Currency risk

Radio New Zealand reports international student visa numbers are down; they blame the high dollar.

The real cost of tertiary education in New Zealand can vary substantially with exchange rates. There isn't much that any University can do about levels, but we could perhaps be doing more to reduce uncertainty.

Who is better placed to mitigate the risk of currency fluctuations: a family sending their kid abroad for study, or large enterprises with budgets in the hundreds of millions and with finance departments?

A first step in mitigating that risk would be exchange-rate-sensitive international student fees. We could offer tuition packages allowing international students a few ways of offloading currency risk:

• Pre-paying multiyear tuition to lock in current exchange rates, with guaranteed refund in home-currency dollars if the student drops out [the University then forward contracts or buys options to limit its exposure, enjoys earning interest on the pre-paid fees];
• Tuition guarantees: for an up-front fee, guarantee that the per-course tuition fee as measured in the student's home-currency will not vary upwards by more than some amount. Set the up-front fee so that it's enough to buy options to lay off the risk. So long as the University can buy those option contracts more cheaply and with fewer hassles than can a student, this should be a worthwhile proposition;
• Exchange rate insurance: the University sells to incoming students contracts that give them a cash bonus if their home currency drops by a set amount. Tuition is maybe a third to a half of an international student's total cost of study. If the home currency tanks or the NZD jumps, living here gets a whole lot more expensive. Universities can use the up-front fees to buy option contracts on foreign currency that would let them pay out the students in case of dramatic currency fluctuation. Again, so long as large institutions have cheaper access to these kinds of contracts, this should work.

As best I'm aware, no university in New Zealand offers these kinds of currency deals; I've never heard of their being offered in other countries either. The odds that I'm missing something big and important seem larger than that it's just the usual non-profit inertia - it's unlikely that everybody would be missing this trick if it really were a twenty dollar bill on the sidewalk. Then again, as Tyler Cowen put it:

I work in what is perhaps the most competitive and successful sector in the most competitive and successful economy of all time.

And yet what I see around me is a total, total mess.  And I believe my school to be considerably above average in terms of how well it is run.

If somebody can tell me what I'm missing, I'd appreciate it. 

Another option that could help, and as suggested previously, the government could guarantee that international students completing a degree at one of our better tertiary institutions would be given permanent residence on degree completion, subject to the usual criminal background and health checks. The path from student visa to work visa and residence is pretty easy, but it adds uncertainty for students who don't know that it's likely to work out. Making the default be permanent residence on completion unless you screw something up badly, rather than having to go back home unless you get everything right, could make the degree more attractive even when the dollar is higher for a longer period. Added benefit: foreign students currently cross-subsidise domestic students. Increasing the ratio of foreign to domestic students would effectively increase tertiary funding without it having to hit the government's books.

Update: Luis suggests some reasons:

@ericcrampton Management costs per student? Risk of screwing uphedging (e.g. ft.com/cms/s/0/adc3b9…)? Ratio private/gov funded students?

— Luis A. Apiolaza (@zentree) March 12, 2013

Management costs per student shouldn't be that high - when the student purchases the contract, you buy the option contracts, then forget about it until you need to execute. Risks of screwing it up are large though if universities are incompetent at this kind of thing. The link Luis provides points to the temptation to overmanage and earn on the hedge rather than just keep it as insurance. I doubt that any university's portfolio of international students includes enough home-government funded students to make the packages not worth offering, but it could be true in some places.

More on Exchange Rates

Eric posted on Monday about the Stuff.co.nz article in which he was extensively quoted. I am mostly in agreement, with the article and Eric’s quoted comments, but there are a couple of places where I take issue.


First, the article takes as a given that the New Zealand dollar is overvalued. Now, this mantra is so commonly stated that one can hardly criticise a journalist for taking it as a received fact. Indeed, the article is able to reference a fairly high authority on this:

And the International Monetary Fund says the kiwi is about 15 per cent overvalued. It has said that repeatedly, at least as far back as May 2010.

Now staffers at the IMF are not stupid, and there is probably a well-defined question to which “overvalued by 15%” is the answer, but assessing that answer would require knowledge of what the underlying question is. The first thing I tell my 2nd-year micro students each year, that to start a piece of economic analysis with a price is to abdicate one’s responsibility as an economist. It is akin to a psychologist explaining some strange observed piece of human behaviour by saying “that is what they wanted to do”.

Let’s revisit some exchange rate basics. We have a clean floating currency. That means that the price of the currency is set at whatever level enables all who want to buy and all who want to sell at that price to do so. At first pass, that sounds like a perfectly valued exchange rate. Furthermore, the complaints about the kiwi being “overvalued” have been consistently heard for about a decade at least, so it would be hard to say that it is the result of a speculative bubble with speculators consistently entering on the demand but not the supply side.

So why is the dollar at the level that it is? One possible reason in recent years is the high demand for milk solids from China creating a boom for New Zealand dairy exports. Yes, this is not so good for manufacturing exporters, but the technical term for such a change is “the terms of trade going in our favour”. Alternatively, we can point to investment opportunities in New Zealand consistently being higher than the available pool of saving, coupled with a large pool of savings from China being available to prevent interest rates rising to choke off that investment. Again, a big increase in supply of foreign capital when NZ is a net buyer counts as a favourable terms of trade shock.

Pretty much the only way I can make sense of the “NZ dollar is overvalued” mantra is as an extension of the argument that New Zealanders are not saving enough, in the same sense that we don’t eat enough fruit and vegetables, drink too much alcohol, don’t attend enough classical music concerts, and have too much sex during rugby world cups.

But, and this is my second issue with the original article,  Eric is coming perilously close to this view when he is quoted as saying,

Fundamentally, New Zealand has a high exchange rate because we're an attractive place for foreign investors to put their money....Our relative lack of domestic savings in things other than housing means that the returns on other kinds of investment here are relatively high.

Hmmm. The fundamental problem with housing in New Zealand is land-use regulations reducing the extent to which savings can be directed into the creation of new housing stock. As I have noted before, the purchasing of existing houses is neither investment nor saving in aggregate, and so cannot explain the net demand for foreign capital.

Exchange rates

Michael Berry looks at New Zealand's exchange rate in this weekend's Christchurch Press. I provided a few comments; he's quoted me accurately. I'm copying below what I'd sent Michael, not because he's gotten anything wrong, but rather because it seems a waste to lose the bits Michael didn't use. The paragraphs answer questions about which he'd asked me to comment.

“The exchange rate reflects a complicated mix of foreign demand for New Zealand assets and exports, domestic demand for foreign goods and assets, domestic savings rates, and trader expectations about what will be happening with real asset returns in New Zealand relative to other countries. Trying to push it around without thinking hard about the reasons that it’s currently high isn’t without risk. If there are structural problems in the economy that, if fixed, would reduce the exchange rate, that would be a good thing – but mostly because those problems are worth addressing regardless of the exchange rate. For example, we rely on capital imported from abroad because a reasonable proportion of domestic savings are invested in housing. Fixing land use policy to reduce the cost of housing would free up some capital for domestic investment, reduce demand for foreign capital, and help push down the dollar.”

“A lower dollar could help some exporters in the short to medium term, but we have to remember the mechanism by which this works. A low dollar helps exporters by reducing the real wage they pay to their employees. At the same time, it increases the cost of machines and equipment that manufacturers import – our manufacturers losing access to those goods hurts us. In the medium to longer term, wages, in New Zealand Dollar terms, are bid up. And then exporters suffer again the next time that the exchange rate rises and they’re stuck with a wage bill that’s high compared to their export earnings.”

“There is absolutely no good reason for New Zealand to be considering quantitative easing. Quantitative easing is a policy that you try when you’ve reduced nominal interest rates to zero, have indicated that long term rates will remain at zero until inflation expectations come back up, and still have inflation outcomes that are at or below the bottom of the Reserve Bank’s target band. We are not in that world. If we tried it now, with so many other options still available to RBNZ if needed, our central bank’s international credibility would be completely shot. It would be like cutting off your hand because you had a hangnail.”

“A pegged currency also is a last-resort kind of policy. If different countries are affected by different economic shocks, independent currencies give economies ways of easing those shocks. A pegged exchange rate effectively means that you’ve given up having an independent monetary policy. That’s not a bad idea if you have a terrible central bank and you’ve not otherwise been able to establish central bank credibility, but it’s a particularly bad idea for a small open economy subject to idiosyncratic resource-price shocks and with a decent central bank.”

“The Tobin Tax is another of those ideas that sound good on paper – stick it to the speculators! – but risk being pretty awful in practice. The transactions tax is meant to reduce currency volatility by requiring that the expected returns from any trade be higher before anyone make the trade. But, there is reasonable argument that this kind of tax instead can work to increase volatility – it opens up the bid-ask spread on a currency and thins out trading markets. Further, New Zealand Dollar exchange rate movements seem to be on longer cycles than we might expect would be smoothed by a transactions tax. Even if this kind of tax reduced volatility, it would seem likely to do more to reduce intraday volatility than the longer term increases and decreases in the dollar that New Zealand experiences. Those persistent swings seem more likely to reflect fundamentals.”

“Fundamentally, New Zealand has a high exchange rate because we’re an attractive place for foreign investors to put their money. Our relative lack of domestic savings in things other than housing means that the returns on other kinds of investment here are relatively high. Because we have decided to impose very tight limits on urban growth, preventing our cities from either increasing in density or expanding at the fringes, property prices have been something of a one-way bet. So it isn’t surprising that Kiwis choose to put a lot of their savings into housing. Changing land use policy so that households could choose to put a bigger portion of their savings into the real economy would reduce our need for foreign capital and would help reduce pressure on the dollar. It’s a policy worth doing for its own sake, and if you want a lower dollar, it would help to work to that end.”

“The most important thing that the government can do in the next year is start fixing land use policy. Current policy hurts young people trying to get into their first homes and consequently helps encourage them to move overseas; it also embeds a lot of fragility into our cities in case of disaster. Imagine what Christchurch would be like today if, after the earthquake, developers had quickly been able to get a pile of new subdivisions up on the edges of town. Instead, we’re only now seeing consents issued for developers to start building. Christchurch home owners are not even allowed to build a secondary flat with a kitchen into existing homes except under regulations that make it uneconomical to do so; letting them do that would have been one of the quickest ways of getting new housing supply into the market after the earthquakes. Instead, it was forbidden.”

Dutch diseases, the dollar, and the MPS

Today's Monetary Policy Statement rightly notes that continued strength in the New Zealand dollar means there's less reason for increasing interest rates.* The Policy Targets Agreement requires that the RBNZ keep the inflation rate over the medium term between 1 and 3 percent. There seems to be no pressure on the CPI: iPredict forecasts through September quarter have it between 1 and 2 percent. At the same time, there's no prediction of interest rate hikes through the end of the year (though backing out cumulative probabilities from the sequence of quarterly "What will RBNZ do" forecasts isn't straightforward). I'd worried that the GST hike might have fed through into more wage settlements despite the offsetting income tax cut; that seems not much to have happened and forward-looking expectations are within bounds. Nice call RBNZ; I might just lose my bet with Matt.

The MPS has been interpreted as sending signals about the RBNZ's views on the appropriate level of the dollar; Alex Tarrant takes it as warning of interest rate cuts if the dollar stays high. And the MPS does wonder whether the recent appreciation is justified:

The New Zealand dollar has appreciated markedly since the publication of the December  Statement. This appreciation is difficult to reconcile with developments in New Zealand’s economic environment, having occurred at a time when export commodity prices have tracked sideways. Instead, the exchange rate appears to have been driven upward by a combination of an easing in global monetary policy and recovery in global risk appetite. 

The March projection assumes the New Zealand dollar TWI depreciates modestly over the next few years. Should this not occur, all else equal, the Bank would see less need to increase the OCR through this time. While helping contain inflation, the high value of the New Zealand dollar is detrimental to the tradable sector, undermines GDP growth, and inhibits rebalancing in the New Zealand economy.

But this doesn't translate into the RBNZ now targeting the exchange rate, even if Bernard Hickey wishes it were so. The high dollar automatically keeps the CPI down by pushing down the price of tradeable goods in the CPI basket. So if the dollar stays high, there's less need for RBNZ to do anything on interest rates. And if policy easing elsewhere is pushing up the New Zealand dollar, that might give reason for easing on our own part to avoid falling below the lower band of the PTA, if there's risk of falling below the lower bound. iPredict says 10% chance of inflation below 1% in either of the next two quarters, so it's not looking particularly likely. RBNZ, in my reading, is just reminding folks that its inflation target is bounded both from above and from below and using that to do a bit of jawboning on the dollar.

I'm less than convinced that a high dollar is such a bad thing. Even if dairy prices have been flat over the recent few quarters' dollar appreciation, it's hard to say whether that means that the dollar's current strength is unjustified or whether it means the weakness during the worldwide recession was a temporary thing. If the appreciation is due to "the increase in risk appetite, higher global commodity prices and further policy easing by major central banks", a decent chunk is just a return to the status quo ex ante, and perhaps only a temporary one with Greece looking more likely to have a messy default sooner or later and with reasonable concerns about malinvestments in China. But if the rest of the world is getting better, we're back to folks being willing to take on currency risk in exchange for relatively higher returns available in NZ.

Import-competing sectors face stronger competition when the dollar is high. But it's debatable whether some of those import-competing sectors should even here exist. Book retailing probably shouldn't survive here outside of a few niches in the long term when BookDepository can get books here from the UK, delivered, for a bit more than half of the current retail price. If the worry is that milk exports drive up the price of the dollar and hurt other manufacturing, that's not unlike the current situation in Canada where oil and commodity exports have strengthened the Canadian dollar. Stephen Gordon there is trenchant:

Firstly, the prospect of fewer Canadians making things for foreigners is to be welcomed: what matters for Canadian economic welfare is consumption by Canadians, not making things that will be consumed by non-Canadians.

The Dutch disease story also supposes that the employment losses in the export sector are not offset by employment gains in other sectors. This has clearly not been the case in Canada: the resource boom of 2002-2008 saw a steady reduction of unemployment rates to their lowest level since the Labour Force Survey started collecting data in 1976. Nor were these jobs systematically lower-paying: after stagnating during the 1990s, real median wages saw significant growth during the resource boom -- even in Ontario.

Real median wages here also increased substantially from 1998 to 2009 or so**, with nominal stagnation and some real decline during the recent period.

Commodity price driven dollar appreciation isn't as much a disease as a recommendation to shift resources to their more highly valued uses. We're shifting towards dairy manufacturing and away from other forms of manufacturing. I wouldn't call it a disease in need of treatment.

* Please take the strong caveat that I am not a macro economist. And, while I think I was right in criticizing the RBNZ back in 2005 for being too slack, they were very right and I was very wrong in early 2008 when I worried about their very rapid cuts in interest rates.

**This is a nominal series; CPI here for adjusting. Real median wages up about 18% over the decade.

Quit freaking out about the (NZ) dollar

Yes, the New Zealand dollar is high currently relative to the US dollar. This has some folks all in a tizzy. But it's not like we're the only ones appreciating relative to the US. Should we be as worried about the drop in the NZ dollar relative to the Australian dollar? The very mild increase relative to the Euro and the Yen? Should we fear that the ghost of Muldoon has come and ensured a devaluation only relative to the Australian dollar? Ok, the ghost of Muldoon does scare me. He's been tweeting.

Here's the New Zealand dollar relative to other major trading partner currencies. I left out the Yuan since it just follows the US dollar. The link gets you the Kiwi versus the US Dollar; add in the others by hitting the "compare" box.

The New Zealand dollar is high relative to the US dollar and the Pound but has only seen lukewarm appreciation relative to the Canadian dollar and the Yen and mild depreciation against the Australian.

Here's the decline in the US dollar relative to everybody else. They've held steady relative to the Pound, but that's about it.

The US is dropping relative to everybody except the Brits.

You should be asking about my choice of start dates. I truncated the series just before a big data glitch in Yahoo Finance where an error in the recorded value of the New Zealand dollar wrecks the whole graph.

Journalist Alex Tarrant pestered Labour leader Phil Goff about the exchange rate, reminding him that a high exchange rate (which Goff opposes) mitigates relatively high current inflation rates (which Goff also opposes). Goff's answer? That economics is a dismal science so making one thing better often makes another thing worse, but that current high exchange rates induce unemployment and that inflation has worse effects when unemployment is high.

Goff didn't say it, but I suppose the policy implication is changing the policy targets agreement to tolerate higher inflation outcomes (or otherwise messing around with the Reserve Bank's mandate), resulting in a lower dollar, potentially higher employment in the short term, and rather higher inflation. But if his real policy preference is higher inflation outcomes with (he hopes) lower unemployment, it would be hard to discern that from his constant sniping at National for the increase in the price level that came from the GST increase - an increase that was fully compensated by income tax cuts. Labour's apparent proposed hike in the inflation rate would be compensated by hopes that the long run aggregate supply curve isn't vertical.