Excellent post on $A Carry Trade in SMH, Age

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Kenneth Davidson has been one of the most consistent voices for sensible economic analysis in the Australian media for decades now (another I'd give a similar accolade to is Brian Toohey), and he's written a brilliant piece in The Age and The Sydney Morning Herald on the specualtive bubble that is the Australian dollar.

Davidson lays out the causes and probable effects superbly in the length of a newspaper feature. The causes are that:

  • The bailout funds in the USA and UK in particular have cashed up financial institutions that don't want to lend any more to mortgages (and have long ago forgotten how to lend to fund productive enterprises), so they're looking for short term hot money gains;
  • The RBA's flagging that it intends raising rates from 2-3% above rates in the USA and UK to possibly 4-5% above is a "sure thing" return on a currency that was already appreciating because of commodity sales to China;
  • This gives the hedge funds a sure fire double whammy gain:
    • borrow in the US or UK at 1% to buy $A and "invest" in floating rate bonds or shares (particularly in banks) and get a higher return (at least 2% better than the borrowing costs, and assured to rise); and
    • drive up the $A in the process, so that when you sell out, you get both a higher return and an appreciated currency in which it is denominated.

The most remarkable thing about this bubble is that the RBA's "we're raising rates now and we're going to keep on doing it for a few months" messages are part of the cause, and yet they seem unaware of both the phenomenon and the dangers it poses. Davidson points out that Brazil, which is experiencing a similar commodity-driven currency appreciation bubble, is aware of the dangers and is doing something about it:

"The rising value of the Brazilian real and the Australian dollar against the US dollar has had a disastrous impact on both countries' non-commodity export and import competing industries. Brazil's popular and largely economically successful left-wing Government led by President Lula da Silva is meeting the problem head on. It has decided to impose a 2 per cent tax on all capital inflows to stop the real appreciating further."

In the meantime, our RBA seems possibly even pleased that this short-term phenomenon is afflicting our manufacturing sector adversely.

Of course, like any speculative bubble, this has an end-game--and that's when you think the rate rises have come to an end, sell out and watch the $A crash for those who are still holding it. Then the dollar (and Australian bank shares) will crash, and our economy will have acted as a dollar pump for the hedge funds.

Davidson also accurately notes that the RBA's obsession with driving rates higher now is driven by the classic "fighting the last war" syndrome of believing that an outbreak of wage-driven commodity-price inflation is the main danger facing the Australian economy--just as it was in, oh, about 1973 (if you ignore private debt levels of course...).

He concludes that:

The world has moved on but the obsessive debate about wage inflation and union powers hasn't. Since the beginning of the '80s, the problem has been periodic bouts of asset price inflation. It is the biggest danger now.

Instead of controlling the unions, there should be control of financial institutions. The Australian dollar bubble and the incipient housing bubble should be micro-managed. Capital inflow could be dampened by a compulsory deposit of 1 to 2 per cent to be redeemed after a year to stop speculative inflow. Home ownership has become a tax shelter. The steam could be taken out of the rise in house prices if negative gearing was limited to new housing. This would obviate the need for higher interest rates that affect everyone.

It's an excellent article--read it and pass it on. The more people who do read it, the higher it will rise in the newspapers' online-indicators of reader interest, which will push it towards the top of the online page. And I'm heading out now to buy a paper copy of the SMH as well. Bravo, Kenneth Davidson.

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87 Responses to Excellent post on $A Carry Trade in SMH, Age

  1. Lyonwiss says:


    The way I see it, one rich with one bil­lion dol­lars has one bil­lion votes (notion of cap­i­tal­ism). Now one mil­lion non-rich with one thou­sand dol­lars each should have the same influ­ence or power. But not so, because the for­mer is con­cen­trated and has the power whereas the lat­ter is dif­fused and have no power. One dol­lar one vote does not apply under actual cap­i­tal­ism, but ought to.

    Democ­racy is a painful way to get fair and decent results. Other ways may be quicker, but run the risk of get­ting serf­dom instead, whether it is through cor­rupt com­mu­nism or klep­to­cratic cap­i­tal­ism, as Philip rightly suggested.

  2. GSM says:


    Japan can cre­ate as many Yen as it wants. Moun­tains and moun­tains of Yen if needed. That is entirely not the point. The point is, who will accept those Yen and under what rate of exchange. Exchange for other cur­ren­cies, wheat, iron ore , coal etc. To think or even believe that exten­sive print­ing of money sim­ply for the pur­pose of increas­ing deficits by wan­ton Govt spend­ing is some­how ben­e­fi­cial and has no neg­a­tive recourse is absurd. Japan has been at it for nearly 2 decades. Prob­lem solved?

  3. PETER_W says:

    GSM #66

    The Japan­ese Gov­ern­ment can never go bank­rupt sell­ing Yen bonds to its own domes­tic pri­vate sector.

    For the Japan­ese domes­tic pri­vate sec­tor a 1.3% 10 year bond yield on Gov­ern­ment Yen bond debt is close enough to the func­tional equiv­a­lent of the domes­tic pri­vate sec­tor vol­un­teer­ing to pay tax ‘at near zero yield’.

    What’s the func­tional dif­fer­ence between a close on zero yield gov­ern­ment bond and tax?

    There is no dif­fer­ence. The Japan­ese domes­tic pri­vate sec­tor are vol­un­teer­ing to hand the gov­ern­ment part of their wage and the gov­ern­ment spends it. (a triv­ial few yen get dis­counted into the paper game).

  4. ak says:


    Please read the expla­na­tions pro­vided by prof Mitchell on his site under which cir­cum­stances cre­at­ing exces­sive amount of yen will lead to infla­tion (ris­ing prices — either domes­tic or for­eign products).

    His point is very clear — these con­straints which have been imposed by neo­clas­si­cal eco­nom­ics are false. How­ever this doesn’t mean that there are no con­straints at all and that a gov­ern­ment can­not over­cook the econ­omy espe­cially under pres­sure from cer­tain pres­sure groups. He has never writ­ten that Japan can cre­ate an unlim­ited amount of cur­rency or issue an unlim­ited amount of debt with­out adverse effects.

    Prof Mitchell him­self is very crit­i­cal to poli­cies of the Japan­ese gov­ern­ment in regards to man­ag­ing the defla­tion­ary cri­sis grip­ping their econ­omy (with a short break) for the last 20 years.

    I haven’t seen him advo­cat­ing bail­ing out insol­vent invest­ment banks.

    I do not buy into 100% of what he has writ­ten any­where. How­ever I do agree with his argu­ments regard­ing con­se­quences of bud­get sur­pluses or deficits and the obvi­ous fact that a sov­er­eign gov­ern­ment is not fis­cally con­strained in its spend­ing (in domes­tic currency).

    If the RBA wants to set cer­tain inter­est rates and deficit must be financed by sell­ing bonds — we have the con­se­quences for exam­ple in the form of uncon­trolled cur­rency appre­ci­a­tion due to carry trade.

    Why do we have to use inter­est rates to mod­er­ate the growth of the hous­ing debt? Why can’t we just impose an upfront tax on new loans exceed­ing 70% of the value of the prop­erty and phase out neg­a­tive gearing?

    It is pos­si­ble to use the hand­brake to con­trol the speed of my car while keep­ing the accel­er­a­tor pedal in the same posi­tion. Even­tu­ally I will burn the brake — but who cares, I am in con­trol for a while!

    I just want to add that the mess we have to deal now in the form of the debt bub­ble is a direct effect of apply­ing incor­rect eco­nomic theories.

  5. Philip says:


    The banks and the revolv­ing door they have within polit­i­cal and eco­nomic insti­tu­tions ensure that through reg­u­la­tory cap­ture and eco­nomic ide­ol­ogy that the banks have, are, and will con­tinue to influ­ence and cre­ate the reg­u­la­tions they prefer.

    The rich con­trol the state, not the other way around. Elec­tions are when groups of investors coa­lesce to con­trol the state for another four years. Enter the util­ity of ‘democ­racy’: peo­ple enter the polit­i­cal arena once every four years to rat­ify state poli­cies, laws and reg­u­la­tions that orig­i­nate else­where e.g. cor­po­rate sec­tor. How long is ‘good’ poli­cies going to last once the banks reassert their power?

    Pre­tend­ing that the state will be nice and reg­u­late in the pub­lic inter­est when they are appar­ently staffed with cor­rupt bureau­crats as you point out is not going to do much unless the source of the cor­rup­tion is dealt with. Treat­ing the symp­toms and not the cause isn’t going to get far.

    How do politi­cians become this cor­rupt? Lay­ing the fault at the doorstep of sta­tism with­out men­tion­ing pri­vate power is disin­gen­u­ous. As the philoso­pher John Dewey once stated: “As long as pol­i­tics is the shadow cast on soci­ety by big busi­ness, the atten­u­a­tion of the shadow will not change the substance.”

    Dur­ing the 1960s/1970s Aus­tralia had some­what work­able reg­u­la­tory appa­ra­tuses. I find it dif­fi­cult to believe that it was all the fault of cor­rupt politi­cians that they undid this themselves.

    As for class war­fare, there is plenty of it: cap­i­tal­ists vs. labor; state vs. labor; cap­i­tal­ists vs. state; upper-class labor vs. middle/working class labor; finan­cial cap­i­tal vs. indus­trial cap­i­tal; big cap­i­tal vs. small cap­i­tal; etc. It take will­ful blind­ness not to see this.

    Tak­ing con­trol of gov­ern­ment, that is, the insti­tu­tion that is respon­si­ble for approx­i­mately 30–40% of the econ­omy while giv­ing a free pass to the rest of it also disingenuous.

    The unelected and unac­count­able cen­tral plan­ners who serve poten­tial life terms within enor­mous and grow­ing cor­po­rate com­mand and con­trol insti­tu­tions have enor­mous power. These are minia­ture com­mu­nist states. Believ­ing that some poten­tial democ­ra­ti­za­tion of the state and not oth­ers (firms) is no real solu­tion at all.

  6. Pingback: Big Crash Coming? :: ASPO-USA: Association for the Study of Peak Oil and Gas

  7. AntiMoralHazard says:

    GSM, “Aus­tralians need to take con­trol of their Govt. Until then we are all sim­ply mus­tered out­side the slaughterhouse.”

    How are we going to do that when many Aus­tralians them­selves are co-opted by their prop­erty speculation?

  8. PETER_W says:

    Anti­Moral­Haz­ard #62

    You allude to the dichotomy of the ‘Neo’ eco­nomic paradigm.

    On one hand we have a major­ity of the nation spec­u­lat­ing in some­thing akin to a fren­zied tulip bub­ble whilst their ‘Neo’ cheer­lead­ers tell them they are engag­ing in ratio­nal self interest.

    OTOH the mar­ket minor­ity who believe this is ponzi spec­u­la­tion are in effect athi­ests that the mar­ket is effi­cient at all prices and at all times.

    It’s axiomatic the effi­cient mar­ket athi­ests are the gen­uine effi­cient mar­ket makers.

    His­tory is lit­tered with evi­dence the mar­ket is not effi­cient and that ‘Neo’s’ are bub­ble cheer­lead­ers and intel­lec­tual charlitans.

  9. Sean says:

    Octo­ber 27th, 2009 at 11:13 pm
    Philip, I feel forced to place a slightly cranky com­ment in defence of my per­sonal lit­tle patch. I am a doc­tor, specif­i­cally a gen­eral prac­ti­tioner, and in return for ten years of train­ing, an IQ in the top 0.1% and a fifty hour week with one in four nights on call I am paid about $240,000 before tax. I keep my patients out of hos­pi­tal, and pro­mote health and pro­duc­tiv­ity for the patients I care for. Work­ing a 35 hour week with no nights my wife’s hair­dresser makes almost $180,000. I’m fairly con­fi­dent I could have done bet­ter finan­cially in other fields.

    Some­thing doesn’t sound right about those fig­ures. A GP in Rand­wick, Syd­ney con­fided to me that he was paid $80K p.a. out of the busi­ness after over­heads, and the aver­age pay level for GPs is under $100K in Aus­tralia — it is some­what higher in the UK and the US. A recent pro­posed change to Medicare would have pushed GPs payscales to about $120K — which didn’t go ahead, so they remain on the lower payrange. A friend of mine con­fided a while ago she was only paid $40 ph to be a locum, equiv­a­lent to about $80K p.a., out of which she had to draw her own super. Pay scale for grad­u­ate Drs in the hos­pi­tal sys­tem start at under $25 p.h., or $50K per year, includ­ing much worse con­di­tions than ‘being on call’ for one night a week, while other Aus­tralian work­ers are work­ing increas­ingly odd and casu­alised hours. Nurses are forced to work night shift reg­u­larly and con­tin­u­ally for much lower pay rates. ‘danmm78’ claims to be mak­ing about 3x the usual GPs rate — s/he must be either very effi­cient or very slap­dash, or dis­cov­ered a model of ser­vice deliv­ery hereto­fore unknown.

    Spe­cial­ists such as anaes­thetists or sur­geons can make $200-300K after many more years study and sit­ting some gru­elling and expen­sive exams. I’ve also seen ‘com­pet­i­tive’ salary rate for Drs in the ADF in the high­est ranks, and it’s nowhere near $240K.

    Hair­dressers are extremely low paid on aver­age, which is one rea­son there is a short­age of them and the need to bring in many immi­grants to be trained as hair­dressers — a typ­i­cal wage would be $30K p.a. Some­how danmm78 has dis­cov­ered what his wife’s hair­dresser earns, and it is appar­ently 6x the aver­age hairdresser’s salary for a ’35 hour week’.

    The aver­age national full-time salary is only $60K.

    And appar­ently there are loads of ways of mak­ing so much money in today’s econ­omy, with­out the auton­omy and dis­cre­tion that doc­tors enjoy, with no boss on their case — per­haps work­ing in a call cen­tre, for instance? Or per­haps work­ing in the finance sec­tor in the GFC with thou­sands of lay­offs of fore­merly well-paid work­ers and anciallry progessi­nals like lawyers also los­ing their jobs. Being a doc­tor is a pretty cushy and pro­tected occu­pa­tion all in all, and they milk that pro­tec­tion while always claim­ing they could have done this or that occu­pa­tion that would not suit their per­son­al­i­ties at all. Being a slightly nerdy sci­ence per­son in your own med­ical prac­tice with auton­omy and free­dom is not he same sort of job as man­ag­ing 10 staff and wip­ing their noses and check­ing their time sheets and hir­ing and fir­ing staff and so on, and all the other unpleas­ant jobs int he world when you look at them in detail, and more doc­tors need to face up to that fact and stop mak­ing super­fi­cial assess­ments of what they ‘coodabeen’.

    darnm78 is also rare among doc­tors in being in the top 0.1% of IQ in the pop­u­la­tion, the spread in the GP pop­u­la­tion is a lit­tle wider than that. I’m per­son­ally also a bit fed up with see­ing over­seas imported doc­tors in 2 local prac­tices as they tend to make wrong diag­noses or the cul­tural dif­fer­ences are such that they are not help­ful at all — and, you know, the Aus­tralian govt is grad­u­at­ing 2,000 doc­tors a year and import­ing 4,000, and the num­bers of grad­u­ates, allow­ing for short-term vis­its by over­seas doc­tors rather than per­ma­nent res­i­dency, should be at least 50% higher. I per­son­ally think that GPs being paid around $80-100K in Aus­tralia is about right given the qual­ity of the work they do and the some­times shod­di­ness and arbi­trari­ness of their work that I have seen. Lots of wasted trips to quacks with wrong diag­noses, basically.

    With regard to the rest, I find most doc­tors aren’t really inter­ested in keep­ing patients out of hos­pi­tal or their health or pro­duc­tiv­ity — they are inter­ested in pus­ing the lat­est drug co rep’s drug onto the pop­u­la­tion, often with debil­i­tat­ing side effects that hurts their pro­duc­tiv­ity, and with ques­tion­able main effects regard­ing effi­cacy. They like to keep peo­ple wait­ing all morn­ing at their surgery, wast­ing a half-day of their time out of work to suit their delib­er­ately over­booked sched­ules (after all, it’s a busi­ness), and give them a drug that will make them tor­pid every day they take it, or worse. They oper­ate in a ‘5 minute model’ of quick-fix med­i­cine which requires the govt to bribe them to stay longer with a patient, apart from the fact that the govt is the main payer of ser­vices already. Despite the ‘high level of care’, Australia’s rate of hos­pi­tal­i­sa­tion is about the high­est in the west­ern world, for some rea­son. Nicola Roxon’s first con­cerns on becom­ing Health Min­is­ter were about ‘pre­ven­tion’, clearly some­thing many doc­tors were not address­ing in their pri­vate prac­tice model. In fact, there is still no onus on donig this, the govt skirts around the prob­lem by run­ning pub­lic health media cam­paigns instead of revis­ing GP pro­to­cols on pre­ven­tion or demand­ing the Col­lege of GPs reform its train­ing content.

  10. PETER_W says:

    Lis­ten to the lan­guage of the MSM ‘Neo’ cheer­lead­ing each night.

    One exam­ple of ‘Neo’ effi­cient mar­ket zeal­ous religion…

    The ‘Neo’ reli­gious spruk­ers will say ‘The maket was down sig­nif­i­cantly today on profit sellers’

    They will NEVER say ‘The mar­ket was down sig­nif­i­cantly today on loss buyers’

    The real estate indus­try is just as zelous in its cheer­lead­ing of effi­cient mar­ket religion.

  11. rluk says:

    Debt defaults hap­pen more than you would think. Nearly every coun­try on earth has defaulted at least once, many sev­eral times.

    The mech­a­nisms of a default would roughly go like this: Trea­sury has debt due. Wants to roll over. Auc­tions bonds. Not enough buy­ers. Can’t rollover = Default.

    I take your point that tech­ni­cally the cen­tral bank can step in and buy the bonds, but who is to say they will? They have failed to count­less times over the past few hun­dred years.

    Fur­ther­more, in lots of coun­tries the cen­tral bank has some mea­sure of inde­pen­dence from trea­sury. For exam­ple the ECB is express­edly pro­hib­ited from pur­chas­ing gov­ern­ment bonds directly from Euro mem­ber states.

    Japan is a pretty unlikely can­di­date for default at the moment, but their gross govt debt is huge and gross national sav­ings are set to reduce as the coun­try ages and the pop­u­la­tion shrinks.

  12. ak says:


    Obvi­ously you are right regard­ing default­ing on bonds when money was based on gold stan­dard. But the par­a­digm has changed. The politi­cians will not allow for this kind of instability.

    Regard­ing the EU they also have rules which they don’t obey regard­ing bud­get deficit of the mem­ber states.


    I wouldn’t worry for them. If the Ger­mans or French need to bend the rules they know per­fectly well how to do it — just look at how they are push­ing the Euro­pean Con­sti­tu­tion down the throat.

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