How tight is tight?

Everyone is primed for higher interest rates: some folks thought the Reserve Bank would even start the process last week, but in any event there's a near-universal consensus that the next Monetary Policy Statement (March 13) will see the first hike in the Official Cash Rate.

Over at The Visible Hand In Economics, the question's been asked, ''Should we hit inflation hard and fast?', if you'd like to contribute to the discussion. My own view is that we've got some potential inflation problems emerging - non-tradable, domestically generated inflation is 2.9% already, and rising -  but even so I'd be concerned about a sharp and quick rise in interest rates, mainly because I'm not sure everyone realises how much monetary policy has effectively tightened already, through the mechanism of the higher Kiwi dollar.

Here's that old measure of overall monetary policy, the Monetary Conditions Index, updated to the present.

It combines the 90 day bank bill rate and the trade-weighted index of the Kiwi dollar into an overall measure of the bite of monetary policy. I know, it's not perfect, but it's a better view of the policy setting than you'd get by looking at interest rates alone. And what it shows is that we're already near the kind of monetary policy tightness that was appropriate towards the end of the strong economic cycles of the mid 1990s and mid 2000s. So in my view it would be easy to overtighten by mistake - especially, as seems likely, if rises in the OCR translate into an even stronger Kiwi dollar.

Follow the money...

I know I've said it before, but there really are so many business surveys around these days that even dedicated economy-watchers can't keep track of all of them. Inevitably some slip under the radar.

One you might have missed (and I came across it only accidentally while foraging a while ago for something else on the bank's website), is the quarterly ASB Kiwi Dollar Barometer. It's well worth having a look at: it's quite a decent sized survey (390 firms with turnover of at least $1 million) of businesses' exchange rate expectations and their forex hedging plans.

The latest one came out last week. The headline result was that businesses (averaging out both importers’ and exporters’ views) expect the Kiwi dollar to peak against the US$ around the 81 cent mark  in the March ’14 quarter, and to decline to 76.5 cents by the end of next year. Currency forecasting, many would say, is a complete waste of time, and perhaps these businesses' expectations will prove just as wide of the mark as any other forecaster's. But I doubt it.

For one thing, consensus forecasts across wide groups tend to do better than a single guy with his spreadsheet.

And for another - and this, to me, was the really interesting bit - the businesses are putting their money where their mouths are, as this graph shows.

Notice that the percentage of importers planning to hedge has hit a new high: in real time, with real dollars, import businesses are increasingly taking out protection against the Kiwi dollar falling.

You might wonder (as the ASB economists did) why the proportion of exporters planning to hedge also ticked up a bit in this latest survey - if they really believed the Kiwi dollar is going to fall, they'd be planning to do less hedging. The ASB team commented that "It is likely the recent strength in the NZD has seen exporters look to protect themselves against further increases in the NZD, even if their core view is that the currency will ease over the year ahead".

I think this is absolutely right, because I've seen this happen before. Years ago I worked for a forex consultancy business in London, and our customer list looked like a hospital ward: every corporate in Europe that had run into financial grief appeared to be on our books as clients. Why? Because they were already in such a difficult position that the last thing they wanted was to have forex losses on top of everything else.

And that's where Kiwi exporters are right now. They might believe the Kiwi dollar is going to fall - but they can't live with the risk that it might tighten the screws even further on them with another bout of appreciation.

A balanced view of financial innovation

I was browsing around Slate magazine, as you do, and in one of those 'From Around The Web' sidebars I came across this - Economist Robert J. Shiller: Greed Isn’t Good, But Capitalism Still Is.

It's a price published in Credit Suisse's online magazine, The Financialist, which the bank describes as offering "An informed but inventive, offbeat take on things—never the conventional wisdom".
The piece certainly achieves that.

The conventional wisdom is that financial innovation in recent years has been the death of us, through not only bringing us the GFC but also contributing to various other issues, including widening income inequality.

What Shiller points out - and he holds more moral authority than pretty much anyone when it comes to overexuberant financial markets, having been correctly sceptical about both the dot.com bubble and US house prices - is that financial innovation has had social benefits, too.

Have a look for yourself. It's a good deal more balanced than a lot of recent academic comment on banking and the financial markets.

Is bad news the only news?

Last night I watched  the BBC World News, on Sky. And it had a major hooha about sharp falls in the Japanese stock market. The big news, apparently, was that the Nikkei had had a substantial fall - they talked about 5%, though the index data at the close weren't to hand, and in the event it was a less newsworthy but still largish  fall of 3.4% (opened at 14,072.9, closed at 13,589.03) - and the programme went on to note that, having hit a five week low, the Nikkei's weakness was causing alarm and unrest in the rest of  the Asian markets. No doubt the other news channels were running similar items.

Talk about something that is literally true, yet unbalanced.

Six months ago (its closing level on November 30 '12) the Nikkei was at 9,446.01. Since then, and even after this latest 'dramatic' fall, it is up by 43.9%. If this is a weak market, please, Oliver-like, could I have more.

Was there equivalent coverage when the market was rising? Were the TV channels as diligently reporting large gains as they have been in reporting large losses? For example, in the space of six days, 2nd to 8th of April)the Nikkei went from 12,003 to 13,193, a gain just shy of 10%. Were last night's handwringers celebrating back then? Cue for a Tui style: yeah, right. Investors becoming massively better off is, apparently, not news.

Irrespective of thoughts about media posturing, what's really going on?

The Japanese market had run hard and run strong. It had some good reasons for it. The new Abe government decided that it wanted substantially more spending on infrastructure, very low interest rates for even longer, and a much lower exchange rate (the whole 'Abenomics' thing). This big reflationary impetus greatly improved the short-term prospects for Japanese GNP growth and for Japanese corporate profits. A big rise in the equity market was entirely consistent with this new set of policy settings.

Did the equity market overdo things? I'd say, very likely. The Japanese share market is not the most transparent or above board of the world's equity markets, and a semi-organised over-ramp of share prices wouldn't have surprised me in the least. And even in less - let's call it collegial - markets, asset prices are well known to have tendencies to overshoot the levels that the fundamentals might justify. In some sectors of the Japanese market (and most notably the property and property development companies) share prices had, to use a technical economic term, gone mad.

The real news, in short, is that an extraordinarily strong equity market had got a bit irrationally exuberant, and needed to be a bit more realistic.

Was that too hard for the media to say?