McKibbin: Australian dollar intervention is not heresy

Cross-posted with permission from Interest.co.nz.

By Alex Tarrant

Australian economist Warwick McKibbin says he was surprised by the reaction to an opinion piece arguing the Reserve Bank of Australia could take upward pressure off the currency by printing Australian dollars and buying foreign exchange to offset foreign central bank purchases of the currency.

Speaking to interest.co.nz while in Wellington this week, McKibbin, a former RBA board member, said his comments had been misinterpreted by his critics, as he was not suggesting a peg of the Australian dollar, and neither had he claimed the plan was to lower the currency.

Writing in the Australian Financial Review earlier this month, McKibbin argued that allowing a pure float of the currency was not always optimal, especially if a central bank knew the nature of one of the shocks driving the exchange rate.

McKibbin noted a particular shock currently driving the Australian dollar higher was foreign central banks increasing their holdings of Australian dollars.

“This is a pure portfolio shock generated in the financial market,” McKibbin wrote.

“If foreigners want to hold more Australian dollars in order to park these dollars in foreign exchange reserves and will not be using these dollars to buy Australian goods and services, then the best response is for the Reserve Bank to print more Australian dollars,” he said.

“These additional dollars should be sold to foreign central banks in return for foreign assets. The foreign assets would appear on the RBA balance sheet exactly balancing the increase in money supply. There would be no effect on the domestic economy from this global shock if the RBA undertook this transaction.”

Other Australian economists jumped on McKibbin’s comments, suggesting speculators like George Soros, who famously bet against the Bank of England’s peg in the early 1990s, might do the same to the RBA.

While in Wellington to speak to the New Zealand Institute of Economic Research’s AGM, McKibbin told interest.co.nz the idea of never intervening in the market needed to be reviewed, especially if authorities knew the extent of a certain shock affecting the core structure of that market.

“My basic premise is it’s always a good idea to just let the exchange rate float,” McKibbin said.

“However if a certain shock could be identified, sometimes it was better to offset that shock directly. In broad terms, if you know where the distortion is, it’s better to deal directly with the distortion in the market than to actually do something else to try and offset the distortion,” he said.

McKibbin said he had been very precise in his writing.

“If [foreign central banks are] holding cash – most central banks don’t – but if they’re holding cash, or currency, then you should be just providing the currency. You should be doing that either directly to the central bank, or if they’re in the market, what you can do is provide the cash. You buy the foreign exchange, put it on the balance sheet of [your] central bank and then increase the money supply,” he said.

“But that increase in the money supply doesn’t have any domestic impacts because the increase has all gone into foreign ownership.That way you can intervene and offset the shock.”

His argument was “totally different” to reacting to a change in the exchange rate driven by commodity prices, better technology, or changes in trade flows.

“Let the market adjust, and let the exchange rate do it, rather than the price level,” McKibbin said of those types of shock.

‘It might not lower the A$’

McKibbin said the exchange rate may not move at all under his approach, which was to take some upward pressure off the currency.

“I’m not even targeting any exchange rate [level]. My proposal was, just shift your foreign exchange reserves on the balance sheet of the central bank to offset the shock,” he said.

McKibbin accepted there were risks involved.

“Because you are accumulating foreign assets, and if you are accumulating euros, and you think the euro’s going to collapse then you’ve got a bit of a change in risk,” he said.

“So it’s not completely risk-free, but the point was firstly to get people to think about…when you’re looking at a market-based system, maybe you should think through this idea that you should never intervene in any market.

“Because in most markets there’s always some reason to intervene if in fact there’s a breakdown of the core structure of the market,” he said.

Reaction

McKibbin said it was the reaction to the article he didn’t expect.

“[To] even question the pure float seemed to be heresy. But again, there’s a lot of literature on leaning against the wind in currency markets, and if everything works perfectly then you never need to worry,” he said.

“But if you have a world of imperfections, which we do, then you’ve got to be at least having the debate on when is the best time to intervene in the market.”

In response to criticism that it would put the RBA up for a speculative attack by other traders betting against it, McKibbin said his plan did not involve any exchange rate pegging.

“I think it shows just the lack of understanding of firstly what I said. That’s why I wrote the AFR article, to make it precisely [clear about] the particular set of circumstances you can make an argument,” he said.

“But a lot of people who responded didn’t respond to what I said, they responded to what they thought I said.”

“It shows you just how much ideology there is out there, and occasionally it’s a good idea to think, rather than speak.”

Never said ‘bring down the currency’

“If you can identify the shock, and if you can offset the shock, then there’s a case to be made for it,” McKibbin said.

“I wouldn’t say I regretted what occurred, because when you start reading that Paul Howes, who’s a union leader in Australia, agrees with me, then my first thought was, probably I’m wrong. Actually he wasn’t agreeing with what I said, he was agreeing with other people’s interpretation of what I said – to bring down the currency,” McKibbin said.

“I never said ‘to bring down the currency’; I said, ‘neutralise the shocks so you can better identify what’s happening, and that makes monetary policy easier, if you can reduce some uncertainties,'” he said.

Arguing that the RBA should print money with the intention to lower the currency was a dangerous slope to go down.

“What could start off as a very sensible argument could end up in a landslide attack in the market. That’s the last thing I want to see occur. But I think the debate has to be had that, there’s no market anywhere that’s completely free,” McKibbin said.

“There’s always some government somewhere intervening. The question is, if that’s happening, then maybe your response is to actively intervene as well,” he said.

Comments

  1. Let’s be realistic about where we are at. Our productive economy is being destroyed by an over-valued dollar caused, not by the sale of the products of the mining industry, but, by the sale of the industry itself. Along with this goes a carry trade that sees as long as this goes on it’s a one-way bet.

    The correct value of a currency should produce a balanced current account. Our currency has not managed this in 50 years. That’s why we are now in such a precarious position.
    So why not call for a lower value for the currency through a managed float or peg accompanied by appropriate capital controls? (whatever they are considered to be)
    The idea of lowering the dollar through lower interest rates is a self-reinforcing disaster in the making.

    • “…a managed float or peg”

      +1. This has been my view for quite some time.

      Thanks MB for this pc and especially the clip. Nothing like a good dose of common sense to shock one into a full wakened state. Always liked Mr McKibbin. Liking him all the more.

  2. P.S. The idea of managing the float IS heresy to the economic cognisante of this country…a bit like the heresy of Galileo Galilee to the Catholic Church in the early 1600’s!

  3. Ronin8317MEMBER

    It is dangerous for the RBA to create the impression of controlling the exchange rate. This opens up the option for politicians to ‘pressure’ the RBA into intervention. Suppose the Australian dollar crashes causing petrol price to go up. The RBA will be expected to ‘save Australian businesses and jobs’. It will not be long before the RBA is no longer independent.

    Furthermore, ‘market worship’ has replace economic analysis for many economists, so any move to intervene will find plenty of opposition in the media.

    • Just as it should be. I for one am not at all convinced of the merits of monetary policy for the nation being placed in the hands of unelected, unaccountable, grossly overpaid astrologers.

      • Ronin I agree with all your concerns and i don’t have an answer for them. Gough’s immediate upward revision of the A$ was a classic piece of stupid political intervention that destroyed hundreds of thousands of jobs and many families especially farmers….I know as i was one at the time!

        However…what in could possibly be worse than the carnage currently inflicted on the nation. At least let’s have it out and discussed.

        Again it MAY not require a managed peg if we could manage the capital flows! The details sure as hell need lots of input from lots of people with better brains than mine!!!

        • P.S. Ronin agree also….Imagine the vested interests trying to maintain the status quo in this…politicians, Banks, Real Estate, Housing and retail building contstruction, Westfield et al, Unions especially Public Service, Woolworths and Coles, etc etc etc The mind boggles.
          The good of the nation doesn’t get a look in!!!!

  4. Thanks 3d1K
    I think the key question and answer was here.
    “5. Which risk is greater – intervening in FX markets, or selling off more domestic assets?

    Intervening in FX markets is the greater risk. Capital markets are clearly imperfect, however i am more confident that the markets can price our assets than I am that the RBA (or anyone else) can identify the appropriate level for the foreign exchange value of the AUD.

    Now this is a ‘judgement’ call. I have the opposite opinion in that I think the continuous 50 year sell-off of our assets to fund over-consumption is a total disaster. My other question would be ‘what the hell happens in a few years when we have sold it all?’

    His tenet that markets are all-wise in relation to the currency value is tenuous at best. At one point he is talking about A$=.60 USD asOK then he is talking as A$=USD2.00 is OK.

    It would be over a long time, as he says, provided it is based on realistic production and balanced Current Account.
    It isn’t and he doesn’t even consider this.
    Lastly the whole international currency regime has been corrupted by the creation of ‘meta-money’ Zero or negative RAT interest rates have created a world of infinite money or credit creation. The whole thing is a farce. So I (FWTW) think think that discussing markets and currency value is just one big fairy story.

    • Nice response Flawse, so much of what is discussed here falls into the ‘judgement call’ box! Suggest you ask Ricardian direct – he is generous with his responses.

      Cheers.

    • You misrepresent my potition. I say that i thought we needed a weaker currency and lower rates in 2008, so i felt the intervention was not in Australia’s interest. I was too pessimistic at the time. Later, in response to a seperate question i answered that if the AUDUSD were $2 and nothing else were different, that i would say the AUD was not overvalued – the logic being that an overvalued currency by definition should be causing macro damage and that if this were the case i would expect rising unemployment, low inflation and sub-par growth … And yet we currently have a steady unemployment rate, trend growth, and on-target inflation. Be fair!

      • I sympathise with some of your thoughts George but in this case we better agree to disagree 🙂

      • ricardo Thank you for your response here.

        I surely wasn’t meaning to misrepresent your position as I considered the whole article very good. I wasn’t trying to argue against your thoughts. However I’d hope you’d accept them as thoughts rather than immutable dictates.
        In trying to be brief I’ve possibly confused the issue around which you centre your complaint.

        I think the position with markets is too short term. This has all sorts of causes but negative RAT rates throughout the western world is the major distortion.
        To go from a position where the A$=USD0.60 to where the A$=USD$1.10 in a matter of two to three years one has to conclude that at least one position is untenable and doesn’t reflect reality. It is not reflected by export production. it is not reflected in GDP. it is not reflected in productivity. What it reflects more is the massive money printing undertaken. Should we let our economy be simply a cork in that turmoil?

        A point or question if you like…Let’s suppose A$ were USD$2, not from export performance as we’d still be running a massive CAD, but because of a flood of paper USD out of China buying everything they can possibly get their hands on. The resultant cash flow passes through the hands of Australians into the same old pot of Real Estate…more houses, beach houses, more retail spending, more SUV’s, more Game Boys for the kids, designer clothes etc etc Man we could be really booming. Everything would be cheap as chips, plenty of employment, Govt revenue, lots of Public Servants…no worries
        Does this make $2.00 the right value?

        Our current prosperity is being financed by cashing in now future cash flows. Enron et all went down wrecked on that rock and countries can as well.

        Now re Q5 I’m sure I did not misrepresent what you said and it is the more relevant point I was trying to make.
        Your judgement is that asset sales to fund consumption is OK. You’d rather that ‘evil’ than the ‘evil’ of some bureaucrat or politician determining the currency value. That’s fine. That’s your value judgement. All I’m doing is arguing for my value judgement here. No more no less!

        So I was just saying that in my view that this asset sale is the the wrong call. Again that is not my essential problem with all this. It’s OK to make the choice for consumption NOW over long-term stability. It’s a democracy…yet! We can fund it a while longer with more asset sales. That’s a choice. However let’s really give people the CHOICE based on facts instead of the baloney that now surrounds it all.

        Treasury, RBA, academic economists, are all saying …bewdy ripper nothing wrong here! Look at how smart we are here in Aus. The rest of the world should do what we do.

        All the while we are selling assets to fund the same sort of over-consumption other western nations have. They just don’t have the inground resource assets to sell.

        We’ve been doing this uninterrupted for 50 years. Yet it never occurs to a any economists anywhere, except a few McKibbin here, DE, Rumples and a couple of contributors, to wonder about why this is so and whether it is a good thing.

        One more thing. In the past we had this high dollar with little unemployment. So therefore ‘no problem’ you say! Yet at the time I was a farmer. The economic and social heart was ripped out of rural Australia. But who gave a rats? You don’t see what you don’t see.

        So markets are distorted. They DO operate with short term limited and, at times, totally incorrect, information. Major factors in our market are determined far from our shores and are often more related to the number of carrier battle fleets in th area than to any economic structure.
        We do accept the market without considering the long term effects. You can close down a factory in a matter of months. It’s a different matter trying to resurrect the facory in five years time. The labour is gone, the skills are gone, the capital structure is likely gone. Even teh kids are being taught ‘human movements’ or ‘social studies’ rather than the science necessary. Suddenly, despite a radically suddenly devalued dollar, you are generations away from being able to reverse your short term position.
        Meanwhile then your revenue streams dry up unemployment grows but you’ve got none of the jobs people are used to. The fragile economy you built based on consumption falls in on itself

        I don’t have the answers but it’s surely time someone started asking some serious questions about the policies.

  5. Said before and I’ll say again;

    A strong currency creates losers AND winners.

    Intervening for the benefit of one party at the expense of the other is arbitrary and purely political.

  6. George Many people are already intervening, in particular, Bernanke, King, ECB et al, Chinese investors etc etc

    It’s a question as to whether we want to intervene on our own behalf.

    • My answer is emphatically “no”.

      If other countries govts are pursuing a policies of eroding the purchasing power of their citizenry, thats their problem.

      • I suppose sending the country broke is preferable to eroding the purchasing power of our citizenry!!!

      • In other words, let us continue pretend to live in a utopian free trade world while the rest of the world pays for real goods with worthless paper.

    • Indeed Flawse, and furthermore, there is also the issue of considering the long term and strategic importance of some sectors vs others. This is my key area of concern and thus reason for being inclined to “interventionism”. It is why I do not see the issue as being one of simple swings and roundabouts.

  7. Strategic, schmeegic.

    Labelling industries as “strategic” is just a fig leaf for pork barrelling and protectionism i.e. shafting the aussie tax payer and aussie consumer.