Property linked to high dollar

MICHAEL BERRY
Last updated 05:00 13/10/2012

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Could the Kiwi love affair with overvalued property be the key to lowering the overvalued exchange rate?

The best way for New Zealand to lower its exchange rate is to become a crackpot, Westpac New Zealand senior economist Michael Gordon says.

Printing money checks that box, but being a crackpot doesn't sound too appealing.

What's the second option?

Well, first, an explanation of why printing money is inadvisable:

The Reserve Bank is tasked with keeping prices relatively stable, that is keeping inflation down. It does that through changing the official cash rate to make borrowing money more or less appealing.

An appealing, low interest rate means more money flowing around the country, encouraging more growth.

A steeper, high interest rate means less money floating around to buy goods and reduces the amount people are willing to pay for things, reducing inflation.

That is the best way to influence the money supply, as learnt over the past 20 years, Gordon says.

The other way - printing more money to inject into the economy directly - is difficult because it's hard to judge just how many million notes is the right amount, he says.

The United States is printing money - quantitative easing it is called - because its interest rates are almost zero and still the economy is not growing. It's the last chance corral. They can't drop their interest rates much more.

New Zealand's official cash rate - an interest rate which sets a benchmark for others - has been at 2.5 per cent since March 2011. So if we needed more stimulus to resurrect our national economic mojo, the Reserve Bank could lower that rate. It hasn't because it believes the balance between our growing economy and low inflation is right.

If it did print money, there's a good chance that inflation would rise and savings and pension funds could be eaten away by lower purchasing power.

University of Canterbury senior economics lecturer Eric Crampton says printing money in the current circumstances would destroy the international credibility of the Reserve Bank.

But we still have a dollar worth almost US82 cents that is killing our exporters, as the New Zealand Manufacturers and Exporters Association has been saying for years.

And the International Monetary Fund says the kiwi is about 15 per cent overvalued. It has said that repeatedly, at least as far back as May 2010.

A high dollar makes life difficult for exporters and better for consumers. Imported goods are cheaper because our dollar buys more compared to other currencies. Each time the dollar goes up it's like a pay rise for 4 million New Zealanders.

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However, that pay rise doesn't come from thin air. Exporters are effectively paying more for their staff and getting less from what they sell overseas because those US dollars and pounds sterling they are selling products for are worth less. However, they do benefit from getting cheaper imported plant and machinery.

Unfortunately, it's also more of an incentive to move jobs offshore where labour is cheaper or cut jobs, which is happening at the moment.

What about pegging the currency to other currencies, like they do in Prime Minister John Key's old stomping ground, Singapore?

That would keep the New Zealand dollar within a targeted band relative either to the US dollar or to a bundle of currencies. To do that, the Reserve Bank would sell large quantities of New Zealand dollars whenever the exchange rate was too high. The dollar decreases. Voila.

However, the Reserve Bank would have to buy and sell massive amounts of money to do that.

Singapore's economy can get away with it, while the New Zealand economy - and the kiwi dollar - is more subject to the ups and downs of commodity prices. And Singapore moves its target exchange rate band in response to changes in underlying fundamentals.

A managed float can carve off the peaks and troughs, but even Singapore does not try to stand against the wind when long-term fundamentals drive up its currency.

How about a financial transactions tax to stop speculation pushing up the exchange rate?

It might sound good on paper, Crampton says. But it also has a decent chance of increasing rather than reducing volatility as the tax would increase the spread between buyers and sellers on currency markets while thinning the market.

Thinly-traded NZX stocks can similarly suffer from marked day to day price fluctuations. It is unlikely to be intraday trades by speculators that are keeping the dollar persistently high, he says.

In short, New Zealand's problem is structural.

First rule of economics: Define the problem Westpac economist Gordon says growth in the manufacturing sector has been slowing compared to the growth in other industries for decades.

That is similar to what is happening in developed countries, he says, as they move toward service-based economies while manufacturing is done in developing countries with lower wages.

New Zealand manufacturing is still growing, just not as quick as other industries, so its proportion of the country's production is falling, he says.

It has been hit in the past four years by the tough global economic climate and the usual trading partners hitting the metaphorical wall.

Having a lower dollar could help make some types of export become profitable again for Kiwis, he says.

However, the problem with the "clever ways" to manipulate the exchange rate is that "it's not clear that the links are strong enough to exploit them for particular purposes", he says. That's economist for you are not changing the cause.

And if the cause isn't fixed, the underlying problem will remain and probably bite in other ways while the exchange rate wriggles its way back to square one.

To lower the exchange rate and make it stay that way, New Zealand needs to make structural changes to its economy, Gordon and Crampton say.

Instead of pulling on the monetary levers (interest rates), which are cyclical in nature, the country should attack the underlying causes of the problem.

One cause economists come back to is property. Home is where the economy is. With most Kiwis' money locked up in their homes - an inert investment - there's not as much money around for funding things that make money - the real economy. So, we rely on overseas lenders to stump up the cash.

"Fundamentally, New Zealand has a high exchange rate because we're an attractive place for foreign investors to put their money," Crampton says.

"Our relative lack of domestic savings in things other than housing means that the returns on other kinds of investment here are relatively high."

When house prices rise, Kiwis come out of recessive funks with their wallets in tow. And each day the sun sets and interest payments flow out of the country to pay foreigners for the massive mortgages Kiwis need to be a homeowner.

Urban sprawl and the land bank New Zealand's cities have some of the most unaffordable housing markets in the world when measured by the ratio of median wage to median house price.

The 2012 Demographia international housing affordability study shows of eight metropolitan areas, five are severely unaffordable (5.1 times annual median income), the other three are seriously unaffordable (between four and five times income).

The old mother's advice is not to spend more than a third of your income on where you live. Demographia says three times annual income is an affordable house price.

Most local authorities employ a city boundary for development to curtail urban sprawl, saying they have judged the supply necessary for demand.

For instance, Environment Canterbury is currently fighting through the courts to determine which blocks of land it will allocate to the market for the next 35 years.

But, by strangling the supply of land, is the nation's local government policy starting a chain of cause and effect that ends with a reliance on foreign cash and a high New Zealand dollar?

Demographia found properties inside the Auckland urban boundary were 10 times more valuable than properties "on the other side of the road", outside the development boundary.

And Christchurch houses were 6.3 times annual incomes, more than double the internationally recognised affordability ratio. Christchurch's housing affordability was ranked 298th out of the 325 cities measured. It is harder to buy a home in Christchurch than New York, which came in one rank higher.

Gordon says less capital being piled into property would help Kiwis' savings levels, easing the pressure on interest rates.

Less need for foreign money means people pay a lower rate for it in interest.

Crampton says by imposing tight limits on urban growth around cities, property prices have been on a one-way ride up. And Kiwis have responded by piling even more money into it.

"If you're putting up five to eight times your family income for a house, what have you got left for domestic investment?"

Crampton is hesitant to predict how much effect lower property prices would have on the exchange rate without doing an extensive study.

But over the medium term he would expect a reasonable drop in the exchange rate if less domestic money went into houses.

"Changing land use policy so that households could choose to put a bigger portion of their savings into the real economy would reduce our need for foreign capital and would help reduce pressure on the dollar," he says.

- BusinessDay.co.nz

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