It’s all Cretan to me

Adam Creighton’s opinions fascinate me. When I used to receive his pieces of work in the Australian for free, I’d relish poring over them to tally the logical fallacies. (Adam-up, I say.) Regardless of the issue he was prosecuting (against a disability commissioner, the welfare state, or the inevitability of inflation from quantitative easing), I could almost guarantee that every time I picked up a Creighton piece I’d be taking the case for the defence. I’d never encountered a series of positions I opposed more comprehensively.

For a time, our continual, invisible disagreements irritated me. As a disciple of Hayek, Creighton appeared to provide example after “extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam,” to purloin Keynes’s evisceration of Hayek’s Prices and Production. In my weaker moments, I considered shouting childish epithets at his by-line, or otherwise punning on the Epimenides paradox, but I slowly realised that, like our respective role models, Creighton and I simply spoke different languages.

To be fair, Mike Wazowski is far more one-eyed.

Thus I was given an opportunity to appreciate his writing anew. Whereas once, I considered the windmills Creighton crafted to be a blight on the landscape, now I recognise that he was providing a renewable, sustainable flow of opinions to tilt at. Reading his columns in this mindset has not aligned our perspectives, but it has strengthened and sharpened mine. And for this, I owe Creighton a considerable debt. But it’s a private debt, so I trust he has no instinctive objection to it.

Australia-New Zealand Currency Union

Our divergence persists. Creighton and I are on opposite sides of the coin regarding his latest proposal, a trans-Tasman currency union. Much like the bilby, this idea typically remains underground for a long time before emerging, often in April, just in time for Easter (or Anzac Day). And much like the bilby (or that tortuous setup), it refuses to die.

Creighton identifies three ‘irrefutable and clear’ benefits of a currency union. It would:

  • Eliminate the bank fees associated with AUD/NZD foreign exchange transactions;
  • End these foreign exchange transactions altogether (the majority of which are ‘speculative flows’, largely unrelated to the ‘real economy’);
  • Abolish the Reserve Bank of New Zealand and cede that nation’s monetary policy to the Reserve Bank of Australia.

While these are facts, their benefits are debatable and the logic used to argue them deserves inspection.

Bank fees

Let’s follow Creighton’s lead by discussing his weakest point first. The fact that bank fees were the first flaw identified with separate currencies (before the elimination of transactions altogether) speaks to the free-marketeer’s natural aversion to fees, taxes, duties and other grains of sand in the gears of an otherwise pristine market economy. While I won’t argue against fees being a deadweight loss in this scenario, why should we stop at those incurred in currency trade? The logic that would combine Australia and New Zealand’s currencies in order to economise on transaction costs could just as easily be invoked to justify merging the equities of Australia’s major banks. Why not combine everyone’s shareholdings and have a single ASX listing, BigFourBanks (BFB)? The banks are structurally similar, their workers are mobile, they’re buffeted by similar shocks and their equity prices regularly move together.

This is a facetious example, but it should draw attention to the inefficiencies in the foreign exchange market which are far more egregious than fees and charges. Speculation might be a blight, but why not adopt a yet more interventionist remedy? The Australia Institute estimates that a Tobin Tax on financial transactions could help to reduce financial market speculation on all traded assets, and net the Australian government between $1 billion and $1.5 billion every year in the process. And we could call off the search for the inevitable native-bird-related nickname for the joint currency. (Though I’d respectfully submit the Crowe.)

In the name of King John, pay or burn.

Speculative flows

Foreign exchange speculation is unquestionably destabilising and, as it dwarfs the flows involved in international trade in goods and services, will typically deliver an exchange rate which is divorced from any of your preferred concepts of underlying ‘fundamentals’. But playing devil’s advocate, Creighton acknowledges that the very reason the currency union debate is re-emerging is because the Australian and New Zealand dollars are close to parity. Does this mean that the speculators have finally, if unwittingly, done the right thing by the ‘real economy’, revealing a true AUD/NZD exchange rate of unity? That would mean that this whole proposal has been prompted by a coincidence. Or does Creighton have the fatal conceit to divine the price of one New Zealand dollar, better than the myriad rational investors in the foreign exchange market? As other ‘wages and prices become more flexible’, why should we volunteer to fix the most important price in a small open economy?

Consolidating central banks 

This is the most contentious point in the piece, and one which I can’t agree with. Creighton celebrates the euro area (whose nations have ceded their currency sovereignty to the European Central Bank), for its apparent contribution to ‘price stability, competition and transparency’. I would hesitate to attribute either the fleeting successes or the ongoing woes of the eurozone (elevated unemployment and underemployment, tendency to deflation, and anaemic GDP growth) to a single cause, but the restrictions of the Maastricht treaty and the inability of constituent nations to draw cheques on their central banks have surely exacerbated the eurozone’s chronic deficiency of demand.

More importantly, in Creighton’s exposition it is unclear who determines New Zealand’s interest rate. In one sentence he acknowledges that, if its central bank were subsumed by Australia’s, ‘New Zealand would lose the ability to set interest rates’. But in the next he attributes the higher interest rates New Zealand has traditionally experienced to the risk premium investors attach to holding its more ‘marginal currency’. Giving Creighton the benefit of the doubt, I’ll assume he’s referring to New Zealand’s Overnight Cash Rate (OCR) in the first instance, and the schedule of bond interest rates in the second. But for as long as the RBNZ exists, the risk premium investors attach to the currency has no effect on the baseline interest rate in the economy. Rather than falling out at the intersection of the investment and saving schedules, the OCR is determined exogenously by the central bank, while investment and saving adjust to this rate via changes in income.

The Bottom Line

The case for a trans-Tasman currency union is not strong; nor is it strengthened by the arguments advanced above. The experience of eurozone nations should caution other countries against yielding their currency sovereignty, unless an equivalent fiscal authority is established in tandem. A union would indeed give New Zealand such a fiscal authority–Australia’s–so it would have more policy space than Greece or Spain, but much less than it enjoys now. Whether the New Zealand government would be content to assume the same fiscal status as an Australian state remains an open question, but one that is unlikely to be answered in the affirmative.

Creighton is correct to suggest that, while Western Australia and Queensland (the states consistently voted Most Likely to Secede) are often economically different enough from the rest of Australia to justify independent currencies, such an arrangement would be ‘ridiculous’. I agree. And for this reason, the Australian government has established a system of transfers to the states, which although imperfect, has no counterpart in the eurozone. State governments, like eurozone nations, cannot draw cheques on the central bank, so their expenditure relies on independently raised taxation revenue, income from the sale of real or financial assets, and–unlike the eurozone nations–transfers from the federal fiscal authority.

In becoming the ninth Australian state/territory, New Zealand would consign itself to an economic fate only slightly improved on that of the eurozone nations. While this would vindicate any journalist who might have previously drawn spurious parallels between the once-sovereign New Zealand and the non-sovereign Greece, the costs of a currency union to the Kiwis would surely outweigh this merely academic benefit.

Postscript: As so often, Wynne Godley argued along these lines most eloquently, in Maastricht and All That, which I highly recommend.

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