I’m very pessimistic about the current state of the NZ economy. I’ve been watching it happen for quite a while now. When we hit and levelled at US$0.65 I was pretty much losing faith in the economy about then. However, now that we’ve topped more than 77c, I’m really starting to get very concerned about where things are going.

Dr Bollard cannot do anything about the dollar except tank the interest rates. Literally. He has to drop the rate right down to next to nothing or our dollar will continue to rise. These threatened interventions by the Reserve Bank are a waste of time and energy and will do nothing except cause us more problems. The market can out buy anything Dr Bollard could ever hope to sell. Its that simple. The market is far bigger than the Reserve Bank.

However, I do think that selling off Kiwi dollars is a good thing in the long term. Its immediate effect on the economy is next to nothing. As long as New Zealand has the highest OCR in the world, nothing short of dropping that OCR is going to stop people from buying into this economy. But dropping the OCR, while in the short term a good thing, is going to screw us even more in the long term unless the RBNZ can raise it again rapidly after scaring off the currency sharks.

Ultimately though, the NZ$ is going to take a massive dive in the near to medium future. And the economy is going to go with it.

Buying foreign currency is a very good thing on behalf of the RBNZ however. Although, I don’t think that buying US$ is quite the right choice at the moment. Far better to go with a much more stable economy like the Euro than the US Dollar which is on the precipice itself. However, the reason I think buying an external currency is a good idea in the long term is because it does build up a value in our own currency in the long term.

When our economy starts to nose dive in a free fall, this reserve currency he is buying now will help provide at least a marginal parachute to slow things down a little. It’ll make the landing more like a boggy marsh than the concrete we’d hit otherwise. It’ll still hurt like hell, but you’re much more likely to survive.

But, by all accounts, that probably won’t matter if you read the following article.

The Bank for International Settlements, the world’s most prestigious financial body, has warned that years of loose monetary policy has fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.

“Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived”, said the bank.

The BIS, the ultimate bank of central bankers, pointed to a confluence a worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.

BIS warns of Great Depression dangers from credit spree – telegraph.co.uk

When will this happen? Actually, I’m personally shoring up my bets right now as it is. Every spare dollar I’m earning is getting turned into hard US currency at the moment. I know, I’m contradicting myself here. But given I intend to be in the US at the end of the year, and hopefully living there next year, its the most useful and functional currency for me at the moment.

But I’m also at the point where I think my money is going to be kept fluid and out of the banks. Its a lot harder to save that way (cash is a lot easier to spend when you have easy access to it) but its also a lot safer.

I know, this all sounds like fear mongering, but look at the signs here in NZ alone.

Interest rates are at an all time high because of inflationary pressures from Government spending, the ballistic housing market and phenomenal returns for the dairy, meat and agriculture industries. With the absolutely massive interest rates, the value of our dollar is so severely over priced that its at a level thats practically killing off our export market. Its like putting a car over a patch of grass for a long time. Sure, there is some light getting under the car, but its not enough to sustain the grass and eventually it dies off.

And the longer the interest rates stay high, the longer the dollar will continue to be over priced. But if we try to drop the interest rates to allow the export markets to breathe again, we start to see the rise of the inflationary pressures all over again.

Worst of all, with things like the housing market, is that the high OCR and interest rates aren’t really affecting international buyers. If you’re living in Japan, why would you get a mortgage in NZ to buy a house here? Why not get the mortgage there in Japan where they have the worlds lowest interest rates?

So we’re seeing major problems.

Whats the only way to resolve this issue?

I really don’t know. But with our dollar climbing to over US$0.77, I’m really starting to get scared. We really cannot sustain this over priced currency. There is nothing substantial holding the value up there other than the high interest rates. The actual GDP based economy is far too small to be able to keep the value up there on its own when the interest rates eventually drop.

And believe me, drop they will. Bollard wants to intervene by buying more foreign currency, but ultimately thats a losing battle. The only way he’ll drop the currency is to dump the interest rates. And he really can’t do that while the government is still spending up large.

Which leads me to an altogether different point…

Part of the inflationary markers that the RBNZ has claimed are that we’re all spending far too much ourselves. We’re not saving enough. With the increased payout to farmers, he’s worried that the money will get put back into the economy and right now thats a bad thing. He sees it as being extremely inflationary.

Dr Bollard said that from a monetary policy perspective, a terms of trade shock of this magnitude poses some challenges. “It will affect inflation by creating higher domestic dairy product prices and the higher dairy prices will provide a substantial boost to rural incomes.

“Of course this is great news. However, we are dealing with a stretched economy at present. Domestic demand is already strong and capacity is tight. If this extra income is spent and/or invested by farmers it will add to this domestic demand pressure.”

Dairy prices and the NZ economy – rbnz.govt.nz

Now, thats the one that the government has been touting about as being the cause of our current inflation problems at the moment. They’re full of it though given back in March Dr Bollard made some very clear statements regarding government spending.

A key message is that the specific details of new spending or taxation initiatives, and their overall scale, need to be taken into account when analysing how economic activity or inflation may be affected. The impact of fiscal policy changes and their significance for monetary policy will also depend on the state of the economy at the time they occur.

The article notes that increases in spending can have a relatively large impact on economic activity if they prompt additional private sector spending. For example, spending on public infrastructure may lead to additional business investment.

The effects of tax policy changes on economic activity are likely to depend partly on the incentives these create to save, work or invest, as well as their initial effect on household or business incomes. For example, dollar for dollar, cutting company taxes is likely to boost demand more than tax cuts designed to support savings. While some spending or tax changes can impact on the economy’s capacity to produce goods and services, particularly if they affect business investment or labour force participation, these effects are likely to be reasonably slow.

As explained in the Bank’s March 2007 Monetary Policy Statement, Government spending has been rising in recent years. Until recently the increase in spending has been more than matched by rising tax revenues. However, the article suggests that increases in spending in recent years may have stimulated activity, because not all of the income that was paid as tax would otherwise have been spent. Fiscal policy is expected to remain stimulatory over the next two fiscal years.

How fiscal policy affects the wider economy – rbnz.govt.nz

What that means is that if the Government doesn’t stop spending money (say, the nearly $3 billion it just dumped into roading) then we’re going to see a very inflationary economy for at least the next couple of years.

What does that mean to you and me? It means that because theres so much money floating around in the economy, whether we have any of it ourselves or not, the cost of everything is going to increase as everyone tries to get their slice of it. So, as we’ve already seen the cost of milk go up by 18c a litre, so till will everything else.

But this increased cost is also driving expenses up as well. The increase in the cost of gas being the most obvious driver of this. But basics such as bread, milk, meat and so on are also good examples.

And its only going to get worse in the near future. Especially with the OPEC nations deliberately keeping the cost of oil elevated. And with threats from Iran of using oil against the West, everyone is dancing on tip-toes around the oil market at the moment.

What can be done about this situation? Well, we cant lower the OCR because that’d increase the CPI growth drastically. We can’t let the inflation statistics push beyond the 1-3% range.

But unless we lower the OCR, the NZ dollar is going to keep soaring, which is going to seriously have a detrimental effect on our export market. Unfortunately, NZ derives the majority of its income from the export market, so whats happening with the high dollar is that NZ is losing money in a major flood. The higher our dollar, the less competitive our export market and the lower our export profits. Low profits means less money that can be spent on staff and investment in the business which ultimately results in cut backs in both expenses and staff.

See where this is heading?

Fisher & Paykel has already moved a large portion of their local manufacturing business off to Thailand, costing several hundred local workers their jobs. We’re seeing similar events happening with textile companies in the South Island. Pumpkin Patch is just one example of a textile company suffering significantly at the moment.

But these truly are just the beginning. We’re already hearing the cries from our meat exporters. Not only are they battling with crazy British folk who claim our meat has extremely high carbon cost and is pushing local farmers out of the market by undercutting them (even though they completely disregard that the meat market is cyclical.)

We’re in serious trouble right now folks. Like it or not, our economy is at the very top of the cresting wave and we’re about to slide down the face of it as the wave breaks over the top of us. We really are looking down the barrel of a depressed market very similar to 1987 in my opinion. Maybe not quite as severe, but we’re building up towards it.

And our cushion? Well, all that foreign currency Dr Bollard is buying will help soften the blow and slow the decent. But it will be kind of like a sea anchor. It’ll slow our drift, but not stop it entirely.

I wish I could be more positive about the outcome, but I’m really starting to be extremely concerned about where our economy is going. If the dollar gets too much higher, we’re truly in big trouble. The economy cannot sustain it at the levels its at already, let alone any higher. Its like watching a massive balloon thats totally over inflated, but no one is shutting off the valve to stop the gas from continuing to inflate it further.

You all thought the dot com bubble was a massive burst? Wait till you see what this one does to the NZ economy.

Sorry. I really can’t be any more positive than that. The worst part is, I’m actually, literally, scared about whats happening. :-/