Friday 1 March 2013

The dollar is a price

Matt Nolan's bemoaned that nobody quite seems to understand that exchange rates are just a price. He would love this particular example.

The story here is bad enough: the Greens calling again for bans on foreigners buying houses in New Zealand. They say it isn't racist, but when pretty much every complaint is around Chinese buyers, I call it a dog whistle.* It's particularly galling when it's smart-growth style, Green-supported policies that have forced the property supply curve to be near-vertical and have made it possible for increased demand to be met primarily by price increases rather than by supply increases. And kudos to Prime Minister Key for batting this one down, despite its populist appeal.

But here's one vox pop understanding of exchange rates. It's always a bad idea to read the comments section of anything (except Worthwhile Canadian Initiative and maybe sometimes this blog). But here's Veda's view on exchange rates, hoisted from the 3 News comments:
The wannabe property speculators are in full swing on this thread... All those who benefit from rising prices keep pushing the emotional spin about racism...

The reality is that foreign countries are manipulating their currencies lower (which pushes our higher) using whatever brute force necessary (low interest rates and massive currency sell offs) and the result is favorable terms for buying NZ property (as our high dollar makes land in NZ cheap when earning money overseas). This is driving NZ property prices well beyond fundamentals (what working kiwis can afford) and precipitates more NZ money flowing offshore (as more and more rentals are now being held by overseas interests). [rest truncated]
Where to begin. It's likely that one country's currency would be bid up relative to others' if others pursue devaluation policies. We can argue about whether it consequently means that New Zealand should follow suit, and I can't see how we can do it in any substantial way while staying withing the Policy Targets Agreement's inflation bounds, but at least that first part isn't completely mad.

But the point of devaluing your currency is to make other countries' products relatively more expensive. You discourage imports and encourage exports by effectively dropping your country's real wages: people from your country can't afford as much when the value of the currency drops. Because real wages drop, nominal wage rigidity doesn't matter as much and employment goes up. At least in the first order. It also makes intermediate imported industrial inputs more expensive and messes up a bunch of other stuff, but we'll take that as read.**

So here's a pop quiz. If we devalued to the point where $1 NZ = $0.01 US, would it become:
a) more expensive, or;
b) less expensive
for somebody earning US dollars to buy a house in Auckland?

Hint: every dollar earned by the American would count for $100 NZD when bidding at auction.

Veda wants to devalue the New Zealand Dollar so that foreigners will have a harder time buying Auckland real estate. And, obviously, rental income being sent abroad to foreigners is entirely offset ex-ante by those foreigners buying New Zealand Dollars to purchase the property in the first place.

Why oh Why does every vote count with weight of one?

* Dogs can hear dog whistles while people can't. Kiwis who hate the Chinese hear the Greens' dog whistle; those who don't, don't notice.

** Devaluation that's consequent to proper application of inflation-targeting policies I don't have a problem with. Monetary easing to keep inflation from being too low will have the consequence of devaluing the currency, but the devaluation isn't the point of the policy. And maybe devaluation is best policy if you've a massive foreign currency debt you can't otherwise repay. Otherwise, read Nolan, linked above.


  1. So, what determines the value of a dollar?

  2. I recall sitting in a meeting with a former PM one Sunday afternoon, years ago, and we were asked by him (several times) why he couldn't just devalue the NZ dollar against the AUS dollar, but leave it unchanged relative to all other currencies (e.g. USD), Of course this was in pre-floating rate days.

  3. So, I've been thinking on this post and Matt Nolan's linked post. And I posted this comment both here and there to get thoughts from both of you.

    I intuitively always assume that a high exchange rate benefits
    exporters (they get paid more) and harms local production. But I hadn't
    thought that all the way through. I've done some thought experiments
    here, and I think my conclusion is:

    - A high exchange rate is universally good for the country if you are a
    price setter - because your exports are worth more in international
    - A high exchange rate makes no difference to your terms of
    trade if you are a price taker, your price in external currency has not
    changed. However, depending on what happens in your local economy (do
    locally produced goods get cheaper in local currency terms or stay
    priced the same) it will alter the distribution of income between
    different segments of the economy.
    In short, I think this debate is
    therefore one in which exporters who are price takers are attempting to
    avoid their incomes reducing relative to the other people in NZ. It
    isn't a discussion about NZ v's the world, it's a discussion about some
    special interests wanting a better deal.

  4. I'd heard the story but didn't know if it were true or apocryphal. Hadn't known you were in the room!

  5. Supply and demand, both of which are more complicated than for other goods.

  6. Let's restrict ourselves to some ceteris paribus exchange rate change driven by, let's say, worries about Spain that otherwise wouldn't directly affect NZ. So that we can have an exchange rate change that's driven by something other than relative demand for NZ exports.

    It cannot be the case that the high exchange rate is universally good for price setters. Take the limit case where we had a monopoly milk exporter who was the whole of international traded milk. The monopolist is already setting quantity and price to maximise surplus; an exchange rate increase would mean the monopolist would need to change its pricing to keep things level.

    Among exporters, those facing a relatively more inelastic demand curve will fare better than those facing a relatively elastic demand curve when the exchange rate goes up, all else equal. You could perhaps imagine cases where the hike acts as a temporary cartel price Schelling point, but if that could hold in the longer term, it would have held without the exchange rate move. But in all cases, "better" here is relative: exporters, all else equal, prefer a lower exchange rate because that lowers their real wage bill and the cost of their domestically produced non-traded inputs. A whole ton is packed into "all else equal" here though. Do they use imported intermediate goods for starters? How flexible are wages? How much can they shift production around a set of countries to re-optimise?

  7. Why is there any demand at all? I know I demand dollars because people accept them as payment for goods and services. But why do they demand dollars? On the face of it, it appears to be mathematical induction without a base case.

  8. Start with Menger's text on money. Gold emerges to facilitate exchange, store value. Bits of paper start representing gold. Update since then to removing the gold backing; fiat money works because everyone trusts that it does and that it will continue to.

  9. Good thing the story didn't get out at the time... as I understand things, RBNZ was then having a hard enough time with runs on the currency. But I suppose it would have been ... interesting to see what currency traders would have done with a PM who believed you could devalue against only one currency in a world without independent central banks.

    The gains from getting everyone up to a 200-level understanding of micro and macro seem just so very large. Might as well wish for ponies at the same time I suppose.

  10. ARRRGH... Xenophobia != Racism. The concern isn't due to the belief that Chinese Asians are an inferior race (which would be racism), the concern is because Chinese "aren't" New Zealanders (Xenophobia).

  11. "fiat money works because everyone trusts that it does and that it will continue to". Perhaps, but this doesn't begin to say why the dollar is worth what it is, rather than twice that much, for instance.

    Or are you suggesting that stickiness is fundamental to the value of a fiat currency, rather than merely a temporary distortion to it? Von Mises seemed to think it fundamental; for example, in Part 2, Chapter 2, of the Theory of Money and Credit he says "This link with a pre-existing exchange-value is necessary not only for commodity money, but equally for credit money and fiat money. No fiat money could ever come into existence if it did not satisfy this condition." I don't find this convincing, though, partly because Bitcoin exists.

  12. I didn't say the policy was racist, I said it could be a dog-whistle for racists. If the press were full of stories about other rich foreigners bidding up prices, I'd dismiss the dog-whistle aspect. But the usual stories are around Chinese investors buying up property. Given that background context, the xenophobic policy is a dog-whistle for racists. If there weren't that background context, it wouldn't be.

  13. Wasn't BitCoin based on something real - the number of computations needed to run some complicated factorisation?

  14. At best the computations put an upper limit on the value of Bitcoins (but I'm not even sure about that; at any given point in time, new Bitcoins enter circulation at the same rate, regardless of how much computational power is devoted to "mining" them, because the difficulty of the computation is automatically adjusted). The computations, which are useless in themselves, don't explain why Bitcoins are worth anything at all.

    Let's try this: if everyone holding NZD notes and coins threw away half of them, and creditors all simultaneously forgave half of each NZD-denominated debt owed to them, would this tend towards doubling the value of the dollar? (Noting that this tendency may be opposed by things like minimum wage laws, for example, which may (or may not) put downward pressure on the value of the dollar.)

  15. In pieces then:
    1) MV=PQ; halving M will halve P assuming price flexibility and no effect on V; currency appreciates
    2) More realistically, RBNZ sees what's happening and offsets entirely to maintain Pdot at 1-3% over the medium term.
    3) If the creditors are domestic, no effect. If foreign, then NZ-based demand for foreign currency to pay back foreign-denominated loans drops and NZD appreciates.

  16. Right. I think I agree so far. Now, what if only the stock of notes and coins is halved (and the NZD claims against the Reserve Bank, if you like), but debts are left intact? Would this still have the full effect of halving P?