Listener: 19 August, 1995.
Keywords: Macroeconomics & Money;
The proposal for “parity parties” when the New Zealand dollar equals the Australian dollar in market value is typical of the bizarre economic thinking by some in the financial sector. The last time parity was attained was in November 1967. Since then consumer prices have risen 12.8 times (i.e. 1180 percent) in New Zealand, while they have risen 8.1 times in Australia. While the consumer price index is not a perfect measure of inflation, the gap between our price levels remains substantial. An OECD study in 1990 found the New Zealand dollar could buy the same as 86 Australia cents. Allowing for the differential inflation rates since the figure is probably about 88 cents today.
This rate really matters because it reflects the average ability of New Zealand firms to export to Australia and to compete against Australian exports here. At parity between the exchange rates, the firms would carry a 12 plus percent cost disadvantage, and lose market share here and abroad.
That is already happening. The engineered fall in the exchange rate between late 1989 and 1991 has been reversed. The export boom it generated is beginning to fade. That is evident in the external deficit which measures how much we earn relative to how much we spend overseas. At the moment it is deteriorating rapidly, because we are buying increasingly more imports while exports are not keeping up. The latest figures show an overall external deficit for the year to March 1995 of $2.5 billion, or 2.9 percent of GDP. A year earlier the deficit was 1.6 percent.
A external deficit of 2.9 percent is not intolerable. The worry is that the deficit has swung around faster than most commentators expected. It seems likely to continue to deteriorate.
We have had low current account deficit for a number of years. There have been three key factors. In the early 1990s the terms of trade were about 10 higher percent than they were in the late 1980s. This better (relative) return to exports has been worth around an extra $2 billion a year. The external deficit would look sick if we had not had that export price boost.
Second, there has been strong growth in key markets, especially Australia. In my view, and that of many thoughtful commentators across the Tasman, their economy is over extended, and its growth rate will have to slow down. A major consequence is will be reduced markets for New Zealand exporters. When and how this slowdown will occur is a bit problematic, because Australia has to have a general election by May 1996. The economic advice would be to go early, so that the election was before the economy visibly deteriorates. However the Australian Labour Government is well behind in the opinion polls. The most likely scenario is that the elections will be left to about March, won by the Opposition, who will immediately slam the economic brakes on, and our exporters will be in trouble by about this time next year. Yet prime minister Keating, an extraordinary politician, may call an early election and win it. In which case the brakes go on earlier.
The third reason for the favourable balance of payments in the recent past is the economy has been so depressed that we have not been buying much overseas. With the economic pickup, imports are beginning to flood in. Imports of investment goods add to productive capacity, and may be funded by overseas lending. But expenditure on imported consumer goods and overseas tourism is picking up too, which overseas lenders may be less willing to finance.
For the current account deficit is offset by overseas borrowing, based on the willingness of overseas lenders to cover our excess expenditure. They appear to judge that a 3 percent of GDP deficit is tolerable, but if it were to blow out to 6 percent there could well be a balance of payments crisis. Lenders would be unwilling to keep pouring funds into New Zealand, interest rates would rise in a desperate attempt to attract them, and yet the exchange rate would fall dramatically.
Such crises blow up very quickly. Far too many financial commentators tell us what they would like to happen, rather than what is happening. Economic forecasters make small fudges, which cumulatively convert a growing deficit into something which is manageable. Then the hard statistical news comes in, and there is a flat panic.
After observing balance of payments crises over a number of years in a variety of countries, one is continually reminded of the irrationality of market behaviour. Experience should teach to expect the unexpected – key markets can swing sharply because of the irrational behaviour of those involved in them. The sharp upward revision in long term economic forecasts in the year after the 1993 election warns that they can be revised as quickly downward.
Admittedly when some financiers announced they were planning a parity party, enough market operators recognized the absurdity of the celebration, and trimmed the exchange rate back. By doing so they delayed the balance of payments crisis. If they follow that logic, the exchange rate should come down steadily, and we may avoid the crisis altogether. But that would be too rational to expect.