New Zealand is one of many countries dealing with strong exchange rates

CONFRONTED by a growing army of speculators, on June 11th the Reserve Bank of New Zealand decided enough was enough—and let rip with the peashooter. It intervened in foreign-exchange markets to weaken a currency that had hit its highest level since it was floated in 1985. The bank struck after it had raised its official cash interest rate to a daunting 8% the week before, eager to halt rising inflationary pressures.

It was a well-timed intervention. Japanese savers, earning next-to-nothing in yen, have poured into investments based on higher-yielding currencies, such as New Zealand's. Other investors have also taken advantage of the “carry trade”, enabling them to borrow at low interest rates in yen and reinvest at higher rates overseas. Like almost everyone else, they were caught by surprise and the New Zealand dollar softened.

New Zealand, with the highest interest rates in the industrialised world, is a special case, but it is not alone in feeling the mixed blessings of a currency on steroids. Other countries with non-greenback dollars also have unusually strong exchange rates. Australia's dollar hit its firmest level in 18 years this year, and the Canadian dollar has risen 30% against its American counterpart in the last three years.

There are some common elements fuelling the strength. All have robust economies and respected central bankers. According to Stephen Jen of Morgan Stanley, they reap the benefits of being open, developed economies, yet partly thanks to the commodities boom, they enjoy some of the fast-growing attributes of emerging markets. Asian economies have snapped up dairy and wood products from New Zealand and metals from Australia, and have helped raise the prices of Canada's oil and natural gas, boosting export revenues. Cross-border takeovers are also putting upward pressure on currencies. The bidding for Bell Canada, the country's largest phone company, involves groups with both domestic and foreign investors.

A strong currency can be a curse for exporters, however. In New Zealand's case, the carry trade has given the kiwi dollar an extra upward push. With the yen nearing five-year lows against the American dollar this week, such trades may well continue.

As rising interest rates in some countries exacerbate the differences between high-yielding currencies and low-yielding ones, such as Japan's, New Zealand's predicament may become more familiar. Most nations with strong currencies should refrain from following its lead. After all, peashooters are of little use against a determined foe.
Jun 14th 2007 From The Economist