N.Z. EXCHANGE

Southland Times, Issue 21649, 10 March 1932, Page 3

N.Z. EXCHANGE

PRESENT POSITION REPORT OF ECONOMISTS' COMMITTEE HIGH RATE DISCUSSED fhe present 10 per cent, rate of exchange and the effects of a higher rate arc discussed in the following section of the economists’ report: Effects on the Budget. With regard to the debt service on the Budget, we have shown that on a gold basis only £6.75 m. would be required to meet the external debt service. Thus parity with gold would actually involve a saving to the Budget of this sum in terms of gold. Would this be a net saving to the Budget? If a bonus of £2.25 m. accrues to the Budget on account of a restoration of gold parity, why should New Zealand not proceed independently to maintain her currency on a parity with gold? The answer is to be found in the effects that a return to parity with gold will have upon export prices, the money value of the national income, and the burden of the internal debt. First, we consider the internal debt. For public and local-body debt the total debt service isj £lB m. Approximately half of this debt service is internal and the remainder external. The internal service is £9 m. m New Zealand currency, whether on a gold basis, parity with sterling, or a rate depreciated in terms of sterling. The external debt service is £9 m. in terms of sterling. It is less in gold values when sterling is depreciated in terms of gold. The real burden of the internal debt ser,4 vice depends upon changes in the internal price level. When prices fall the burden increases, and the greater the fall in the internal price level the heavier the burden. Thus at parity with sterling a fall in internal prices of over 40 per cent, on the 1929 level may be necessary to bring about an adjustment of conditions to the lower level of export prices. The real burden of the internal debt service is accordingly increased. Thus the interest on the internal debt would represent two-thirds more goods and services than it did at the higher price level in 1929. If parity with gold were restored, the. price level would fall still further—namely, by approximately 60 per cent, from 1929. This would be necessary to enable an economic adjustment to be made on the basis of the gold value of exports. A fall of 60 per cent, brings the price level down from, say, 100 to 40. Thus goods which formerly were worth £lOO would then be worth £4O. Hence internal-interest charges would represent two and a half times as many goods and services as nt the higher price level in 1929. They would, in fact, become an intolerable burden. The return to gold parity reduces the money value of the external interest payments from £9 m. to £6.75 m., as we have shown above. It does not, however, reduce the real burden of these payments, because export goods are lower in price and the same quantity at this lower price is required to pay £6.75 m. as is required to pay £9 m. at parity with sterling. The internal interest burden, however, would be greatly increased by a return to gold. National Income at Parity with Gold. With regard to the size of the national income, we have pointed out that the restoration to parity with gold would tend to lower the income to £6O m. as compared with £l5O m. before the war. This would resu.t from the catastrophic fall in gold prices that has taken place throughout the world. Countries that have a depreciated currency might claim that it is the value of gold currencies that has increased, and not the value of their currencies that has decreased. With such a low money value of national income it would be impossible to meet the expenditure of local bodies and the Government without the most drastic scaling-down of all payments.. It would certainly be more difficult to balance the Budget at parity with gold than at parity with sterling, despite the fact that the budgets of local bodies and the Government would derive an advantage in terms of money of £2.25 m. on account of the lower gold value of external interest payments. This may appear a surprising • conclusion, but it is not less surprising than a view that it might be to the advantage of the country to have a rate of exchange above parity with sterling, despite the fact that the external debt charge will increase the cost of exchange on external interest. We consider this view below. (Paragraph 74.) We have no hesitation in coming to the conclusion that, in view of the present level of gold prices, parity with sterling is preferable to parity with gold. It means a higher money income, a readjustment of less magnitude, the maintenance of the ■values of securities, less financial disturbance, and, finally, a less disturbing budgetary situation. Having reached this conclusion, we now consider the economic effects of a rate above sterling. (C) CONSIDERATION OF THE PRESENT 10 PER CENT. RATE. At present the exchange is 10 per cent, above parity with sterling. This increases export values in New Zealand currency and sustains the New Zealand price level above what it would otherwise be. If export prices in sterling remain at their present level, the money value of the national income will tend to be adjusted to an export income of £35 m. in terms of New Zealand currency, instead of £32 m. at parity with sterling. In Section 111. we estimated the national income as settling at approximately £9O m. at the present 10 per cent, and present export prices. From the point of view of farm production the exchange rate raises export prices approximately 10 per cent, above the sterling figure and reduces the decline in costs required to make farm production profitable. In other words, the general adjustment in money income and in all fixed charges in the community is lessened. For the same reason, it helps to sustain the values of securities against which debts have been created, and thus lessens the financial disturbances associated with the problem of readjustment. Further, it sustains revenue at a higher money level than would be possible at parity of exchange. On the other hand, it increases the money cost of the external debt service when expressed in terms of New Zealand currency. If the budgets of local bodies and the Government as a whole be taken, the external debt charges are approximately £8.2 m. in sterling and £0.76 m. in Australian currency. On the latter there is at present an advantage on account of the higher level of the Australian exchange. This advantage is approximately £O.l m. The additional cost on the sterling interest is approximately £O.B m. The net cost is therefore £0.7 m. To meet this it would be necessary to collect only £0.7 m. additional revenue upon an additional national income of approximately £lO m. Thus, if the total revenue is only 7 per cent, on national income, the Budget should not suffer any loss from the higher rate of exchange on account of exchange charges on the debt service. Before the crisis, local-body and Government revenue amounted to about £4O m. on a national income of £l5O m.— that is, more than 25 per cent. If this percentage is maintained on the lower national incoine, the additional revenue of £lO m. on national income would be £2.5 m. against a cost of £0.7 m. There is a balance of £l.B m. to meet any increases in the cost of stores and goods on account of the higher exchange rate. The total of these costs should not increase more than 10 per cent., and the internal debt service would not increase at all. It is clear, therefore, that the 10 per cent, exchange involves a net gain to the budgets of local bodies and the Government as a whole. This benefit is not immediate. It accrues

as economic adjustment proceeds, and the ful benefit is not realized until the process of adjustment is completed. During the transition period the additional exchange cost on the Budget is stabilized at £0.7 in. The 10 per cent, exchange rate, however, prevents the national income from falling as much as it otherwise would. Therefore from the outset it sustains revenue at a higher level than would otherwise be possible. The additional revenue, however, is not immediately £2.5 m., but substantially lower than this sum. (D) CONSIDERATION OF Tire EFFECTS OF A HIGH RATE-SAY, 40 PER CENT. We now proceed to consider the case of a high premium on exchange—say, 40 per cent, exchange. In this case the additional cost of the sterling interest would be approximately £3.3 m. in New Zealand currency. The Australian interest would cost £0.09 m., making a total of £3.4 m. But the additional money value of the ■ national income would be about £32 m. Hence the exchange charges on external interest would amount to about 10 per cent, of the additional national income, compared with a 25 per cent, ratio of revenue to national income before, the depression. If this rate is maintained, the additional revenue possible from £32 m. of income will amount to £8 m. against which is to be set the additional cost of exchange on the external debt charges amounting to £3.4 m. and any increase in the cost of. goods and stores as before. Even though these costs increased by the full 40 per cent., the internal debt service I would remain the same. Thus there would similarly be a net gain to the budgets. If the Hoover moratorium were continued, the external debt charge in terms of sterling would be reduced by £1.3 m. In this event the additional cost of exchange would amount approximately to £2.9 m. An exchange rate of 40 per cent, would raise the values of export prices from their present basis of 40 per cent, below 1928-29 levels to approximately 24 per cent, below the 1929 level. At the present time export prices have fallen from, say, 100 in 1928-29 to 60. This is the position at a 10-per-cent. exchange. At a 40-per-cent. exchange export prices in New Zealand currency would tend to rise in the ratio of 140 to 110 —that is, to 76. The rise would, therefore, be from 60 to 76— 1 namely, 27 per cent. This would give an addition of this order to the gross income of the exporter and place him in a better position to meet costs which had not fallen in conformity with the fall in export prices. The adjustment in costs required to make export production profitable at the lower level of real income would be less than 24 per cent, from the 1929 level. If the farmer is sharing in the loss of real income proportionately to the rest of the community, a reduction in costs of the order of 20 per cent, might suffice at 40-per-cent. exchange rate, compared with 35 per cent, at 10-per-cent. rate and over 40 per cent, at parity of exchange. Hence the revision of fixed charges and other costs that tend to stick would be a less formidable task at a 40-per-cent. exchange than at parity of exchange or at a 10-per-cent. exchange. Additional Costs of Imports. It has been shown above (paragraphs 73-74) that the higher rate of exchange would not involve an additional net burden to the budgets of local bodies as a whole or of fhe Government. Hence it cannot be regarded as a net burden on the taxpayer. It would, however, increase the prices of imports when measured in New Zealand curency. With exports of £32 m. in sterling and an external interest burden of £9 m. sterling, imports would be approximately £23 m. A 40-per-cent. exchange rate would add nearly £9 m. to the cost of these imports in New Zealand currency. We have to consider (i) whether this is a net cost to the community, (ii) whether it is inequitable to importers, and (iii) whether it would tend to put up costs to the farmer and thus to destroy part of the benefit he receives from the higher prices of his exports. We shall consider these questions apart from any other adjustments that may be made, (i) With regard to the first, it is clear that there is no net cost to the community as a whole. Income is transferred from some sections of the community to exporters. This transfer Is a matter of adjustment within the community itself. If economic conditions are to be adjusted to the lower level of export prices a transfer of this order must, in any case, take place eventually. It may be done through the exchange rate, or through drastic cuts in money incomes for the purpose of reducing the costs of export production, or by other measure of relief to exporters at the expense of the community. On this point any measures adopted involve a loss of present real income to come 'Sections of the community in order to restore part of the loss of income that exporters have suffered. In other words, the problem of adjustment is to spread more evenly throughout the community the loss of national income that now falls with special severity upon exporters. It is not a valid argument against the high exchange rate, or any other measure of relief that it imposes a burden upon the rest of the community for the benefit of farmers who are suffering from price disparity, (ii) Hence we reach our second question—namely, whether it is inequitable to importers. The additional cost of imports in New Zealand currency will be passed on to the rest of the community. The high rate will not reduce imports below what the community can afford to buy, though its immediate effect would be to bring down the value of imports in sterling rapidly 1 to this position. This amount is determined by the sterling value of exports, less the debt service. Since the high rate maintains a higher internal price level, it will be possible for importers to sell imports at higher prices, when stabilization is reached at the exchange rate agreed upon. Effect on Costs. i (iii) The third question is that of costs. 1 We distinguish money costs from real costs. It is true that by adopting the rate of 1 exchange at 40 per cent, prices will be higher than at parity of exchange, and 1 therefore money costs will be higher. This does not, however, apply to all money 1 costs. Fixed charges, such as rent and interest, will not necessarily be higher. They will tend to remain the same. They will be a less real burden at 40-per-cent. exchange than at parity, because the gross income of producers will be raised by 40 per cent., while their fixed charges are less subject to variation. Similarly, money wages and incomes will be higher at 40 per cent, than at parity of exchange, but real incomes and real wages will be lower. The reduction in money wages required to bring about a reduction in real wages at parity of exchange is of such a magnitude that the adjustment cannot be made without difficulty and delay. It is true that the price level would settle at a figure substantially above the ultimate position at parity of exchange. But we have not yet reached that ultimate position. Indeed, our cost of living has fallen only 11 per cent, compared with a fall of 40 per cent, in export prices. At a 40-per-cent. exchange rate export prices would be 24 per cent, below 1929, and the additional adjustment in the cost of living would thus be of the order of 15 per cent. At parity of exchange it would be over 30 per cent. Clearly, it is much easier to get an adjustment of 15 per cent, than one of 30 per cent. Despite a 10-per-cent. exchange rate, import prices have fallen in Ngw Zealand currency. According to the index number published by the Government Statistician, import prices have fallen by 3 per cent, in New Zealand currency. This fall is due to a decline in the prices of imports of at least 12 per cent, in terms of sterling. It may be expected that the adjustment of the prices of secondary production throughout the world' l to the lower level of raw materials and foodstuffs vrill gradually increase this figure. As the sterling prices of imports fall, the cost of imports in New Zealand

currency will tend to approximate to the 1929 level, despite a 40-per-cent. exchange rate. Effect on Security Values. A higher nite of exchange will sustain security values and ease the process of financial adjustment. The credit structure cannot easily withstand the shock of a sudden and drastic fall in all security values. As mentioned before, liabilities tend to be fixed in terms of money claims that are not easily adjustable to a rapid >nd heavy fall in prices. Assets, however, ’are vitally affected by such a fall. They shrink or become frozen, and it becomes difficult to meet obligations in terms of fixed money claims. Over a period of years an adjustment to a lower level of prices can be made without undue financial disturbance. This is not the case if the fall in prices is rapid and severe. The price level is, indeed, a central feature of the economic system. Any sudden disturbance of it transmits a shock to the whole system that may have serious consequences. A high exchange rate by preserving the higher level might prove economically beneficial. There is the question whether a high exchange rate would damage the credit of the Dominion overseas. This is a question upon which opinion varies. In the immediate future, the Dominion’s credit abroad would be adversely affected, because the rise in the rate would draw attention to the gravity of the economic situation in New Zealand. This is a point for consideration in connection with necessary loan operations overseas. (Section XIII.) If, however,' the situation was being met with courage and determination, and the country demonstrated its capacity to restore sound trading conditions and meet its external obligations, national credit would recover even if the higher rate be maintained and if the currency be devalued. (See Section IX.) In present circumstances there is a net gain to the community from an exchange rate above parity. The analysis of the problem given in this section may lead people to believe that a complete readjustment could be made through the exchange policy alone. This is a wrong conclusion. The mere raising of the exchange rate will not set in motion all the necessary adjustments. A very high rate might lead to lack of confidence in the currency and cause considerable financial disturbance. This would delay rather than expedite the process of economic recovery. It is therefore undesirable to place too much strain upon the currency and exchange mechanism. An exchange rate above parity should be associated with other economic adjustments. These are considered in Sections X to XIII. Even with a rate of 40 per cent., which has been taken for the purposes of illustration, some adjustments in fixed charges, rent, wages, and public finance would be required. At a 10-per-cent. rate the adjustments required would be greater. Alternative: Primage Duty and Export Bounty. The general effects of a rise in exchange rates might be illustrated by reference to a possible alternative method of attaining to a similar end. Supposing that New Zealand’s payments abroad balanced with exports at £35 m., imports £25 m., and interest payable £lO m. These prices are in sterling, and sterling prices are beyond New Zealand’s control. A 20 per cent, rise in exchange would add that proportion to all items in the. balance of payments expressed in New 1 Zealand currency. Exporters would receive £7 m. more; importers would pay £5 m. more, and £2 m. would have to be found by taxpayers to meet additional interest. Thus £7 m. paid by importers and taxpayers would be received by exporters. A similar result might be achieved in another way. Let a primage duty of 20 per cent, be placed on all imports, to yield £5 m., and the extra £2 m. be raised from the taxpayer as under the higher exchange proposal. There would then be £7 m. available with which to pay a bounty on export. In these conditions all the effects would be similar to those caused by a higher exchange. The prices in New Zealand currency of export and import goods would tend to be 20 per cent, higher, taxation for interest 20 per cent, higher, the money value of the national income and the taxable capacity of the people would in the long-run be raised in similar degree, and the same transfer to exporters from other sections of the community would be made. The higher exchange has the advantage that it would be automatic, more certain in its working, and, if necessary, easily capable of permanent adoption by devaluation. On this question see Section IX. The primage duty would be less certain, more difficult to administer, and open to political interference, but it would enable the bounty to be distributed according to need. If the primage duty were regarded as a temporary measure it might not sustain security values. But the far-reach-ing effects of allowing matters such as these to become the subject of political pressure points to the danger of deciding them on grounds of political expediency. (To be Continued).