceed payments made from those funds, and the credits to customers’ accounts in New Zealand will exceed the debits. A favourable balance of payments, therefore, means an expansion both of bank funds held overseas and of bank liabilities in New Zealand. The overseas fund is thus the real reserve held against bank liabilities in New Zealand, and automatically fluctuates with these liabilities. This balance of payments is determined by the total payments to New Zealand on the one side, which may be regarded as credits, and by the total payments by New Zealand on the other, which may be regarded as debits. On the credit side are the proceeds of exports, of loans raised abroad on public or private account, the expenditure of overseas tourists in New Zealand, immigrants’ capital, etc. On the debit side are payments made for imports, for interest, and debt-redemption abroad (whether public qr private), for dividends payable abroad, New Zealand tourists’ expenditure in overseas countries, capital taken out by emigrants, etc. Exchange Funds Overseas. It is not possible to determine the total amount of funds held on New Zealand account abroad. This depends on the varying amount of bank capital devoted to New Zealand business: but it is possible to estimate the variations in these funds due to changes in the New Zealand balance of payments. The banks publish quarterly details and totals of their average assets and liabilities in New Zealand. The excess of liabilities over assets in New Zealand must necessarily be balanced by an exc&ss of assets over liabilities overseas if the total banks’ balance-sheets are to balance. A favourable balance of payments to New Zealand will increase these surplus assets overseas and similiarly increase the surplus liabilities in New Zealand, while a favourable balance of payments will have the opposite effect. Hence variations in the margin between bank liabilities and assets in New Zealand must necessarily reflect changes in the volume of funds held mainly for exchange purposes on New Zealand’s account in overseas centres. It is generally considered that in conditions of free competition exchange rates will be determined solely by the supply and demand for exchange funds held in overseas centres. In centres where competition is keen, and there are many operators, the exchange rate may fluctuate from hour to hour and from dealer to dealer. Under normal conditions the fluctuations are kept narrow by the willingness and ability of certain large dealers to add considerable sums to the exchange funds available when the demand is greater than the supply, and to hold large sums off the market when the supply is greater than the demand. Such stabilization of the exchange market is a part of normal exchange business in every country in the world. For New Zealand this stabilization was provided because the banks could hold varying amounts of over j seas funds knowing that they had a stable value in New Zealand in New Zealand currency. They provided this through the sterling exchange standard. In a normal year exports are very heavy in the first half of the year, when they may exceed imports by many millions. In addition, Government loans have usually been raised in London about May. In these circumstances the supply of funds in London may exceed the demand over the first half of the year by, between £lO m. and £2O m. An injpossible position would arise if the exchange fluctuated in response to these changes. In the latter part of the year imports normally exceed exports, and the demand for funds overseas may be greater than the supply. If the exchange rate responded sensitively to changes in London funds, therefore, we might expect the rate to be abnormally low during the first half of

’the year and abnormally high during the second, half. In practice the banks allow funds to accumulate in London during that part of the year when the balance of payments is favourable and allow these funds to become reduced in the latter part of the year without changing the exchange rate. Periodic Changes in Funds. This involves a considerable measure of control; but that control is customary and necessary, and would require to be maintained under any system of exchange operations. But New Zealand’s exchange funds are affected by causes other than normal seasonal variations in the balance of payments. It is recognized that prices of New Zealand exports are subject to much wider price fluctuations than prices of New Zealand imi>orts. When export prices rise, the country’s national income is increased, more is spent, and imports tend to increase some time after an expansion of exports. When export prices fall, the country’s national income is decreased and the community cannot then buy as many imports; but the import figures do not respond to the change in the community’s purchasing-power until some time after, often about a year after the fall in export prices. There are thus periods during which payments made to New Zealand substantially exceed payments made by. New Zealand. These are usually periods of prosperity. There are also periods during which the payments made by New Zealand substantially exceed the payments made to New Zealand, and these are usually times of financial restriction and depression. It has been shown that it is possible to estimate from the banks’ assets and liabilities published in New Zealand the variations in the amount of their funds held on New Zealand’s account overseas. Let us consider the figures for the March quarter during recent years. In 1925, a season of high export prices, funds held overseas were substantial. Export prices then fell and the balance of payments became unfavourable. By March, 1927, these funds had been reduced by nearly £ll m. Then export prices turned upwards, export values increased, and imports fell. By 1929 an additional £l4 m. had accrued in funds held overseas. At this point prices fell heavily and the balance of payments became again unfavourable. By the December quarter of 1930 funds overseas had been reduced by £12.5 m. By the December quarter of 1931 imports had been reduced very heavily, the balance of payments had become favourable, and the funds had increased by £1 m. The funds held 'overseas in the December quarter last were about £2.5 m. greater than in the March quarter of 1927, and £11.5 m. less than in the March quarter ' of 1929. In these circumstances it might be expected that the exchange rate would not be depreciated more than in 1927, when it moved only 4 per cent, from par. On this occasion, however, the fall in export prices has been heavier and more substantial.

Other Influences on Rate. But conditions other than the existing supply of funds influence the rate. The prospective supply and demand have also to be taken into account. It is probable that the New Zealand rate was raised to 10 per cent, largely because the banks an ; ticipated heavy depletion of their overseas funds if the rate had remained lower. Two influences might have caused such depletion. First, at lower rates imports would undoubtedly have been heavier and the drain on their funds greater; secondly, no country can consider its exchange market in complete isolation from other maikets which may influence it. In addition, the liquidity, and not merely the supply, of such funds must be considered. Events in the money world in times of depression may freeze bank assets which previously were regarded as ;>erfectly liquid, and it is possible that funds held overseas and normally available for New Zealand exchange purposes may be invested in securities at the moment less liquid than they were expected to be. In this complex of influences, therefore, it is difficult to determine from a mere estimate of funds what should be the exchange rate. (B) CONSIDERATION OF THE RESTORATION OF THE GOLD STANDARD. We have given a general description of the working of the exchanges. New' Zealand is now 10 per cent, off parity with sterling. Whatever the circumstances determining this rate, it checks imports and thus helps to safeguard London funds. It also encourages exports by raising the gross meme of the exporter by 10 per cent, above what it would be at sterling figures. At parity of exchange with sterling, national income will tend to be adjusted on the basis of an overseas income of £32 m. On this basis we found in Section 111. (paragraph 18' that, after the process of economic adjustment was completed, the national income would tend to fall to £BO m. If, however, the rate of exchange moves and remains away from parity, the money value of the national income will be different-. The rate of exchange thus has an important bearing upon the money value of national income. We proceed to consider typical examples of three possible exchange objectives: First, a restoration of P/rity with gold; secondly, the maintenance of the existing 10 per cent, rate of exchange; and, thirdly, the adoption of a high premium, illustrated'by taking a rate of 40 per cent. Normally, the exchange mechanism of New Zealand keeps the New Zealand exchange very close to parity with sterling. Before the war, and between 1925 and 1931, Great Britain was on the gold standard; hence New Zealand currency was then closely Jinked to gold through the exchange relationship with sterling. When Great Britain moved from the gold standard, in 19ul, British exchange depreciated in terms of the currencies of countries such as the. United States and France. The New Zealand exchange, which had already depreciated 10 per cent, in terms of sterling, maintained its relationship with sterling, so that the depreciation of sterling on gold-standard countries resulted in a similar but additional depreciation of New Zealand currency. Return to Parity With Gold. The present adverse exchange of 10 per cent, on sterling causes export prices expressed in New Zealand currency to be approximately 10 per cent, higher than the prices expressed in sterling. The money receipts of the farmer are therefore increased, If New Zealand currency had remained at parity with gold, the New Zealand exchange in London would have been below parity with sterling. Hence the effects on export prices would have been the reverse of those at the present rate of 10 per cent. New Zealand export prices expressed in sterling would have remained the same as at present; but export prices in New Zealand currency would have been lower than sterling prices by approximately the amount of the depreciation of sterling in terms of the gold parity, or parity with the dollar. The following table shows the level of export prices and the estimated value of exports in New Zealand, at the present 10 per cent, rate, at parity with sterling, parity with gold, and at a 40 per cent, exchange. Export Exports. Prices, Estimated December, Value,

In order to demonstrate the probable effects which would follow from maintaining the pre-war parity with gold, let us assume that the exchange between London and New York is established at 3.60 dollars to £1 sterling, instead of the normal gold parity of 4.86 dollars — £1 sterling. In other words, let us assume that Great Britain stabilizes her currency at a level which is depreciated 25 per cent, in terms of the gold parity. In fact, sterling at the moment has depreciated by 27 per cent. If New Zealand currency were maintained at parity with gold, this would mean that export prices in New Zealand would fall 25 per cent, below export prices expressed in sterling. The value of exports is now round about £32 m. expressed in sterling. Hence Jhe value of exports expressed in New Zealand currency would fall to about £24 m. As a consequence, the national income would

fall from the 1928-29 level of about £l5O m. to about £6O m. It will be apparent at once that the problem of readjusting our economic life to a national income of £6O m. would be very difficult indeed—much more so than the problem of adjusting it to a national income of £BO m., to which the national income would tend to fall at parity with sterling. But it is never assumed that New Zealand should return to the old parity with gold. There is general agreement that parity of exchange with a depreciated sterling has economic advantages over parity of exchange with gold currency' at the old rate. The main reason for this view is the higher level of export prices when these prices are measured in a sterling currency depreciated in terms of gold. Effects of Deflation. We now discuss briefly the economic arguments for and against this view. Maintaining the exchange at parity with sterling does not bring ;my additional real income into New Zealand, over the amount, at. parity with gold. But on the assumption that sterling is depreciated 25 per cent, in terms of the gold parity, it, does support the money income in New Zealand at a level 25 per cent, higher. By holding export prices above their level in gold it lessens the magnitude of the necessary adjustment between farm costs and farm prices. It also lessens the extent to which all values will fall. This is important. Debts are created against securities, the value of which is determined largely by the average level of prices and the longterm profits of enterprise. If prices fall rapidly and profits arc destroyed, security values also fall; but they fall in greater proportion than the fall in prices, because their value is dependent upon the profit margin. This is quickly destroyed in a period of acute deflation. Hence the value of securities upon which debts have been arranged falls rapidly until profits are restored by rising prices. All individuals and all institutions dealing in these debts must then experience difficulties in maintaining a proper balance between assets and liabilities, unless they have available liquid reserves. Liabilities of financial institutions are expressed in fixed money terms, and they do not respond to a fall in prices. Hence a rapid fall, by destroying part of the current value of assets, is likely to embarras such institutions. The lower the new price level the greater will be the embarrassment. This is one important reason why parity with the depreciated sterling is preferred to parity with gold- .. * Though exporters reap the benefit of higher prices in terms of depreciated sterling, the addition to price is paid to them by the rest of the community. At parity with gold, exports would realize £24 m. Parity with sterling places this value at £32 m. Who pays the additional £8 m.? Consideration of the value of exports, expressed in gold, and of the effect of exchange upon the New Zealand value of these exports supplies the answer. Out of £24 m. of exports, expressed in gold, New Zealand would have to meet about £9 m. of overseas interest in sterling values. This would require only £6.75 m. of exports expressed in gold, leaving a margin of £2.25 m. of relief to the Budgets of State and local bodies compared with 1929. With exports at £24 m. and debt services at £6.75 m. the value of the amount available for imports would be £17.25 in. in terms of gold. When, however, parity with sterling is the basis of the currency, the debt services are £9 m., and the sterling value of exports £32 m. This leaves £23 m. for imports in terms of sterling. Hence imports cost. £5.75 m. more at parity with the depreciated sterling than at parity with gold. In addition, the interest on the overseas debt is £2.25 m. more, making up the total of £8 m. This sum of £8 in. comes from the taxpayer and the consumer of imported goods in the first instance. It is well to bear this in mind. Both imports and the overseas debt service cost more in money on a depreciated sterling basis. This cost comes from the rest of the community, and is paid over to the exporters, who receive a higher price in sterling for their exports. (To be continued.)

1931. Current £m. Year. £m. At present rah. 95.0 35.1 At parity with sterling 86.5 32 At parity with gold 61.0 23 At 40 p.c. above sterling 121.10 45