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Edition 01 : 13 September, 2012.

Edition 03 : 09 February, 2013.

(VERSION EN FRANÇAIS PAS DISPONIBLE)

Summaries of monetary reform papers by L.F. Manning published at http://www.integrateddevelopment.org

The referenced papers :

NEW Capital is debt.

NEW Comments on the IMF (Benes and Kumhof) paper “The Chicago Plan Revisited”.

DNA of the debt-based economy.

General summary of all papers published.(Revised edition).

How to create stable financial systems in four complementary steps. (Revised edition).

How to introduce an e-money financed virtual minimum wage system in New Zealand. (Revised edition) .

How to introduce a guaranteed minimum income in New Zealand. (Revised edition).

Interest-bearing debt system and its economic impacts. (Revised edition).

Manifesto of 95 principles of the debt-based economy.

The Manning plan for permanent debt reduction in the national economy.

Missing links between growth, saving, deposits and GDP.

Savings Myth. (Revised edition).

Unified text of the manifesto of the debt-based economy.

Using a foreign transactions surcharge (FTS) to manage the exchange rate.

(The following items have not been revised. They show the historic development of the work. )

Financial system mechanics explained for the first time. “The Ripple Starts Here.”

Short summary of the paper The Ripple Starts Here.

Financial system mechanics: Power-point presentation.

USING A FOREIGN TRANSACTIONS SURCHARGE (FTS) TO MANAGE THE EXCHANGE RATE.

SUSTENTO INSTITUTE CHRISTCHURCH

WORKING PAPER: USING A FOREIGN TRANSACTIONS SURCHARGE (FTS) TO MANAGE THE EXCHANGE RATE.

By Lowell Manning and Raf Manji

Version 3 19th May 2012

INTRODUCTION

There is now wide recognition among economists and politicians in New Zealand that New Zealand’s exchange rate is too high ¹ and this is causing a further deterioration in the country’s current account.

The exchange rate is too high because foreign ownership of New Zealand’s economy measured either as its accumulated current account deficit or net international investment position has reached crisis level and is expanding rapidly ².

The foreign ownership manifests itself in two main ways.

The first way is through direct foreign ownership of domestic businesses, property, land and resources. The New Zealand banking system is a good example of direct foreign ownership.

The second way is by claims on New Zealand businesses, property, land and resources created by private bank offshore borrowing to satisfy the foreign exchange mechanism. That level of borrowing is NZ$74.5 billion ³. But for that borrowing, New Zealand would have been forced to sell another NZ$74.5 billion of its businesses, property, land and resources to foreigners. Further sales of that scale would lead to foreign ownership of most of New Zealand’s productive capacity. Much of it is already foreign owned ⁴.

[1] For example, New Zealand Reserve Bank Governor Allan Bollard Official Cash Rate (OCR) review 26/4/12: “The New Zealand dollar has stayed elevated despite recent falls in commodity prices. Should the exchange rate remain strong without anything else changing, the Bank would need to reassess the outlook for monetary policy settings.”

2 The rate of increase slowed briefly in the March 2010 and March 2011 years because of low bank profits and a highly positive balance of trade following the 2008/2009 recession, but both of those elements are returning towards past trends. The rate of increase in the current account deficit is rising again. There have also been large inflows of re-insurance money due to the Canterbury earthquakes but they are now recorded in the capital account of the National Accounts rather than the Current Account.

3 Reserve Bank of New Zealand Statistics Table C3 Monetary aggregate components – current- March 2012

4 New Zealand net capital stock by asset type current prices (replacement) March 2011 excluding residential dwellings was NZ$304 billion. (NZ national accounts Table 1.7) The accumulated current account deficit was NZ$181.9 billion. NZ$181.9b/NZ$304b = 60% foreign ownership of which (181.9-74.5)/304 = 35% is direct foreign ownership and 25% indirect through foreign borrowing by M3 institutions. The figures do not take into account RBNZ net foreign currency assets,

The recent sale of New Zealand assets such as the Crafar farms to Chinese interests or the partial sale of New Zealand public energy companies and other public assets is pointless and self-defeating. Not only is the scale too small to be effective in reducing foreign ownership of New Zealand land and productive resources, but the current account deficit will expand even further as profits derived from foreign ownership are remitted offshore.

New Zealand has become the Greece of the Southern Hemisphere. Greece faces its crisis because it does not have an independent currency. It is tied to the Euro and is therefore unable to adjust its exchange rate to protect its balance of trade and improve its current account deficit by making exports cheaper and imported goods and services dearer. New Zealand is facing a similar crisis because its floating exchange rate mechanism doesn’t work and never has worked since the New Zealand dollar was floated in 1985. This is because the large foreign debt held by domestic banks has to be continually refinanced abroad. Historically, a current account deficit would see a weaker currency as investors refused to finance the debt until the currency fell to a level that was likely to improve the balance of payment and, consequently, the broader current account. In the post 1980s world of deregulated global capital flows, investors’ searches for yield often sideline concerns about overall debt levels ⁵. New Zealand’s domestic monetary policy has been captured by offshore funding requirements and foreign investors delight in the high yields on offer for its debt, a situation that has persisted now for nearly forty years.

5 The UK balance of payments crisis in 1974 is a good example of this.

The offshore funding requirements mean that New Zealand must pay the worldwide “going rate” for investment funds to attract foreign lenders. This process is euphemistically called “foreign investment” within the orthodox economics fraternity, but it is really an international pawnshop that has turned New Zealand into an investment price taker, not a price maker. The price it pays to keep further direct foreign ownership of its assets at bay is the opportunity cost of foreign capital. The United States or other major trading partners may choose to invest elsewhere whenever they can get a higher return on their investment. That is why New Zealand does not control its own exchange rate and, by inference, its currency.

Generally speaking, the lenders of funds to countries with an accumulated current account deficit come from countries with accumulated current account surpluses. Worldwide, total deficits bear a close relationship to total current account surpluses. The risks and moral hazard of chronic imbalances in international accounts was the reason JM Keynes tried to get support for a balanced international trading system at Bretton Woods in 1944. He was effectively vetoed there by the United States that, at that time, held a stranglehold on international trade and wanted to make sure the US$ was at the centre of the new global trading system.

The scale and size of notional foreign ownership (debt) of the New Zealand economy is rapidly driving the country to its knees and is a direct cause of its relatively poor economic performance in recent decades. When faced with real impending economic doom, the orthodox response that “nothing can be done about the exchange rate” borders on gross negligence. If there are no economic tools in the toolbox to fix the problem, economic policy makers (Treasury, Reserve Bank, Academia) have a duty of care to the country at large to create new tools that will work.

FOREIGN TRANSACTIONS SURCHARGE (FTS)

One way to correct the exchange rate is to use a variable automatically collected Foreign Transactions Surcharge or FTS, which would be simple to administer ⁶. It has only very rarely been used in the past ⁷.

Some academic literature supports the need for foreign exchange management or “capital controls” to correct the balance of payments and the current account. Capital controls have been used in countries like Singapore, Brazil and Malaysia. Similar policies such as “pegged” exchange rates have been widely used by major countries around the world, including Japan and China. The use of the United States dollar as the world’s “reserve” currency also comes into the same general category. The FTS maintains a full currency float, but manages outward financial flows.

FTS is a fiscal policy rather than a monetary policy, and it works at a conceptual level by creating a dual exchange rate, one for inward monetary flows and one for outward monetary flows.

One objection to a unilateral FTS is that banks and traders might be able to evade the surcharge by “bundling” transactions and reporting, say, only a single daily settlement sum, or else trading in New Zealand dollars offshore. However, such objections, even if they purport to apply to international card and Internet transactions, are a regulatory matter rather than one of policy or principle. There seems to be no valid reason why, with the availability of modern technology, individual reporting and processing of transactions should not be required in New Zealand or, where relevant, by offshore correspondents and affiliates, backed by a legally enforceable regulatory framework ⁸.

A broader issue is whether a foreign transactions surcharge would contravene international financial agreements. There are provisions in the relevant international World Trade Organisation (WTO) protocols for countries to protect their balance of payments and the GATT Article XI clause 1specifically permits appropriate taxes to be applied.

The proposed FTS is not a tariff or trade barrier of any kind but simply a process that pays “due regard to the need for maintaining or restoring equilibrium in their balance of payments on a sound and lasting basis” ⁹. Nor is it a restriction on capital flows as such. It is, in principle, temporary, because it will apply only until the net foreign debt has been repaid. It is a variable fiscally neutral tax on all outgoing foreign exchange transactions. It goes no further than the specified objective of balancing the current account and progressively repaying, over time, the accumulated net foreign ownership claims on the economy. This proposal mirrors the historical position that existed prior to the removal of the US$ gold peg in 1971 ¹⁰, and it is also very similar to the position advocated by J.M Keynes and the British delegation at Bretton Woods in 1944 ¹¹.

⁶ The “beauty” of FTS is that it applies to outward capital flows, not inward capital flows. Moreover, FTS is not a “restriction” on capital flows but a temporary universal tax on all outward transactions.

7 It was used successfully in Tonga in the 1980’s, but repealed when it had done its job. However, the Tongan FTS was neither variable nor tax neutral. Source: personal discussion with the former Tongan Minister of Finance.

8 Setting the parameters for that regulatory framework falls beyond the scope of this paper.

9 General Agreement on Tariffs and Trade (1947) (GATT), Art XII, 3(a)

[1]⁰ Under the gold standard, capital flows do not appear to have been directly restricted, but they were influenced by the exchange rates fixed from time to time.

[1]¹The famous Bretton Woods meeting was where the basis for the post World War II financial architecture was agreed among the allied powers. The British position was effectively vetoed by the United States that sought (and obtained) the broadest possible global role for the United States dollar as the world’s reserve currency.

Financial receipts from the surcharge would be used to offset a corresponding amount of domestic taxation (for example by reducing GST), to make the surcharge tax-neutral apart from any receipts put towards foreign debt reduction. Its intent is to correct the current account, part of the balance of payments as defined in the legal WTO, GATT, GATS texts, by removing the existing subsidy enjoyed by those engaging in foreign currency transactions at the expense of those who do not engage in such transactions or engage less in them ¹².

Those using foreign currency in New Zealand will, for the first time in decades, pay the actual price of doing so. The subsidising of heavy foreign exchange “users” by foreign exchange “savers” may be indirect, but it is very real and very large. New Zealand’s large current account deficits and heavy foreign ownership (debt) burden mean its interest rate structure is considerably higher than in other comparable countries with a strong international debt rating. This keeps both domestic debt servicing and the exchange rate well above what they need to be, seriously affecting the country’s potential economic performance.

The overall saving to the wider New Zealand economy from the introduction of an FTS is likely to be more than the annual current account deficit itself ¹³. In addition to the obvious reduction in interest costs and the amount of foreign debt there are consequential downstream benefits to the economy of a country like New Zealand from using an FTS to properly manage its current account:

A foreign transactions surcharge would cause the exchange rate to fall towards a stable base level allowing exports to increase and imports to decrease, providing a more even playing field for local manufacturers and producers ¹⁴.

1² This will also help to offset the increase in the domestic price of some essential items like fuel that result from the application of FTS.

[1]³ Each 1% in interest rate alone represents nearly NZ$3.2 billion per year on domestic credit of around NZ$320b, including foreign debt held by the commercial banks, as at March 2012 (Reserve bank of New Zealand Statistics Table C3 Credit aggregates–current) . Estimating the actual economic effect of FTS is outside the scope of this paper, but, according to the System of National Accounts, every dollar off the current account deficit is a national “saving” before taking into account other downstream benefits.

[1]⁴ Rose D (2009), “Overseas Indebtedness, Country Risk and Interest Rates”, Policy Quarterly, Vol 5 Issue 1, February 2009, notes that, historically, exchange rates have relatively little influence on imports, but it is likely that the FTS would act more directly on the import sector because it is visible, being drawn directly from bank accounts.

Introduction of the FTS policy could allow the removal of all remaining tariffs and subsidies in the New Zealand economy making it one of very few tariff-free nations in the developed world. The FTS would make imported goods more expensive ¹⁵ and locally produced goods relatively cheaper thereby stimulating the domestic economy. There would be no further NZ dollar currency speculation because the FTS would be higher than any conceivable short-term gain from present speculative capital flows. At the same time, long-term capital investment should not be affected ¹⁶.

The FTS can also be seen as a correction designed to offset the unmanaged volatility in New Zealand’s exchange rate since the currency float in 1985. In New Zealand in March 2008 the Trade Weighted Index (TWI 5) that reflects the country’s exchange rates against the currencies of its five major trading partners stood at 71.6. A year later in March 2009 it was 53.8, a fall of 25%. As of mid June 2010 it was back up to 67.7. In April 2012 it was back over 72 ¹⁷. Such volatility makes long term planning by exporters all but impossible.

An FTS starting, say at 10% would, on the basis of current total payments to the rest of the world of NZ$77 billion, ¹⁸ realise perhaps NZ$6 billion in FTS surcharge income ¹⁹. That would be enough to reduce GST to 10% from 15% and begin foreign debt repayment ²⁰. A higher level of FTS might be needed during a transition period to reduce any initial tendency toward capital flight and to manage the Keynesian “transfer problem” ²¹. The government would adjust the FTS as and when required. A 10% FTS would induce a significant adjustment in the prevailing Trade Weighted Index (TWI) though probably less than the short term New Zealand dollar exchange rate volatility in recent years.

[1]⁵ FTS would be a powerful incentive to progress towards the energy self sufficiency being promoted by most New Zealand political parties.

[1]⁶ It might be possible to have a separate FTS rate for speculative capital flows. This paper proposes a single rate so that speculative investment flows will cease.

[1]⁷ Source: Reserve Bank of New Zealand statistical series B1. The series base is 100 back in 1979 when exchange rates were still fixed. As of 18/05/2012 it had fallen back again to 68.8.

[1]⁸ New Zealand National Accounts year ended March 2009.

[1]⁹ The outward payments would fall from their present level and inward receipts would increase.

2⁰ This could be done through a tender process.

2¹ The Keynesian transfer problem implies the current account should go far enough into surplus to meet all transitional foreign investment claims, though that might be optimistic in the short term.

There would be a substantial reduction in interest rate premiums as the current account is brought under control, foreign debt repayment begins and inflation is progressively reduced to very low levels. On the other hand, the New Zealand dollar “value” of foreign debt would rise, so it would seem to be prudent to have as much of that debt as possible denominated in domestic currency ²². The FTS is a very powerful economic tool because of its redistributive impact within the domestic economy ²³.

Nearly all New Zealand’s current account deficits in recent years have been funded by capital inflows to the foreign owned banks. Bertram ²⁴ notes that:

New Zealand’s current account deficit basically reflects the servicing requirements on its overseas debt.

Banks would quickly unwind their dependency on foreign debt when the domestic funding rate falls below what they are paying offshore. There will also be a foreign currency dividend loss from the repatriated earnings of foreign companies operating in New Zealand equivalent to the FTS they would (indirectly) pay on those dividends to New Zealand consumers.

Preston ²⁵ also argues that the levels of the New Zealand current account and foreign debt are substantially due to (over)reliance by the New Zealand banking system on external borrowing, but he does not acknowledge that the borrowing is forced onto the banks by the foreign exchange settlement process in the absence of increased direct foreign ownership of the country’s businesses, property, land and resources.

²² While Kauri, Uridashi and Eurokiwi (NZ$ denominated) foreign bonds are not as popular as they were a few years ago, most offshore foreign currency borrowing by NZ banks is hedged through the cross rate currency swap market. See, for example: http://www.rbnz.govt.nz/finstab/fsreport/fsr_may12_boxB.pdf The swap rate spread has widened in recent years, increasing foreign borrowing costs.

²³ Since the volume of exports cannot be rapidly increased, the FTS must rely on changing the relationship between the NZ$ value of exports and imports.

²⁴ Bertram G (2009), “The Banks, the Current Account, the Financial Crisis and the Outlook”, Policy Quarterly, Vol 5 Issue 1, February 2009.

²⁵Preston D (2009), “Putting Credit back into Monetary Policy: Reconstructing the New Zealand Monetary Policy Framework”, Paper for NZ Association of Economists 50^th Anniversary Conference, July 1-3 2009.

CONCLUSION

Actual and notional foreign ownership of the New Zealand economy through it its accumulated current account deficits have reached frightening proportions.

The point has been reached where New Zealand must fix its overvalued exchange rate without further delay or rapidly devolve toward third world status.

The accumulated current account deficit (or net foreign investment position) can only be reduced and eventually eliminated by reversing unnecessary foreign ownership of the domestic economy. The Foreign Transactions Surcharge (FTS) proposed in this paper does not exclude productive foreign investment.

Some countries have tried to address the problem by printing money and inflating the domestic economy. Claims that domestic inflation reduces export prices and increases import prices appear to be false because inflation does not necessarily reduce import demand. Domestic production costs and incomes increase together as long as the inflation is passed on in the domestic economy, leaving import volumes much the same as they were before. Inflation may superficially alter the exchange rate but it does not alter the underlying current account deficits that (in countries like New Zealand) produce the high and volatile exchange rates in the first place. The inflation increases both the domestic money price of exports and dollars available to pay for imports at higher domestic prices. That’s why printing money does not solve the foreign exchange issue in practice.

A Foreign Transactions Surcharge (FTS) produces the necessary foreign exchange adjustment because it directly changes the balance between imports and domestic production, effectively stimulating the domestic economy.

The long-term goal of any fiscally responsible government should be to eliminate the current account deficit that is a serious drag on both the New Zealand economy and the wealth of its citizens.

The Foreign Transactions Surcharge (FTS) is a serious practical policy to achieve that goal.

Lowell Manning and Raf Manji

Sustento Institute Christchurch

THE REFERENCED PAPERS