"A rapid and substantial market-led exchange rate depreciation"

Treasury says our currency valuation is 17% overstated, "as a consequence we have revised down our exchange rate assumption by bringing forward the fall in the NZD by one quarter..." Maybe it's time to take advantage of that information now when the Kiwi is at almost 71c US.

The Pre-election fiscal update says quite clearly in the summary:

A continued build-up of these imbalances - through, for instance, domestic demand growth not slowing as expected - would increase the risk of further monetary policy tightening and/or a rapid and substantial market-led exchange rate depreciation. In either case a much more pronounced growth cycle may eventuate.

and:

B.16 | 15
Assumptions Underlying the Economic Forecasts

Oil prices. Brent crude oil prices... assumed trise from their estimated level of US$56.00 per barrel in the September quarter 2005 to US$59.10 per barrel in the first quarter of 2006, before declining gradually over the remainder of the forecast period to US$53.60 per barrel in the March quarter 2009.

Monetary conditions. The New Zealand dollar exchange rate as measured by the TWI is assumed to depreciate from its level of 70.8 in the second quarter of 2005. The TWI declines steadily to its estimated equilibrium level of around 59. A neutral short-term interest rate of 5.8% is assumed.

and then this:

"Should the recent high level of the exchange rate have a greater impact on export volumes, or if the exchange rate does not depreciate as is assumed, it is possible that the economy may face a more protracted slowdown period with the recovery pushed further out... any adjustment may occur in a less orderly manner with the potential that economic growth could prove more volatile than the profile incorporated in these forecasts."

And earlier the "market-led" scenario seems in a context that implied the RBNZ, or at least the Treasury does not advise any intervention above 17% of current value ie. US$ 0.57-60c. AND that is exactly where it should end up very shortly according to Treasury, BUT have they told the Reserve Bank?

They seem to think we need it to stay high enough to attract currency traders and maintain foreigner's value in NZ. The 0-3% target for inflation has effectively exported inflation as a problem to deal with from the Treasury to the Reserve Bank - and the only way they can do it is through only two tools: 1. interest rates and 2. the creation of credit - this has led them to create an inflation in the exchange rate because that is not controlled and effectively acts as a yet underestimated third tool. The use of the second tool has created a huge surge in the inflation of real estate and the first a huge inflation in interest rates. So be it? This is the price of cheap food, plasma screens and the $2 shop?

The Governor of the Reserve bank's key performance indicator is a consumers price index rating AND managing the money markets and banking. And they do too good a job. There is no inflation target for the exchange rate. This has externalised the inflationary pressure. RBNZ can create credit for overseas market and not create internal inflation - which is their job description. And a good manager can create enough external inflation to create the markets and Brash did this. But not including an "exchange rate target" or TWI target means they will keep operating their perfect system of markets steadily until... crunch. Because they can't manage a crisis where stability is important but they have to maintain a high interest rate to attract capital and the value of that capital and also have low inflation. The 4% sudden depreciation in early July should have been a warning (it was predicted in this blog just beforehand.)

Treasury seem amazed it doesn't each time it gets worse. The underlying value is slipping because of our entire economy's high debt as expressed in the declining terms of trade and a current account deficit. Our interest rates are high to attract overseas currency and keep our credit rating high. Why? In whose interests? The economy is mortgaged up the ya-ya to foreign finance and they pull their profits out at terms that they have effectively set, whilst our exporters suffer a high exchange rate.

Our system, as operated legally and within all KPIs with targets met is pushing the max. CPI rate of 3% and is expected to go slightly over for a short period. Interest rates are the highest in the Western world and property values are inflated and the exchange rate is almost one-fifth over-valued by the Treasury's own figures and they predict every likilihood of an extreme "market-led" adjustment downwards if the conditions don't improve very soon. We are very close to that very soon priviso. At this point my ears prick up. Our national investment base is so weak and our thinking so short-term that when we have all these inflationary things in alignment I must ask: what is the Governor to do?

He can't go over 3% CPI inflation or he'll get fired and there will be a financial crisis and our triple AAA international credit rating that the Governor defends as the de facto benchmark KPI is up the ya-ya. So he cannot push inflation above 3% - even to ask will send jitters through the market and could trigger a crash. We are operating the machine at full tilt according to the PREFU:

consumer price inflation is predicted to peak at 3.1% in the September quarter of 2005 and remain near 3% for much of the next two years.

So he has no room to move at all. Can't touch it.

He can drag interest rates higher and kill off growth and drive the currency up even further that would keep the CPI under control?!! But all of Treasury's forecasts are shredded if that happens because of the expectations that the system can only come right with low rate of inflation, steady growth and a low exchange rate. Well that's all up the ya-ya too because Treasury thinks interest rates should be about 1% less. Something must give.

He could let the exchange rate find it's new level as people cash in their revalued chips at the exotic Casino Zealandia. And that's what I think will happen - and soon.

This is where I can't work out whether Cullen is a fool or a genius. By stashing away so much loot in overseas currency - $6b (?) (90% odd of it) in the Superannuation Fund and bolstering the RBNZ stealthily over the last year when the dollar has been so high has improved it's real long-term value to us in NZ$ despite not investing in the country's internal capital. Making hay while the sun shines? If so, does it mean that he will use it to defend the NZ$ in an emergency to keep the exchange rate up, or not? I think not. Others might think differently. Others might say @65c, or $60c some would say @50c? Who knows?

The EU solved many of these problems by agreeing to fix the exchange rate with a majority of their trade partners. Maybe we could investigate doing the same?

I don't want to rain on the parade, but when we hit 0.71c US and Treasury thinks we're only worth 0.60c US we do have a problem.

--------UPDATE---------
@12:30am 7 Sept.
Just passed the US$0.71c barrier in trading- buy US$ now with your Kiwi - it won't be much more affordable than this. Esp. in oil futures.
Kiwi buys €0.57c is at the moment that's also too high.
--------------------------