Devaluation!: Five Turbulent Days in 1984 and then …

Listener:27 July 1985

Keywords: Macroeconomics & Money;


I was woken at midnight by a reporter to be told that Sir Robert Muldoon had called a snap election, As I drifted back to sleep I wondered if difficulty with the Budget was the reason for the election.

The same thought occurred to the Morning Report team, but when they questioned Muldoon he denied it. He said that the Budget was complete except that decisions had to be made about export incentives to manufacturers and supplementary minimum payments to farmers, What he meant was that he was still talking to the manufacturers and the farmers, but it sounded as if he had decided on everything except exchange rate policy.

The thought may also have occurred to those who deal in foreign exchange. Early in the trading day the forward market for foreign exchange “collapsed”. The forward market is where those who will receive foreign exchange (say yen) in the future (say three months) sell it for domestic currency (New Zealand dollars) to those who will need the yen in three months. It enables traders to protect themselves from the unexpected, But on the Friday no one was willing to sell the yen on the forward market – that is what is meant by “collapsed”.

Traders desperate to buy the yen turned to the Reserve Bank which, in the fixed rate regime that was operating, underpinned the exchange rate by buying and selling foreign exchange on demand. Suddenly the Reserve Bank found its foreign exchange reserves being run down. This run on the dollar occurred in previous elections. As a result the Treasury builds up the official foreign exchange reserves just before an election through its overseas borrowing programme. Given that Muldoon had warned his National Party that they had to be ready for a snap election, one wonders whether he also warned the Treasury to be ready.


The Friday reaction in the business world was that Muldoon had outmanoeuvred the Labour Party and would win the election. By Saturday, particularly following Derek Quigley’s announcement he would not stand again for the Rangiora electorate, they realised that Labour could win, Anyway, that is what they told me a fortnight or so later. The point here is that the first run on the dollar occurred when National was expected to win.


We know now that on the Sunday the Treasury and Reserve Bank took a paper to Muldoon proposing measures to deal with the run. The officials recommended a 15 percent devaluation, but given that on Friday they had been told by Muldoon that it was unacceptable, alternatives of the Reserve Bank entering the forward exchange market (I’ll explain that below) and exchange controls were mentioned.

There has been some criticism of the officials’ advice. One criticism was that the exchange control option was played down. Having seen the official papers, I take the view that the case for exchange control was not strongly argued or at sufficient length, but that Muldoon could have asked for an additional, more detailed paper if he had wished. Perhaps more seriously, there is no mention of “closing the window” – that is, the Reserve Bank refusing to sell foreign exchange, thus preventing any rundown of its reserves, If at the same time exchange rate regulations had been changed, this would have been a temporary floating of the exchange rate.

The dilemma the officials faced was that, as they had warned in February, the Government’s monetary policy (of low interest rates and considerable monetary injection into the economy) left the Reserve Bank exposed to the potential of a run on the dollar. There were no monetary mechanisms to stop it. Normally, rising interest rates and monetary shortages would discourage the continuation of the run. Without them any measures the officials proposed would be at best temporary and, in the long run, painful.

The dilemma Muldoon faced was that any effective measures would damage his electoral standing, At worst his opponents would argue that the measures demonstrated that his economic policies had collapsed. Particularly given Muldoon’s known long-standing opposition to a devaluation, such a measure would have decimated his electoral support. In other circumstances the closing of the window (or float) might have been on politically, (He could have argued something like: “The business community is behaving irresponsibly in the foreign exchange market. There is no way my government is going to risk New Zealand’s foreign exchange reserves because of such irresponsibility. So we shall not sell them any further foreign exchange until they learn to behave.”) But the New Zealand Party’s policy included floating the exchange rate. In the circumstances of 1984, but not 1981 say, closing the window could have been electorally damaging.


On the Monday the Reserve Bank entered the forward exchange market. That is, it agreed to sell foreign exchange in exchange for NZ dollars at some point in the future (eg, three months) at the current exchange rate, even if there was a devaluation, It made a small charge (called a “premium”) for this, but nevertheless the business community switched to the facility with alacrity. Indeed, some even sold foreign exchange back to the bank.

Their reasoning was that, given that it was politically impossible for the National Government to devalue before the election. they had over three weeks to plan their moves. In particular they could (and did) wait until the days just before the election before they had another run on the currency.

It is easy to accuse the business sector of misbehaviour in this regard. But look at it this way. If you expect the price of something you want to buy to go up (say the day before the Budget there is a rumour of extra taxes on alcohol, tobacco, cars, petrol, etc), do you resoluteJy stay at home and not use the information? Or do you stock up? And do we accuse customers who cause the run on alcohol, tobacco, cars, petrol, etc. of misbehaviour?

Businesses “speculate” mainJy for prudential reasons, protecting themselves from expected cost rises. Some of the benefits appear in reduced prices to consumers. some in increased costs. Under the exchange controls at the time such “speculation” was legal.


On the campaign trail Muldoon announced that Roger Douglas, Labour spokesman on finance, had just distributed a paper advocating devaluation. Apparently an old discussion paper which considered devaluation as one of the options had been released in the haste following the snap election. It was an office mistake. One hopes that Douglas’s current office is more careful.

The Labour Party’s position on the exchange rate during the election campaign is a bit of a mystery. One strategist told me they planned to float the currency down in a series of steps. I got many other opinions from other sources. It is well to remember that the choice in principle was not merely between keeping the current fixed exchange rate and devaluing.

In campaign terms Muldoon was right to lambast Douglas for the mistaken release. But later he claimed Colin Moyle discussed devaluation with a committee of the Dairy Board. This time it was the farmers who raised the matter, and by all accounts Moyle’s behaviour was entirely proper.

The unfortunate consequence was that it supported the business community’s suspicion that Muldoon was planning to devalue after the election and blame it on the Labour Party, It was widely (and a, we now know, correctly) rumoured in business that the officials had recommended a devaluation. Muldoon kept coming back to the topic.

During the campaign there were two almost totally divergent economic debates. one in the media to the electorate and another in the business community. One can understand why the National and Labour parties did not tell the electorate what was going on in the business sector, but it remains a puzzle why the New Zealand Party was so quiet.

I do not believe that Muldoon was planning to devalue after the election. But had he been re-elected there would have been little option, given the slack monetary situation, the low foreign exchange reserves, and the lack of effective measures to stem the speculation in the previous month.

A week after the snap election was called a devaluation following the election was all but inevitable.