Thursday, May 19, 2011

Take that, Friedman

I keep hearing about how the UK gov't is cutting spending, in a desperate and probably doomed effort to bring the finances into something like balance within a reasonable timeframe.

Meanwhile, the New Zealand government continues spending as if it seriously believes the Rapture will strike on Saturday. In the wake of economic disasters (the collapse of one mine, and the announcement after an investigation that fully half of those remaining open have unsafe working practices), natural disasters (the Christchurch earthquake) and financial disasters (still no end to the stream of financial firms needing bailouts), the government doesn't hestitate to reach for its chequebook.

Yet for some reason, the foreign exchange markets love the Kiwi dollar over the pound. Can't get enough of it.

Each time some fresh disaster strikes New Zealand, the dollar rises. It's uncanny, really.

I can only conclude that free markets (I think the forex markets are about as close to 'perfectly free' as any existing market) believe strongly in the merits of heavy-handed Keynesian economic intervention.

Think about that, next time someone tries to tell you that governments shouldn't interfere because free markets know best.


Anonymous said...

Let's see if blogger will let me post today (having rejected my last couple of attempts with obscure error messages on which googling fails to throw any light).

1. You can't ignore historic imbalances. I see the current rate is £1 to $2.04, but I'd still expect $2 to come closer than £1 to buying you a loaf of bread.

2. You can't ignore regional trends: the world is rebalancing away from historically-rich but aging and debt-ridden Europe towards other areas, while the Pacific is rising.

3. Not sure how bad NZ is, but the UK should've crashed and burned about five years earlier than it did and is still feeling the pain not only of a huge bubble, but of the government as was in 2008 printing Weimar money. Or, to put it another way, the UK's decline has brewed in the Pork Futures Warehouse since about 2001.

4. Today's "cuts" story is just that: a story. It just means public spending is rising more slowly than ... well, than it might be if every special interest group got its pork-barrel in full, plus something on top.

Anonymous said...

Aha, it will let me post today!

Let's add another point. Forex is free, but for whom? It's a generation ago that Soros vs a UK government that wasn't quite prepared to "do whatever it takes" at any price demonstrated how markets can be manipulated. The world today is caught up in the fallout between currencies bigger than ours: the dollar (how much does it take to shake out reserve currency status?), the Euro (political motivations vs financial ones), and the rise of China.

vet said...

Last time I saw any convincing figures on the subject, the PPP equilibrium level between the two currencies should be about $1 = £0.46. Today the exchange rate is about £0.485. So that doesn't explain further changes at this point.

What gets to me is how, whenever I check the rates after some particularly disastrous item of news. For instance, on 7 April the government announced a bailout package for an insurance company that was threatened by bankruptcy after the Christchurch earthquake - and the NZ dollar promptly jumped from 0.471 to 0.476.

(This particular bailout - not the only one in the past 12 months - cost about 0.3% of GDP. That's equivalent to £6.5 billion to the UK economy.)

Granted the UK has a huge hangover from the 2000s, but if there is anything at all to this "free market" theory, that should have been factored into forex rates years ago. And the regional balancing idea would be more convincing if the Pacific was looking at all stable; but we've just had the Japanese tsunami, bad economic news from Japan, and Fiji and Tonga are looking very dodgy right now - if that flares up, we'll be up to our neck in Pacific refugees, on top of the Christchurch ones.

I agree that forex markets are routinely manipulated for various reasons, but market theory says that these manipulations can only be short-lived (and the more short-lived, the better for the manipulator). It was failing to grasp that idea that led Norman Lamont to grief in 1992.