Parity parties

The Prime Minister is reported as reckoning we should celebrate parity with the Australian dollar.  It hasn’t happened quite yet, there has been a bit of a pullback today, and market positioning means there are probably still a few obstacles to getting there.  But at current exchange rates one would be brave to bet much against parity happening sometime soon.

But is it something to celebrate?  I don’t think so.  A high (real) exchange rate lowers the relative price of consumption.  And since consumption is often thought of as the point of economic life, the cheaper consumption is, the more of it we can have.  But, over time, one can consume only from what one earns, and – all else equal – an exchange rate that skews things towards consumption tends to reduce the ability of firms and individuals to earn more in future.  That issue doesn’t arise if the exchange rate rises because (and to the extent that) the terms of trade rise, or because New Zealand firms have found new or better products, or smarter ways of organising themselves.  As Krugman put, it in the longer-term if productivity isn’t everything, it is almost everything.

So let’s stand back and consider near-parity against the AUD.   Our terms of trade have been falling more slowly than Australia’s, so relatively speaking that is a positive for us.  But this morning’s papers contain reports of record grain gluts.  The combination of very weak oil prices, abundant grain stocks, and falling grain prices doesn’t bode well for dairy prices (nor does China’s drive for self-sufficiency, or the removal of European quotas).  Exports are a larger share of the New Zealand economy than they are of the Australian economy.  And whereas the New Zealand export sector is largely locally owned, so that all the income losses are borne by New Zealanders, much of Australia’s export sector is foreign-owned, so funds managers around the world will be sharing the pain as iron ore prices keep falling.  I’ve shown before that there has been no sign in recent years that productivity growth in New Zealand is improving relative to that in Australia.

The exchange rate is not strong just against the Australian dollar.  At around 79 on the TWI  – an index that probably puts too much weight on the Australian dollar –  the exchange rate is less than 5 per cent below its post-float peak.

So what does support the NZD, against the AUD and more generally.   Over the last year, the Reserve Bank of New Zealand raised its policy interest rate by 100 basis points, while Australia (and most other advanced country central banks) were cutting policy rates and easing monetary policy.  (I’m deliberately posting this before 4:30: whether, as everyone assumes, the RBA cuts again today or leaves it another month or so isn’t really the point here.)

OCR increases would have made sense if inflation was picking up, but it has stayed low (headline has collapsed, but core measures have remained persistently weak despite the allegedly robust recovery).  The Reserve Bank Governor, who talked confidently a year ago about 200 basis points of OCR increases, has slowly had to walk back his rhetoric and then his actions, but we are still left with a policy rate quite out of line with those elsewhere in the advanced world, when core inflation is consistently below the target midpoint, wage inflation is weak, inflation expectations  are falling, credit growth is quiescent, and the unemployment rate  –  real people, losing real skills –  remains uncomfortably high.

If it comes, parity is nothing to celebrate – any more than the previous peaks were things to celebrate.  Rather, taking together all the information, those peaks have typically been markers of some unsustainable imbalances building up.  This time, that looks like the gap between our OCR and policy interest rates abroad.  And probably a misplaced confidence (in official circles and among private commentators) in the ability of the New Zealand economy to remain relatively resilient as the commodity slump goes on, the economies of our two largest trading partners weaken, and as Christchurch no longer represents much, if any, of a source of new growth in demand.

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