Keeping it all together on bond sales
Hey all, I’ve been away – and I still am. I’ll be back next week. However, I have to write on this. Over on Rates Blog, Bernard Hickey stated the following:
The most interesting revelation from today’s Monetary Policy Statement was Graeme Wheeler’s comment that he knew other central banks were buying New Zealand government bonds as part of their Reserve buying programmes.
This is how printed money is lifting our currency to over-valued levels.
Ok, now I don’t know what the RBNZ has been saying – I don’t go to their media lock-up. But lets think through this a bit.
“Bond buying” will push up the currency if there is some sort of financial flow – such as the government increasing borrowing (and it being funded from overseas) or bond holders in NZ selling bonds to overseas buyers. From what is indicated, it seems like we’ve had a bit of both. So the government is borrowing to pay for a bunch of stuff, and this is increasing the current account deficit. We need a corresponding lift in the capital account surplus to pay for it – hence we have this financial inflow. People are willing to lend to us incredibly cheaply so this is pretty nice of them.
The two complaints I’m hearing are:
- It pushes up the dollar: Investment+consumption > savings, so yes this pushes up the dollar. The question is why the interest rate and exchange rates that puts us in our current “balance” seem so high relative to other countries. Is it because our growth prospects are better? If so this is good. Is it because of some structural issues in our economy? If so this could be bad. Is it because, as the RBNZ seems to believe, there is a bubble in the dollar/bond markets – if so we have people overpaying New Zealander’s to buy bonds that will decline in price … interesting.
- Why don’t we print/pay for it domestically: This is part of the “QE for NZ” crew view, and it is inappropriate. Keep the ideas together here, what are we trying to “solve” by getting the central bank to buy government bonds? Are we trying to loosen monetary conditions … if so cut interest rates, as QE is really a form of this. Are we trying to reduce foriegn lending … if so we need to reduce domestic borrowing, we are a small open economy and so we pay the world interest rate to borrow as much as we want (in a sense). If monetary conditions are appropriate, then QE will just be inflationary, and it does nothing about the inherent “savings-investment imbalance” that people are concerned about when they discuss people lending to NZers.
Matt,
I totally agree with your crusade for 1. let’s fix the real economic imbalances first and 2 NZ does not need QE. However, I still have some doubts…
In my experience, economists don’t describe FX markets well. The story you are describing is a real economy story and this doesn’t match up with what you see in markets, which is turnover of 15x GDP or so. I think that the current world of “flow” products, prime brokerages, derivatives, ETFs and central bank buying is more complicated and this is why currencies tend not to behave in ways that economists expect. I’ve tried talking to FX traders about who’s really trading with whom in the FX market and I’m not sure they even know. Second, it’s at least plausible that funny money abroad is in part responsible for distortions in our real economy. For example, foreign HF/CB buying causes us to run a capital account surplus, and the real economy adjusts by reducing production relative to consumption+investment such that we get a balancing current account deficit. In other words, inadequate domestic saving is likely made more inadequate by money creation by foreign HFs (or their prime brokers) and CBs.
Similarly the RBNZ research you link to is incomplete because it looks almost entirely at macroeconomic variables. These are only relevant because they influence HF behaviour.
My own view, which is based on observing the markets, is that FX used to be real economy driven until about the 1980s, then became a story about interest rate differentials, and more recently became dominated by portfolio rebalancing effects. I have not seen any academic write knowledgeably about this modern world except perhaps Michael Pettis who used to be a trader at Bear Stearns. You may be aware of others.
If the above theory was correct you would expect to see a large and persistent CAD in NZ, low saving, and low investment (because the high RER has pushed down the marginal return to capital across the curve). This is what we are seeing – investment still hasn’t recovered since the GFC.
Yeah… nah… I think you are over thinking it a bit. The exchange rate is a relative price that reflects both the reality and expectations about the future.
Now given the state of the world a freely floating currency in a relatively stable economy is a good place for people to park their money – low risk of a blow up… NZ has structurally high real interest rates and thus a structurally high real exchange rate because of the issues Matt has noted.
The overvaluation comes because of the risk preferences for NZ dollars vs other currencies – if the world becomes more stable economically then one would expect the overvaluation to dissipate…
Although I know plenty of people who have predicted a return to fundamentals for a long time… they are still waiting….
Boris, my argument was that the explanatory power of interest rate differentials peaked a few years ago. There is something else going on. Regarding foreign CB intervention, I agree with the views of ANU Prof Warwick McKibbin expressed here: http://tinyurl.com/aqyvmb2. Excerpt: “The general point is that even though allowing markets to work is usually the best policy, when markets are distorted by the policies of foreign central banks, it might be better to deal directly with the distortion rather than allowing markets to propagate the shock unnecessarily”.
I like the crusade call – both for its positive and negative connotations 😉
With regards to the size of the FX market, I would be careful reading too much into that. Generally highly liquid markets should be less vulnerable to bubbles, not more vulnerable, and so this is really a good thing.
With regards to foriegn intervention, lets think about that issue for a second. Foriegn economies are highly depressed, and are trying to close their output gap/reach inflation outcomes that meet their mandate. In that situation, their monetary stimulus does have a spillover impact on us.
However, this isn’t an argument for them to not meet their mandate.
Now our own central bank is setting monetary conditions such that we meet our output-inflation target. Cool. If interest rates here are truly that much higher than overseas, we are just inherently stronger than they are.
Now you rule this out, and state that the high dollar is not to do with interest rates, or forward looking commodity prices, it is instead due to … say … a bubble in bond markets. Ok, so foriegn central banks are willing to transfer New Zealand wealth for some reason, and this has pushed up the dollar (note if they were doing it by pushing inflation past target, then the nominal currency appreciation makes sense as a forward looking price, it isn’t a bubble).
It isn’t clear to me that New Zealand is the place struggling in all of this.