Rough ride with the greenback

Auckland furniture-maker Criterion is hurting. It exports four-fifths of its production, but a 10 per cent rise in the New Zealand dollar against the United States dollar over the last three months has really turned the screws.

"The pain at the moment is extremely acute but we are committed to exporting and we find ways to at least get by," says managing director Laurie Margrain.

"We certainly don't make money exporting at this point in time. We have in the past and we will again but, right now, it's very painful."

But - as he says - you can't just come and go from export markets that have taken years to develop. You have to hang in there.

"You can't jack up prices to compensate for currency changes. If we went to a US retailer looking to get a 10 or 15 per cent price increase because our currency had strengthened - well it would not be a long discussion. That option does not exist."

Margrain would not be surprised if the dollar, which is trading around 16-year highs of 72USc, reaches 75USc by February.

Brad Govan, general manager of Pacific Seafoods, is in a similar position. He says seafood exporters have not benefited from the offset of higher world prices to the same extent that meat and dairy exporters have.

"The US is 50 per cent of our market and its dollar seems to be in long-term decline, so we are going to hurt for a few years I think."

He expects some smaller players to "fall off the perch" and larger ones to amalgamate in search of greater efficiency.

The kiwi, now close to the highest it has been since it floated 20 years ago, poses the biggest risk that the economy will not glide into a soft landing over the next year or two, but drop with a thud.

Economists say it takes five quarters or so for changes in the exchange rate to have their main impact on economic growth and jobs.

Some of the exchange rate's rise can be put down to factors specific to New Zealand such as having the highest interest rates in the developed world and commodity prices at 18-year highs.

But the main factor lately has been the weakening of the almighty greenback. Since the start of 2002, the US dollar has fallen 27 per cent on average against seven leading currencies.

More to the point it is hard to see what will arrest the fall.

The US dollar is sliding because of its current account deficit. That is the gap - more of a gaping chasm - between what the US earns from the rest of the world through trade and investment, and what the rest of the world earns from it.

Put another way, Americans are spending too much and saving too little.

Rather like New Zealanders.

But unlike New Zealand, it is not just households that are running on credit. It is the Government too.

The federal budget deficit accounts for about two-thirds of the current account shortfall, which is running at US$665 billion ($927 billion) a year.

So the US has to attract nearly US$2 billion a day of other people's savings to finance the shortfall.

Even by US standards that is a lot. The annual deficit is equivalent to three weeks' worth of the entire output of the US economy or alternatively a whole year's output of 17 million Americans.

The deficit has been growing for the last seven years. For most of that period, the financial markets have basically ignored it, focusing instead on the US's attractions as an investment destination and its superior economic growth performance.

But lately the eyes of the market seem to be firmly fixed on the deficit, not only because it has grown so large but also because there doesn't seem to be anything on the horizon that will stop it from continuing to swell.

Ttwo weeks ago, Federal Reserve chairman Alan Greenspan gave a warning that foreigners' claims against the US economy could not continue to increase forever at their recent pace.

At some point, they will decide they have too many eggs in that basket or seek higher returns for continuing to invest.

But when and at what level of the dollar? Greenspan doesn't know and nor does anyone else.

Morgan Stanley chief economist Stephen Roach, writing in the New York Times last week, put it in more apocalyptic terms.

"The day could come when foreign investors demand better terms for financing America's spending spree and savings shortfall. That is the day the dollar will collapse, interest rates will soar and the stockmarket will plunge," he said.

"In such a crisis, a US recession would be a near certainty. And the rest of an America-centric world would be quick to follow."

This is why US Treasury Secretary John Snow calls the US current account deficit a "shared responsibility".

He said there were three key parts to addressing the issue.

One was for the US to boost its savings rate. He said President George W. Bush had a plan, to halve the Federal deficit and to boost household savings.

Unfortunately, the Bush Administration does not have a lot of credibility when it comes to fiscal self-denial. There is little prospect of a reversal of the tax cuts of the first term or a swift exit from the costly morass of Iraq.

So what about the second part of Snow's recipe for reducing the current account deficit?

It is for the rest of the world, Europe in particular, to grow faster so that it will buy more US exports and help reduce the trade gap.

After all, since the mid-1990s, consumption in the US has been growing on average at almost twice the pace of the rest of the industrialised world.

Unfortunately forecasters, such as the OECD this week, expect Continental Europe to just keep plodding along next year while Japan, which was looking perky earlier this year, subsides back to a similar pace of about 2 per cent.

High exchange rates hardly help export-led economies such as Germany and Japan to grow faster, and there are deep structural impediments to their being able to rev up internal demand as the US might like.

The third part of Snow's prescription for reducing the deficit is for China to move from having an exchange rate pegged to the US dollar to one set by the market.

The Chinese currency peg, unchanged for the past 10 years, means that the burden of adjusting to a weaker US dollar falls disproportionately on the the euro, commodity currencies like the New Zealand dollar, and (despite costly bursts of intervention) the Japanese yen.

China, you might say, is on the other side of the seesaw.

The flipside of a fixed exchange rate is China's central bank, and those of some neighbouring countries which dare not appreciate too much against the yuan and the greenback, have had to make huge purchases of US dollars and US securities, especially Government debt.

They piggyback on a weaker US dollar but suffer huge losses on their US investments as the dollar falls.

The Chinese have acknowledged a market-determined exchange rate as a long-term goal and are moving in that direction, but in their own sweet time. Nobody believes they are ready for a floating exchange rate yet. But the markets speculate about the possibility of a revaluation of the yuan.

All of this suggests that big changes to get the world economy back on an even keel are in the don't-hold-your-breath category.

And that means the downward pressure on the US dollar is likely to persist.

From the New Zealand perspective several factors are taking some of the sting out of a high exchange rate:

* Prices on world markets for export commodities are generally high.

* Imports are cheaper, including the plant and machinery firms need to boost capacity and productivity.

* If the exchange rate were not this high, interest rates would probably still be rising.

Deustche Bank chief economist Ulf Schoefisch, who believes the US dollar has much further to fall, says the question is how much that is offset by the Kiwi dollar losing ground against other currencies. There are grounds for expecting that, he says. The gap between New Zealand interest rates and other countries' should narrow.

The world economy is forecast to slow next year, which normally portends a softening of commodity prices.

And New Zealand's own current account deficit is getting bigger. If we are judged by the same standards as the Americans, that should be a reason to sell the kiwi.

Many exporters have been shielded from the latest surge in the kiwi-US exchange rate by hedging cover that locked in more tolerable rates.

The third option is options - contracts that provide insurance against further adverse movements in the exchange rate but allow the exporter to benefit if it moves the right way.

Bancorp Treasury Services director Earl White says: "We are getting to a stage now where exporter clients are saying, 'We can't afford to be caught out with hedging up at these levels, especially when commodity prices turn around in six or 12 months' time, but we can't afford to just shut our eyes and hope it is going to come down.'

"So we are seeing them make much more use of options."

The long-term average level for the New Zealand dollar is around 55USc. "Forty US cents is ridiculously cheap and 70USc is ridiculously dear," White said.

But there is a silver lining. Having raised interest rates aggressively this year, the Reserve Bank has plenty of scope to reduce them again.

"The New Zealand dollar can go against the flow. We strengthened much more than anybody else in the first half of the year, so there is no reason we couldn't stay stable or fall when everyone else is still going up against the US dollar," White said.