However, what they’ve decided to say in this brief post was one of the clearest example of beating on the West because it is fashionable – there is a line between showing a respect for those who are struggling, and trying to switch the blame away from a corrupt regime and onto everyone else:

What they found surprised them – a people who were poor, yes, but wonderfully engaged, well-dressed, fully employed and well informed. In Gareth’s view, what North Korea has achieved economically despite its lack of access to international money has been magnificent.

Surely they read through this passage before stating it.  Praising the economic policies of North Korea, the same North Korea that through central planning and mismanagement had starved a large number of its people throughout the 1990s, the same North Korea with an epidemic of meth addiction, the same North Korea that is 163rd on GDP per capita (5.9% of NZ levels), and the same North Korea that openly and massively restricts individual freedoms (disrespecting the heterogeneity of individuals) and constantly threatens war with the South.

Yes, the North Korean situation is more complicated than we often hear, the choices of South Korea (which was long a military dictatorship) are far from innocent, and I have no doubt that many North Koreans are trying to live their life with pride and dignity.  But then trying to blame the rest of the world for this (which is how these comments read) – I’m sorry Gareth but that is a massive step too far.

I like the fact you try to make us think, and that you are willing to take contrarian positions.  But these comments come across like support from a corrupt and frankly immoral regime – and I’m just noting it how I see it.

Sidenote: I struggle note to read this with a furrowed brow.  Most of the concerns about income inequality stem from the idea that the “relative poverty matters” because of competition for status/Veblen goods.  Such as the quality of clothing thanks to local screen printing companies.  Mentioning how well they dress implies there is competition for status goods, and given the low calorie intake of many in the country this is in itself a concern.

We may say “ahh, that was just the people Gareth met on his tour, it isn’t representative” – in which case this is just a biased sample in the first place, which wouldn’t be surprising given government guidance …. hmmmm.

Good.

Some will call this a currency war, or “monetization” – but again, this is the Bank targeting a specific inflation target in a forward looking manner.  This is what they should have been doing all along – and given it is a rule, it helps set expectations and acts as a “no-monetization” condition.

Some will say this destroys central bank independence.  I would note that the purpose of independence is to sovle “time inconsistency” in central banks – rule based policy does this fine.  It would only be a problem if the Japanese government tried to force them to violate the rule.

New Zealander’s will complain about the dollar.  Remember here that the BOJ has commited to inflation of 2%pa (where previously it was expected to, on average, be lower).  The return on holding a Yen has become more negative per year … and so the asset price of the Yen much fall.  This is what has happened, however the price inflation will ensure that the real exchange rate trends back to its true level.  Remember, the exchange rate is a price, and we need to think about the primitive causes of any issue in order to figure out if there is one.  The BOJ actually doing normal monetary policy isn’t negative for NZ – although it will sting the bottom line of people trying to sell to Japan in the near term (hola Rio Tinto).

Posts:  Money Illusion, Market Monetarist. (Where is the rest of the blogsphere, a credible commitment by the BOJ is actually a massive event … I haven’t seen much in the way of posts yet though.

By speeding the flood of less expensive imported products into Japan, the strong yen is contributing to a broader drop in the prices of goods and services, known as deflation, that has helped retirees stretch their pensions and savings. The resulting inaction on the yen, according to a growing number of economists and politicians, reflects a new political reality, with already indecisive leaders loath to upset retirees from the postwar baby boom who make up nearly a third of the population and tend to vote in high numbers.

To me, this comment is relatively nonsensical for two reasons.

Firstly, The Yen has “strengthened” from an incredibly weak level in 2007 – incredibly weak by historic standards!  Yes the Yen is now strong against the US dollar, but if you compared it to a wider basket of currencies this is hardly the case.

When talking about currency, historical context isn’t particularly useful.  Instead we need to ask things such as “what is purchasing power parity like” and “are they running a trade surplus”. It turns out that Japan is still running sizable trade surpluses, suggesting that (if anything) the Yen may still be too weak …

My second complaint is this view of the Yen and inflation – inflation is the growth in the general price level over time, a “high Yen” is a one-off price level shock … it doesn’t change the rate of growth in the general price level it merely knocks down the level as a one-off.  The endemic deflation in Japan isn’t a result of “fiddling with tradable prices”, it is the result of persistent deflation expectations feeding into the wage and price setting behaviour in the country.

Now if there is a generational war in this context, it relies on Japan’s pensions not being inflation adjusted.  Is this the case?  If not, this is much ado about nothing.

In truth the BOJ has tried to hold back from an explicit 1% inflation target, and is just discussing it as a “near term goal”.  While this isn’t as positive as the Fed move to an explicit inflation target, and Australia and New Zealand’s long-term policy of having an explicit inflation target and printed rate track, it is an improvement.

With Fed and BOJ policy improving, credit markets in Europe consistently settling since mid-December, implied volatility on markets way down (the VIX), and the cost of credit down significantly in the past 6 weeks we could be seeing a real improvement on financial markets.

What does that mean in little old New Zealand?  Well our higher exchange rate is tempering part of any stimulus coming from offshore, while its up to the RBNZ to keep an eye on the rate track.  If financial conditions look like they are going to improve in the near future the Bank may suggest that they will be lifting rates in larger chunks when they do get around to it.  It will be interesting to see what happens when we get to the March meeting.

Take into account that inflation has been stronger in China than it has in the US, and you get a story where the real exchange rate is probably lower than it was in 1994!

China is buying up US bonds at an incredibly low rate of return, as long as US isn’t “pissing the money in the wind” I can only see this sort of action hurting China – not the United States.  If the US is going to criticise China for creating and now maintaining “imbalances” I would like a slightly more sophisticated argument than “look at the exchange rate”.

How about “look at the artificially low rates of return in the past due to excessive artificial savings” – you make that argument, and it becomes obvious that fighting against China loosening global monetary conditions during a period where the world is suffering from tight money (even with amazingly low interest rates – as the equilibrium real interest rate has dropped markedly) and the  developed economy’s central banks wont doesn’t really make sense …

Hold up a second.  China maintains a “low” exchange rate by “saving” too much – and using that savings to do things like by US currency and bonds right.  Any subsidy on Chinese exports is “implicit”.

If  this is indeed the case, introducing duties is not the way to go about things – and by ignoring the central issue it will at best lead to an uncomfortable situation and poorer US consumers, and at worst will lead to a full scale trade war and a severe economic crisis.

If you think that having China save excessively creates risks to your own economy (as that sort of subsidy actually sounds pretty welfare enhancing in a direct sense – so we need to think about risks), then deal with it directly – eg by taxing capital flows from that specific country.  Don’t start rubbish protectionism.

In the past month the dollar has been falling, first as a result of the Canterbury earthquake, then due to the 50bp cut in the official cash rate by the RBNZ.  This all makes sense.  But then the dollar dropped very sharply from around the 15th of March – this was well after the MPS, and nothing had happened in NZ.  What was going on?

via NBNZ.

Specifically, the dollar dropped heavily against the Yen:

via NBNZ.

While the dollar was largely unchanged against the Aussie (apart from a random brief spike).

So what can we take from this?  Well, what was going on on the 15th.

• A few days earlier a massive earthquake hit Japan.
• By the 14th and 15th there were increasingly dangerous explosions in Japanese nuclear power plants following the quake.

With nothing else going on, it appears that concerns around nuclear fallout in Japan was the primary driver of a steep fall in the New Zealand dollar – especially against the Yen.

Read this another way, Japan has been hit by a major crisis and its dollar is appreciating!  I’ve seen this happen before in another large open economy called the United States – and I don’t like it.

So how does a negative shock to a country lead their dollar to appreciate – and why does it appreciate most strongly against countries like New Zealand and Australia.  Well there are a few theories we can speculate with:

1. Even with the crisis, Japan and the US are seen as “safe havens” while NZ and Aussie are “risky” – as a result, when people get nervous they sell risky assets (NZ currency) and buy safer assets (Japanese currency).  My main issue with this is that we also saw the Yen appreciate against the US dollar – however it could just be that the Yen is an even safer asset than the US currency.
2. A large amount of NZ’s external debt is financed by savings in Japan.  If Japanese residents are going to pull money back following the crisis (or are at least expected to) this could drive down the value of the NZ dollar.
3. The crisis in Japan is expected to interrupt, and reduce, global growth.  Given that we are a small open economy we are more vulnerable to changes in the global economic cycle – leading to our dollar responding more aggressively to such events.

Update:  Good comments regarding the issue from Eric Crampton and Miguel Sanchez.

I will however take some bits out for those who don’t want to leave right now:

In a game theoretic context, we usually think of competitive devaluation as a form of the prisoner’s dilemma, where the devalue option dominates the no-devalue option, and both parties end up with a devalued currency, but no net improvement because countries cannot all devalue against each other.

Indeed, we normally assume it is a net loss because of the costs of implementing policy in the future place.  However, things are different.  We have:

1. Some countries stuck at the zero lower bound for interest rates
2. Other countries with inflation problems brewing, who use capital controls to keep their dollar “devalued”.

So …

The Chinese can raise interest rates in order to stabilize inflation by cooling off the economy. However, that interest rate increase would exacerbate the capital inflow that would tend to appreciate the CNY. That in turn implies even greater forex intervention by PBoC, which in turn requires even greater sterilization measures, either by issuing more PBoC bonds, or by raising reserve requirements. The US measures to push down long term rates via QE2 have made that option more difficult.

Hazzah!  Further easing by the Fed actually makes matters more difficult for China in terms of keeping its currency devalued.  I would also note that there is a trade off for China given that it is building up reserves of US currency with these controls – if it extends controls, it increases the potential loss on currency reserves … implying that they will want to balance the competing goals of devaluation, and not being “too exposed” to the US dollar.  This implies some appreciation in the Yuan.

And finally …

One last speculation. The other countries facing a negative output gap (primarily other advanced countries) will face the same incentives as the US, and so will more likely try to depreciate their currencies. It’s true that this will tend to negate the US depreciation — but to the extent that this induces greater monetary easing in those countries, this is a positive outcome.

Yes, yes and yes.  This is why I find Europe’s view of what is going on perplexing (and to a lesser degree our Bank’s view of exchange rate movements) – I thought that an appreciating dollar would lead to central banks in advanced economies with depressed activity cutting interest rates (relative to what they would have done – so holding still instead of raising counts).

Why are so many developing countries acting like they can’t loosen monetary policy in the face of this.  If they don’t think its appropriate, it is because they MUST believe that current policy is consistent with their mandate (to keep inflation near target) and in that case why do they have a problem?

The US isn’t intervening in currency markets to try and change relative prices per see, it is simply easing monetary conditions because inflation is expected to come in below target.

Overall

Overall, it appears to me that a “currency war” that doesn’t turn into a trade war, and is based on independent central banks moving in the interest of their inflation targets is a GOOD thing.  It both ensures that:

1. Monetary stimulus is sufficient
2. There is additional pressure on countries that devalue their currency to allow appreciation.

Concerns about exchange rate volatility in this environment are important, and concerns about the potential for trade wars are also important.  But are we really going to blame the US for this?

I would blame Europe (as they seem unwilling to work with the US to ensure appropriate international monetary conditions) and countries that are determined to fiddle their currency – such as China.  And I’ll tell you want, if the Western World prints a bunch of money and they make an asset loss on their reserves, that’s China’s own fault – that was the cost they took on the build up their manufacturing industries.

Discuss   [I say this as I’ve taken a specific, extreme, position in the overall section of this post in the hope of getting push back]

Description of the world

Do I disagree that there were incentive problems and imperfections in the global economy.  Not at all.  However, I would hardly blame this on the “orthodox thought”.

The very fact that the losses could be socialised was part of the institutional setting that was provided by government – there was a trade-off between the moral hazard associated with such bail outs and the risk of a systematic bank run.  Helping to drive such problems were a host of other issues in the market – namely asymmetric information, a problem that may have actually been exacerbated by ratings agencies rather than helped.

However, none of this suggests massive socialist style capital controls – it simply suggests that policy makers have to be aware of the potential for government and market failure with regards to the finance industry.

Better information and education are the solutions – not enforcement of arbitrary central controls.

I would also note that the term Great Moderation was termed in 2002 to describe the 1990s – it wasn’t initially about the period 2002-2007 as Hickey suggests.  I would also note that it has not been invalidated, and was not a fiction – inflation expectations remain remarkably anchored, growth around the world responded amazingly rapidly to changes in the economic situation.

We experienced one hell of a shock in 2007 for sure – but that doesn’t invalidate the fact that we had 20 years of amazingly stable growth and inflation going on around the world.  The key lesson is to understand what happened now – not to rail against the good things that did occur!

Back to New Zealand

However, Hickey’s discussion on the world is simply a primer for his policy suggestions for New Zealand.  As a result, this must be the main focus.

We increased our foreign debt by NZ$97.5 billion inside the last six years, but all that happened is our per capita GDP actually fell over that period.We borrowed from the free and easy and low interest rate global capital flows to pump up asset prices and go on a spending spree. All we have left for it now is some leaky homes, a big debt and a hollowed out workforce.

Ok, lets think about these statistics a bit.  There are several issues:

The fall in per-capita GDP:

Yar, it has fallen.  Of course RGNDI (Real gross national disposable income eg *) has risen, which for a small open economy that has experienced a large change in the terms of trade and international transfers of income is a better indicator of actual income – but lets ignore that.

The key point here is “what has happened to potential GDP” – we are currently near the bottom of our “cycle” when in 2004 we were well on the way up on an “upswing” in our cycle.  We aren’t comparing like with like here – for example per-capita GDP took until June 1994 to recover to its previous peak from the 1991/2 recession!

As the economy recovers and unemployment falls, per-capita GDP will rise – as a result, looking at the current artificially low figure exaggerates the size of our relative debt position.

Liabilities:

Yes, liabilities have risen.  Furthermore the generally more relevant figure of net liabilities has risen, albeit by a smaller amount of $59bn.  Now, given this is an aggregate figure we should compare it to total GDP not per capita GDP.  So our net liability position as a % of a single year’s production is 88% in June, compared to 74% in June 2004.

Remember how I mentioned RGNDI before as well – you might say we should probably compare it to that, since that is a better measure of our underlying current income per year.  That would look a lot worse than the GDP stat, with debt rising from 90% to 128%!  However, this is a mistake as we are comparing a nominal variable (net foreign liabilities) to a real variable – so one is adjusted for the change in prices and one is not.

Working out GNDI manually (but excluding indirect business tax, as I didn’t get around to looking for it) debt rose from 78% of GNDI to 92% by June 2010. [Note:  Nominal GDP already captures the terms of trade impact, so using GNDI helps us capture the result of investment and transfer flows – which we know are a negative thing for NZ.  This is why we are getting out some bigger numbers ].

Now, these are some big looking numbers – but lets put it in perspective.  We are talking about a STOCK of borrowing that accounts for nearly a year of income (a FLOW).  In essence this doesn’t tell us anything about anything – and without actually digging down and asking what has happened with the money, and why, we can’t say whether this growth in debt makes sense or not.

Have people been investing, have they been consuming on the basis of future growth, or has their been some sort of market or government failure leading to a poor allocation of resources and leading to “over-borrowing”?

We need to answer these questions before we can interpret what is going on – if the high debt level in on the back of good investments that will lead to future growth, arbitrary restrictions are a bad thing.  If it is on the back of the fact that people WANT to borrow now, restrictions are bad.  But if there is an identifiable issue – we should tackle that issue, instead of throwing around random macro-policies and hoping we hit some arbitrary target set by a management consultant.

Of course – this entire debate requires that our statistics are perfect.  Stats NZ does a great job, but in a small economy like New Zealand we often find that it is hard to measure stocks of things, like net debt and wealth.

Liabilities part 2:

We borrowed from the free and easy and low interest rate global capital flows to pump up asset prices and go on a spending spree. All we have left for it now is some leaky homes, a big debt and a hollowed out workforce.

Two things scream out at me when I see this:

1. Interest rates were low and credit was cheap – so WE GOT A GOOD DEAL.  Surely the person who loses out is the person who is holding the asset with the low rate of return!!!
2. Is it even true we went on a spending spree?

If we look at the GDP statistics (*, *), we find that nominal consumption as a % of GDP was actually BELOW historic averages over most of the last decade.  It was spending on residential construction that was high.

So we may well have spent too much building houses that are “too big”, or houses where the cost of construction was “too high”.  But if this is the case then we know that there is a single INDUSTRY with an issue – not the whole economy.  It is an issue of POOR INVESTMENT rather than too many non-housing consumer goods.

And what has the government just done?  It has tightened tax rules around investment housing and it has tried to move housing in line with other investments.  It sounds to me like this “issue” has been identified and dealt with – why do we suddenly need to artificially restrict capital flows.

External shifts

We need to recognise that in a world of competitive devaluations, growing trade tensions and nakedly selfish vested interests (governments, multinationals and global investment banks) that we have to defend ourselves and be just as nakedly nationalistic.

We have to assume, just as Marx pointed out, that free markets will eventually overheat and blow up if we allow them free rein.

I would note several things here.  We are a social democracy, not the type of free market Marx discussed.  Furthermore, when there are “competitive devaluations” this increases the New Zealand exchange rate, which reduces inflationary pressure, which leads to lower interest rates from our Reserve Bank – this is part of the system in place.

The dollar has been high compared to history, well at least against the US and Yen.  I would note that commodity prices have been elevated and our terms of trade as a result strong.  Our dollar captures part of these external pressures, it distributes the income gains from higher commodity prices around the economy, it is doing what it is supposed to.

Fundamentally, there is a point here regarding currency – but I reach a different conclusion than Hickey.  Trade, capital, and exchange rate controls are a prisoners dilemma – a prisoners dilemma that helped make the Great Depression much worse.

However, unlike Hickey I can’t see us going down this road again – the monetary policy easings overseas AREN’T begger thy neighbour in the way Paul Krugman is suggesting if all monetary policy agents are responding by printing money.  Given that this response is part of a central banks reaction function, I think we are sufficiently fine here.

Now Paul Krugman is not wrong – he is far too smart to be.  He correctly recognises that, in practical terms, the US would be extremely slow to respond to a change in international monetary surroundings – given that they now have to do it through QE (Quantitative Easing).  NZ can still cut rates, and has the scope to get involved in the earlier, easier, stages of QE should things really deteriorate.

I realise that many people will fear that our Bank will not do enough in the face of lots of monetary easing overseas – that is a legitimate fear, given the observation of what has happened in the US.  However, in this case it STILL just says that we need to watch the issue of Reserve Bank action, not arbitrarily limit trade, currency, and capital flows.

Pure abhorrent 1984 style controls

Income needs to be redistributed to offset the concentration of wealth that naturally occurs in such a globalised, free flowing world of capital. Ownership of assets needs to be monitored and controlled. The growth of foreign debt needs to be restricted.

Consumers and bankers need to be saved from themselves.

Sorry what.

Seriously, this is just saying “I think other people are stupid and we need a central planner to live large portions of their life for them”.  This is abhorrent policy – it is a small step from this to supporting dictatorship.

Suppose there is some issue here – suppose there are legitimate income issues for example, or a belief in the social value of land.  If that is the case introduce redistributory policy or a land tax – don’t control peoples lives.

The state only has a role to take away someones liberty when they impinge on someone else “excessively” – the state SHOULD NOT do this just because the individuals involved in government think someone is borrowing too much.  Talk about an out of proportion response, gosh.

Debates

Stop the fudging and have a debate

Here I agree.  We should have an informed debate, with a clear theoretical framework for framing how these things function – and clear data, which we can use to analyse what is going on.

There may be legitimate reasons for introducing macro-policies.  I would personally always prefer it if we found the micro-drivers for any imbalance and dealt with them directly (whether it be the fault of government or elements in the market), but the debate should be had in a fully reasoned environment.

Calling on highly unorthodox trade, currency, and capital restrictions on the basis of how things “feel” is far from this.  So I don’t disagree with actual research – but I do disagree with the extreme policy prescriptions that have been raised, especially given that there is an unclear basis for these policies.

Currency wars

Brazil, like Australia and New Zealand, has a freeish floating currency that is rising as others try to devalue and buy into countries with hard rather than paper assets.

So people are buying things voluntarily off us, that is nice.

I believe I’ve covered this off before – if everyone else is printing money because they believe there is insufficient domestic demand (or they are implicitly defaulting on debt) then we can do the same.  Now, if this leads to inflation then hello … we don’t have a deficient demand problem anymore, and any unemployment is likely to be structural – indicating that we can’t really do anything.

Instead of focusing on relative currency rates I believe Hickey should be looking at the deficiency in aggregate demand – my good man just look at the money supply statistics, the money stock is falling at record rates and private sector borrowing is anemic, if you want a negative story you can take it from right there!

Conclusions

From a cursory look at the figures, it became clear that many of the issues that are being bemoaned can be solved simply by calling on the RBNZ to print more or less money.  Outside of the abhorrent call for central control of our ability to smooth our lifetime spending, this was the sole thing required.

The calls for trade, currency, and exchange rate controls seemed to stem more from fear than any underlying model of the economy.

Now I agree with his conclusion here:

I’d just like to have a debate and start looking for a new way to run our economy.

Although I would rephrase “way to run our economy” to “ways to improve outcomes in the economy” – as after all we aren’t communist.  This fact stopped me from writing immediately – but then these appeared (initial, 2nd, 3rd) and I knew I had to reply.

Hickey has fallen for the fallacy that we can centrally plan an economy and end up with outcomes that make us better off as a society – but when the central planners are imperfect, preferences are unknown, data is imprecise, and the consequences of our actions are unknown does it really make sense to shove our nose into peoples voluntary trade – if there are institutional issues deal with them directly, don’t just chuck in a bunch of macro policies that restrict voluntary trade in the hope of hitting your target.

And this is the key point of it, Hickey discusses the “free market system” – but he is merely bemoaning what occurs because people are voluntarily allowed to trade with each other, and when these people are able to form institutions are arrangements given this.  He is illustrating that the desire for “benevolent philosopher kings” did not die with Plato – or with the totalitarians of the early 20th century for that matter.

However, work has been done … a while back.

The linked to paper found that reserves were not excessive anywhere, expect China.  A good point to keep in mind no doubt.