Eric posted on Monday about the Stuff.co.nz article in which he was extensively quoted. I am mostly in agreement, with the article and Eric’s quoted comments, but there are a couple of places where I take issue.
First, the article takes as a given that the New Zealand dollar is overvalued. Now, this mantra is so commonly stated that one can hardly criticise a journalist for taking it as a received fact. Indeed, the article is able to reference a fairly high authority on this:
And the International Monetary Fund says the kiwi is about 15 per cent overvalued. It has said that repeatedly, at least as far back as May 2010.
Now staffers at the IMF are not stupid, and there is probably a well-defined question to which “overvalued by 15%” is the answer, but assessing that answer would require knowledge of what the underlying question is. The first thing I tell my 2nd-year micro students each year, that to start a piece of economic analysis with a price is to abdicate one’s responsibility as an economist. It is akin to a psychologist explaining some strange observed piece of human behaviour by saying “that is what they wanted to do”.
Let’s revisit some exchange rate basics. We have a clean floating currency. That means that the price of the currency is set at whatever level enables all who want to buy and all who want to sell at that price to do so. At first pass, that sounds like a perfectly valued exchange rate. Furthermore, the complaints about the kiwi being “overvalued” have been consistently heard for about a decade at least, so it would be hard to say that it is the result of a speculative bubble with speculators consistently entering on the demand but not the supply side.
So why is the dollar at the level that it is? One possible reason in recent years is the high demand for milk solids from China creating a boom for New Zealand dairy exports. Yes, this is not so good for manufacturing exporters, but the technical term for such a change is “the terms of trade going in our favour”. Alternatively, we can point to investment opportunities in New Zealand consistently being higher than the available pool of saving, coupled with a large pool of savings from China being available to prevent interest rates rising to choke off that investment. Again, a big increase in supply of foreign capital when NZ is a net buyer counts as a favourable terms of trade shock.
Pretty much the only way I can make sense of the “NZ dollar is overvalued” mantra is as an extension of the argument that New Zealanders are not saving enough, in the same sense that we don’t eat enough fruit and vegetables, drink too much alcohol, don’t attend enough classical music concerts, and have too much sex during rugby world cups.
But, and this is my second issue with the original article, Eric is coming perilously close to this view when he is quoted as saying,
Fundamentally, New Zealand has a high exchange rate because we’re an attractive place for foreign investors to put their money….Our relative lack of domestic savings in things other than housing means that the returns on other kinds of investment here are relatively high.
Hmmm. The fundamental problem with housing in New Zealand is land-use regulations reducing the extent to which savings can be directed into the creation of new housing stock. As I have noted before, the purchasing of existing houses is neither investment nor saving in aggregate, and so cannot explain the net demand for foreign capital.
[Editor’s Note from Eric: catch the comments thread at Offsetting; Seamus and I aren’t really disagreeing that much. At least I don’t think we are.]