By Michael Daly of NZPA

Wellington, Dec 18 NZPA - The sharp fall in the value of the New Zealand dollar was just one more wild ride in a year when the world economy careered into scary, unknown territory.

The tendency of the floating New Zealand currency to go through big swings over multi-year periods is a regular cause of much wailing and gnashing of teeth, but even against the backdrop of such habitual instability, 2008 was outstanding.

Despite the obvious weaknesses in the floating rate system, most thinking about it seems to focus on how to make it work a little less badly, rather than doing away with it.

Other options for the currency have been tried, former Reserve Bank governor Don Brash said.

"I think the general view, and it's a view I share, is that the floating exchange rate system is the least bad."

But he also said that the big three- to five-year swings in the dollar made planning an investment in the export sector a nightmare.

If New Zealand wanted strong growth in export earnings, finding a way to moderate the swings was essential, Dr Brash said.

The swing over eight months of 2008 is as emphatic an example of the problem with the currency as anyone seeking to make a point could wish to have.

As the greenback crumbled early in the year, the NZ dollar topped US82c on brief occasions in February and March, its highest level since being floated in 1985.

After the peak, the kiwi edged lower for a couple of months before falling off a cliff -- dropping from above US77c in mid-July to a six year-low below US52c in November.

The NZ dollar's peak against the United States currency came during a period when this country's official interest rate sat at 8.25 percent, among the highest in the industrialised world.

It was propelled at least partly as a side effect of the carry trade -- where traders buy high risk, high interest rate currencies such as the NZ dollar with cheaper currencies such as the yen.

But even as the kiwi peaked the outlook for the New Zealand economy was deteriorating, and by the middle of the year it was apparent the economy was slowing sharply.

Then in July the Reserve Bank made its first small -- 25 basis points -- cut to interest rates. By the end of the year the cumulative reduction was 3.25 percentage points, taking rates to 5 percent, the lowest in five years.

As 2008 went on and world sharemarkets plummeted, investors' aversion to risk grew, as did their enthusiasm to sell growth sensitive currencies, such as the kiwi.

By late in the year, panicking investors were liquidating positions in those currencies as melt-down in the global financial sector wrought havoc.

Given the size of New Zealand's balance of payments deficit, and the need to reduce it, some reduction in the exchange rate had been constructive and desirable, Dr Brash said.

"That doesn't mean that falling at the current rate has been helpful."

Above US80c, the NZ dollar had been overvalued, he said.

"What it meant was that almost every exporter, except dairy farmers, was having huge difficulty staying afloat."

So, while the speed of the fall may have been unsettling, the fact the currency dropped was warmly welcomed by many.

But this month (December) business intelligence firm Dun & Bradstreet warned that the benefits of a sharply lower currency were outweighed for now by the collapse in global demand for the soft commodities in which New Zealand specialised.

In addition, many exporters were locked into currency hedge contracts written close to the NZ dollar peak.

Corporate financial consultant Pat Duignan said exporters were being cushioned because as international commodity prices fell in foreign currency terms, the fall in NZ dollar terms had not been as great.

Beyond that, the immediate impact of the fall in the currency had not been as potentially damaging to corporate New Zealand as perhaps some past episodes of volatility had been, he said.

As a generalisation, companies had learned from past experiences and hedged their exposures, particularly their debt exposures.

But some exporters who had bought hedges at values higher than the current exchange rate faced the prospect in the short term, of not enjoying the benefit of the fall in the currency, Mr Duignan said.

"But you would expect that provided they are able to get through the phase where they are running off their hedges they will benefit after that when they become exposed to the currency."

He also pointed out that predicting what the currency would do was "one of the most hazardous forms of economic prediction, and the market continues usually to prove people wrong".

"Most of the economic phenomena you can think of can be expected sooner or later to have an effect on the currency. Deciding how they all add up is very difficult," Mr Duignan said.

While the fall in the NZ dollar was good for exporters it would also affect the price of imported goods.

The full impact had yet to be felt, he said and suggested there was likely to be a turnaround in the price of electronic equipment, where sustained price falls have been experienced.

Many ideas have been floated for reducing the NZ dollar's swings.

University of Auckland head of economics Prof Tim Hazledine has suggested looking into whether this country and Australia could "combine forces" on currency.

"I don't think we gain much as a little country of four million plus people having our own independent currency. It means it does fluctuate a heck of a lot. It's quite vulnerable to speculation and short-term capital inflows blasting in and out," he said.

Also, if New Zealand shared an "Anzac" dollar with the Australians, or even just had the Australian dollar, the fifth to a quarter of trade with Australia would be stable instantly.

In an "election manifesto" the New Zealand Chambers of Commerce said other policy settings -- such as government spending, labour market rules and resource management regulations -- needed to be addressed to take the pressure of interest and exchange rates.

"High interest rates and an overvalued exchange rate reveal more about the failure of other policy settings than problems with the monetary policy framework," the chambers said.

Ganesh Nana, senior economist at independent economic researchers Berl, proposed legislating to make investment and exports targets for policy makers, using interest and exchange rates as tools.

And in an article early this year, Dr Brash said serious consideration should be given to giving the Reserve Bank governor authority to vary the excise tax on petrol.

The Reserve Bank (RB) had tried to find solutions to the exchange rate problem, but all its ideas had been rejected as impractical or politically unacceptable.

What was needed was a way for the RB to reduce the general level of spending in the economy without raising interest rates.

"I don't know if that was the best solution," Dr Brash said.

"But we need some kind of solution because the big swings make life very difficult." NZPA WGT mjd kn