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.
Citydoc #51
AUD/USD exchange rate history
The US inflated against gold and Australia inflated against USD
Australia, 1928 – 2008
1928 0.2070 Australian Pound
1929 0.2080 Australian Pound
1930 0.2180 Australian Pound
1931 0.2840 Australian Pound
1932 0.3570 Australian Pound
1933 0.2970 Australian Pound
1934 0.2490 Australian Pound
1935 0.2570 Australian Pound
1936 0.2530 Australian Pound
1937 0.2540 Australian Pound
1938 0.2570 Australian Pound
1939 0.2830 Australian Pound
1940 0.3280 Australian Pound
1950 0.4480 Australian Pound
Yes, the printing of money certainly spurred the AUD-carry trade but it is caused by the US as well. The US is running a Current Account Deficit ever since the early 1960s and that means the rest of the world is still accumulating USDs. These dollars end up e.g. in China. And China is buying a lot of commodities e.g. iron ore in Australia. So, those USD printed in the US end up in Australia. This inflow of USDs into Australia is the cause the RBA is raising rates. The RBA fears this monetary inflation could drive prices across the board soaring higher. I think we should brace ourselves for huge swings in rates and in exchange rates in the coming months.
The RBA is between a rock and a hard place because high rates is good to stem the flood of AUD flowing out of the country (Current Account Deficit) but it will attrack more speculation as well. And it will be detrimental for those who want to buy a house with a mortgage.
B.T.W. Today (10/29/09) the USD/AUD is going up !! The hot money is starting to flee Aussie-land !
PETER_W,
True enough. Once the property bubble deflation is in full swing, the RBA will have no choice but to savagely cut interest rates in order to stimulate the economy – it will benefit all those with debt, and those who want to take on new debt with very small rates.
On the other hand, considering our net external debt is ~$AUD650 billion, a falling Aussie dollar is going to make it all the harder to pay back the external debt to overseas lenders. We will become debt-serfs enslaved to international banks.
So the RBA is in a position of ‘damned if you do, damned if you don’t.’
Interestingly enough, if Steve is right in his future prediction and the interest rate is set to 0%, the AUD will become the focus of the new carry trade like Japan experienced with the Yen. What will be the effect of this on Australia? Positive or negative?
For those still in employment, picking the bottom of the property market combined with a mortgage with super-low rates will be great.
“On the other hand, considering our net external debt is ~$AUD650 billion, a falling Aussie dollar is going to make it all the harder to pay back the external debt to overseas lenders.”
This only applies to the part of the debt denominated in foreign currencies. $AUD400 billion (I’m making up that number) is still $AUD400 billion regardless of the USD/AUD exch rate. Stimulating export and throttling import by weakening AUD may in fact make debt foreign debt repayment easier.
Welcome back Prudentsaver. Why did you come back? Is it because the markets are having an intermediate correction or just coincidence?
Are you still bullish railroads and soft commodities?
Did you see that the Naz broke its trend line two nights ago, R2000 broke, S&P broke last night and the DOW is yet to break? What do you make of that? Bear trap or new trend?
ak @ #55
” This only applies to the part of the debt denominated in foreign currencies. $AUD400 billion (I’m making up that number) is still $AUD400 billion regardless of the USD/AUD exch rate. Stimulating export and throttling import by weakening AUD may in fact make debt foreign debt repayment easier ”
That’s $400bn + interest. Falling currency = higher interest repayments.
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Peter W @ 51 / 52
” I can’t see the RBA defending the AUD at the cost of homeowners, the economy & jobs.”
I hope you’re right, but if the foreign capital in Australia takes flight and leaves our shores, I think the RBA will have no choice but to jack up rates. Look at the Iceland’s 18% interest rates. That Central Bank raised their rates dramatically and screwed their own country in the process.
The govt willl make $20b less in tax revenue this year. That’s 7% drop from forecast.
Also
http://www.bloomberg.com/apps/news?pid=20670001&sid=atM.DMNswuJU
Option ARM Defaults Shrink Recast Wave, Barclays Says (Update1) Share Business ExchangeTwitterFacebook| Email | Print | A A A
By Jody Shenn
July 27 (Bloomberg) — The wave of “option” adjustable- rate mortgages recasting to higher payments, projected by some economists to represent a looming source of foreclosures that will hurt housing markets over the next few years, will be smaller than “feared” because many borrowers will default before their bills change, Barclays Capital analysts said.
Option ARMs offer initial minimum payments that fall below the interest borrowers owe, creating growing balances and potential spikes in monthly bills. Payment resets occur after five years or when the debt grows to a preset amount, typically 110 percent to 120 percent of the original principal.
About 40 percent of borrowers with option ARMs are already delinquent, and “many” of the others will start missing payments before their obligations change, the Barclays mortgage- bond analysts wrote in a July 24 report. Recasts of securitized option ARMs will peak at about $6 billion a month in mid-2011 and include “volumes lower than feared” overall, they said.
“The additional risk really will only be for borrowers who manage to stay current over the next couple of years and might default due to a payment shock,” the New York-based analysts including Sandeep Bordia and Jasraj Vaidya wrote.
Whitney Tilson’s hedge fund, T2 Partners LLC, in a presentation dated July 3 said option ARM recasts may peak in the second half of 2011 at more than $16 billion a month, citing Credit Suisse Group data. While the lower number from Barclays analysts suggests an earlier end to the foreclosures contributing to record home-price declines, investors and some analysts including at Barclays and JPMorgan Chase & Co. have said the U.S. government’s effort to have more bad mortgages reworked will delay some defaults.
Super-Senior Securities
The Barclays analysts, who wrote that about 88 percent of option ARMs packaged into securities in 2007 will eventually default, said that after a rally in prices they no longer suggest owning related bonds, “a trade we have been recommending for months.”
Typical prices for the most-senior option ARM bonds from 2007 have jumped about 40 percent from March lows to 46 cents on the dollar, according to their report. JPMorgan analysts in New York including John Sim and Chris Flanagan wrote in a July 24 report that prices for so-called super-senior securities may reach the “mid-to-high 50” cents on the dollar.
The bonds “still represent one of the last double-digit yielding assets (for even bad scenarios) in the resi mortgage space,” Jesse Litvak, a mortgage-bond trader for Jefferies & Co. in New York, wrote in an e-mail. “One of the biggest risks” will be the size of losses per foreclosure, he said.
Lower short-term interest rates are benefiting option ARM borrowers in two ways, the Barclays analysts added.
Lower Payment Increases
They have lessened balance growth, allowing more recasts to happen only after five years. They also have reduced payment increases to a projected 30 percent to 35 percent for loans recasting over the next year and an estimated 50 percent to 80 percent for later recasts, compared with a more than doubling of payments under calculations last year, their report said.
More than $750 billion of option ARMs were originated between 2004 and 2008 as borrowers used their low initial payments to afford higher-priced homes, according to newsletter Inside Mortgage Finance. Outstanding U.S. home loans totaled $10.5 trillion on March 31, according to Federal Reserve data.
To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net or
Citidoc,
“Falling currency = higher interest repayments”
Only if RBA reacts by raising interest rates. IMO they shouldn’t. This will pull the plug. If they do it – fine, we will have neoliberal Liberals instead of neoliberal Labor cleaning neoliberal mess.
The case of Iceland is unique because they had their mortgage loans indexed to CPI. Mine is not.
Also – they want to join EU. Nobody knows whether they haven’t been promised a big fat injection of Euros if they agree to conditions imposed by the EU. This was the case when Poland joined.
IMHO… Australia will not be the source of anything other than a speculative short term currency carry trade.
Near zero deposit rates for any extended period would cause bank deposits to be withdrawn and sent o/s from the ‘four horsemen’… sorry! ‘four pillars’. Deposit outflow would force the banks into increasing the ratio of commercial funding as a percentage of total funding = an increase in net foreign debt which in turn would increase mortgage rates.
PETER_W,
“Deposit outflow would force the banks into increasing the ratio of commercial funding as a percentage of total funding = an increase in net foreign debt which in turn would increase mortgage rates.”
Instead of that they should start reading prof Mitchell or listen to prof Hudson.
Why do we need a foreign central banker to create fiat currency with a mouse click if our own central bank can do the same? We don’t need any foreign debt to finance the pillars of whatever.
But you are right they are neoliberals so they will do the right thing and chop off the branch they are sitting on.
What then did Japan do for 18 years of very low interest rates?
My opinion is based on the same AK #61 perspective.
I’m a fan of Hudson but I can’t see the Australian ‘Neo’s’ embracing fiscal deficits to credit private sector accounts. I see the Neo’s serving the interests of the ‘extractive industries’ of which we have both in spades in Australia – mining and domestic/foreign banking debt.
In Japan the domestic private sector saved like crazy and internally funded the Japanese Governments massive fiscal deficit.
PETER_W,
“In Japan the domestic private sector saved like crazy and internally funded the Japanese Governments massive fiscal deficit.”
…….and thereby transferred what was, still is and shall remain as toxic bad debts from the private sphere onto Govt ie Taxpayer books. It took them a while but they got a lot of it there. Hundreds of Billions $ of bridges and roads to nowhere, a port in every city, railways lines without trains.Public Works! Nation Building! Sound familiar? It’s all just Debt.
Again more comments long the lines of printing our way out of a debt deflation.It has never worked and it won’t work, not in the real world. In some quirky thesis or study paper, one a million economic models- perhaps. But in reality it is a fantasy.
This GFC cannot be resolved until Govt’s start respecting the money they coin and confiscate. As long as they consider money confetti, to be conjured up at will to fund vote getting stupid bailouts, make work construction and cash handouts, there can be no resolution for this debt deflation.
Willy2 #53
China is ‘hell for leather’ spending its USD in Australia on commodities which it’s presently using to ‘build GDP’. Roughly 50 – 55% of Chinas GDP is ‘urban infrastructure’. OTOH… China has a massive 30 – 40% contraction in manufactured exports which shows up in the contraction in the US trade deficit. The US trade deficit is heading toward balance, possibly surplus. China is buying time and Australia gets carried along. How sustainable is all this? China is over producing steel and will be in residential appartment surplus within a few years.
More on the ongoing economic collapse of Japan;
http://globaleconomicanalysis.blogspot.com/2009/10/japanese-moratorium-will-postpone.html
“Japan Lending Statistics
•Japan’s three largest banks, including Mitsubishi UFJ Financial Group Inc., posted combined losses of almost $14 billion last fiscal year as bad-debt charges surged.
•Corporate bankruptcies increased 12 percent to 16,146 in the year ended March 31, the highest in six years.
In spite of the above Kamei states: “We’re going to get financial institutions to provide these firms with more loans,”
Unbridled Greed and Stupidity
Kamei blames “unbridled capitalism” for the global credit crisis.
The reality is this crisis was caused by the Fed (central banks in general) and Fractional Reserve Lending policies that fostered an environment of unbridled greed and stupidity. Ridiculous proposals such as offered by Kamei are guaranteed to make matters worse”
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http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100001459/dollar-hegemony-for-another-century/
“Japan is about to go bankrupt. It is on the cusp of a fiscal crisis that will change perceptions of Asia dramatically. The IMF says gross public debt will reach 218pc of GDP this year. This is compounding very fast. It will be 246pc in 2014.
The Hatoyama government is spending as if there is no tomorrow. It plans to issue ¥50 trillion or $550bn in fresh bonds. I have no idea when this will spiral out of control. It could take another two or three years. It could start next week. Yes, I know that Japan has been borrowing merrily at ever lower rates for 20 years without the sky falling. The 10-year yield is 1.3pc. What happens when it rises to global levels of 3pc to 4pc? People made the same sort of arguments about the global boom before it suddenly tipped over.”
Just because Mr Print Hard saw a reversal in the trend of falling dollar doesn’t mean anything.
Recycling old arguments which have been debunked doesn’t add more to the discussion.
As long as Japan can sell goods (as far as I know they have a trade surplus) they will be able to buy raw materials required for production. So how can they possibly go bankrupt?
Saying that Japan can go bankrupt only shows to what extent the neoliberal “science” can poison thinking. Will they run out of yen to buy back bonds? No, they can create as many yen as they want. They can lower bond yields if they want to – by buying them back.
So how can they default? On what? Having almost 1 trillion USD of foreign reservers? Will they have an inflation? Their problem is exactly the opposite – the lack of domestic demand and deflation.
Please read the following and produce meaningful arguments proving that Japan can bankrupt on their own souvereign debt:
“Irrespective of whether the government has been spending more than revenue (taxation and bond sales) or less, on any particular day the government has the same capacity to spend as it did yesterday. There is no such concept of the government being “out of money” or not being able to afford to fund a program. How much the national government spends is entirely of its own choosing. There are no financial restrictions on this capacity.
This is not to say there are no restrictions on government spending. There clearly are – the quantity of real goods and services available for sale including all the unemployed labour. Further, it is important to understand that while the national government issuing a fiat currency is not financially constrained its spending decisions (and taxation and borrowing decisions) impact on interest rates, economic growth, private investment, and price level movements.
We should never fall prey to the argument that the government has to get revenue from taxation or borrowing to “finance” its spending under a fiat currency system. It had to do this under a gold standard (or derivative system) but not under a fiat currency system. Most commentators fail to understand this difference and still apply the economics they learned at university which is fundamentally based on the gold standard/fixed exchange rate system.”
http://bilbo.economicoutlook.net/blog/?p=2562
Also this can help to understand what’s wrong with Mr Print Hard – the neoliberal theory is described and debunked here:
http://bilbo.economicoutlook.net/blog/?p=930
“In mainstream economics, money creation is erroneously depicted as the government asking the central bank to buy treasury bonds which the central bank in return then prints money. The government then spends this money. This is called debt monetisation and we have shown in the Deficits 101 series how this conception is incorrect. Anyway, the mainstream claims that if the government is willing to increase the money growth rate it can finance a growing deficit but also inflation because there will be too much money chasing too few goods! But an economy constrained by deficient demand (defined as demand below the full employment level) responds to a nominal impulse by expanding real output not prices.
But because they believe that inflation is inevitable if “printing money” occurs, mainstream economists recommend that governments use debt issuance to “finance” their deficits. But then they scream that this will merely require higher future taxes. Why should taxes have to be increased?
Well the textbooks are full of elaborate models of debt pay-back, debt stabilisation etc which all “prove” (not!) that the legacy of past deficits is higher debt and to stabilise the debt, the government must eliminate the deficit which means it must then run a primary surplus equal to interest payments on the existing debt. Nothing is included about the swings and roundabouts provided by the automatic stabilisers as the results of the deficits stimulate private activity and welfare spending drops and tax revenue rises automatically in line with the increased economic growth. Most orthodox models are based on the assumption of full employment anyway, which makes them nonsensical depictions of the real world.
More sophisticated mainstream analyses focus on the ratio of debt to GDP rather than the level of debt per se. “
ak @ #61,
” Why do we need a foreign central banker to create fiat currency with a mouse click if our own central bank can do the same? We don’t need any foreign debt to finance the pillars of whatever.”
Absolutely right. And the reason this has not occurred is because the foreign banks and their lobbyists control and dictate the rules for our economy. Always have and always will.
“This GFC cannot be resolved until Govt’s start respecting the money they coin and confiscate. As long as they consider money confetti, to be conjured up at will to fund vote getting stupid bailouts, make work construction and cash handouts, there can be no resolution for this debt deflation.”
From Steve’s analysis, clearly the problem isn’t fiat money created by the central bank or tax revenue, its the ability of private banks to endogenously create credit independently of the central bank, which is orders of magnitude larger than fiat money and taxpayer dollars.
As such, the government can’t respect the money (endogenously created bank credit/debt) they neither created nor have control over. Banks have used this ability in order to saturate the entire economy in it (finance & industrial businesses, households & individuals).
Once the inevitable bust occurs, there is a free market way out of this as Michael Hudson has mentioned: let the financial and banking firms go bankrupt, and they can be bought up for pennies to the dollar, with their assets (debts) either scrapped or greatly reduced. Then they can be put back into operation. Thus there is no real need for debt moratorium.
Unfortunately, this is never going to happen because the rich welfare freaks in the private sector will do what they have always been the best at throughout history: using their power and influence to ensure that a powerful and highly interventionist nanny state will ensure that they will not face the discipline of the market so the quivering rich can huddle together.
They will loudly proclaim that individuals must honor their debt obligations while the state is busily transferring colossal amounts of taxpayers dollars to prop up the banks and financial system.
In the US, this has aggregated to an insane $US23.7 trillion. It is likely the same thing will occur here in Australia on a relative scale.
I don’t see anything else occurring until workers actually have democratic control of the institutions they spend half their waking hours in.
Philip
You said: “… the rich welfare freaks in the private sector will do what they have always been the best at throughout history: using their power and influence to ensure that a powerful and highly interventionist nanny state will ensure that they will not face the discipline of the market so the quivering rich can huddle together.”
Spot on. We need to democratize capitalism, because the rich are individually rich, but they are not collective rich (at least not yet), in democratic countries. The not-so-rich are collectively, but diffusively, rich. So under the current form of capitalism, few concentrated rich rule the rest of society. It is simply not democratic.
Lyonwiss.
I suppose the balance is that the individually “rich” only have one vote and there are fewer of them than the majority individual democratic “non rich”
My belief system was to try to be one of the fewer than that of the many. Of course it is a matter of degrees in what definition is achiveable, The aim is the thing it is the purpose for living not the lack of aim. “Aspire to inspire before you retire” is what I believe.
If you have a vote and the right to form a political party then surely you can use the masses to democratise Capitalism for the numbers are on your side.
I prefer to aspire ro be the best that I can be rather than bring something down to a lower level
“From Steve’s analysis, clearly the problem isn’t fiat money created by the central bank or tax revenue, its the ability of private banks to endogenously create credit independently of the central bank, which is orders of magnitude larger than fiat money and taxpayer dollars.”
And who regulates and controls the Banks who endogenously create all that credit? The toothfairy? Banks are allowed this “ability”. Then curtail it. This is just more academic semantics that simply over complicates what is quite a clear and present problem. Control the credit issued by Banks and make Govts spend within strictly defined limits. Much of the problem is then solved. Immediately, Bankster influence is cropped.
The reason why Banks have been bailed out so obscenely is because politians have been corrupted beyond all recognition. This can be bitterly spun as class warfare (“rich welfare freaks”), but it’s simply human nature- corruption does corrupt.ANYONE is corruptible. So a strict and heavily policed regulatory structure IS the answer. One that places the benefit and welfare of the whole nation first and not the elite few.
Philip, you can bemoan the hated “system” ad nauseam and offer any ammount of excellent theories, but in the end it is the parasite politicians who decide the winners and losers. Australians need to take control of their Govt. Until then we are all simply mustered outside the slaughterhouse.
Lyonwiss,
Good to see you back on the forum. Yes, you are right when you assert that “it is simply not democratic.” Unfortunately, I am beginning to see that ‘democratic capitalism’ is an oxymoron, not a logical term.
Despite the amount of propaganda that is spewed forth from the state, corporations, economic departments, think tanks, etc. about capitalism been the paragon of liberty, freedom, efficiency and democracy, capitalism is far too similar to communism for me to think that it can be ever democratic.
Under communism, unaccountable and unelected state central planners determine the course of the economy. Under capitalism, unaccountable and unelected corporate central planners determine the course of the economy.
Under both, the workplace where we spend half our waking hours resembles the conditions of a police state. The major difference is that under capitalism we have a choice as to which boss we can sell our liberty to in order to gain a wage. Under communism, there is only one boss.
In my opinion, there is not a lot of difference. In both, the rich control the levers of power and spread myths of “laissez-faire” (capitalism) and “workers paradise” (communism) as population control mechanisms.
Progressives (like me) are going to have to do something other than believe that these two forms of illegitimate economic authority are the only options to choose from.
Even under Australian capitalism, there is a lot that can be done to make things better. Unfortunately, given a few decades or half a century, the corporate pathology backed by the state will eventually reassert itself and we will be back to square one.
This is what has made me dump social democracy and take up anarchism: the state is not a friend of labor and people in general. It never was when the nation-state system came into being centuries ago, it currently is not and never will be.
Thus ends my rant.
On a side note, I am currently reading through the journal article you recommended to me:
Bergmann, Barbara R. 2009. “The Economy and the Economics Profession: Both Need Work,” Eastern Economic Journal, Vol. 35, No. 1, pp. 2-9.
Over the months, I have been reading a fantastic collection of heterodox journal articles. If you want a reference list or the actual PDFs, I can send them to you if you want.
It’s a Plutocracy, its not democratic capitalism or a meritocracy. Total business failures are showered by ‘the State’ with personal dynastic wealth. A few public beheadings would soon tighten up lending standards.
In a lighthearted attempt to counter the revolutionary zeal pervading some of the threads, here’s one way to pay off debt. I wonder if it would work for Iceland! :0)
http://www.abc.net.au/news/stories/2009/10/29/2728075.htm
Quite frankly, I would have paid for her to keep her clothes on!
gaday,
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.