Fair point.

“So if it’s not a given, there’s no point in hoping for a downgrade to force a change in our bad behaviour, as an alarming number of people seem to favour”

Personally I do think it will influence the exchange rate – but I think the impact will be small, so I feel a similar way.

Also I don’t like the idea of a crisis to “force us to change our behaviour”. Ultimately there are some structural issues in the economy that we should try and figure out at a micro level – waiting until the rest of the world calls us a risky proposition and punishes us isn’t really the best idea methinks

And I think the only place where we disagree is that I don’t believe the above is a given – the minimal evidence we have locally would suggest it isn’t, and more broadly, there’s a huge Iceland-shaped hole in that theory (how high did their currency get between the rating downgrade in 2006 and the collapse of their banking system in 2008?). So if it’s not a given, there’s no point in hoping for a downgrade to force a change in our bad behaviour, as an alarming number of people seem to favour.

Hi Miguel,

I don’t think we are disagreeing here at all – I think we might be slightly talking past each other.

All I’m saying is that if Fitch did move it would increase the perceived risk associated with us for some investors. If this is the case then the exchange rate would fall – I am not asking for artificial depreciation of the currency (that is bull I agree), I am just saying that this is what would happen is nation specific risk expectations changed. Note that this would also lead to higher interest rates, irrespective of RBNZ policy.

My focus with this specific mentioning of Fitch is on how the world drives our interest rates and exchange rate – not on domestic policy per see.

I agree that a weaker currency is not a “quick-fix” to imbalances that are the result of domestic structural issues – in policy terms we should be focusing on these issues not the exchange rate.

http://www.tvhe.co.nz/2009/07/29/high-dollar-is-a-symptom-not-a-cause/

However, this discussion came about because I was replying to your comment that a downgrade wouldn’t impact on the currency. I believe it would – although I agree that the magnitude of the impact is highly exaggerated.

“Fitch estimates that a sizable 4.5 percentage points of GDP turnaround in the CAD position is necessary to bring the deficit on NZ’s net international investment position (NIIP) back down below 100% by 2011. This could entail a severe and/or protracted economic contraction to correct the country’s structural savings-investment imbalance. Such a correction is not a certainty, however, with historically low real interest rates and the beginning of a housing recovery raising the risk that household borrowing and consumption, as well as net external borrowing, do not abate.”

To me, that’s a pretty blatant argument for higher interest rates, not for a lower currency. Trying to engineer a weaker currency is just another way of saying “let’s inflate our way out of trouble”, and I’d be really concerned to see a ratings agency recommending that.

“But they did say that there is an imbalance in terms of our trade position – an imbalance that could be (paritially) corrected through a lower exchange rate.”

They said the first part, not the second. The upshot is that in order to return the outlook to stable, Fitch want to see evidence of a structural improvement in the current account deficit, beyond the cyclical improvement that we can expect as a result of the recession. The quick-fix of a weaker currency has no bearing on their view.

I said that the idea of a focal point seemed applicable given experience. I then said that in the case of an observable bias we can use this to forecast some change – Fitch downgrade has a bias.

“If we could “know” these things, we would have “known” that the negative outlook by Fitch, and by S&P earlier this year, would have no impact of any consequence on the currency. But would you have dared say so before the fact?”

The S&P threat did influence the value of the currency – and given our lack of relative increase in the face of rising commodity prices and increasing risk aversion I would say that the Fitch announcement has had some impact on investor behaviour into NZ. And I would have said so before hand.

I would not have picked the collapse in risk premiums in recent weeks, or the rising commodity prices though.

“Fitch say no such thing – they strongly argue that the macro adjustment has to come from within, not through the expediency of a temporarily weaker exchange rate.”

But they did say that there is an imbalance in terms of our trade position – an imbalance that could be (paritially) corrected through a lower exchange rate.

By saying that there was a greater risk associated with our currency than is priced in they are implicitly saying that the exchange rate should be lower!

Note: In net terms my point is solely that a Fitch downgrade would lead to a lower dollar CP, I do believe that is justifiable. However, I agree with you that the magnitude of such movements is HEAVILY over-rated by the media and the such – any such impact is likely to be small.

Matt Nolan :@Miguel Sanchez
Huh, I said that I believe a focal point can throw around the exchange rate in a way that is foreseeable – if you know they bias associated with it.

Um, no you didn’t:

One reason why I believe this theory is because it matches my observations when data has been released. Data can come in matching expectations exactly and there can be a huge swing in the currency. Only focal points can explain this to me.

The problem is that even if these focal points do exist, we don’t know about them beforehand. We might, after the fact, kid ourselves that we knew all along. But we don’t.

If we could “know” these things, we would have “known” that the negative outlook by Fitch, and by S&P earlier this year, would have no impact of any consequence on the currency. But would you have dared say so before the fact?

Oh, and since you raised it:

Fitch has moved and said that they don’t believe the dollar is worth as much.

Fitch say no such thing – they strongly argue that the macro adjustment has to come from within, not through the expediency of a temporarily weaker exchange rate.

http://www.interest.co.nz/ratesblog/index.php/2009/08/03/opinion-heres-10-reasons-why-fitch-should-downgrade-nzs-aa-rating/#comment-31588

Huh, I said that I believe a focal point can throw around the exchange rate in a way that is foreseeable – if you know they bias associated with it.

If we get a credit downgrade on known information, market participants would cut the dollar – even if the actual information behind the dollar was completely known.

Why? Because the price of the “asset” depends in part on expectations of what other people will do. In this situation, Fitch has moved and said that they don’t believe the dollar is worth as much. All this needs to do is change the expectations/beliefs of a small number of traders and the dollar will move, which will reinforce a belief for other traders to move and etc and etc until we reach a new equilibrium.

With other news releases the adjustment is not observable – it is a random walk. However, in the case of a credit downgrade we know exactly where the bias is.

And thank you for demonstrating my point. Setting aside the issues of (1) whether your idea of a “huge swing” in the currency is the same as mine, and (2) whether you actually knew beforehand the expectations of the broader market, as opposed to just economists – you’re remembering the few occasions on which this appeared to happen, and spinning a story around it. But if I asked you, before a data release, what the currency would do if the data matched expectations, you’d have no reason to say anything other than “no change”.