If the Productivity Commission really is contemplating monetary union with Australia it can drive that thought from its mind with blows and curses.

The gruesome example of the weaker members of the eurozone ought to be a compelling enough argument against this zombie idea.

If not, it could ask exporters and firms competing with imports this question: If an exchange rate of US82c is hard to live with, how would you like US$1.02 (which is where the aussie has been trading)?

More likely currency union is included for the sake of completeness in last week's issues paper from the New Zealand and Australian productivity commissions on strengthening the transtasman economic relationship.


The advantages and disadvantages of a common currency, after all, is only one of 37 questions the paper poses.

But it is a proposition which has in the past commanded considerable support among parts of the business community. It was politicians, on both sides of the House, who recognised the dangers.

Currency union would in effect involve not only adopting the Australian dollar but outsourcing monetary policy to the Reserve Bank of Australia, with perhaps a token Kiwi on its board.

Indeed the prospect of generally lower, Australian interest rates is one of the key attractions.

But the European example demonstrates that monetary union is powerful medicine with strong side effects.

The risk for the weaker members in a common monetary policy is interest rates that are too low and an exchange rate that is too high for their national circumstances.

For a while, when times are good, this can feel great.

Asset bubbles inflate, creating a false sense of prosperity. Imported goods are cheaper, even if exporters are struggling.

When the next shock hits, however, it is a very different story.

Having your own freely floating exchange rate is an important cushion against external shocks, as the International Monetary Fund recently reminded us.

Following the Asian crisis world prices for New Zealand's export commodities tumbled - falling 17 per cent between December 1996 and December 1998 as measured by ANZ's commodity price index.

But over the same period the New Zealand dollar dropped 26 per cent on a trade-weighted basis, spreading the impact across the broader economy via higher prices for imported goods.

It was the same story with the global financial crisis 10 years later.

During the five quarters of the 2008/09 recession, export prices fell 30 per cent but the exchange rate fell 25 per cent.

Thank goodness for that buffer, given that farm debt had quadrupled between 2000 and 2009.

Since then the kiwi dollar has rebounded, of course, appreciating by more than a third, but the ANZ commodity index has risen by nearly two-thirds.

At its peak last year the terms of trade, which measures prices for the kinds of things we export against prices for the kinds of things we import, hit a 37-year high.

Australia has enjoyed an even stronger terms of trade cycle, reflecting voracious Chinese demand for its minerals.

But the flipside is a bad dose of the "Dutch disease", where a surge in export income from a natural resource, North Sea gas in the Netherlands' case, drives up its exchange rate and makes it much harder for other exporters and import-competing firms to compete.

Hence Australia's two-speed economy. And hence the RBA's difficulty in setting a single monetary policy which straddles both.

As Australia illustrates, the difficulties of a one-size-fits-all monetary policy can bedevil a single national economy.

But in that case there are mitigating mechanisms, like a federal budget and tax system, which ensure that tax money flows from the richer to the poorer regions, while people can flow in the other direction.

In the eurozone's case the fiscal transfers are quite limited; the European Union's budget is tiny compared with its member states'. And the mobility of labour is restricted to some degree by linguistic differences.

In the transtasman case the labour mobility condition is already met, but the fiscal transfers one is very definitely not - short of reversing the historic decision a century ago not to joint the Australian Commonwealth.

And whatever their constitution may say, it is fatuous to suggest the Australians would have no say in the matter if New Zealand, cap in hand, came knocking on the door of full political union.

When economists Sir Frank Holmes and Arthur Grimes studied the issue of an Anzac currency more than 10 years ago they found about a 70 per cent fit between New Zealand's GDP cycle and Australia's.

That suggests that quite a lot of the time New Zealand, under a common currency, would have ill-fitting monetary conditions, perhaps interest rates too low to contain inflationary pressures or an exchange rate uncomfortably high because minerals prices are high.

Australia remains our largest trading partner, but its share of total two-way trade is just 19 per cent. Removing currency risk from transtasman trade would do nothing to reduce it for the other 81 per cent of our trade.

Westpac economist Dominick Stephens in a 2009 study compared the volatility of export commodity prices since 1992, adjusted for inflation, in US dollars and New Zealand dollars.

Over those 17 years New Zealand's export commodities were 25 per cent more volatile in US dollar terms than in NZ dollar terms.

And if we had had the Australian dollar volatility would have been one-third higher.

Australia's relative importance, while high, is declining with the rise of China, which has now overtaken it as New Zealand's largest source of imports.

Australia remains, however, the largest export market. The $10.8 billion worth of goods exported to it in the year ended February represented 15.6 per cent of total exports and bilateral trade was in New Zealand's favour by $3.4 billion.

A common currency would avoid the transaction costs involved in having two currencies.

Perhaps the strongest argument Holmes and Grimes advanced for a single currency was that it would help small firms over the hump into exporting by giving them one less thing to worry about, assuming Australia would be the first export market they tried.

They found that for firms with under 20 staff exports represented only 6 or 7 per cent of sales; over 20 staff the ratio jumped to 14 per cent.

"Up to 20 employees, exporting is hard work. Beyond there it starts getting easier," Grimes said.

"If we can help firms which are on that growth path to make that big step, it could be a big advantage for New Zealand."

Maybe so.

But how many firms would have preferred the removal of currency risk for the advantage they have gained in recent years from a more favourable exchange rate as the Aussie climbed to parity with the US dollar and beyond?

And what policymaker would trade a marginal micro-economic benefit against the risk of a potentially calamitous macro-economic cost?

The chairman of the Productivity Commission, Murray Sherwin, is a former deputy governor of the Reserve Bank.

So he probably doesn't need anyone to make these arguments to him.

But just in case, submissions close on May 31.