Fran O'Sullivan

An open letter to Dr Alan Bollard of the Reserve Bank

What's it to be, Alan? Another interest rate rise to satisfy the economists and commentariat who believe your credibility will now be seriously impinged if you don't deal to the Finance Minister?  Or do you carefully weigh the broader consequences of yet another rate hike and take soundings from business people in the real economy, exporters, householders and your own board members before reacting Pavlovian-style to those who say "you have no alternative" if you are to show Michael Cullen that you are the independent master of monetary policy?

You may be stuck between a rock and a hard place.  That's simply what comes with the big jobs.  But you should think carefully indeed before you go public at 9am tomorrow. Most of us would rather you made a truly independent decision rather than be dragged into a "pissing contest" (excuse the vernacular) where, if you do raise rates, that decision will be read as "teaching Cullen a lesson".

If you do decide to leave rates where they are, we are hardly likely to crucify you for exercising an independent decision.  There's plenty who think you should do just that. National Party leader John Key for one - and he owes Cullen no favours.  If you do raise them, we would rather that decision was the result of careful reflection rather than a sense that you have been stampeded into a bad move simply to retain mana with "the market".

The reality is that the game's much bigger than either you or Cullen, and your actions have real consequences for local businesses.  That's where the debate should be. Not one of your respective credibilities.  If you place that much emphasis on your own ego (which I am sure you don't), you should resign, because you have failed to persuade Cullen that monetary policy "needs mates" and get him to reduce Government spending.

Hence the punishment you may dish out tomorrow will have a lop-sided effect on the economy.  Those on the state teat will prosper but business will get that much harder.

You have also failed to stop people paying ridiculous prices for housing.  That will happen anyway when the housing bubble bursts, as it always does. It's all about the extent of the collapse.  You have even failed to bring a rampant dollar under control even though you have intervened at least three times in the forex market since it scored in the mid-US70c range.

Best not to panic at this stage because pushing up interest rates while you are simultaneously trying to nudge the kiwi downwards by selling the dollar is not very smart.  Giant American hedge funds get this. They are among those who are driving much of the carry trade and are lining up for yet another turkey shoot.

That's obvious from the strengthening of the kiwi, which yesterday hit US81c. Read the chatter on currency traders' websites and the blogs of those who follow international speculation. They don't rate us as very bright.  Major trading banks can also be expected to cash in as they shift mortgage rates up again despite the fact that many have already priced in another rate rise.

What's really at issue is what some economists say is an "impossible trinity". Nations cannot simultaneously target domestic inflation, exchange rates and free cross-border capital flows all at once.  At least, not without provoking instability in at least one of the three areas.  So if you want to ensure constant prices, keep inflation under control and ensure free cross-border capital flows, your influence on the exchange rate is lessened if interest rates are raised upwards.

Thus if interest rates go up tomorrow - as most financial markets economists are urging - international investors ranging from Cullen's mythical Mrs Watanabe through to speculative hedge funds will find the kiwi more attractive than other currencies.  It will go up further.  This paradigm is not unique to New Zealand. As the value of sterling rises to reach highs against the United States dollar not seen for almost three decades, Britain (just like New Zealand) has become a magnet for the estimated US$1 trillion ($1.23 trillion) of "hot money" surging round the world.  Australia has similar issues.

If - when you weigh up the issues today - you decide exchange-rate stability and cross-border capital flows are more important in the near term (which is where you appeared to be a few weeks ago), you might have to put domestic price stability on hold.  Would that really matter?  Because trying to manage price stability and exchange rates at the same time would appear to require the imposition of much stronger tools than you have.

No one wants to see currency controls. You have discussed other options with Cullen and Key, before the National leader decided to take his rattle elsewhere.  Maybe it's time to have another discussion. Just don't tell anyone else until decisions are made or you will be said to have compromised yourself.

Why not have another shot at getting Cullen to slash Government spending? The previous Government was persuaded to do just this during the East Asian crisis. In return, you could cut the rest of us some slack on interest rates. Leave them where they are or even reduce them.  Cullen can use other tools to make housing investment less attractive. If the two of you can't do this rather elegant tango, try another alternative.

For goodness sake get Cullen to join us up to the Australian currency quick and form a joint Reserve Bank to run the shop.

Best,
Fran

Michael Cullen stands accused of sabre-rattling because he seeks solutions to the currency crisis which run counter to established orthodoxy.  Well good on him. That's what we pay the Finance Minister to do.

When the New Zealand dollar has been gamed so obviously by offshore speculators that even blue-chip investors like Warren Buffett's Berkshire Hathaway can boast in their annual reports of the multi-millions of dollars they make playing our small nation's currency, only a mug refuses to investigate options.  Unfortunately the body politic in this country has become so entrenched that rationality has flown out the window.

A lot of poppycock has been spouted since Cullen reminded financial markets of the reserve powers he has under section 12 of the Reserve Bank Act to override the central bank's sole focus on price stability. But it is unfathomable that a finance minister cannot float possible mechanisms such as a levy on fixed interest mortgages, or capital gains taxes. Or even expanding the Reserve Bank's monetary policy focus to include, as an objective, the stability of our currency, the maintenance of full employment here, or the maintenance of our economic prosperity and welfare of our people (as happens in Australia) without provoking an insular backlash.

We're not alone in facing such problems. There has been plenty of debate in international forums this year over how small countries can "escape" the US dollar effect, and, how they can protect their currencies from speculation by major investors armed with wads of dough from a world awash with cash.  Much of the debate is sophisticated. But any attempt to have a conversation which focuses on how realistic is it for a small country to continue to have a free-floating dollar, or continue to run an interest-rates policy that results in the cash sucked in from international speculators pushing our currency up simply runs into an ideological wall.

Unfortunately we have been conditioned too much by the doctrine of the current Reserve Bank Governor's predecessor to look outside the box and examine what may have changed since Don Brash made a virtue out of washing his smalls in hotel rooms to ram home his anti-inflation mantra.

The National Party - led by a former currency trader - is indulging in political point-scoring at the expense of New Zealand's prosperity.  It's hard to credit the cynicism which is displayed daily in Parliament. Just three months ago John Key went public warning this portending crisis required both main political parties to put their heads together and come up with a creative solution.  He wanted to stem the massive flows of hot money into New Zealand that were "pumping the exchange rate to crippling levels". He told me the New Zealand economy was particularly exposed because of the impact of Japanese retail investors and major currency speculation on the back of the US$1 trillion of hot money washing about in Asia.  "We're very happy to work with the Government on this - it's totally a capital markets and hot money issue."  Since then the currency has gone through the roof and shows no signs of abating.

Not surprising perhaps when some of the heat is due to a depreciating US dollar - some of it to speculation by offshore investors drawn to our currency by the usurious interest rates the central bank offers.  But the National Party leader is no bunny.  Key has managed international currency flows. He's speculated against other nations' currencies and no doubt New Zealand's. He knows all the tricks of his trade. He's skilled in picking the inflexion points on currency swings and knowing just when to capitalise by making a deal or quitting a position.

That's why he should be getting round the table with Cullen - as he previously offered - instead of allowing his party to impose a slow Chinese water torture on the Finance minister.  Two months ago, Key was more than willing to have that conversation with Cullen. In fact he was gagging for it. He had ideas - none of which he wanted to publicly disclose in case the market became prematurely alerted.  But these days he won't even play ball. Every time the Finance Minister floats a possible change to the status quo to try and bring an abrupt stop to the obvious gaming, Key falls in behind his deputy and Finance spokesman Bill English.

Do National's strategists seriously believe their prospects of tipping Labour out at next year's election will be enhanced if the currency crisis changes into a recession? That is exactly what Key feared two months ago.  This after all is a party that delighted in bloodying Labour's nose by refusing to support moves for a joint therapeutics agency with Australia. But voters won't - and shouldn't - thank National if it continues to play politics on a truly significant issue.

Time for Key to show some leadership and make good on that promise to get round the table with Cullen - this is much more important than photo-ops with Helen over anti-smacking legislation!

Cabinet ministers reacted like headless chooks to news that major NZ exporters are upping sticks to Asia.  Instead of lashing out at political opponents ("Just take a cold shower please, Trevor Mallard"), they would have been better off calling a summit to find a common accord on how to avert a looming exchange-rate crisis.

There's no need to subject National to another round of wedge politicking, as Mallard is obviously attempting by focusing on his opponents instead of a rather serious problem. Ministers and their National counterparts tried to do just that at a secret meeting with the heads of the Reserve Bank and Treasury last year.

They got together to study a range of supplementary stabilisation instruments devised by Reserve Bank and Treasury officials. The secrecy was blown in February after some politicking from both sides.

On the agenda this time should be an investigation into non-politically correct options: These could include currency controls under study in much of Asia; Reserve Bank intervention in the dollar; pegging the NZ dollar to its Australian counterpart, and dropping interest rates to spark an outflow of hot money.

None of these are particularly palatable. They could all fail - and might attract another judgment from Bollard that they simply won't work.

What should go onto the agenda are the elements over which the politicians do have control. Primarily lavish government spending levels, which are increasing the pressure on monetary policy, as Bollard notes.

We are all paying for the 2005 electoral auction. Labour offered interest-free student loans and expanded its Working for Families tax credits. National countered with wide-ranging tax cuts.  Irrespective of the ideological differences between the respective policy stances, the impact is obvious.

The OECD suggests that, while supplementary stablisation instruments should be pursued, adjustments to fiscal settings provide an obvious alternative. It noted that the Treasury forecasts a significant fiscal impulse in the current and next two fiscal years, which is helping to underpin domestic demand. If the stance was neutral, the burden on monetary policy would be easier and interest rates could be lower.

It suggested there is limited ability to scale back spending plans. But there should be greater flexibility around 2008-09, which happens to be smack in the middle of the 2008 election bidding cycle.

The OECD doesn't say so outright, but if Labour and National could reach an accommodation for 2008-09 - or, better still, allow Labour to reduce committed spend in 2007-08 in return for a National ceasefire on opportunistic political attacks - much economic heartache may be avoided.

The outlook for exporters is not great. If the NZ dollar remains high, squeezed profits in the tradeables sector will spread via slower wage growth, job losses and postponed or forgone business investment.

The OECD notes three potential possibilities over where the burden of adjustment might fall:

* On exporters and import-competing producers;
* Through households deciding to cut back their consumption in response to the impact of higher interest rates; and
* The risk of a less benign scenario triggered by a sharp shift in foreign investor sentiment.

If investors decided to pull out of NZ dollar denominated assets, this could lead to a large, potentially disorderly fall in the exchange rate, which would restore the external balance and boost exporters' competitiveness.  This, in turn, would place households under renewed stress as the Reserve Bank would have to increase the interest rate premium to attract investors back into the currency.

Given the potential variables, we should not be surprised at the decisions by some of our leading exporters to shift production offshore.

Fisher & Paykel's plant move to Thailand had been widely telegraphed among the Auckland business community. But the forthcoming departure of this iconic company has touched many New Zealanders, as F&P had defied the odds by keeping its Auckland plant going for so long.

The decision to move closer to markets is a rational one. The alternative is to stay at home, be punished by crippling exchange and interest rates - and still be left without sufficient critical mass to achieve the economies of scale to stay competitive.

Other competitive pressures will emerge as we slip further behind Australia. The New Zealand Institute's number-crunchers released a graphic report at last week's Australia New Zealand Leadership Forum in Sydney.

Australia's GDP per capita (A$47,181) is about 30 per cent higher than New Zealand's (A$33,682), with NZ well below the OECD average. NZ's figure is now lower than all Australian states, including Tasmania.  Top performers are resource-rich Northern Territory (A$59,649) and Western Australia (A$58,688). The lowest is Tasmania at A$35,253 - but even that state heads off New Zealand on A$33,682.

Those low incomes are driven off the low wages are paid here, which have acted as an incentive to keep manufacturing exporters here.  But there's problems ahead. Each week, about 700 Kiwis join the exodus to Australia.

If companies want to stay here and develop high-growth technologically advanced industries to replace the departing manufacturing base, they will be hard-pressed to compete for highly-skilled labour.

Other figures presented to the forum suggest that a million New Zealanders now live offshore - roughly 20 per cent of our population.

Australia, with a population of 20 million, has just 800,000 offshore.  While Australia turns to our highly-skilled people to fill gaps, New Zealand's ethnic mix is changing as we turn to the rest of the world to cover shortages. The business implications from this are profound.

Half of New Zealanders want a common transtasman currency, says a poll issued last night in Australia.

The UMR poll reveals 49 per cent of New Zealanders favour a shared dollar, against 41 per cent of Australians.

That is a dramatic change since 2000 when only 29 per cent of New Zealanders supported such a change.

But Prime Minister Helen Clark warned today that a common transtasman currency would mean New Zealand adopting the Australian dollar.

"The convergence of trying to bring the two together could be quite rough on the smaller party," she said.

Miss Clark said an Anzac dollar had never been on offer and it had always been clear there would be one currency - the Australian dollar.

The issue has been debated for years, but shot back into the limelight after National Party leader John Key suggested last week it was an idea that should be explored.

Finance Minister Michael Cullen attacked Mr Key then, and repeated his opposition last night, saying New Zealand would lose control of monetary policy if the Kiwi dollar was abandoned in favour of a joint currency.

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He was backed by National Bank chief economist Cameron Bagrie, who said: "We would have to be insane to do it."

The poll result was revealed at the Australia New Zealand Leadership Forum in Sydney.

The annual two-day forum, attended by 80 leaders in their fields, tries to develop economic and other links between the two countries.

Dr Cullen said the poll should have asked whether New Zealanders supported the adoption of the Australian dollar, as the Howard Government had already made it clear it would not abandon its currency in favour of an Anzac dollar.

But Mr Key - who is also at the forum - pledged to raise the issue again at today's economic debate.

Supporters of a joint currency say lower transaction costs in transtasman trade and the removal of currency uncertainty between New Zealand and its most important trading partner should contribute to increased trade and enhanced economic integration.

But opponents say full currency union would mean the end of an independent monetary policy, loss of economic sovereignty, and a reduced ability to insulate ourselves from any shocks that might befall the Australian economy.

Inflation

Inflation in Australia was 3.3 per cent to last December. In New Zealand, it was 2.5 per cent to March 31.

But New Zealand's interest rates are higher. The official cash rate is 7.5 per cent, against 6.25 per cent in Australia.

Mr Bagrie said New Zealand would be "giving up a lot for getting nothing in return".  "Our currency will be dictated by Australian conditions, by what the Reserve Bank of Australia does, by hard commodity prices such as gold, tin and coal which Australia exports but we don't."

UBS New Zealand economist Robin Clements agreed that having a joint currency would make New Zealand too dependent on what was happening in Australia.  "If exporters here now are complaining about the dollar, and homeowners are complaining about interest rates rising because Auckland house prices are going up, how will people feel when it gets painful because Sydney house prices are going up?"

There were benefits for companies moving into Australia, but the two economies would have to be far more closely integrated before it could make sense.  "The conditions aren't there for it, and I don't think it's a sound argument."

Mr Clements and Mr Bagrie were surprised the level of public support was so high, and said the way the question in the poll was worded could have influenced the replies.

"If it asked, 'Are you prepared to have monetary policy run by the Reserve Bank of Australia?' you might get a different answer" said Mr Clements.  In the UMR poll, 70 per cent of those surveyed are positive about Australia.

But they are concerned about the hollowing-out of the NZ economy, and 62 per cent feel the permanent movement of New Zealanders to Australia is bad for New Zealand.

At a pre-forum press conference Australian Foreign Minister Alexander Downer said the increasing amount of investment by companies across the Tasman showed the trans-tasman relationship was working.

Australian companies have invested about $A40 billion ($44 billion) in New Zealand, and New Zealand companies have put about $A22 billion into Australia.  But the UMR poll suggests New Zealanders are not comfortable with the Aussie buy-up - 52 per cent of those polled believed the increasing Australian ownership of New Zealand companies was bad.

- Additional reporting Claire Trevett, NZPA