Cut rates for a lower dollar

That’s the argument made by many MB commenters and today by Westpac’s Huw Mackay (of Phat Dragon fame)  at the AFR.

…the most recent balance of payments data show that gross foreign purchases of Australian assets were 42 per cent debt and 58 per cent equity. Westpac proprietary customer data shows that foreign sovereign purchases of Australian fixed income products were about one-eighth of flows (including domestic players) over the past year. The case that sovereign inflows are now an important element in deficit financing is easy to make. Making the case that they are dominant across the entirety of Australian capital flows is much harder.

The attractiveness of Australian short-dated interest rates as a hedge against global Armageddon scenarios is a further driver of “non-productive” demand for the Australian dollar. The fact is that there is a considerable shortage of low risk assets available around the world with room for reasonable capital gains before they hit the nominal zero bound should a financial calamity strike.

…With the terms of trade now falling, the real exchange rate should depreciate. With monetary policy set as it is, the RBA is choosing to push more of the burden of adjustment on to the local economy, and less on to the nominal exchange rate, than has been traditional in the post-float era. Although foreign exchange intervention would be one way of returning balance to this equation, lowering interest rates would reduce the incentive for foreigners to hold and procure more Australian dollar assets and allow the interest rate and currency-sensitive elements of the domestic economy some needed breathing space.

Mackay ends by saying inflation is low so its within the RBA mandate to cut.  Mackay is as elegant as usual. But I have have two issues with this analysis. The first is that nobody I know has argued that foreign sovereign flows into yield is a dominant factor “across the entirety of Australian capital flows”. Mckibbin and others have argued  that the flows are substantial enough to make a difference. For instance, would we even be having this debate right now if the dollar were at 98 cents with a downtrend in place? I might add that a move upon sovereign flows would surely too put some doubt into the heads of the one-way bet currently assumed by the carry traders so it would have larger effects.

Second, it’s all well and good to tell the RBA to cut rates to lower the dollar without making reference to the key component of the Mckibbin position, which is that giving sovereign buyers freshly minted dollars won’t increase local  money supply. It’s much harder to argue that cutting rates to lower the dollar is a good idea if you acknowledge that you still have a quite large housing and credit bubble you’re trying to deflate.

If Mackay had argued that the RBA could cut rates to lower the dollar and simultaneously use macroprudential policy to prevent a loosening in local liquidity (as well as an unintended credit expansion) then he’d have my ear.

Houses and Holes

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 fouding 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.

Comments

  1. Right. Getting there .

    And as I mentioned earlier, there is a need for firm action on loan deposit rates to counter the speculative attraction of lower mortgage rates. If the RBA cuts rates significantly without taking that action, well shame on them.

  2. Quite a good call to lower rates, property bubble is well burst and even miners share prices are dead in the water, hard to see what we are waiting for. Swan made the point that economy is 10% bigger than in 2007, but govt net contribution 25%, looks like a fiscal cliff here to me next year!

    • Burst ???

      you re probably from Melbourne but elsewhere I can tell you, property market is full of life.I did exchange on 2 this week and it was not easy by any mean.

      a drop of rate will just make property investors even more comfortable and cash flow +++ .

      I dont think a rate cut is the appropriate measure in the current situation.

      • The Sydney average property price is flat and down in real terms by 20+% since 2004, on average it gains 8% per year, that is a bust or as bad as the property market gets, historically it is due for a major rally.

  3. “that you still have a quite large housing and credit bubble you’re trying to deflate” and the last series of cuts, in some states, seems to be blowing that bubble up again.

      • agree, but if the RBA cuts and cuts it will suck capital flow into housing again without fiscal policy change, and I doubt the politicians have the gut for that. We still think we’re different.

        • I know what you are saying but the price rises in these areas are for a reason. Labour is tight and housing is in short supply, the price rises provide a mechanism to balance this shortage. Leaning against it simply prolongs the shortage. The areas that need relief are in the eastern states that are struggling and the bubble is burst.

          • Housing is in in short supply because land suitable for housing is in short supply. Without fixing this issue we will just continue to have grossly overreactive market conditions (more severe boom bust cycles). Making money cheaper to borrow will just mean we need to keep it cheaper to maintain affordability, but that is not a real solution deplugging the land supply pipeline is a major part solution.

          • not to mention keeping it cheaper also prevents retirement and robs younger people of jobs. A thing that will bite us when the BB elite eventually dies out and we have no expertise in any industry in this country.

      • no they are not. Check out Auckland in NZ – economy is stagnating, but mortgages are below 5%. Where else do you put your money – in a savings account yielding 2% after tax?? Lowering interest rates is simply another means of money creation, that money has to go smoewhere

        … and yes – i know it has not worked in USA / Japan, but it often does. Continuing to manage the deflation of Aus housing bubble should be the priority.

  4. LabrynthMEMBER

    Simple, cut rates and at the same time get the APRA to make all new mortgages for property from a certain date Non-Recourse. This means banks will need to re-adjust for risk and possible leverage for housing will fall from current 95%-90% to 80% with LMI or 70% without LMI.

    Less leverage = less bubble

    • agree – the OCR is a blunt tool, but the RBA / govt are too gutless to acknowledge that debt is just another form of money creation that can very quickly reallocate wealth and therefore should be subjected to VERY strict controls.

  5. Who will benefit from lower interest rates? Did that save USA jobs, family incomes and budget deficit? Did that work anywhere in the world during this protracted crisis? Whose wealth was consolidated through lower interest rates? And last question: when it is pretty obvious that the monetarist wing of economics and their policy is total failure, what should else happen to understand that without regulating capital unproductive expansion (financial markets, banks and derivatives) lowering interest rates is a stupid policy? Can lower interest rate encourage capital productive allocation? NO. Than why are we willing to pour more oil into the fire, e.g. into bankers’ exuberance and excesses?

    • Well you have a choice, follow the austerity in Europe or follow the money printing in the states. It is clear the US for now is performing much better. The exuberance in Australia last time I looked was in the trades and mining salaries hardly in the financial markets who have taken massive pay cuts without any strikes. I think that rate cuts could save our manufacturing and tourism business,and further down the road our banks capital.

      • If there were some kind of regulations about the speculative capital inflow and outflow we could have had better manufacturing and tourism. Now even with lower interest we can’t save neither the manufacturing, nor the tourism, which, by the way, was compromised by the exuberant prices on foreign tourists, especially Japanese, who are use to pay big money, but for quality, not for nothing.

        • Yep – that is the way.

          If we are concerned about foreigners /Central Banks buying up Australian Dollars, and thereby forcing up the price, so they can acquire Australian financial assets like squirrels hoarding nuts for winter, then the simplest solution is to limit the nuts they can buy.

          * less reliance on the savings habits of foreigners. (ie more local saving)

          * restrict sale of govt securities (Fed and State) to foreigners (ie more local saving)

          * better manage the sale of domestic assets to foreigners so that we do what other countries do and just let foreigners invest in things that are not important – ie let the chinese buy as many home units as Harry can build)

          No need to fix the currency if foreign investment policy limits the options for foreign speculators and increases the supply of local capital.

      • Bob it appears to be working in the US? The jury is still out on that. More importantly pre GFC the US was running an economy that was simply unsustainable. It was characterised by over-consumption and increased debt one form and another. Nothing has changed in that regard. Each time there is a whiff of recovery their CAD increases. Now this is fine if you regard foreign capital as a free and infinite source of funds. Nearly every economist in the modern world, including Huw Mackay, takes that as a given fact. The irrationality of the belief beggars the imagination.
        Sure the US is currently able to flog its Treasuries at zero interest because it is the world Reserve currency however pressure on that status mounts every day as the profligacy of US policy becomes more and more apparent. The destruction of the value of the US currency is all too apparent as is the inflation waiting in the wings.

        So, here in Australia we have a nation with no savings and a chronic CAD that has already needed to sell off most of its assets and resources to maintain consumption. As a nation we are over-consuming…grossly. The current high Aus dollar is exacerbating that problem. There is a need to get the value of the A$ down of that there is no doubt. However the call to devalue the dollar by simply lowering interest rates is at least as destructive as the current suicidal policy.

        The Real Estate bubble is far from burst. The lowering of interest rates in the past 12 months is now having an effect. This is obvious to anyone who has anything to do with the RE market in any way. The difficulties of the last 12 months have been very minor and are regarded as just a pause before the next long leg up. In any case, as I’ve opined before, in Australia under current policy settings what else would/could you rationally invest in?

        The only way to bust a bubble is to bust the damned thing…really bust it so that all the illusions are killed and all the pretty colours associated with a bubble are revealed to be what they are…NOTHING!

        Indeed the whole object of all those who are calling for an interest rate cut in Australia is restore the old pre GFC economic structure. It has no rationale. The old structure was unsustainable and is even more unsustainable now.

        • +1
          Too early to call it a burst.

          And lower dollar is not guaranteed by dropping IR. Do we really want ZIRP in AU?

        • Seems some commentators here rely on interest rates for an income. It colours your view. The high $A is bad for the Australian economy as a whole and the RBA must act as inflation is well in control.
          Yes, I know you savers get upset at the prospect of less income but that does not change the reality.

          • You don’t need to rely on interest for an income (I don’t) to understand the limitations (and dangers) in relying on interest rates as a economic management tool.

            The idea that you would yank on interest rates to address foreign speculation in our currency is bizarre.

            Like developing a speed addiction to overcome the effects of the common cold.

          • “there is no inflation whatsoever, irrespective of the AUD currently”

            Dam
            You maybe right there IS, at the moment, no inflation as measured in total by the ABS. Yet within that there is obvious inflation. Did you read Rumplestilskin’s post on the subject?
            Further the coming inflation is already written in.

            Inflation cometh!

            Do you ever think what is going to be the result for this nation and its people if you happen to be wrong?

            Again I recommend Shaun rein’s book “The End of Cheap China”

            I think nobody should comment on inflation until they have read it.

          • Webspyda
            You said “Seems some commentators here rely on interest rates for an income. It colours your view”

            Would you care to elaborate on the commentators you consider whose views are coloured by this factor?

        • “The lowering of interest rates in the past 12 months is now having an effect. This is obvious to anyone who has anything to do with the RE market in any way”

          Is it really flawse? Or has activity in the RE market picked up not becuase of rate cuts becuase vendors have been dropping their price? Id say its the latter.

  6. MacKay is right. The RBA needs to cut rates to get the AUD down.

    McKibbin’s plan is a good second best alternative and definitely worth a try. But unless it was 100% sterilized, it would increase the domestic money supply. If it was 100% sterilized there would be a fiscal cost. There is also the issue of credibility. It is easy to intervene when the policy rate is 0% and deflation is -1% (ala Switzerland), because the market is willing to believe that the CB will go to any lengths to protect an exchange rate. It isn’t so easy when the policy rate is 3.5% and inflation is positive.

    I don’t think the fear of lower interest rates causing another credit binge is warranted. People’s behaviours have changed and deleveraging has set in. Lower rates should actually speed up deleveraging – if they ensure that debtors have the (nominal) income to repay debts.

    • rubbish – check out NZ esp Akld. Stagnant economy, but hooray the housing market is rising again.

    • Interest rates that are manipulated down send distortions right through the economy that are not easily reversed (as we can see only too well right around the globe).

      The $AUS is high because people (including central banks) are speculating or engaged in the manipulation of their currency.

      Policies designed to deny the speculators their day at the races are the solution.

      However, the McKibben suggestion worries me because while it sounds good in theory I fear it requires a skill set on the part of the RBA or the Fed Govt that I don’t think they have. Plus I think it would be a very hard sell politically – especially by our communications challenged political leadership.

    • +1 Sweeper
      Its the savers shrill complaints that are deaf to the required reality. Self interest is hard to reason with.

      • You are making the assumption that those who disagree with trying to drive down the currency by driving down interest rates approve of a high $AUS.

        Most of those arguing against your solution (slash interest rates) are also concerned by the impact on the $AUS by foreign speculation in our currency and the mining boom.

        It is just that we take a bit more care with our babies when considering our options for the bathwater.

        • “You are making the assumption that those who disagree with trying to drive down the currency by driving down interest rates approve of a high $AUS”.

          By and large, the same people who want high interest rates also want an overvalued currency. There are exceptions.. like McKibbin.

          • The carry trade is when foreigners with foreign money convert it into $AUS and lend it to Australians (especially a debt printing Federal/State governments.)

            If they can’t lend it to anyone because of capital controls or there are limits on govt debt being sold to foreigners, local banks using the saving habits of foreigners, then they will not be buying $AUS.

            Currency problem solved QED.

            Of course it means we need to do more saving and less consuming and we seem to think that is the job of the developing world.

      • Again please justify the ‘self-interest’ comment. You have used it to justify your opinions without giving any logical reasoning.
        You accuse anyone who argues differently to you as only arguing from ‘self-interest’
        So let’s have who you are talking about.

  7. “It is easy to intervene when the policy rate is 0% and deflation is -1% (ala Switzerland), because the market is willing to believe that the CB will go to any lengths to protect an exchange rate. It isn’t so easy when the policy rate is 3.5% and inflation is positive.”

    Yep!
    As has been opined here by a few writers, and well demonstrated by Rumplestilskin, the low inflation figure here is only being achieved by the constant rise in the value of the A$.
    Our non-tradable inflation is running at some 5% +/-1. There is every sign that even this figure is about to rise
    With FOB prices for imported goods continuing to rise a lower dollar WILL result in significant and immediate inflation.
    Then where do we go?

    • I dont remember a huge inflation pressure last time the AUD was at 0.6.

      there is no inflation whatsoever, irrespective of the AUD currently, vegetable/grocery/non-mining salary/IT/restaurant/services/rent, inflation pressure is nowhere to find (beside city council rates & utilities ).We would be in pure deflation without the electricity prices and carbon tax.

      • Ahh the old deflation bogeyman makes an appearance.

        The deflation bogeyman, designed to scare the kids, goes like this.

        “When people think prices might fall they stop breathing, eating, listening to music, watching movies, going out to eat, ordering takeway, using clothing, shelter, transport because they figure they can start doing all those things again at some unknown point in the future”

        TV prices have been falling like a stone over the last 5 years. Are you still watching your old 68 cm CTV because you are waiting for the deflation in TV prices to stop???

        Falling prices are a good thing!

        It means we are more productive and able to sell things for lower prices.

        Yes – we might stop buying things that we don’t “need” because the price is falling but since when has it been a problem for people to stop buying random stuff that they don’t need to live.

        • I never say deflation was a bad thing but if we get into one I expect you to be the first to see your boss to demand a pay cut 😉

          • “Demand” is not the word I would use but if the market price for labour is falling and the boss noticed that then I guess I would be prepared to negotiate – as a last resort! 🙂

          • “deflation on what you own, inflation on what you need ”

            Yes – that sums up the likely reality.

            Needless to say that those who ‘own’ stuff secured by debts don’t like deflation. But providing they can meet their repayments on the debts on their deflating assets they will be unhappy but not destitute.

            Though probably will never use a credit card again and will wince every time someone talks about the ‘power of leverage’.

      • Dam

        I dont remember a huge inflation pressure last time the AUD was at 0.6.

        The world doesn’t stay the same. There is a huge danger in looking in the rear view mirror and thinking what you are seeing is tomorrow’s reality.

        • There is also a huge danger following unproven dogmas/fallacies, and there are plenty when it come to inflation and money printing.

          there is an obvious problem with the AUD and the miraculous invisible hand of the market (long for economist cluelessness, oxymoron) is doing sh$t.

          • dam

            Can you demonstrate anywhere that I have claimed that increased money supply is going to cause the inflation that is coming?

            In fact i have argued in the past, I hope cogently, that it seems probable that increased money supply has in fact led to LOWER inflation than would otherwise have been the case. It’s not something I can mathematically prove yet there is good logical argument for that scenario.

            It’s converse is also the reason why increasing interest rates in the face of rising inflation is not going to work.

            WRT the A$ the last thing I’ve wanted is for the miraculous hand of the market to be the sole guide. I think pfh, myself and others have been seeking direct intervention. I cannot think of any disaster intervention would bring that is worse than the current debacle.
            However I would say that if you had other policy settings right the currency should be left to float around a bit. “Managed float’ if you like.

    • Then where do we go?

      The RBA does the job it is supposed to and adjusts rates to maintain a steady competitive currency/economy.
      They get it wrong. Finally react in panic and then sit back getting it wrong again. With all the corruption coming to light in the banking sector it begs the question which master do these guys serve??

      • Web FWIW I don’t think it is the RBA particularly at fault. I really think the Western world has been operating on false premise and false theory for so long. Now there is no way out.
        So, personally, I wouldn’t accuse the RBA of serving some alien master of some sort. The whole thing is totally screwed.

  8. Mr Mackay’s piece lost all credibility with me at the line, “The attractiveness of Australian short-dated interest rates as a hedge against global Armageddon scenarios..”

    Oh dear. Someone please show Mr Mackay an AUD:USD 5y chart.

  9. Mr SquiggleMEMBER

    Next time there is a GFC, and our dollar crashes to $0.60, should we start calling for rate hikes? Rate hikes to prop up the dollar, in the middle of an economic crash?

    Why call for rate cuts when we are swimming along pretty strong. The dollar reflects our point in the economic cycle, why risk a pro-cyclical setting on interest rates?

    I still don’t get MCkibbon’s idea, if we print money to sell only to other Central Banks, then how do we stop them selling it at a moment of their choosing?

    • Agree with you Mr Squiggle.

      Most of the economic literate don’t see the benefits of a strong currency. As Frederic Bastiat said we have to take into account “what is seen AND what is not seen.”

      Everything we import is now cheaper than it was a few years ago. While a few sectors will contract, it just releases labour, capital and land to be used in more productive sectors of the economy.

      The other simple fact that currency interventions do not work should counter any argument to suppress the AUD. Just ask the Bank of Japan.

      Using interest rates to manipulate the currency will also fail since it will cause inflation in a year or two as the money supply expands.

      • ” economic literate”

        I had a laugh at this one, sound like religious literate, fairytale literate, divination literate, coffee cup readings literate.

        so funny

      • “The other simple fact that currency interventions do not work should counter any argument to suppress the AUD. Just ask the Bank of Japan”

        Just ask the Swiss National Bank 😉

        that s work, some should drop the dogmas 😉

        • The Swiss National Bank will lose in the end, just like every other time they sold CHF into the market. They will eventually take huge losses on their EUR FX reserves once they admit defeat.

          http://t.co/mOMlV7V0

          Central bank currency interventions are unsustainable and ineffective. The SNB have the advantage of still being considered a safe haven, but this can change very quickly.

    • Good point Mr Squiggle on the last line. Also they are free to use the currency to buy up our assets which puts it straight back into our economy while at the same time they still have their toehold in the economy.

      I keep thinking about McKibbin’s idea. I think it is good it got thrown around and maybe his efforts and ensuing discussion will bring forward some coherent ideas.

      Printing money seems to be seldom, if ever, a good idea

      • Yep unless there is something tangible, to back it otherwise Zimbabwee would be a model nation.

        Nations like the Swiss who are manipulating their currency are doing so from a position of strength. They run a CAS, have huge multinational corparations domiciled in Zurich and are repatring profits from their overseas operations back to SNB.

        The RBA if it wants to partake in the Global currency war needs to do so in a covert way as our currency is now more highly traded that the british pound.

        • given the importance of the currency and its consequences in the real economy I find totally amazing that we consider perfectly fine that traders/algos (which are at best unqualified at worst borderline psychopath ) are the best persons to set the level of the currency.

          truly unbelievable
          🙁

          • dam, a friend was at her London office two weeks ago, and what she told me matches what you’re saying. Also other banking issues were being run with what she considered to be a massive lack of care and knowledge.

        • Jack, the Swiss banks also have a pretty good trade is selling customers banking details to foreign governments. I think is about 10k a pop. But it’s odd that none of the politicians or bigger customers have been prosecuted as far as I’m aware.

    • spot on squiggleman.

      “if we print money to sell only to other Central Banks, then how do we stop them selling it at a moment of their choosing?”

      We cant. But its not just CB’s buying. Due to the massive global liquidy sloshing aroung much of this is fast money, speculative flows that will turn on a dime. If we print and deliver to foreign speculators we only embolden them and they will just keep coming back for more.
      If the RBA wants to bring down the AUD it should only be becuase inflation is falling and unemplyment is rising and if this is happening the correct monetary response is to lower the OCR. Instead of encouraging the currency speculators lowering the OCR takes them on and you will see them running for the hills, looking for another sandpit to play in.

      Money printing is a last resort, not a first. If inflation is falling and employment rising you cut all the way to zero if you have to. If inflation is still falling and unemployment remians high or is still rising that is when you print, and only then, once conventional monetary policy is exhausted. Its dangerous stuff and is not something central banks should be doing on a whim like has been argued here.

      But your second point is also good.

      “Why call for rate cuts when we are swimming along pretty strong. The dollar reflects our point in the economic cycle, why risk a pro-cyclical setting on interest rates?”

      So far the debate has been how best to get the AUD down…cut the OCR or print. We all seem in agreeance that the AUD is too high.

      But what if we are all wrong and have all been indulging a bit groupthink and the AUD isnt actually too high at all?

      The economic data suggest that maybe it isnt too high. Maybe those benefiting from the high AUD is offsetting those suffering?

      Maybe the debate shouldnt really be about how best to get the AUD down but if we actually need to get it down at all?

      • Mr SquiggleMEMBER

        Thanks GB, good to know your thoughts. I doubt anyone is still reading at this stage, (I only came back myself after half a bottle of Gapsted Cab Merlot), but the idea goes around my head at the moment.

        If we printed more money, for the express purpose of selling it to other central banks, and at the same time, gave no restrictions on when it could be sold by the central banks, then why should we expect a different outcome to printing more money for the general economy? ( I don’t see much difference myself).

        An alternative response is to start restricting demand for the currency for fundamental use (eg trade, foreigners buying our commodities, etc).

        Isn’t this what the floating of the dollar was supposed to do anyway?

  10. I’m quite happy with the dollar where it is.

    My global purchasing power has never been better, and my company is using the opportunity to buy shiny new machinery from abroad that will significantly cut production cost, boost output and improve our bottom line.
    Improved productivity also creates breathing room for better salary and wage outcomes within the company.

    Wins and grins all round.

    • George, what industry are you in? And do you export?

      If it’s working for you congratulations.