Australia, the new Switzerland?

I have been away for a while and have many things I want to talk about as we enter a new possibly tumultuous year. So this post is a question and a catalyst for future blogs on this and related topics over the next week or so as I prepare to get back into the swing of things.

The Australian Dollar is having its time in the sun once again with a fresh all time high against the Euro (EUR) this week at 0.7955, which is well above the 200 week moving average of just 0.6478 and way above the range top for the past year of 0.7735.

I’ll have a look at the prospects for the AUD/EUR cross in the next few days as I’m wondering if this is not something akin to the massive break in the Australian Dollar v British Pound rate a few years back.

For the moment however I wanted to focus on the demand for Australian Government bonds by foreigners. Yesterday morning I tweeted Byron Weins 10 predictions for 2012 from Business Insider. One of the predictions is that,

Investors go long on currencies of prudent governments

Now some here in Australia may quibble a little with the policies of the current Government and the Opposition party would certainly seek to highlight the increase in borrowings that have occurred over the past few years.
But there is no arguing that Australia is still currently in reasonable  “relative” economic health and that by the metrics of modern-day Sovereign analysis the nation is in fine fettle.
Indeed the interest rate on offer on Australian Government debt compared to what you get as an offshore investor relative to yields available in your home or other jurisdiction starkly highlight that on a risk adjusted basis Australia is in the top-tier of AAA rated nations in the Sovereign sweep stakes. 
Indeed the catalyst for this post was a question asked of me by a colleague on whether the spread between the 2 year OIS in Australia and the Australian Government Bond rate, which is at its widest in a year told me anything about a potential move in OIS.
Which got me thinking, is Australia the new Switzerland?
Sure there are other contenders as Byron Wein points out, Singapore and Scandinavia amongst them. But there is something different about the Australian Dollar over the past year or so, it doesn’t crash anywhere near as much as it used to. Equally we know that the percentage of Australian government bonds held overseas is at an all time high as well and now the Australian Dollar Euro rate is equally buoyant.
I’ve never bought the argument, and still don’t, that the Australian Dollar is now a safe haven. Sure its been re-rated with more central bankers and investors than ever holding it and Australian assets. But if the Swiss national Bank doesn’t want Switzerland to be Switzerland than perhaps Australia has no choice.


  1. Great to have you back DFM!

    Relatively “prudent” and relatively “safe”…. I can’t use the words prudent and safe about Australia without qualifying using relatively AND putting quotes around the adjectives…. in any case, I agree that’s probably enough for the Aussie to do well in 2012.

  2. I’ve had the view that the AUD would remain strong and be perceived as a safe haven until we have substantial stress in our banking system. Any changes to the stability of our system could quickly change perceptions of the AUD and potential govt debt loads.

    Until our banking system weakens, AUD seems very solid.

  3. “I’ve never bought the argument, and still don’t, that the Australian Dollar is now a safe haven”

    DFM, You know I have made that comment and thought to myself how in the world can the Aussie still be so high. I think it is two things

    1. Australia still has one of the highest interest rates in the Western World but if rates get cut another 1% this year will that keep the dollar up?

    2. The currency wars between China and the US are keeping the AUD high. If China and the US stop playing the game of who can make their currency lower then the AUD will drop.

    • Deus Forex Machina

      Dont forget though bond investors are (or should be) more interested on the return OF their capital than the return ON their capital…so a fall doesnt necessarily kill the AUD

      Also if you think AUD rates are going lower there is a lot of capital gain to be made in the intervening period and you dont need to seel to protect that gain unless or until you think the interest rate cycle is turning

      i’m going to write about China over coming weeks but i think over the next few years it will really start to emerge as the next reserve currency. convertibility is the first step but this of itself will keep the usd in check and help the aud…IMHO at least

      • “i’m going to write about China over coming weeks but i think over the next few years it will really start to emerge as the next reserve currency”

        DFM I got to disagree with you on this one. China is going to have to really open up and also let the RMB currency really appreciate to the level it should be. Until then I doubt this will ever happen.

      • For any currency to work effectively as a “reserve currency”, it needs to be available in sufficiently large quantities to serve as a freely-obtainable measure and unit of exchange between economies other than its issuing country. Take the USD, for example, which is used to settle international trade in nearly all products between nearly all participants in the world economy, not merely between transactors inside the US or between the US and its own trading partners.

        This means a permanent surplus of reserves has to be generated – in practice, the issuing country has to be willing to run permanent current account deficits that will be funded by reserve-users-and-holders.

        This has been all very well for the US, but certainly has its limits, as we have seen in recent years. A feature of this has been the very rapid growth in reserves – at least matching the growth in world trade, but far exceeding the growth in the US economy and contributing to both the financial imbalances and contradictions that currently beset the global system.

        As things stand, however, there is almost no chance at all that the Chinese will accept the idea of running permanent current account deficits on the scale that would be needed for the Yuan to replace the USD as a reserve currency. The entire Chinese ethic is built upon thrift, accumulation and nationally-focused self-determination. Japan also declined to take on such a role in the 1980’s, preferring to position itself as a permanent creditor-economy, thereby preventing the Yen from being used as a substitute or complimentary reserve currency, and eschewing the chance to internationalize and grow their economy. Likewise, in spite of the prominence of Europe in world trade and finance, the Euro has not so far evolved as a reserve currency for the same reason: the Europeans do not want to produce surplus currency for use in extra-European financial and trade flows. (One might surmise that this is another example of design flaws in the Euro, which is proving to be a D-mark with a garlic and balsamic dressing: it looks good in the photos and smells even better, but is really just pretzel by another name.)

        This is not to say the USD can continue to serve indefinitely as the universal reserve unit. A better system has to be created, but surely it will be time to move beyond national favourites to a global synthetic unit – to a poly-national reserve medium.

      • Deus Forex Machina

        It is a question of timeframe – dont disagree with your comments but I believe that China is emerging as the next reserve currrency and will move to convertibility and beyond to become at least as important as the USD in the years ahead.

        In 1914 the GBP was the globes dominant currency but by 1924 it had been replaced by the USD. 10 years a long time in a life but not much in the history of the world. In less than 10 years time China could probably be the biggest economy in the world and with that will come confidence in a more open economy and with that a status likely equal to the USD.

        Over the next year the CNY might apprecuiate 5-8% which isnt much in the world of currency volatility but it is a move in the right direction – convertibility and opening of debt markets ala the deal with japan over Christmas are steps toward the new CNY

        At least IMHO.

  4. Having lived in Switzerland for a few years (and aiming to return permanently in about 10), it’s a struggle to see how anyone with knowledge of both places could equate them in any way. 🙂

    The difference in approach towards the housing market is but one example.

    • 100,000 signatures required for a referendum is another.

      But I think the article is talking about sovereign bonds and exchange rates.

  5. Thanks DFM.

    “it doesn’t crash anywhere near as much as it used to”

    Agree, and I think it’s because the general long-term view of the USD negative, so this is driving people to stay out of the USD until liquidity S really HTF (i.e. until the really have to move).

    Once the central banker efforts to hold back the next liquidity crunch begin to fail (weeks, months?) I think we’ll hit lows in the order of what we saw through 2009.

  6. Come on, are we really that naive to believe that we live in a “safe haven” country? Im passionate about this great country but lets not kid ourselves. The AUD is a risk currency and will never be seen as a genuine safe haven like the CHF or JPY.
    It is a volatile currency which makes it great to trade with some current fundamental support as noted above. The idea that we can compare it to the CHF may give us aussies a warm fuzzy feeling and certainly the government would be wrapped to hear the huge compliment but, unfortunately, it is far from the truth.

    • Deus Forex Machina

      Personally I prefer the currency in the 60-80 zone against the USD rather than up here above 1 and i dont revel in it nor does it make me feel warm and fuzzy…

      but the reality is we dont get to choose whether or not we are popular – others do – so it not necessarily me or us that is comaring us but them.

      As I said though I dont buy the safe haven thing long term when i see aud rally every time equities fall for a year or so then I might rethink my cycnicism toward this line of thought but the rerating and new found love for the aud from offshore is undeniable…

      interesting idea for a post though – what is a safe haven – I’ll put it on my list

  7. A holder of fiat currency needs to believe that what he holds is backed by the real assets owned by the country of issue.

    Just as those who yearn for a return to a gold standard advocate a backing by gold, we all need to know that there is tangible value in every note that we hold, even if that backing is an alternate to gold.

    In Australia’s case it is quite easy to accept that for every dollar held there is likely to be $10,000 worth of gold, silver, iron ore, coal, natural gas, oil, copper, lead, tin, bauxite, diamonds, precious stones, farming potential, fish stock etc etc etc.

    What does Greece have to offer – what does Zimbabwe have to offer? Without doing a stocktake of all of the natural resources and minerals held by this country, or a due diligence on its management and earning potential, it’s not difficult to understand that investors appreciate our stable political system, abundance of natural wealth, and a lack of any significant military threat.

    In this world an investor could do a hell of a lot worse than hold Aussie dollars. I can’t think of any currency that I would exchange mine for at the moment.

      • And NZ has milk powder, right? If you look at the value of the NZD relative to USD and most major currencies in 2011, you see a similar pattern. So has something fundamentally changed about NZD as well?

    • “I can’t think of any currency that I would exchange mine for at the moment.”
      NOK has crossed my mind.

  8. Hey DFM, in a world of currency debasement, how long can Australia sit out and not join the party before the consequences of a strong currency really bite?

    Could Australia engage in some QE at some stage?

    A severe housing downturn and a blanket guarantee of the banks just like happened in Ireland and debt/GDP levels might not be in such good shape.

    • Deus Forex Machina

      Yes indeed – I’m not advocating we become Switzerland just we might be being percieved as a safe receptical of offshore capital

      the unfortunate reality of this is that Australia cant pull its usual trick of letting the AUD crash and devalue to get us through any economic weakness

      which suggests to me that eventually rates will go below 3% because the economy will need it…we’ll see how the battler goes then

  9. Steven Spadijer

    Of course, Switzerland, unlike Australia, is the wealthiest country in the world per capita when you measure financial and non-financial assets while possessing a robust and innovative manufacturing sector (with its central bank having the balls to intervene in its currency market). More importantly, it is a country where real estate speculation is frowned upon and 70% of the population does not own there own home. House prices, like in Germany, have been a straight line.

    Australia is not a new Switzerland. Australia has no “direct democracy” to enforce the federal structure (most centralised power proceeds undemocratically) while the Swiss cantons are extremely competitive, some offering no company taxes. Our constitutional engineering is shameful – even with all the resources in the world we are not as affluent as Switzerland.

    This has to do with the way our system of government operates. As James Buchannan observed our system of “representative” government rests upon the notion of “adverse selection”:

    [S]uppose that a monopoly right is to be auctioned; whom will we predict to be the highest bidder? Surely we can presume that the person who intends to exploit the monopoly power most fully, the one for whom the expected profit is highest, will be among the highest bidders for the franchise. In the same way, positions of political power will tend to attract those persons who place higher values on the possession of such power. These persons will tend to be the highest bidders in the allocation of political offices. . . . Is there any presumption that political rent seeking will ultimately allocate offices to the ‘best’ persons? Is there not the overwhelming presumption that offices will be secured by those who value power most highly and who seek to use such power of discretion in the furtherance of their personal projects, be these moral or otherwise? Genuine public-interest motivations may exist and may even be widespread, but are these motivations sufficiently passionate to stimulate people to fight for political office, to compete with those whose passions include the desire to wield power over others?

    Under these conditions it is entirely predictable that the system will adversely select odious politicians who act in their own interests, with minimal regard for the subjects they rule. It is inevitable that the dishonest politicians will deliberately misrepresents the state of affairs to the public in their desperate attempts to secure votes. It is inevitable that power-crazed politicians will engage in obscene competitions to hand out bread and circuses – each side seeking to outdo the other to secure power – running up unsustainable public debts in the process. It is inevitable that the revolting politicians will engage in grubby auctions, buying off special interest groups and powerful lobbies piecemeal with gifts from the public purse . . . and look to receive favours in return, either in the form of support in government or employment in later life. And it is only a matter of time before the megalomaniacs pursue some expensive, harebrained, self-serving scheme (like the EU, the Euro debacle, or a war – all of which were rejected by the people) that brings down disaster on their subjects. Does anyone, for example, believe Ireland would be in the position it is today if it had the Swiss system of government, handing over your own sovereignty to the EU? I doubt it.

    By contrast, James Buchanan supported direct democracy as it “adds-on to existing decision-making rules” – creating new rules like a competitive tax regime, decentralized government/competitive federalism and lower taxes. Australia has no mechanism to allow people to make themselves more competitive, innovative or productive. It is ultimately pray to the long-run forces of paternalistic government.

    This blog would do well to study Switzerland more closely, particularly the role direct democracy has in economic growth (so called “constitutional economics”).

    • +1

      Australians argue over political parties, when in fact it is the system that is the problem. A Westminster system that worked for the English over 100 years ago, no longer works effectively for us today in Australia. Go figure.

      • Steven Spadijer

        Agreed. Actually, direct democracy was considered in the 1890s by the founding fathers during the Convention Debates (Kingston contained it in his 1891 draft constitution), but it was rejected under the grounds it would “make the people the master of the situation”. Instead, what they wanted to create was responsible government where Parliament was accountable to a “chamber elected by the people”. As such, it was anti-British and hence was rejected.

        This raises a more philosophical question: why were the Australian people never given the full range of options to choose from? Why was direct democracy pre-vetted by a powerful, organised political class?

      • Why was direct democracy pre-vetted by a powerful, organised political class?

        Because we were a bunch of convicts! And no different 100 years later when the republic referendum question was posed.

      • Steven Spadijer

        I’m glad you raised the Republic – I think the only model the Australian people would support is the Swiss (and it seems like the natural progression – a large federation like ours is precisely the sort that needs decentralized government!)

        The convict argument, I would have thought, works to other way: there are more of them then elites, so they’d rally for it. One poll I read found 63% in favour of DD, 13% opposed – the rest undecided:

      • My problem with the republic debate was the direct election of the President.
        The political climate in Australia has been so bereft of worthy people for so long, and the standard of political debate so low that I did not want a President (Honorary position replacing the GG)from one political party or the other. There would be no dignity to either the debate or the office of President.
        If the election of the President required the vote of 2/3 the members of parliament then the President would have to be someone who had respect from both sides of the political divide and of the community.
        I’d rather have an appointed GG than some political hack out of one of the parties

        Just my two bob’s worth

      • Steven Spadijer

        I have written a bit about direct-election, looking at Singapore, Austria and Finland. Generally:

        a) 64% of our GG’s since Federation have former politicians’.

        b)The figure for Austria (since 1929, 44) is 14%; 50% in Finland; 50% in Singapore; 50% Iceland.

        c) Where the people can nominate the President, they tend to be former academics, Professors, artists etc. Where Parliament nominates, they tend to be party hacks.

        d) Just have a prohibition that the President cannot be a former politician, or a member of a party for several decades.

        Ultimately, as long as there is direct democracy, the Presidency is irrelevant. Under direct democracy, the people are The Sovereign. They become the monarch (effectively direct democracy means the reserve powers are now vested in the people, including the power to veto legislation). They would be simply symbolic and if they do anything wild we can simply replace them.

        I expect the only model the people would support is non-executive direct election with Swiss-style direct democracy.
        I’ve pretty much come to the conclusion the best system is one where there is no Head of State… or at least one where nobody knows the head of state (so there is no “cult of personality” or disappointed when footage emerges that they were involved in a gangbang). What sad, paternalist country needs to look at a hand-waving glove puppet? Who cares who the Head of State of the country is, if the people can represent themselves? Just let the Presidency rotate among members of Cabinet or State Premiers if you have a federation. I expect that while direct-election will be popular next time, ultimately it will be abolished (through the initiative process) as people realise how useless personalities are.

        Once again… Switzerland provides that model (nobody knows who the President of Switzerland is without googling it). Strangely, Ron Paul puts this point well:

    • This blog would do well to study Switzerland more closely, particularly the role direct democracy has in economic growth (so called “constitutional economics”).

      I would really love to see this seed of an idea expanded, to try and identify which countries can be considered to be the “best” from the perspective of sustainable economic policies.

      • Steven Spadijer

        Of course, on issue of hare-brained, centralized uncompetitive regimes the people naturally say ‘no’ (look at s128 referendum in Australia – most of them are defeated). Likewise, the people are not fans of excessive taxation. As such, we should expect these regions tend to be more competitive and government opinion more responsive to local needs (e.g. infrastructure bottleneck necks).

        It may be observed the richest (and most efficient and stable) parts of the world are those with direct democracy – despite these regions having no natural resources. Hamburg (the richest German state per capita) is an avid user of direct democracy; Bavaria (the second or third richest German state) has had over 1500 initiatives between 1995-2005 and actually using the initiative more than some parts of Switzerland; Liechtenstein (the first or second richest country in the world per capita GDP) uses the device locally (Prince Hans-Adams II wrote an entire book on the matter, showing how direct democracy and federalism make a nation wealthier – Liechtenstein, despite being so small, is still very decentralized); Massachusetts, Colorado, North and South Dakota, Alaska etc are all doing well, as is Uruguay (the latter provisions are not very “user-friendly”).

        As a matter of record we know:

        1. Regions which use direct democracy more have higher rates of economic growth, all things equal: Lars P. Feld and Marcel R. Savioz, ‘Direct Democracy Matters for Economic Performance: An Empirical Investigation’ Volume 50, Issue 4, pages 507–538, November 1997 and

        2. Decentralization leads to better education outcomes: search the paper Iwan Barankaya and Ben Lockwood, “Decentralization and the productive efficiency of government: Evidence from Swiss cantons”, Journal of Public Economics Volume 91, Issues 5-6, June 2007, pp. 1197-1218

        3. Similar results are found in the US.

        At this point I should address the “California” counterargument (notwithstanding California was, and possibly still is, one of the most prosperous, innovative and progressive regions in the last 100 years):

        Firstly, initiatives account for 3% of the entire state budget – that is excluding Proposition 98 which raises this to school expenditure (money that would have been spent anyways). It might also be worth noting Switzerland and Bavaria often run budget surpluses (which is fine given they have strong external sectors and little real estate speculation). Worth noting areas in Switzerland that have compulsory ‘budget’ referendums spend 20% lower: search the paper “Budget referendums and government spending: evidence from Swiss cantons”

        Secondly, Proposition 13 was a response to the decision in Serrano v Priest, not by the “super rich”. California had the best education system in America, indeed the world as local property taxes would go directly into funding local schools. The courts held this was unconstitutional (it violated “equality” as different countries would set different rates) and thus property taxes had to be uniform. Enter the uniform cap on property. TWICE before voters rejected initiatives (by 66%) attempting to limit property taxes. The Serrano decision eliminated the connection between local schools and local expenditure. The problem with California is a lack of democracy, not because it is a democracy.

        Thirdly, every attempt to limit excessive corporate expenditure is invalidated by the courts.

        Fourthly, there is no regulations on immigration that a state government (in a federation) can impose – so hoards of Mexicans and other third world countries come rushing into California, creating bottlenecks and ghettos.

        As such, California is not a “direct democracy” – the final voice is not the people, but the oligarch’s that is the US Supreme Court.

  10. The A$ is currently underpinned by the gathering momentum of Chinese investors (of one form and another) wanting to get rid of their paper dollars. Chinese buyers are running thei9r financial tape measure of almost anything that is ‘real’ in this country.
    We are happy to sell whatever assets anyone wants for paper dollars printed so recklessly by the Fed. It’s insane but that’s how it is. So as Perter Fraser points out we have pretty much got more natural resources per head of population than anyone on earth and we are more than willing to sell them.

    Under such circumstances it’s difficult to see a severe drop in the AUD/USD and seems to me the reason the A$ doesn’t fall as it used to (according to DFM)

    However, and I’m open to correction, the purely speculative money that bets on the overnight cash rate and the direction of the currency in the very short term, far outweighs all the Chinese investment money. If this is the case then some ‘unforseen’ event could still put the cat amongst the pigeons or, if you like, the A$ in the doghouse.

    • Deus Forex Machina

      “some ‘unforseen’ event could still put the cat amongst the pigeons or, if you like, the A$ in the doghouse.”

      yep…thats why i dont buy the safe haven idea and have being saying rerating for a year now…

      but rerating means the doghouse recently was 92/93 v the USD when it could easily have been 80 or lower based on historical relationships with market funks…

  11. Might be a good cue to start acting like the Swiss.
    First step would be to stop selling the farm off to overseas entities, in particular those which front unelected governments.

    • We’re on the same page AlanR but it would require a major adjustment to living standards. We depend on asset sales for our current consumption.
      Inflation would be horrific, then what would we do with interest rates etc etc etc.
      It gives me a hollow feeling in the pit of my stomach. I’ve nearly given up the fight against stupidity. Right now my investment strategy, for my future and that of my family, is that I’m just trying to identify companies or resources that the Chinese are going to buy next!!

      The answer lies back in time

      • “The answer lies back in time”

        Please explain.
        (try to imagine Ms Hanson, I’m basically thick)

      • Hi AlanR
        I’v e been writing on this problem for quite some time. I’ll try to summarise in a way that makes sense.

        The genesis of the problems that now face us go back as far as 1959 (at least) The distortions that started then have just grown worse, virtually year after year, very year since then.
        We now have a bloated service sector that services, more or less, nothing except itself. In fact this was portrayed as a desirable trend in university economic teaching back in 1969! Not that some of the trash now being taught in Universities isn’t a damn side worse!
        Government is now out of control and sees its role as attempting to smash productivity no matter what the cost. We have never saved so we have over-consumed. The over-consumption has been caused by artificially low interest rates that have murdered savers. (Note Rumples post on RAT interest rates)So we have had no savings to invest. As a result pretty much all our industries are now foreign owned and we have a massive foreign debt to boot.
        Our debts are so high we cannot raise interest rates to increase saving because that would immediately bankrupt about half the nation.
        The Asian / Chinese contribution of negative inflation to offset our high domestic inflation is about to end. We will shortly be importing significant inflation.

        In 1959, before our debts got out of control, before our economy became impossibly distorted towards consumption,a bit of a tweak of fiscal and monetary policy would have adjusted the economy to fix the problem with a minimum of dislocation.
        The dislocation necessary to fix the economy now will be too high a price to pay. Unfortunately the price of not fixing the problems will be much higher.
        I do not mean in just money terms but that is a whole other topic.

    • Deus Forex Machina

      Hey V

      Yeah still risk on risk off in terms of price movements but I think the “levels” correlation is breakinig down

      I’m going to have a look at this in the weeks ahead

      hope you are trading well

    • Risk On, Risk Off via carry. All else is noise.

      The economic fundamentals of Australia changed what between Sep 2008 and Mar 2009.

      0.97 to 0.60 in 8 months.

      • I think the argument is that AUD has fundamentally changed since the GFC. But as I mentioned earlier, it must be the blogger’s opinion that NZD has “fundamentally” changed as well. The relationship between AUD/USD looks remarkably similar to NZD/USD pre- andb post-GFC. The common factor between NZ and AUD is obviously high-interest bearing, commodity producing and wholesale debt binging.

      • Check! tanmedia. Add in the increasingly desperate Chinese looking to get rid of all the paper USD they can in exchange for anything REAL.

      • A global credit freeze ala 2008 and everyone tries to repatriate FX as lines of credit disappear and cash dries up. Flows are to YEN 1st and USD 2nd.

        Go further back to the dotcom pop in 2000 and that was a shallow pop where the dow only fell 36%. AUD went from 0.68 to 0.48 (-30%) BUT back then hadn’t got into a foreign borrowing fuelled debt orgy feeding a property bubble.

        Watch a Eurobank fail and see what happens. particularly as our economy is built on a housing bubble via banks borrowing heavily overseas.