Tuesday, July 01, 2008

$4.2 billion spent on destructive economics

Bollocks I bet you didn't know that the Reserve Bank spent $4.2 billion of your money last year in order to prop up its flawed economic model.  $4.2 billion!  Reports NBR:

   " The biggest gambler on the New Zealand dollar is the Reserve Bank, which has been playing the currency market to the tune of $4.2 billion in the last year to try and keep the price of the dollar down, according to figures published by the Bank.
    "This raises two obvious questions: how long can the Bank continue to sell into the market while the dollar remains relatively high? And should our central Bank be taking a punt of this size with public money in the hope that it may be helping exporters keep the dollar slightly lower?"

Here's some questions that might occur to you about now:
Why is the Reserve Bank trying to keep the price of the NZ dollar down?
Because NZ interest rates are higher than the rates of other comparable countries round the world, attracting foreign buyers for local dollars.
Why are NZ interest rates higher than the rates of other comparable countries round the world?
Because the Reserve Bank's flawed economic model requires that it jack up to interest rates to squelch rising prices.
Are prices rising?
Yes.  Partly for reasons of supply and demand -- important price signals the Reserve Bank is trying to squelch -- partly because Government spending is out of control; and partly because the Reserve Bank itself has been inflating the money supply.  (To the extent it's been inflating the money supply by fifteen percent year on year for the last half-dozen years, the Reserve Bank hasn't been fighting inflation, it's been causing it.)
Is this sustainable?
No.
Is this rational?
What do you think. In this headlong and destructive pursuit of what it calls 'price stability', there are two prices which experience rampant instability: the price of the NZ dollar, and the price of  money. That's right, the myopia over price stability has led to galloping instability in interest rates and mortgage rates and the exchange rate -- along with dislocations, malinvestment, and the threat of a lingering recession . The rationalistic "basket of goods" by which price inflation is measure may be made to appear stable, but the prices we actually pay for mortgages, capital and foreign exchange are all over the place, and the economy the Bank was supposed to stabilise is found to be anything but.  The $4.2 billion the Reserve Bank spent last year is only a small part of the cost of this flawed economic model.

In other words: removing real price signals from the market (or trying to) plays havoc with your markets.  The law of unintended consequences strikes again.

NB: If at this stage you'd like to get your hands on a more rationally sustainable economics to understand all that's gone wrong, and why, and what to do about it, The Austrian Business Cycle Theory is online and free, and with essays by Ludwig von Mises, Friedrich Hayek, Roger Garrison and others explaining both the Austrian concept of the capital structure, and how governments and their central banks are the central cause of both inflation and depressions, it's timely reading.

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7 Comments:

Blogger Matt Nolan said...

"I bet you didn't know that the Reserve Bank spent $4.2 billion"

It spent the money on an asset - when the NZ dollar falls they will make a profit on that money.

"Because the Reserve Bank's flawed economic model requires that it jack up to interest rates to squelch rising prices ... and partly because the Reserve Bank itself has been inflating the money supply"

If we are criticising the Bank for "inflating the money supply" and causing inflation, then we are saying we would want interest rates to be higher - as interest rates are the "price" of money.

You can't criticise high interest rates and "too much money supply" at the same time - as those statement contridict.

7/01/2008 12:50:00 pm  
Blogger PC said...

Matt, you said, "If we are criticising the Bank for 'inflating the money supply and causing inflation, then we are saying we would want interest rates to be higher..."

No, not at all. There are two related data points here and one unrelated; two we know, and one we don't know.
We do know that the Reserve Bank is inflating the money supply. There's no question about that.

We do know that it is setting interest rates, the levels of which are far above the levels of other comparable countries.

Amongst other things, what this means is that there is not a free markets in money, and as long as there isn't, we have no idea what the price of money would be. (As I'm sure you're aware, Matt, the calculation of prices and value can only be done in a market. As long as money itself is socialised, there's no way of knowing what the 'natural' rate of interest would be.)

It's true that as long as there's a free market in money, then lower interest rates equals more credit. But we don't have one.

In my view, there's four things needed to move towards a free market in money ...

7/01/2008 02:04:00 pm  
Anonymous Anonymous said...

The Reserve Bank has taken a tactical bet. This is undeniable. They are betting that they know better than the world's currency traders as to the "value" of the NZ dollar. Well I do not think that they possess such insight - the evidence does not support it. Whether or not they have purchased a foreign currency - which in this case is foreign currency is irrelevant.

There is however a tanglible loss. The exchange risk premium which is currently about 4% means that investors in the NZD earn an extra 4% per year for investments in the NZ dollar. The sale of NZ dollars therefore means that each year - we are losing about $150m - that is about $36 per New Zealander.

7/01/2008 03:01:00 pm  
Blogger Crampton said...

Odd that the insider trading laws that apply to everyone else don't apply to the RBNZ. I mean, all they need to do to make their bet come up aces is to cut the interest rate by a bit more than they're forecasting. The currency will plummet. Now, the inflation rate will take a big jump (fuelled by higher import prices with a lower dollar), but we already know that they stopped caring about inflation some time ago

7/01/2008 04:55:00 pm  
Blogger Matt Nolan said...

"We do know that the Reserve Bank is inflating the money supply."

The Reserve Bank is printing money in line with money demand and the interest rate - they are not arbitrarily setting a quantity of money (although we may feel they are arbitrarily setting the price :) ).

As a result, money demand is still a binding constraint on the banks actions. As money demand slopes downwards the bank could only increase the quantity of money it is pumping into the economy by cutting interest rates - as a result there is a direct trade-off between the two.

We might not have a free market for credit - but nonetheless we do still have a market, as money demand provides a binding constraint

7/02/2008 08:59:00 am  
Blogger Matt Nolan said...

BTW, following Mr Mallards discussion of trashing the Reserve Bank Act today I've put together a post where I've asked people to comment, talking about what they think we should do with monetary policy.

I greatly appreciate a comment from you.

http://tvhe.wordpress.com/2008/07/03/re-thinking-interest-rate-policy-asking-for-submissions/#more-476

I would have emailed you, but I couldn't find a contact address on the site :)

7/03/2008 12:16:00 pm  
Blogger Eric Olthwaite said...

The Reserve Bank is printing money in line with money demand

Really! I demand $20,000,000

Ta :-)

7/04/2008 09:03:00 am  

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