Swaggering unarmed in the global currency war


The RBA appears to have rolled out board member John Edwards to counter yesterday’s government leak that it was annoyed that the bank had allowed the dollar to rise beyond forecasts. From the AFR:

Speaking after The Australian ­Financial Review revealed the government’s anger at the Reserve Bank’s ­decision to drop its easing bias, which has been blamed for boosting the­ ­dollar, Dr Edwards said Australia was in the grip of a “bountiful” mining and energy export-driven revenue surge.

…“It’s very difficult to expect rhetoric to have an impact on economic forces which are running in the opposite direction,” he said.“If you’ve got a mood going on in the currency, then rhetoric alone is not going change it.”

…“The currency argument is that a fall in the terms of trade should see lower exports and therefore less demand for the Australian dollar,” Dr Edwards said. “It’s not working out like that. In fact US dollar revenues have increased [for local mining companies].”

“And the balance of trade has for several months been positive, once again. And that means, in terms of what happens in foreign exchange markets, you wouldn’t necessarily expect to see a weaker dollar if it’s associated with, effectively, a boom in exports.”

…Opposition spokesman on finance Tony Burke said the government’s anger about the Reserve Bank was extraordinary. “After years of both sides of ­politics agreeing on the need to have an independent Reserve Bank, Joe Hockey has decided his political needs are more important than the independent status of the bank.”

The dollar has turned for a number of reasons, the volumes boom being just one and probably the smallest. The current trade surplus will disappear in the next few months as much lower bulk commodity prices filter through to quarterly contracts, despite volume growth. The trade deficit will grow further over the next twelve months as iron ore goes much lower.  Equity markets, too, are underestimating the impact of falling iron ore prices on earnings with RIO and FMG both holding up better than they should given their prospects. In short, markets are not discounting the future that is coming. That could be seen as a “mood”.

That attitude comes from four combined shifts in Q1 in global circumstance which really amount to one thing. The US recovery has again disappointed, pushing back rate hike expectations. China has hit the stimulus accelerator again (albeit mildly), the EU is clearly in the process of entering the money printing race as deflation looms, and Japan’s Abenomics burst is slowing and requires more money printing to get going again.

In short, we’re traversing an echo period of competitive monetary devaluation in which the US dollar is held down, commodity-intensive emerging markets are seen as the growth driver and real assets are seen as value protection. This is putting upwards pressure on all of the commodity currencies, and gold, not just the Australian dollar. Here is the Aussie versus the Brazilian real:


Or the South African rand:


Or the Norwegian kroner:


I could have chosen just about any commodity currency and the charts look the same (with the exception of Chile, where copper is all that matters).

So, as we wring our hands, there are several points to make. The first is that we aren’t losing competitiveness against commodity competitors, for the most part. It’s against the manufacturing and service economies that we’re losing production.

There are two questions then. How long will it last and can anything be done about it?

These kinds of global flows will have their way. Money managers have, for the time being, decided that China is going to keep growing at breakneck speed and the US is going to under-perform (or they over-bet on the opposite late last year and are covering positions). But the macro truth is most probably the opposite – the US should accelerate out of its winter slump and China will keep slowing in the medium term – so these flows will likely reverse again in the next six months.

Second, can anything be done about it? Well, yes. Something should have been done about it three years ago. Macro themes are a part of the story but the underpinning investment calculus is the interest rate spread. The countries benefiting most from the renewed push into commodity currencies are  those with higher interest rates, or the  prospect of them, and it is here that the RBA has stuffed up.

When it began slashing interest rates two and half years ago, the RBA explicitly targeted a housing boom. Now it has a growing bubble on its hands and hence interest rate markets are pricing interest rate rises in the next twelve months, long before the real economy is ready for them given the long unwind ahead in mining investment. That has global hot money flows pursuing the carry trade into the Australian dollar as the interest rate spread has climbed a long way off last year’s lows:


What the RBA should have done was introduce macroprudential tools, which would have insured that housing credit was controlled in this recovery cycle and interest rates could be another 50-100 bps lower. The recovery we should have had is in tradables with support from housing construction, not the other way around.

It could still be done and would have an effect. But the risk now is that it would work too well and cause a housing bust, just as we head of the mining capex cliff.

Likewise, Joe Hockey need not wait for the RBA. He too can have his lower dollar quite easily. He could shift negative gearing to new dwellings only. That would stall house prices and offer the opportunity for rate cuts to close the carry trade spread. He could install Tobin taxes on hot money inflows, which would help take the edge off and raise extra revenue. He could slash and burn in the Budget and force interest rates and the dollar lower.

However, Joe Hockey is mostly innocent (even if his Party’s previous policies are not). Competitive monetary devaluation has been a global reality for five years. The RBA and former Labor government ignored it, preferring to pat themselves on the back and see movements in the dollar as the result of Australian (and their own) exceptionalism. Now they’d rather play a blame game than address their own blunders. As such, we’re still swaggering unarmed through the global currency war.

22 Responses to “ “Swaggering unarmed in the global currency war”

  1. migtronix says:

    Great piece H’n’H, I think this the first time I’ve seen you really take the currency issue apart – or maybe all the other times I got lost at the “lower rates yesterday” line.

    On the tradables though, Japan trashed the Yen and got a massive rise in trade deficit (yes their biggest issue is energy imports) and a stall in wages, but apparently sushi chefs (their baristas) are in high demand…

    As for the opposition line about the “independence of the bank” – shoot me!

    • NMT says:

      As I understand Section 51 of the Australian constitution, it would be illegal to have an independent bank making decisions beyond the ‘will or direction’ of parliament.

      • migtronix says:

        My reading of it is that the parliament has power to assert such laws and regulations, but if they choose not to exercise the privilege then I can’t see why it’s illegal. The problem is if the opposition are willing to call the bank “independent” then parliament has abrogated the responsibility and feels indignant at the suggestion it ought to take charge.

      • NMT says:

        because if they fail to exercise their ‘Responsibility NOT privilege’ then they are in violation of their oath of office and must be dismissed immediately

      • migtronix says:

        “and must be dismissed immediately”

        Count me in!!!

      • NMT says:

        I’ll get the hot tar, you bring the feathers :-)

  2. aj. says:

    That is a great and beautifully concise summary HnH. We really don’t have our best brains at the helm of this ship.

  3. Pfh007 says:

    Very good,

    A double approach – MP plus turning down the volume on capital flows (increased regulation of capital transactions) is a sensible strategy.

    Though to really cut to the core of the problem the emphasis must be on the capital transactions that allow the currency wars (competitive devaluations) to damage the local economy and cause imbalances and instability.

    They are the battering rams, seige engines and other devices that allow the manipulated currency flows through our defences.

    Asking them to behave (with MP) once they are running around inside the economy is a very difficult exercise.

    “However, Joe Hockey is mostly innocent. Competitive monetary devaluation has been a global reality for five years.”

    That is a little too kind.

    Mr Hockey was a player in the Howard govt and throughout the opposition years and is now Treasurer.

    It is time he is held to account and forced to address the central failure of economic policy making over the last 20 years.

    Assuming that a free trade in capital transactions is no different to free trade in TV sets or lobsters.

    • aj. says:

      +1 Hockey should not be allowed to pretend he was not part of the team that brought private debt hell to Australia.

    • migtronix says:

      Pfh you’ve let your imagination run, truly the catapults and assorted siege engines are encircling the moat, but it’s only for show because in fact we have a “independent” central bank lowering the bridge, rendering the turret defences useless.

      The Chinese and others may find the victory pyrrhic in the end, buying in when the AUD is this high seems like a guarantee of loses down the road.

  4. The Patrician says:

    “Joe Hockey is mostly innocent”

    You are too kind HnH.
    Joe has an array of unused tools lying idle in his shed.

    Sitting pristenely in his portfolio still in its wrapping is the FIRB with all its attached laws and powers. Sure he has asked Kelly O’Dwyer to see if it is working but everyone knows that it has never been switched on.

    The recent NAB residential property survey indicates that as many as 30,000 existing dwellings may have been illegally purchased by foreign buyers, contrary to FIRB rules, just in the last year.

    Prove me wrong Joe. Audit the Sydney and Melbourne sales for compliance with FIRB rules.

    Publish the results.

    You are too kind HnH.

  5. China-Bob says:

    Good analysis HnH BUT what happened to yesterday’s announcement that the Carry trade was driven strictly by the interest rate differentials?

    Should I understand that you are now on board the:
    Hot-Money flow produces volatile exchange rates club?

    • Roberto says:

      Yes, the rate diff can help one read the AUDUSD direction but it is very nuanced and most of the time there is nothing but noise.
      The current 6mth divergence of the 10yr rate diff says NOTHING about the bullish direction of the AUDUSD. If anything its short period and lack of any signs of strength (new highs) point to a failed signal (which make up about half of all divergence signals). A failed signal here means AUDUSD down.
      Download 20 years of data into excel and look at the charts. There are interesting technical signals – 1. rates break out on 3 occasions in the last 20yrs 7-12mths ahead of AUDUSD 2. the divergence signals over 1.5yrs long and those with a lot of strength (higher highs in a downtrend) are probably useful.
      ps – by divergence signals I mean: rate diff indicator makes higher low in a downtrend while AUD makes lower low in downtrend or vice versa: diff makes lower high in uptrend while AUD makes HH in uptrend.

      • migtronix says:

        +50 pips

      • China-Bob says:

        Thanks Roberto,
        I’m not real big on traditional chart style technicals, I actually prefer to try to solve the Matrix of currency crosses with all available future hedge positions, its a nasty bit of math similar to material a Finite Element Analysis. I do a matrix reduction on this and construct a system of multi-dimensional Z-domain filters. I do this because there is lots of existing math/methodology I can leverage for solving Digital Time domain filter problems.

        . This analysis highlights hedge arbitrage positions particularly in the crosses. At the moment I generally I try to look for pair-trades so I’m naturally hedged, I’ll start to take naked positions once I have a little more confidence.

        It’s a work in progress …..maybe I’m just reinventing the wheel but its fun in a perverted geek sort of way!

      • migtronix says:

        .maybe I’m just reinventing the wheel but its fun in a perverted geek sort of way!

        Music to my ears :)

      • migtronix says:

        BTW CB what algos are you using for sparse matrix reduction?.MapReduce?

        And what do you use to filter noise? Low pass/band pass?

      • China-Bob says:

        Yea I need to take a closer look at the solver problem, at the moment I’m just using a standard Minimum Residual method.

        As for noise: I’m focused on constructing bandpass Z domian filters, so the only issue is with inband noise. At the moment I select the filter bandwidth and center freq to complement the delays in order decision process, basically I only turn up opportunities I can act on.

        BTW I might need to redo the filter section because I recently noticed a pattern in the data that correlates well with a very simple Spreading code. The orders are BIG so I’m really surprised that they appear to be reusing a fixed order spreading code. This is extremely bad opsec for any crypto function, so somewhere somebodies head needs to role, of course I’m not about to tell anyone….oops… The trick of course is to catch them reusing a code in real time…..I’m working on this.

  6. Hugh Akston says:

    “When it began slashing interest rates two and half years ago, the RBA explicitly targeted a housing boom.” – Shock horror! You’re saying they did it on purpose!

  7. notsofast says:

    The RBA, and by extension Australia, is turning up to a gun fight with a knife.

    What does that make Australia?