INSIGHTS BLOG

NZ DOLLAR DOING ITS JOB AS A SHOCK ABSORBER

Roy Davidson, 20 March 2020

In recent weeks as the fallout from the coronavirus outbreak has escalated, the NZ dollar has fallen sharply against other major currencies, namely the US dollar and the euro.

NZ dollar has weakened sharply in recent weeks

NZ dollar has weakened sharply in recent weeksv2

A weak currency isn’t necessarily a good thing, especially if you rely on importing goods into the country. However, at times like this, it’s not an entirely bad thing either. In fact, a weaker currency can act as a useful ‘shock absorber’ when our own economy, or the broader global economy, weakens.

How does this work?

Sudden upheaval offshore, of which there aren’t too many better examples than the shutdowns caused by coronavirus, can throw markets into a spin. In these instances, overall demand levels decrease, resulting in falling prices for our export commodities. This is a clear negative for a small open economy like New Zealand which is heavily reliant on its export sector.

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However, a declining currency immediately acts to offset this weakness, boosting NZ dollar denominated prices and allowing the economy to more quickly adjust to the new conditions than if the exchange rate was fixed (as it was in the past). This supports the crucial export sector, protects employment and keeps things ticking over. Obviously, the nature of the coronavirus serves up a whole host of unique issues. Nonetheless, the principle remains.

On the flipside, a stronger dollar can help keep a lid on things during periods of comparative economic strength. A stronger dollar helps prevent the economy overheating (by acting in reverse to that described above), and also helps keep inflation under control.

We can see this in action by looking back over the period since the NZ dollar was first floated in 1985. The experience since this time shows that, while having a currency that can at times be volatile can be annoying, its ability to act as a shock absorber in a small country that is heavily reliant on trade, is incredibly valuable.

1987 and the years following were particularly harsh for New Zealand which had just liberalised its economy via a series of much needed market reforms. While painful, a declining currency helped insulate the impact. Fast forward to the Asian Financial Crisis beginning in 1997 and the dollar, which had appreciated in value over the prior years, again sold off sharply. As with before, this helped New Zealand, and the struggling export sector, get through the crisis.

The currency then recovered through a period of strength in the 2000s before the global financial crisis plunged the world into recession. The NZ dollar sold off, though the dollar was much quicker to recover this time with New Zealand experiencing a better economic environment than the rest of the world, helped by our ties to China which stimulated its economy heavily.

Value of the NZ dollar vs. the US dollar over time

Value of the NZ dollar vs. the US dollar over time

Now with coronavirus (and in fact over the preceding few years), we can see the same thing happening. So, while its’ probably going to be a bit more expensive to buy things from offshore for the next little while, just bear in mind that a weaker NZ dollar is providing crucial support for our exporters, and, in turn, all of us.