Mixed signals from the RBA on Europe

Advertisement

John Edwards of the RBA was on the hustings yesterday talking up the prospects for Australia amidst European worries. From MarketWatch:

A European recession won’t be enough to seriously endanger growth in Australia and Asia as a whole, a recently-appointed board member of the Reserve Bank of Australia, or RBA, said Thursday.

A likely European downturn won’t be “catastrophic for us or the region,” John Edwards said in a speech in Melbourne. “A financial crisis caused by a banking crisis in Europe remains a threat but not one I expect to occur.”

…”On the whole we are seeing progress,” he said of Europe’s moves to address its economic problems. “Europe and the Euro zone is likely to come out of this stronger than it went into.”

Speaking to Dow Jones Newswires on the sidelines of the conference, Edwards said the Australian federal government’s commitment to return the budget to surplus in 2012-13 was “taking the right position.”

“The experience in Europe really underlines the importance of reassuring markets that you have a strong fiscal position and so it’s a question of balancing that strength against the impact on the economy of further reductions in expected spending,” he said.

Edwards told the conference he doubted the direct impact on Australia of Europe’s likely slide into a “mild” recession would be consequential given the Euro zone only took around 6% of Australia’s exports.

While no economy was immune from the global downturn in business and consumer confidence associated with the crisis in Europe, he said, Australia’s main vulnerability was to any slowdown in China.

“But there are many offsetting forces to that. One is that China has plenty of potential for switching to consumption. And growth in the rest of the world isn’t bad,” he said.

In a report by The Australian, Edwards goes on to say that:

Much of it, he said, resulted from inefficiency, which meant there was potential to grow through reforms under its new technocrat government.

“It is a large and well-balanced economy, growing by an average 1.5 per cent a year with low population growth, so its productivity increase is similar to Australia’s, 1 per cent or so.

“It can handle renewal of its debt by making adjustments, which are well within its scope.”

There was “a serious risk” of the problems triggering a financial crisis, Dr Edwards said.

But Europe was starting to make changes that would not otherwise have been made, “which will improve the functioning of the economy, and the eurozone is likely to come out of this stronger, and with the same members. The markets will be imposing disciplines that the nations ought to have done over the last decade.”

It was surprising, he said, that growth in the past quarter had not been worse. “If there is a recession, it is likely to be relatively mild.”

Europe bought only 6 per cent of Australia’s exports, he said, so the direct impact was of little consequence. However, the indirect effects would be greater.

“No economy will be immune from the decline in asset prices that has flowed from the resulting loss of confidence,” Dr Edwards said. “We have been expecting a correction in commodity prices, which we may as a result be beginning to see. Our principle vulnerability to Europe comes via China.”

About 20 per cent of China’s goods exports were bought by Europe, and a downturn in steel production would have an impact on Australia.

Advertisement

That’s all good sense but I doubt what is coming down the pipe for Europe is a “mild recession”. Perhaps Dr Edwards can explain how Europe will exit that recession at all given fiscal policy is going to remain dramatically pro cyclical on the downside and monetary policy is already so slow. I also reckon China’s scope for stimulating domestic demand is inhibited in some degree by the obstacle of tightening measures around property (that is, unless things get so bad that they reach for the panic button).

The RBA is not given to these kinds of casual utterances so one can only assume that Edwards view is in some way offering the official view.

Meanwhile, on the policy front, it is more reassuring to note, in a backhanded sort of way, that the RBA are clearly assuming the worst. On Wednesday, the bank dropped its threshold for acceptable collateral for repo transactions with Australian ADIs to BBB-, that’s the lowest of the investment grade ratings. Acceptable collateral now includes:

Advertisement

General Collateral ($A)

  • Commonwealth Government Securities
  • Securities issued by State and Territory Government Central Borrowing Authorities (Semis)
  • Securities with an Australian Government Guarantee
  • Securities with a Foreign Sovereign Government Guarantee
  • Securities Issued by the New Zealand Government or with a New Zealand Government Guarantee
  • Domestic Issues by Supranationals and other Foreign Governments

Private Securities ($A)

  • ADI-issued debt securities, including bills and certificates of deposit
  • Asset-backed commercial paper
  • Asset-backed securities, including residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and securities backed by auto loans/leases and credit card receivables
Yes, bankers can probably get cash in return for their cat right now. For those hardy readers that recall pre-MB blog, Houses and Holes, you may remember my post from last year on declining repo standards, Invisopower!:

If you examine the graph closely, you will see that in late 2007, right around the time the French declared the US asset-backed market a circus, the RBA suddenly begins accepting some new forms of collateral for repo loans: asset-backed securities (ABS) and residential mortgage-backed securities (RMBS). Prior to this time, such assets were not considered of sufficient quality for the RBA to accept them as collateral. Then, having suddenly been allowed, they mysteriously disappear – poof!

No, the assets did not enter a wormhole. Rather, the RBA changed the rules by which it categorises repo collateral so that from late 2008 all are recorded equally as “private securities”. So, having torn up its rule book, the RBA replaced it with a shiny new one, with no pages in it.

The problem, then, for this blogger’s argument, is that we have no idea who, why or what is being provided liquidity.

Add to this that we don’t know the who, why or what for banks that used the government guarantee and we have very little to go on.

Except, of course, the deep sense of suspicion that this Invisopower! leaves behind.

Advertisement
So, now we have another rule change, again lowering standards. This can only be an effort to increase the width of the liquidity pipe running from the RBA to the majors through a wider array or eligible securities and even more so for the smaller ADIs whose ratings are lower. The RBA is talking the best and preparing for the worst.
About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.