At first glance, New Zealand appears to enjoy the same “hot money” problem as emerging economies such as Thailand. There, global investors have been driving the currency higher by flooding the country with money.
But the problem for New Zealand is that its own investors and consumers refuse to hold cash over anything else. The Reserve Bank in Auckland hiked its base rates once again this month. The tenth hike in three years, it took overnight yields on Kiwi Dollars to 7.50%, giving New Zealand the second highest rate of interest in the developed world after Iceland – a position it’s enjoyed for the last 7 years straight.
Yet still the Kiwis treat cash like an embarrassing friend they failed to ditch during their first year at college!
Real estate prices keep rising. Imports keep outpacing exports so fast, the trade gap now stands at 7.4% of the economy. Inflation by 2008 will rise from 2.3% to 2.7%, says the Reserve Bank. But higher rates still haven’t eased New Zealand’s disdain for cash.
“Given our relatively high interest rates,” said Alan Bolland, governor of the Reserve Bank, in a speech last Thursday, “New Zealand has attracted a disproportionate share of global liquidity in recent years, putting upward pressure on the NZ dollar despite a relatively large current account deficit.”
No kidding! Bonds issued by foreign speculators in NZD – those “EuroKiwi” and “Uridashi” bonds pumped out by Frankfurt and Tokyo investment banks looking for free profits – now total NZ$55 billion. That’s equal to one-third of New Zealand’s GDP.
Source: Reuters, Bloomberg, RBNZ
“The upward pressure this has put on the New Zealand Dollar and downward pressure on [long-term] interest rates,” says Bolland, “has exacerbated the current problematic imbalance between traded and non-traded sectors in New Zealand.”
In plain English, financial assets have soared, but the real economy has sunk. In 2006, New Zealand racked up the 15th largest trade deficit in the world. Not bad for a nation of just four million people. (The US came top, followed by Spain and then Britain.)
New Zealand’s also got a max’ed-out housing market and a bubble in consumer-credit. Its currency looks over-valued on any kind of fundamental basis. And sitting atop this must-have collection of “haute finance” springwear – as worn by all of the most fashionable Anglo-Saxon economies this year – you’ll find an inverted yield curve.
Just as with Sterling, US and Australian Dollars, it’s now cheaper per annum to borrow New Zealand’s money for repayment five years from now than for repayment in 2008. The bond market doesn’t believe rates will stay high, in short. So why bother hiking?
“There’s increased skepticism that the combination of high rates and the high currency will be sustainable,” reckons John Body, head of financial markets at ANZ National Bank in Auckland. “It could lead to a slowing of the economy and so we could see the exchange rate go down.”
“New Zealand’s growth is skewered to the downside and that has sucked fresh buyers from the kiwi,” says Body.
But most problematic of all, however, is what’s going to happen when all those Euro-Kiwi and Uridashi bonds reach maturity. Tokyo and Frankfurt investors alike will need to redeem the bonds with Euros and Yen. And to raise that cash they’ll need to sell New Zealand Dollars.
New issues of Uridashi and Euro-Kiwi bonds peaked at the end of 2005. A two-year play on the free profits between New Zealand rates and the low-yielding currencies proved most popular. So redemptions are set to peak at the end of this year.
Okay, the “free money” gap has since widened out to 700 points. That might help create fresh Uridashi and Euro-Kiwi bonds for a while. But when confidence in the New Zealand Dollar finally catches up with the hard facts of New Zealand’s own cash-hating economy, something’s going to give.
We guess it won’t be the price of gold measured against the Kiwi currency.
for Markets and Money
Editor’s Note: City correspondent for Markets and Money in London, Adrian Ash is head of gold research at BullionVault.com. – giving you direct access to investment gold, vaulted in Zurich, and low-cost gold investing.