Dollars & Sense: NZ economy needs Aussies more than ever

One of the great things about economics is everything is connected with everything else.

If you move something here, it will affect something else over there.

Amateur economists only see the direct links between things, which is where ridiculous policies like raising tariffs on imported goods will force people to buy local.

Another thing you learn in studying economics is that things have the tendency to move in cycles. Unfortunately, the cycles change in timing and amplitude, and sometimes disappear entirely for a while before reappearing.

What you learn—less through formal study and more through practical experience—is that it’s hard to predict many things because there are always shocks appearing.

Some shocks are big, some are small. Some last a long time, some pass quickly. At the moment we are seeing a deepening European economic and financial shock tied to the risk of Greece leaving the Euro, and Spain’s banks enduring a slow-running build.

The thing about shocks is that just because you know one is happening does not mean you have the foggiest idea how it will develop. This is a key problem with the European situation. Not a single soul knows how Greece will leave the Euro if they do, whether Spanish banks can survive and the economic consequences if they do not.

Similarly, we can’t guess if other countries will leave the Euro, and how exchange rates and commodity prices will move in response to all of these unknowns.

So we get what we had this week with the NZ dollar jumping by one and a half cents against the greenback, in spite of the situation in Europe getting worse.

Why the rise? There were two factors in play.

The first is that across the ditch, right after the Reserve Bank of Australia (RBA) reacted to the deteriorating global situation by cutting interest rates another 0.25 per cent, after slicing them 0.5 per cent two weeks ago, they received a shock: better than expected economic data.

The Australian economy grew by 1.3 per cent during the three months to March and not 0.6 per cent as had been estimated.

Plus, another 39,000 net extra jobs appeared in May, and employment now sits 1 per cent ahead of a year ago.

I suspect had the RBA known these numbers were going to appear, they would have stayed their hand for another month at least.

The growth in Australia’s economy was a strong factor which helped our economy through the global recession of 2008-2009, and their continuing growth will be an ongoing source of support.

It will also be a factor in our labour market tightening up, while encouraging more and more Australian companies to move here in order to reduce their labour costs.

The other shock causing a rise in the NZ dollar this week was the expectation the United States Federal Reserve would engage in what is called QE3.

This means the third bout of quantitative easing, or printing money. But from where I sit, the 287 point surge in the Dow Jones share index on Wednesday night, following rumours of an announced easing, and expectations of better US economic growth, show the poor knowledge which still exists and the inability of centralised authorities to do anything about the current weak US and world environment.

QE3 would not be needed if QE1 and QE2 had worked. Printing money merely leads to extra weakness in the newly debased greenback, and leads to more funds going into assets like government bonds and commodities. Some money even goes into the sharemarket.

The week has been one in which the markets appear to have pulled back from the brink in their assessment of what the impacts of Europe’s downward spiral will be.

But apart from the obvious strength in Australia, there is the smell of desperation around which suggests this strength in our currency will not persist in the short term. 

Tony Alexander is the chief economist of the Bank of New Zealand