During the run-up to the 1984 election, that was to usher in the Roger Douglas government and change forever the face of New Zealand politics, Bob Jones liked to make a typically brave and simplistic claim. You don’t need to worry about trade imbalances, he said. All you need to do is float your exchange rate, and the system will automatically balance itself.
The basic thinking was this. When we export goods and services, the overseas customers must buy $NZ in order to complete the transaction. Similarly, when we buy goods and services from overseas, we must sell our $NZ in order to purchase the required oversees currency. If, by Sir Bob’s reasoning, imports outstripped exports, there would be more people trying to sell $NZ than trying to buy them, the exchange rate would fall, making our exports cheaper to the world, and imports dearer to us. So exports would rise, and imports fall until the whole system was in balance. Simple.
During the subsequent years, exactly this experiment was tried, and coincidentally they were the years when I was in university, completing an economics degree, so it was an issue I followed with interest. The economists who taught me warned that things would not be quite so simple. For, apart from buying and selling exports, currency is also traded by people seeking to lend and borrow in foreign markets, and indeed by speculators betting on long term trends in currency values. So, for example, a country could run long and sustained current account deficits under a floating exchange rate, if the circumstances were such that foreign investors were consistently purchasing $NZ in order to lend on our financial markets, or indeed if they were seeking, and able to, buy up local assets or invest in local infrastructure.
The pattern of the last thirty years post float has been pretty much this. Sustained and very high current account deficits (our balance of business with the rest of the world) without a correcting fall in the exchange rate, due to strong capital inflows. In essence, on the back of the amount of overseas money coming into the country, we have been able to consume far more of the world’s produce than we in turn have been able to sell to the world. This is a problem for a number of reasons. First, over time it means that less of the local economy is locally owned, and so each year more income goes off shore in the form of dividends and interest. It also means that the Government, which is answerable to both its voters, and the business community, becomes increasingly answerable to non-local interests, so trade imbalances can lead to a slow eroding of democracy. And finally, it makes us very vulnerable to international shocks. If, for any reason, international financiers were to lose confidence in the NZ economy, their withdrawal of credit could force a massive correction. So, there are good reasons to be concerned about our inability to deal to the large (by international standards) current account deficit, even though it’s barely made the headlines over the recent decades.
Labour’s monetary policy, announced yesterday, is perhaps the first serious attempt in three decades to address this issue, and as such is to be applauded. Working out what exactly drives the financial inflows is not easy, but two factors are often mentioned. One is a low savings rate, so that local savers do not provide the deposits the banks need to meet their lending needs, and so they go overseas. Some dispute the extent to which we are a low savings economy, when housing ownership is factored in, but nevertheless the idea that if we saved more, there would be less demand for international finance, appears to have merit. The other big factor is the interest rate. If the return on lending on the NZ market is greater than the return foreign investors can find elsewhere, then of course they will seek to lend here (once other factors such as risk are accounted for). And since the reforms of the eighties, we have deliberately used interest rates as a mechanism to choke off nascent inflation. Higher interest rates both suppress local spending, and make imports cheaper through the higher exchange rate, and the Reserve Bank has explicitly targeted the exchange rate in this way. As a matter of policy, then, we’ve been asking our export sector to pay the price of reining in inflation. No wonder our current account has suffered.
Labour’s idea, then, is to increase savings rates through compulsory Kiwisaver contributions, and then using variations in the contribution rate as an alternative tool for suppressing local demand, rather than pushing up interest rates. So, rather than being hit by a mortgage increase, you get hit by higher savings deductions, the difference being, in the long term the money is still yours. And, for the first time in thirty years, the export sector doesn’t suffer every time a dysfunctional housing market threatens inflation targets.
In conjunction with this, Labour also hope to be able to bring the pressure off the housing market by building a great number of low cost houses. And, probably most importantly of all, they’re broadening the Reserve Bank’s brief, so that the oddly single-minded pursuit of an arbitrary inflationary target will no longer become the altar at which all other economic policies must worship. It’s slightly embarrassing it’s taken us this long to shake free of the shackles of our 1980’s ideological excesses, but so be it. For the first time in a very long while, I find myself excited at the prospect of voting for Labour.