Quantitative Easing for Idiots
Last month Russel Norman boldly proposed that the Reserve Bank should print money to reduce the value of our dollar. When I heard this it made me wonder if the Green’s were up at night smoking their economic policies rather than attempting to understand them. Yes, the sentiment is noble, the dollar is at record highs, our exporters are hurting and we must close our trade deficits. Yes, also Russel Norman is no slug. He has a doctorate (in politics) and has had a successful career.
I wanted to find out what I didn’t know so dug a little deeper.
The Reserve Bank of New Zealand (“RBNZ”) Act gives the RBNZ the authority to intervene in currency markets. Section 16 of the RBNZ Act states that the RBNZ should intervene in currency markets if the exchange rate is at unjustifiable levels. It does so by buying foreign currency and selling New Zealand Dollars (“NZD”) on the foreign exchange swap markets. The RBNZ currently has a 7 billion dollar fighting fund to cover any foreign currency positions that it may be required to take to stablise our dollar.
This ‘speculative-type’ intervention began in 2007 when the RBNZ felt the value of the NZD was unjustifiable. The NZD/UDS cross rate was at a record high of 76 cents, so the RBNZ took an un-hedged position selling NZ dollars into the market. It hoped this intervention would reduce the value of the NZD through increased supply and send a message of uncertainty to market speculators who may have been artificially inflating our currency. In the short term the intervention was a success and the dollar fell to 74 cents. It did, however, rise to an all-time high of 81 cents a month later.
It is difficult to say if the intervention was successful due to relative increase in value of the NZD only a month after the intervention. Interestingly, however, because the NZD had increased in value relative to the USD, the RBNZ made a profit of around half a billion dollars when it closed out of the transaction in early 2008.
The RBNZ must act covertly in its currency trading otherwise speculators would attempt to predict the RBNZ’s next move and take market positions for profit. This could destablise our dollar and make it unattractive for foreign investment. Ultimately the RBNZ does reveal itself in the books of the governments annual accounts where it will have to post any FX losses or gains incurred while trading. Central Banks such as Japan have lost billions by ending up at the wrong end of options while trying to regulate their value of its currency.
The RBNZ could also lower interest rates in an attempt to reduce the exchange rate because, at 2.5%, our cash rate is much higher than the rest of the world. Given the recent decline in the output of our manufacturing sector a cash rate reduction may be a possibility in the New Year to stimulate the local economy. The RBNZ will act cautiously though because relaxing interest rates will have a negative effect on overseas investment in New Zealand.
Currently New Zealand has over 200 billion dollars of private borrowing through foreign owned banks, (not to be confused with government borrowings of about 100 billion used to fund trade deficits). Our very Kiwi way of life, our ability to fund the mortgage, is very dependent on overseas debt.
The RBNZ will carefully consider the investment effect on any cash rate reductions before using this method to stabilise our dollar.
Now finally, let’s consider Norman Russel’s proposition and consider printing money or, as it is less offensively stated, quantitate easing.
Quantitative easing has been an important strategy to the US lately. The Fed put new money into circulation by purchasing financial assets from commercial banks. It was hoped that this would soften the toxic debt crisis while stimulating the economy. General consensus is that this strategy failed in one of the greatest economic blunders of our time.
The Government purchase of toxic debt in New Zealand (i.e the government guarantee scheme) came from the government’s kitty and not through newly printed notes. If New Zealand were to consider quantitative easing it would do so through the purchase of government bonds with freshly created money.
While the Green’s suggestion that that newly created money would put downward pressure on the dollar does make sense, the mental gymnastics of what follows is like one of those maddening scenes from the film Inception that falls into circular arguments and makes no sense.. Here we go:
Printing money devalues the currency through extra supply which stimulates the economy. The lower valued dollar increases interest rates to ensure overseas investment. The high interest rates increase the exchange rate and decreases stimulation. So we are back where we started with more money in the economy an inflation crisis, so we print more money…
The apparent lunacy of quantitate easing is summed up in this popular YouTube video.
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