The Reserve Bank of New Zealand took the step of lowering interest rates overnight, defying market expectations. For the first time in four years, the central bank cut rates by 25 basis points to 3.25%.
The RBNZ last lowered rates in 2011, when the cash rate fell by 50 basis points to 2.5%. Since then it has actually raised rates three times, back up to 3.5%.
This latest move tells us two things. The first is that New Zealand’s long term economic prospects are poor. For that very reason, it may be the catalyst for an aggressive rate cutting policy in the future.
This leads us directly into the second point. If the RBNZ is to further relax its monetary policy, it will signal New Zealand’s re-entry in the international currency wars.
What are currency wars…
Currency wars are primarily the preserve of central bankers. As defacto rulers over monetary policy, central banks have the power to affect economic conditions to try and promote growth. By weakening currencies, the theory goes that central banks can boost an economy’s export potential.
The concept of currency wars was re-popularised by leading economist and investment banker Jim Rickards in 2012. His book, Currency Wars, opened up many people’s thinking to the realities of what’s really going on in the global economy.
It’s become self-evident that central banks have become reliant on this tool to spur economic growth. But as Jim points out, looser monetary policy is based upon a flawed logic.
‘What is happening is that countries are using cheap currencies to steal growth from their trading partners. But the impact on overall growth is negative.
‘The impact of a strong currency is highly deflationary in a world where there is not enough growth to go around. [And] deflation makes debt harder to repay because the real cost of nominal debt goes up’.
That hasn’t stopped the central banks from trying to ‘devalue’ their way to growth. Since the start of 2015, twenty central banks have lowered interest rates worldwide. But the current phase of currency wars didn’t start this year. It’s been in force since at least the beginning of the decade. Jim explains:
‘This new currency war began in 2010. It’s not surprising that the war is still raging in 2015. After all, it has been only five years since it started.
‘Based on the past two currency wars, the one now being fought could easily last until 2020. If the international monetary system doesn’t collapse first, which it might’.
…and why is New Zealand taking part?
It’s not all that surprising that New Zealand has joined the currency war bandwagon.
Slowing growth; an overvalued currency; and weak exports have been a growing problem in New Zealand. These are, by and large, the same difficulties afflicting Australia.
But with rates above 3%, the RBNZ has had ample room to go lower. That’s especially true if we compare them to other developed economies that have hit a zero interest rate floor. So why did the RNBZ decide to act now?
In their official statement, the RBNZ states:
‘The New Zealand economy is growing at an annual rate around 3%. That’s supported by low interest rates, high net migration, construction activity, and [lower] fuel prices.
‘However, the fall in export commodity prices that began in mid-2014 is proving more pronounced.
‘The weaker prospects for dairy prices and the recent rises in petrol prices will slow income and demand growth. [That will] increase the risk that the return of inflation to the mid-point would be delayed’.
Curiously, the RBNZ also mentioned in their statement that further cuts could be ‘appropriate’. That’s a signal to the market that the RBNZ is serious about driving down the value of the NZ dollar. They wouldn’t have made mention if they didn’t want an instant reaction in the market. And they got it. The NZ dollar fell from US$72 cents to US$70 almost immediately.
Their signals make it almost certain the RBNZ will make further cuts in the coming months. Some economists are already penning another 0.25% rate cut for next month. National Australia Bank analysts also believe this could be followed by a third rate cut in September.
What’s to stop them? With inflation well below the target level, there’s no reason for the RBNZ to keep rates above levels of other developed economies.
The prescription drug for all modern economies is just too addictive for central bankers to resist. In the short term, it’s appears to be a reasonable policy. But because all economies are engaged in the same practice, the overall impact on growth is negative. In the long run, that could make the downturn all the more painful when reality catches up with central bankers.
Contributor, The Daily Reckoning
PS: Currency wars are the last stop resort to halt the terminal decline of developed economies.
The Daily Reckoning’s Greg Canavan, like Jim Rickards, sees through the currency war deception. It may delay the inevitability of a recession. But it won’t prevent its ultimate arrival. As one of Australia’s leading investment analysts, Greg is convinced that Australia faces a recession in 2015.
In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why the Aussie economy is in its current state. He’ll show you why our national and household debt has spiralled out of control — and why that makes a recession inevitable.
But he also wants to show you a way to protect your wealth. Greg knows what steps you need to take right now to protect yourself from the fallout of the imminent recession. To find out how to download his free report now, click here.