[This post was published online at Stuff and also in most Fairfax Media New Zealand newspapers on 21 August 2018 as part of my fortnightly Stuff column]
The recent decline in the value of the New Zealand dollar is about to breathe new life into agriculture. It will take some months before the benefits flow through to farm level, but the macro signs are there to be seen.
The key question is whether we are seeing a strategic reset or is it just short term. My own thinking is that it is medium term through to around three years and maybe beyond, but with inevitable volatility. Beyond that I cannot see.
First let’s get the basic maths sorted out. A lower value of the New Zealand dollar means that we get more New Zealand dollars for exports. And in the New Zealand context, that largely relates to our primary industries, principally agriculture and horticulture, but also forestry and fishing.
A lower exchange rate will further increase the attractiveness of New Zealand to foreign tourists. However, the prices received by Kiwi operators will basically stay the same because they are set in New Zealand dollars.
A lower exchange rate also increases costs for all New Zealanders. That means more expensive petrol, more expensive foreign travel, more expensive cars. more expensive pharmaceuticals, and more expensive computers. Inflation will rear its head.
In summary, a low exchange rate breathes air into the export industries and this flows through to the rest of the economy, but it does raise costs for everyone.
To understand something of the future, we first need to understand something of the past. In particular, why has our exchange rate been so strong for most of the last ten years? We also need to understand the basics of how exchange rates are set.
The basic model I use is a ‘flow of funds’ model, recognising that total inflows and outflows of the combined capital and current accounts must always balance. Exchange rate and interest rates are the mechanisms by which this is achieved.
In the last fifteen years of the 20th century the New Zealand economy underwent painful restructuring. Agriculture was also struggling from low international prices. Times were tough and Kiwis were leaving each day by the planeload for Australia and further afield. They took their money with them. By the turn of the century, the dollar had dropped to around US40 cents,
Then from 2000 to 2010, world prices rose for most agricultural products, and particularly the ones New Zealand is good at producing. This pushed the exchange rate up to around 70c by 2008. These were good years both for agriculture and the broader New Zealand economy. The high exchange rate also kept a lid on inflation.
The global financial crisis in 2008 and 2009 saw the New Zealand dollar drop back to around 50c, before recovering in 2010. This helped keep the economy insulated from some of the worldwide problems. Agricultural prices wobbled around but the overall trend remained upwards.
Whereas the driver in exchange rates in the first decade of this century was primarily the better prices for our exports, since 2010 the big drivers have been capital inflows. Just like exports, they keep the exchange rate high.
There have been three well-recognised fundamental forces that have been driving these capital inflows. One has been that Kiwis started returning home, mainly from Australia but also the UK. Inward immigration also increased, fuelled by easy entry. Capital also flowed in for both productive investments and housing, with New Zealand a refuge for Asian investors in particular.
There was also a fourth force which has been largely underestimated. It was the Christchurch earthquake.
Most New Zealand insurance policies are underwritten from overseas. My estimate is that this led to inward flows of about $NZ20 billion in the five or so years after the earthquake.
In response to all of these forces, there was only thing that could happen – our exchange rate rose. For approximately three years it was in the mid $US80 cents range until the dairy crash of 2014/15 brought it down. Since then it has largely bounced between 70 and 75 cents but currently is down into the mid 60s.
The key point is that all four of the big capital inflow drivers of recent years have now gone. It is going to be a new world here in New Zealand as we refocus on a sustainable economy.
If lower exchange rates prevail in the years ahead, then that does not necessarily mean it will be plain sailing for agriculture. There are too many other forces out there to be confident of that. But it does mean that New Zealand agriculture will be buttressed against some cold winds that might blow in from overseas. It may therefore help provide an environment where agriculture has some financial resilience needed to address some of its other challenges.