Overvalued NZ dollar slips away from the high life

I’m back from a holiday in Thailand where the pleasant feeling was tempered by the realisation the NZ dollar had fallen almost 20 per cent against the Thai baht in the past few years. That sneaky Chang beer with breakfast tasted a lot dearer. So much for our rockstar economy.

Effectively, this means the buying power of Kiwi incomes has fallen significantly in the “land of smiles” in the past few years. Get used to it. Our overseas holidays are going to get more expensive.

The reason lies at the heart of the world economy since the global financial crisis. It’s all about money. Or more specifically, the value of each country’s money.

Reserve Bank governor Adrian Orr is proving to be a very activist central banker. This may be a good thing in turbulent times, though painful.

In August he slashed the official cash rate by 0.5 per cent. The magnitude caught financial markets by surprise, which was what he wanted. He is trying to drive down the value of the NZ dollar to give our export sector a boost.

Short-term interest rates are largely determined by central bankers using monetary policy. These rates tend to be the main drivers of exchange rates which are the value of a currency against other currencies. Funds, or hot money, flow around the world seeking higher returns. When a central banker makes a surprisingly large cut in interest rates, funds flow out of a country, in a cacophony of mouse clicks. They are seeking higher returns elsewhere. This pushes down the currency’s value.

In recent years, central bankers around the world have tried to drive down their exchange rates to give their exporters a competitive advantage. Orr has joined the game. He was likely aware he couldn’t afford not to.

The Swiss and other countries have even set negative interest rates in recent years. They don’t want their currency treated as a safe haven in uncertain times. If funds flow into Swiss francs this would drive their currency higher in value. A high franc would be disastrous for their export sector because their products would be more expensive for foreign buyers. Negative interest rates are being used as insect repellent against hot money flows and a higher currency.

What is concerning is the last time countries tried to deliberately drive down their currencies was in the Great Depression, a time of competitive devaluations and protectionism to try to gain economic advantage over other nations. Countries put their interests first. All ended up worse off. Sound familiar?

It seems we are sliding back into that ugly economic terrain. The problem is that if all countries seek to gain advantage through driving down their currencies and using protectionism then all lose because world trade declines. It would be bad for New Zealand, which is reliant on international trade given a small domestic market. These Great Depression policies were called “beggar thy neighbour”. It was a race to the bottom.

It is likely our dollar has been overvalued against others in recent decades. Our short-term interest rates have been relatively high compared with other countries. The NZ dollar has been one of the top 10 traded currencies. Our relatively higher interest rates have attracted “hot” money, driving up our dollar’s value. Orr appears intent on reversing this.

Our overvalued dollar allowed us to live beyond our means. This may be about to change. That Chang beer in Thailand may need to be replaced by an Emerson’s in Otago. And maybe delayed till lunch.