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.

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  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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