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SECTION VIII.—EXCHANGE AND ECONOMIC ADJUSTMENT.* (A) The Mechanism of Exchange in New Zealand and its Working. 52. The monetary system of New Zealand is best described as a sterling exchange standard. This system has evolved over a long period of years in response to the needs of the Dominion's industry and trade. Under this system exchange has been kept stable in comparison with other exchanges, despite wide fluctuations in the factors that usually determine exchange rates. During the war period, for instance, when many exchange rates fluctuated very widely, New Zealand exchange on London was kept stable. In 1921, despite the heavy unfavourable balance of payments, the exchange moved only about 3 per cent, above par. It dropped about 3 per cent, below par in 1924, when the balance swung in the other direction, but returned to parity again. In 1927, when the balance of trade was against New Zealand, the exchange rate moved by only J per cent. 53. Dealings in exchange consist in the provision of money overseas in exchange for money in New Zealand, and vice versa. The exchange-dealer must therefore be in a position to supply money overseas, or, alternatively, money in New Zealand, when called upon to do so. Most of the exchange work is done by the banks, and the operations can best be described by reference to their methods, taking transactions between New Zealand and its chief market —London —for purposes of illustration. 54. All the six banks operating in New Zealand have offices in London and are accustomed to hold there considerable liquid funds for exchange purposes. When New Zealand goods are exported to Britain the proceeds are paid into these London funds and held there. They are transferred to New Zealand not usually by shipping money in any form, but by crediting exporters' accounts in New Zealand with the amounts due to them. Thus payments for exports will increase bank funds held in London, and increase bank liabilities to customers, mainly depositors in New Zealand. Generally speaking, the same procedure is followed in regard to all payments from overseas countries to New Zealand. The money is paid into funds held in overseas centres and at the same time is credited to customers' accounts in New Zealand. When imports are paid for or when money is paid out from New Zealand for any other purpose, the process is reversed. Actually payment is made from the banks' funds held in London or other overseas centre and the amount of the payment, with adjustment for bank charges, is debited to the customer's account in New Zealand. 55. It follows, therefore, that all payments made to New Zealand will tend to increase bank funds held for exchange purposes overseas, and will at the same time tend to increase the bank's liabilities, chiefly customers' deposits in New Zealand. On the other hand, all payments made by New Zealand will tend to decrease bank funds held overseas and will tend to decrease similarly bank liabilities in New Zealand. If, therefore, over any period payments made by New Zealand exceed payments made to New Zealand, more will be paid out of overseas exchange funds than is paid in, and more will be debited to customers' accounts in New Zealand than is credited to them. In these conditions there is a diminution both of bank funds held in London and bank liabilities in New Zealand. On the other hand, if payments made to New Zealand for exports, &c., exceed payments made by New Zealand for imports, &c., the payments into bank funds held overseas will exceed payments made from those funds, and the credits to customers' accounts in New Zealand will exceed the debits. A favourable balance of payments, therefore, means an expansion both of bank funds held overseas and of bank liabilities in New Zealand. The overseas fund is thus the real reserve held against bank liabilities in New Zealand, and automatically fluctuates with these liabilities. 56. This balance of payments is determined by the total payments to New Zealand on the one side, which may be regarded as credits, and by the total payments by New Zealand on the other, which may be regarded as debits. On the credit side are the proceeds of exports, of loans raised abroad on public or private account, the expenditure of overseas tourists in New Zealand, immigrants' capital, &c. On the debit side are payments made for imports, for interest and debt-redemption abroad (whether public or private), for dividends payable abroad, New Zealand tourists' expenditure in overseas countries, capital taken out by emigrants, &c. 57. It is not possible to determine the total amount of funds held on New Zealand account abroad. This depends on the varying amount of bank capital devoted to New Zealand business : but it is possible to estimate the variations in these funds due to changes in the New Zealand balance of payments. The banks publish quarterly details and totals of their average assets and liabilities in New Zealand. The excess of liabilities over assets in New Zealand must necessarily be balanced by an excess of assets over liabilities overseas if the total banks' balance-sheets are to balance. A favourable balance of payments to New Zealand will increase these surplus assets overseas and similarly increase the surplus liabilities in New Zealand, while a favourable balance of payments will have the opposite effect. Hence variations in the margin between bank liabilities and assets in New Zealand must necessarily reflect changes in the volume of funds held mainly for exchange purposes on New Zealand's account in overseas centres.

The New Zealand Exchange System.

Dealings in Exchange.

How Money is transferred.

Changes in Bank Funds.

Balance of Payments.

Exchange Funds Overseas.

* See Addendum by Mr. Park.

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