Should we print too?

The great mystery for many New Zealanders in this recession is why our currency is so strong.

The New Zealand dollar is up near 11 month highs against both the US dollar and against the basket of currencies known as the Trade Weighted Index (TWI). This is despite our Official Cash Rate (OCR) being at a record low of 2.5 per cent and demand for our main commodities of dairy, timber and fish being low (only beef and lamb are the exception). It is also despite threatened foreign currency credit rating downgrades. Standard and Poor's backed down from its threatened downgrade in May, but Fitch is currently looking at cutting our AA+ rating.

This currency strength is a killer for our export sector and will make it even more difficult to keep paying the interest on the net foreign debt we now have that stands at over 140 per cent of GDP and rising.

It has forced Reserve Bank Governor Alan Bollard to threaten further cuts in the OCR and talk tough various times in the last few months. He and the entire export sector is frustrated and befuddled.

Unfortunately there is little he and they can do that is palatable. But something unthinkable could be done. More on that later.

Firstly, to understand why our currency has strengthened you have to look at what other central banks and economies have done and are doing. The US Federal Reserve and Treasury have pumped trillions of created dollars into the US banking system and is in the process of buying back US$300 billion worth of Treasury bonds. This is known as 'quantitative easing' or QE for short. Essentially it is printing money. These days, of course, it is done on a spreadsheet rather than in printing plant. It's amazing what you can accomplish in the world of finance with the copy/paste function.

The Bank of England has been copy/pasting at an even greater rate, proportionally. Earlier this month it increased its bond buying (QE) programme to 175 billion pounds from 125 billion pounds. The European Central Bank has professed not to be printing money, but in May announced plans to buy 60 billion euros of covered bonds and is lending 442 billion euros to European banks directly. It is just as guilty.

The Bank of Japan has been in money printing mode for most of the last 20 years as it seeks to keep a low yen and try to pull its economy out of its lost decades. It is failing, but at least it still has an export sector.

These central banks are essentially engaging in competitive devaluations. This is fine as long as everyone does it.

Right now the Reserve Bank of New Zealand, the Reserve Bank of Australia and the Bank of Canada are alone in choosing not to crank up their spreadsheets to print money. It's no surprise then that all three currencies have risen against the US dollar, the Euro, the British pound and the Yen.

Some might argue the relative out-performance of these three 'commodity' currencies is because of rising commodity prices in recent months on hopes for a global economic rebound or that their interest rates are relatively higher than the rest. All of these things are essentially symptoms of the British, Americans, Europeans and the Japanese printing while the rest haven't.

So should the Reserve Bank of New Zealand fire up the printing presses too? Could global deflation be such a risk that it makes sense? Could this be the last resort to give our currency the trashing it needs?

I think this would be a mistake for a few reasons. Firstly, it would pump an awful lot of money into New Zealand asset prices and inevitably would end up in the housing market first. Secondly, it would damage our reputation in international markets for having a sensible and independent central bank that is serious about fighting inflation. It would also encourage the government to think it can borrow the NZ$50 billion it needs over the next 4 years without consequences.

The better solution would be to try to slow down the sucking in of foreign capital that is pushing the New Zealand dollar up. Statistics NZ figures show total foreign investing in New Zealand and lending to New Zealand rose NZ$17.9 billion to NZ$301.2 billion in the six months to the end of March, including NZ$15.3 billion in bank lending. That was six months of foreign borrowing by our banks on our behalf. It was lent on to our farmers and home buyers largely. Business lending has actually fallen in recent months.

We are borrowing at a rate of almost 15 per cent of GDP per year. This is unsustainable.

Firstly, the Reserve Bank needs to slow down this massive debt sucking machine by forcing the banks to hold more capital for all the home lending they are doing. The Reserve Bank has the power under Basle II rules on capital adequacy and has already imposed a 'regulatory adjustment'. It just needs to be bigger.

Secondly, the government should signal now that either a capital gains tax or a land tax is likely within a few years. Thirdly, it needs to shut down the rorts that allow many people on salaries to use trusts to make losses on rental properties and reduce their tax bills.

Fourthly, the Reserve Bank should give up on its promise to keep the OCR at or below 2.5 per cent until the end of next year. Given the foreign exchange market seems to be ignoring low interest rates anyway and banks are not passing on OCR cuts to businesses, the only real solution is to put up the OCR. That would shut down the sucking sound that is pushing up our currency and destroying our productive sector.

Finally, we should all pray for a credit rating downgrade. Or several. We need them.


Bernard Hickey