Economics & Development: Time for something new

[chickenfunkstar]

Thats right. Much of the money lent in NZ is borrowed by the banks from retail (ie mum and dad) Japanese investors. These are known as Uridashi bonds.

Our interest rates are extremely attractive to Japanese and European investors because at home 2 - 3% is all they can get. What is more, they actually take on the exchange rate risk meaning they can lose money if our currency drops.

So NZ banks don't need to worry too much about the Reserve Bank rate because they can buy money from overseas cheaper than locally.

And here we have a significant example of what our small economy is up against. Even our central bank cannot control the flow of money from the rest of the world.

Robert Muldoon had a weapon called the Reserve Ratio. It required all banks to deposit a percentage of their funds with the Reserve Bank at all times. By changing the percentage Muldoon could shape the money supply that banks could lend.

A fine idea but you'll recall that mortgage interest rates under Muldoon reached 21% for a brief time. Term deposit rates were 17%. Nobody wants to go there again.

How much cheaper can banks borrow from overseas investors? Is it significantly cheaper than the tax / regulatory advantages of Euro currency?

If its quite a bit cheaper couldn't banks just undertake an arbitrage strategy by borrowing from from overseas and depositing the money at the reserve bank at 25 points below the OCR?

Or why do overseas investors not just bypass the bank and buy NZ Govt bonds?

[Marmoot]

First of all, sorry if my quotes are not in order, but I am replying to points for a bigger picture in point #3 below....

Dropping interest rates right now would probably lead to a $NZ collapse.

#1. Given that I come from tourism industry, and I know this country heavily depends on income from export and tourism, wouldn't this NZ$ collapse be exactly the thing that we need at the moment?

Secondly spare a kind thought for all the poor countries with over-valued currencies

#2. Related to point #1 above, our currency seems to be overvalued at the moment, which is leading to a slump in our core income: export and tourism. Buying from NZ (export) or coming to NZ (tourism) simply has become too expensive that the market has shrunk significantly in the last few months. In tourism areas, we have discussions on how pathetic this summer has been compared to normal times in previous years. From export areas, we have heard talks about job cuts due to companies cannot support themselves, caused by reduction in sales. If these income slump continues, would it not lead to national budget running on deficit and looming economic malaise/depression? It would be a disaster if it happens, no?

Firstly lets remember that NZ has had a booming economy for the past 4 years despite also having a relatively high dollar. The currency hasn't prevented economic good times. In fact it has helped because imports such as cars, bikes, machinery etc have been cheaper than ever which means we've been able to buy the stuff instead of just wishing.

#3. Yes, the price has got cheaper by much due to our currency exchange. Which is exactly my point that government should try to reduce our currency rate if they want to control public spending. If our currency rate falls, import prices will soar up and people will be reluctant to get a loan to buy anything. This is exactly what the government is trying (and fails) to achieve with increasing rate at the moment, no? I think it is time they start trying the opposite of increasing rate, since increasing rate has been proven to only increase currency exchange which decreases import prices and increases people spending.........which leads to economic disaster quicker.

Great thoughts here. I am really interested in testing my hypothesis and see if it makes sense. Keep it up

[Winston001]

How much cheaper can banks borrow from overseas investors? Is it significantly cheaper than the tax / regulatory advantages of Euro currency?

If its quite a bit cheaper couldn't banks just undertake an arbitrage strategy by borrowing from from overseas and depositing the money at the reserve bank at 25 points below the OCR?

Or why do overseas investors not just bypass the bank and buy NZ Govt bonds?

Excellent questions and to be completely honest - I don't know.

However I assume the rate paid is 0.25 - 0.5% above Govt bonds.

As to borrowing and depositing rather then lending - the exchange rate risk would be with the bank. So if the $NZ dropped the bank would look sick. The attraction of the Uradashi and Kiwi Eurobonds is that they are denominated in $NZ, not euros or yen. Thus the lender/investor takes the currency risk.

[rogson]

Remember, the governor of the reserve bank's employment contract requires him to keep the inflation rate within a target range (if I recall correctly its something like 1 - 3%). In fact, I suspect this is the only quantitative measure he has.

Lowering interest rates will likely raise inflation. So, ultimately its got nothing to do with the economy - its about one man's job security.

[Winston001]

OK, have a look at this thread from Sharetrader http://www.sharetrader.co.nz/topic.asp?TOPIC_ID=22790 It is of some help for this topic.


As to lowering the Reserve Bank rate - the fear is that it will be inflationary and people will start spending up large again.

But it isn't a silly idea because human behaviour isn't entirely predictable. In the 1970-80s interest rates hit 21% and the conventional theory was that people would stop spending and borrowing. But they didn't. Kiwi behaviour confounded classical economics. Buyers kept buying houses and paying extraordinary interest.

It all came to a blinding halt when the new Lange govt floated the $NZ (which had been tied to the $US) and it fell like a stone.

[Marmoot]

Lowering interest rates will likely raise inflation. So, ultimately its got nothing to do with the economy - its about one man's job security.

Ah....then it all makes sense.
This is the best economic revelation I've had in the past few years.

Green bling awarded!

[ManDownUnder]

I'm bored at work, but not that bored.

The last thing I need is the pacific peso to be devalued when I got to send money back to the motherland!

Yeah you do - you're just looking at the problem wrong...

Borrow NZD from an NZ bank - and send it to the motherland.

When the dollar plummets, bring it back from the motherland (at it's increased value) and pay off the trifling loan with it... pocketing the rest...

Leverage (without a bending moment)

[Lou Girardin]

But it isn't a silly idea because human behaviour isn't entirely predictable. In the 1970-80s interest rates hit 21% and the conventional theory was that people would stop spending and borrowing. But they didn't. Kiwi behaviour confounded classical economics. Buyers kept buying houses and paying extraordinary interest.

It was predictable to a degree. While interest rates were high, so was inflation. What started as an onerous mortgage for me became very affordable after a few wage rises. So you borrowed till it hurt, knowing that the hurt wouldn't be for long.

[Marmoot]

It was predictable to a degree. While interest rates were high, so was inflation. What started as an onerous mortgage for me became very affordable after a few wage rises. So you borrowed till it hurt, knowing that the hurt wouldn't be for long.

and that was where my hypothesis of 'government should push the interest rate down' came from

[Winston001]

and that was where my hypothesis of 'government should push the interest rate down' came from

While your idea is contrary to economic logic, it could work. What would be needed is for our currency to fall at the same time and consumers to stop spending. That is quite possible given all the warnings of economic gloom and the raw reality of people now being laid off.

But no central bank anywhere would risk the experiment. Pity.

Keynesian economics requires governments to spend money in recessions which is why Dr Cullen has been holding onto a budget surplus - we are going to need it.