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Home / Business / Markets / Currency

Brace for a currency war

Bernard Hickey
By Bernard Hickey
Columnist·Herald on Sunday·
15 Aug, 2015 05:00 PM4 mins to read

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Kiwifruit exporters are loving the fall in the New Zealand dollar against the US dollar. Photo / Alan Gibson

Kiwifruit exporters are loving the fall in the New Zealand dollar against the US dollar. Photo / Alan Gibson

Bernard Hickey
Opinion by Bernard Hickey
Bernard is an economics columnist for the NZ Herald
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The fall in the New Zealand dollar to US65c from US85c a year ago has been a blessing and a curse.

It's wonderful news for exporters, particularly those selling wine, apples, kiwifruit, beef, lamb and holidays at still-high prices. These farmers and moteliers can thank their neighbours on dairy farms.

A 42 per cent slump in the US dollar prices of dairy commodities triggered the New Zealand dollar's 14 per cent fall over the past three months, the fastest fall for the Kiwi dollar since the global financial crisis.

Consumers, online shoppers, car buyers and businesses buying imported equipment will have to pay much higher prices.

The currency's fall has been helpful for the Reserve Bank and the Government in helping to cushion the blow of the dairy shock and to try to boost inflation back towards the 2 per cent mark governor Graeme Wheeler is supposed to target. The combination of lower interest rates and the lower currency are "automatic stabilisers" for the economy and are the great benefits of our flexible exchange rate and inflation targeting system.

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Finance Minister Bill English and Prime Minister John Key argue that these stabilisers are enough to soften the blow from a dairy crash and there's no reason yet to unleash a Government spending programme to stimulate the economy.

That's all fine when exchange rates are freely floated and responding to movements in commodity prices and the relative fortunes of economies.

Wheeler has bemoaned how the New Zealand dollar was unsustainably and unjustifiably high relative to commodity prices and our foreign debts, particularly last year when dairy prices fell 50 per cent and the currency hardly fell at all.

But now the currency and interest rates are moving in the same direction so the last thing New Zealand needs is for some sort of screwing of the scrum in the world of currency trading.

Yet that is what some argue we saw this week, from China.

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The Peoples Bank of China allowed (or forced) the yuan to drop 4 per cent on Tuesday and Wednesday. This unwound more than half of the yuan's appreciation seen in the past five years. There is debate about whether the Chinese Government is deliberately engineering a devaluation to boost its flagging export sector, or whether it is allowing market forces to work, and the depreciation is natural.

The sharp fall in the yuan against the US dollar shocked financial markets and raised more fears about the health of the world's second-largest economy. For years the Chinese Government has been saying it needed a stronger yuan to help rebalance its economy towards consumption and the services sectors.

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So the sudden about-face reinforced suspicions that all was not well behind the opaque facade represented by China's economic statistics. Some feared it would spark competitive devaluations across Asia as countries worried that China's exports would become more competitive than theirs. This is often described as a "beggar thy neighbour" policy leading to "currency wars".

Currencies and commodities across Asia slumped in response.

The yuan's sudden fall also raises fear about capital flight out of China before the yuan falls further.

A full-scale worldwide currency war would be incredibly damaging for New Zealand's exporters.

The New Zealand dollar rose 4.4 per cent this week against the yuan, despite last week's 10.3 per cent fall in milk powder prices, making life even tougher for dairy farmers.

Any such war should increase the pressure though for the Reserve Bank to cut its OCR, and for the Government to consider accelerating infrastructure investment into the regions.

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The story of the New Zealand economy was a simple one until this week. It has been a tale of one commodity (dairy) and one city (Auckland). Now there may be a third player - the People's Bank of China.

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