Time to bring down the Australian dollar

One of the more strident ideas that have put forth by Australia’s chorus of economic elites – which includes the Government, RBA and senior media commentators – is that there is nothing that we can do about the high Australian dollar. This is poppycock. Let me explain.

The Australian dollar is rising once more because Ben Bernanke has announced QE3. He will be printing an additional $US40 billion per month to buy MBS. The reasoning of markets goes that this will debase the US dollar so it therefore sells US dollars, and buys ours.

But in truth, $40 billion is not a lot of money nor a persuasive debasement of the currency at all. QE1 was $1.5 trillion. QE2 was $600 billion. Moreover, and here’s the real point, the $US is so completely dominant in global currency trade that it turns over some $3.6 trillion per day. While we’re not supposed to compare a stock (amount of dollars in circulation) with a flow (the turnover of those dollars), the discrepancy in the comparison is so vast that it gives you an idea of just how paltry the Fed’s efforts really are.

Yet in the days leading up to and since the announcement of QE3, the US dollar reacted as if Ben Bernanke were printing $4o billion per minute. The printing press is yet to roll but the US dollar has already fallen 5%.

This is because of one simple reason. The real power of the Fed’s decision is in the symbolism. Contemporary markets are not some simplistic abacus that calculates how many US dollars there are in circulation every day. No! Markets are made up of a dynamic set of traders and investors that make bets with other people’s money against one another. They position themselves based upon what is supposed to happen, what they’ve been told will happen, as well as against what they think other traders think is going to happen.

Hence, the power of symbolism is mighty. All the more so on this occasion because Bernanke and Co have made a commitment to keep printing their monthly $40 billion forever or until unemployment falls (whichever comes first!).

So, with this in mind, let’s speculate about what might be done to lower the local dollar. “Economists” are suddenly awake to the danger and are offering one way:

…economists warned that the Fed’s plan, which followed further stimulus from the European Central Bank last week, could damage the Australian economy by keeping the currency at elevated levels, forcing the RBA to cut interest rates.

Macquarie Group economist Brian Redican said the latest round of quantitative easing was unlikely to boost iron ore prices, which fell from $US100 a tonne earlier in the week to $US96 following Fed chairman Ben Bernanke’s announcement.

“That crunches mining company cashflow and raises a big question over mining investment,” Mr Redican said. “If that happens then that blows a big hole in your growth profile. This is why I don’t think the RBA can continue to ignore [the Australian dollar].”

Correct, it cannot. And Redican’s solution of lowering interest rates is not inconsistent with the needs of the economy. We are are likely going to need a further two rate cuts by year end, my guess is in November and December.

But markets know this already and it is self-evidently not enough to prevent the current charge into the currency. One reason is that rate cuts actually encourage an inflow of capital initially because it means the coupon value of Australian government bonds will rise as yields fall. There’s good capital gains to be made. Another is Keynes’ maxim about currencies, that they are a beauty parade, and the least ugly will win, period.

If you want to lower the currency you need more. You need to do something that introduces the fear to traders and investors that other traders and investors might be afraid of currency-related losses.

This might be done with threats from the RBA that it is targeting the dollar. But given this threat implicitly involves risking changes to local money supply that the economy in aggregate does not justify, you have to question whether it is good idea. Also, the RBA’s effort to contain credit growth over the past few years, which were in part based upon the knowledge that we have overly indebted households, may mean markets do not believe the RBA’s threats.

An alternative is that the government could lend a hand by calling for an urgent inquiry into how to lower the dollar. It might explore Tobin taxes or reversing some of the tax breaks that hot money inflows enjoy, any number of fiscal nudges that would place a question mark over the one-way bet that traders currently reckon that they enjoy. But again, the threat needs to be credible and after cheerleading the dollar ceaselessly through the cycle, I’m not sure markets would believe a government backflip now.

And you do have to be careful. There is a reason our elites are so terrified of questioning the value of the dollar. As a current account deficit nation, we need to attract capital to keep growing. Moreover, the principal driver of that current account deficit is excessive investment into housing via offshore bank borrowing. The elite are terrified, I suspect, of doing lasting damage to these flows and, at the extreme, plunging us into a either a bank-funding or current account crisis. And with justification.

But you can’t just sit around watching an over-valued dollar hand your production base to everyone else. This increasingly applies to mining as much as it does to other tradeable sectors. That is why all other nations are locked in a struggle to lower their currencies. To protect their market shares and steal more production and jobs from anyone else that they can, including Australia. A high dollar that is decoupled from bulk commodity prices is not a badge of honour. It is a target painted on your back.

So, is there a way out of this quandary?

Yes, there is. What you need is an action that is symbolically powerful enough to create the resonance of fear in traders and investors but not so extensive or ill-conceived that it upsets long term capital flows.

To me, that is the solution that has been proposed by former RBA board member, Warwick McKibbin; that the RBA can declare it will print money and give it to the 70 or 80 central banks that are also piling into the dollar owing to “portfolio flows”:

It is clear that it is better to take the appreciation of the real exchange rate caused by a commodities boom through a stronger currency rather than through higher inflation. However, it is important to understand that whether or not to intervene in the foreign exchange market depends on the shock hitting the economy. Allowing a pure float is not always optimal, especially if you have information on the nature of the shock driving the exchange rate.

There are many factors driving the value of the Australian dollar. The case of foreign central banks buying Australian dollars is particularly unusual…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. 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.

The symbolic power of this would be much more important than the actual amounts. As in the case of the US, traders would have no choice but to take currency debasement seriously.

But because the central bank portfolio flows are unprecedented and will not last anyway, they can be rightly represented as an aberration, and any move to contained them equally so. The measures can be removed as soon as no longer deemed necessary, and it will not do permanent damage to the integrity of the currency.

Some have suggested that the McKibbin plan is driven by vested interests. That is true. We all have an interest in not waiting until the realpolitik of other nations does so much damage to our economy that plunging interest rates and a government deficit will be needed to support it.

Comments

  1. “.. it will not do permanent damage to the integrity of the currency.” Perhaps that what Gideon Gono thought.

      • Not at all! But I favour the alternative suggestions that you mention elsewhere in this, an other, posts. As one who is 100% in cash, I’d welcome lower interest rates, and whatever penalty I incur personally, see it as ‘doing my bit’. Someone; all of us, will have to, one way or another.

        • One problem with lowering interest rates is that it lowers the value of work. As one person pointed out, if you can borrow money at 0% what the people working working for?

          • Gold has a 0% interest rate and it has performed very well over the last 5 “GFC recovery” years.

  2. Top article

    There is no inconsistency in supporting a floating exchange rate yet imposing regulations that:

    * reduce the demand for the currency to what is required for trade or direct investment, and

    * discourages trades that are essentially speculative in character.

    Plenty of ways of doing that, as you point out, but it would require some imagination and spine on the part of the government and the treasurer in particular and that is expecting a lot.

    As usual what we will get is paralysis and desperate proxy action by the RBA in the form of interest rate cuts. Which is the worst and most likely ineffective approach to the juiced up exchange rate.

    • I agree interest rate cuts in isolation may be probably counter-productive; the obvious beneficiary comes to mind. But bring in companion tax changes; borrowing restrictions or bank capital ratios at the same time, and surely, that’s go to be better than ‘joining the war’? So,yes, spine is required!

  3. With trillions being spoken of with such ease $40B each month sounds like chicken feed, and i suppose it is, but it does mean that every month the Fed becomes the proud owner of the equivalent of 160,000 mortgages of $250,000 each.

    Thank goodness that they managed to fix all those dodgy mortgage origination problems that caused such problems befor 2008.

    No wonder Mr Benanke is so fond of putting a floor under house prices.

    But then Enfinity is a long time.

  4. Jumping jack flash

    Consider that if the boom actually has ended, and if China is in freefall, then our dollar may naturally correct lower in the near future.

    Does that mean that if we are too alarmist and take to the dollar with an axe, we risk trashing it too much? I think we should tread carefully.

    Don’t forget the real problem is the disconnect between our globally ranked living standards and wages, compared to our globally ranked competitiveness and productivity.

    We’re too used to living it up, high atop a mountain of debt, plus a mining boom lotto win. It will be tough for people to face the reality that there is no more money because it has all been spent overseas.

  5. “That is why all other nations are locked in a struggle to lower their currencies. To protect their market shares and steal more production and jobs from anyone else that they can, including Australia.”

    The first thing the Govt and RBA have to do is realize that the mining boom isnt going to last another 2 to 3 years or forever. The second thing is to realize that Australia is in its own debt issues as debt per person and GDP is at a record high plus is higher than the other countries at their peak. The third thing is wake up and realize China is slowing down is not going grow like it has in the past. Once they realize all this then they will do something other wise they are going to sit on their high horse pointing the finger at all the other western countries in crisis. Meanwhile all these other countries are laughing at Australia Govt and RBA for not realizing all the above then take the Australian jobs etc from them. The funny thing is they will then point the finger back going you should have worried about your own economy/country.

  6. It’s interesting that while protectionism is considered taboo even if still practised in part, currency manipulation which is what they are engaging in without shame appears the new vogue.

    What about inflation. It is fairly benign at the moment and is that because we’re exporting our inflation with the high dollar. We just need a lot more bad news in mining. Maybe a FMG fire sale disaster to make those pesky foreign investors think twice about filling up on mining biased Australia paper. 🙂

  7. HnH,, I may have missed it – but what at what level would you suggest the AUD be?

    FWIW I suspect any intervention will have unintended consequences, not all of them desired. Timely to remember that given QEinfinity and geopolitical reality, oil unlikely to come back to much in medium term – AUD at say 80 and oil price alone may negate much of the assumed benefit of a lower dollar – not sure, perhaps someone with expertise can advise. In an import dependent nation it remains that one of the benefits of strong currency is reduced import costs – these directly impact household and business in myriad ways (inflation?).

    I accept that the strong currency is an impediment to some sectors but fail to be fully persuaded that a significantly lower currency at a time of reduced global growth and consequent demand will substantially reinvigorate productive capacity. Doesn’t appear to have done so in any major way anywhere else. But I’m open to the debate on that one.

    Ricardian Ambivalence has had several informative posts on FX intervention. The following a Q&A where many questions some readers may have are answered (and many of the questions themselves were raised by Rumples!).

    http://ricardianambivalence.com/2012/08/26/rba-fx-intervention-qna/

    Tread carefully.

    • Treading carefully is very good advice with the amount of extraordinary lever pulling being conducted by various Central Banks.

      It is probably best not to ‘target’ a particular exchange rate. Rather to target the two main things that are bending it out of shape and accept whatever rate results when the impact of those things are reduced.

      On the assumption that no-one is interested in trying to limit the volumes of minerals that are being exported (or the speed of investment in new supply) there is probably not much that can be done with regards to the upward pressure on the currency as a result of the boom.

      Has anybody estimated what that effect actually is? I suspect it is over-rated simply because so much of what we are flogging is in $US and thus not nearly as much may be converted in $AUS as the exports might suggest.

      The pressure on the exchange rate from direct investment in property or business may also be less than expected – especially as the banks seem to treading a little more carefully in that regard.

      That just leaves upward pressure due to financial flows from speculators and those CB’s trying to get their paws on the govt securities that Mr Swan has been cranking out with such enthusiasm over the last few years (including those off balance sheet ones for the NBN).

      Less flows due to speculation and ‘safe haven’ thinking and less foreign financing of govt debt might be all the downward pressure that is appropriate (and needed). That just requires a few regulations and a bit more reliance on internal sources of investment.

    • HnH, really like to know at what level you think the AUD best serves the whole economy and whether not current and apparently continuing high oil price (god forbid if Israel/Iran conflict, even China/Japan (other Asia)) reduces ‘effectiveness’ of a lower AUD.

    • I think Australia’s too small to trigger a war but there is a real chance that the big countries might and might do it deliberately if they think it is politically advantageous for them to do so.

  8. What is completely missing from this piece is the simple fact that currency interventions never work.

    I don’t know how much faith you put in the RBA to accurately set interest rates but it must be pretty high since you think they can accurately predict where the AUDUSD should be.

    • “What is completely missing from this piece is the simple fact that currency interventions never work.”

      Right tell that to the Chinese, Singaporeans or Swiss.

      Fact is there are plenty of examples of currency interventions being successful. The key though is that they are only successful in the long term when the intervention is to lower the currency. Given CBs can print as many of their own currency as they like there is no limit to intervention in that direction.

      As to sterilising the printed cash that results the Chinese show it is relatively simple to increase bank reserves to remove unwanted money from circulation.

  9. thats all good and well but based on facts and not speculation im yet to see a single compelling explanation of why the AUD needs to come down?

    The facts are the AUD has been at this level or higher for the past 18 months. More than long enough to be cuasing an economic problem if it was going to do so. So why is unemployment only 5.1%? why is GDP still +3%? why is inflation still 2%?

    If the AUD was the real problem everyone keeps saying it is why is the economy continuing to do so well? Is it possible the high AUD isnt actually anywhere near the problem everyon keeps saying it is? Is it possible there are also many economic benefits of a strong currency? Clearly there are but no one seems to want to discuss them. I guess we will never know becuase the mainstream media continues its one sided coverage.

    personally i dont care where the AUD trades and i also thought it would be cuasing a problem by now but after 18 months of a “too high” AUD the facts and data clearly dont support the arguments aginst it.

    • Our economy was going down the toilet in your view just a few months ago, and unemployment, GDP and inflation were all at those levels when you were exhorting people to go ‘maximum’ short the ‘massively overvalued’ AUD at 1.05.

      What ‘facts’ were informing that view ?

      • ponz,

        which part of

        “and i also thought it would be cuasing a problem by now”

        didnt you understand?

        i never said “Our economy was going down the toilet”, ive been long equities since the market bottomed this time last year. You dont go long stocks if you think the economy is going down the toilet.

        “GDP and inflation were all at those levels when you were exhorting people to go ‘maximum’ short the ‘massively overvalued’ AUD at 1.05”

        no they werent. I said go maximum short at the begining of the year when the AUD was 107, not a few months ago. It went to 108 then went to 96. That was a very profitable short i can assure you.

        in the first q 2012 it was reported GDP growth had halved to 0.4% from 0.8% in the last q of 2011. in q1 GDP rose to a staggering 1.4% and just reported 0.6% for the 2q. Same with inflation which collapsed late last year and earlier this year but has since stabalised during the more recent period. unemployment hasnt risen as everyone including me thought it would.

        the short AUD was based on a falling house prices (which is happening) spilling over and the RBA being forced to cut to contain the fallout. So far the housing market downturn is occuring but not really affecting anything else so the RBA hasnt needed to keep cuting and the AUD has remianed well supported.

        what this got to do with the endless calls to bring down the AUD anyway? the point i was making is that the economic data doesnt support the calls to lower the AUD. what your veiw Mr. Critical?

        • You did say our economy was going down the toilet. Here …

          http://www.macrobusiness.com.au/2012/05/australian-dollar-oversold/#comment-150630

          Your maximum short call was at 1.05

          You have never specified over what time frame nor against which currencies to go short the AUD. It has not been a profitable trade at all for someone who has been long EUR AUD, or who has maintained a short AUDUSD and has copped 8 months of negative carry.

          House prices are still falling and still threaten to spill over into further slowing consumption, disleveraging, unemployment and deflation. The RBA is facing the same picture. You spend the last six months berating the RBA for not cutting rates, for those very same reasons.

          im sure all the businesses out their struggling under the weight of an artificially high AUD really appreciated the 1 cent move caused by the RBA’s basesless speculation

    • Unemployment is only at that level because of an unprecedented collapse in the participation rate. Y-o-Y jobs and hours worked growth has now been running below the growth in the working age population for about a year. And remember this is before we see the impact of the massive job shedding occuring in mining, mining services and state public employment.

  10. I tend to agree the dollar “being high” for the last few years interspersed with the risk off episodes has probably done the damage to the tourism and manufacturing sectors unfortunatly the quality ones will be picked up by Overseas investors. I was thinking about some form of financial product and then decided that if I think the AUD is too high i just buy overseas assets.
    Which I have been doing and I am not complaining, hopefully everything balances out, still unrestricted money printing by everybody cant end well can it.

  11. In addition to prof McKibben’s proposal there are other ideas as well-including the imposition of a tax wedge between local and foreign AUD buyers.This whole subject of AUD management(wash my mouth out I know!) is too important to be debated behind closed doors.We need a fully fledged enquiry-like Wallis-where all the pros and cons can be aired publicly with total transparency.If USD and EUR weakness persists for another 3-5 years or so(which is really what we are talking about rather than AUD strength)then its simply curtains for a lot of otherwise viable businesses.Why just lie down and die?

    • Terry

      I agree with you but do we have enough people with competence to even examine this?
      Universities teach that Current Account Deficits and the resulting Foreign Debt don’t matter. You can see the result of that preponderance of teaching here on the pages of MB. How do you think we will go trying to find people in the wider business and academic community to examine this.
      The mantra that we are a ‘Current Account Deficit’ country mantra illustrates such a poor understanding of economic flows and feed-backs yet that is all you hear from Economists at the Banks and Universities.

      So yes you are right re needing to really look at this problem with new eyes by people of competence. But where will you find the latter?

      • Being a CAD country may be bad, but being a CAS country can be pretty bad too. See the example of Japan, as detailed in the Ted Rule article I linked to above.

        Long term imbalances of any kind need to at least be for a good reason. Some of the time, our CAD has been for a good reason. Some of the time (like during the housing bubble) it has been for very bad reasons.

        • Agree re long term imbalances either way… and yes Japan is about to pay the price for their long-term CAS.

          Yes you can have a short term CAD for good reasons. 50 years of CAD with our resources is just plain nuts!!!! We need to run a CAS if all we are doing is depleting our land.

    • I actually think Prof McKibbins idea on doing direct deals with international central banks like the Swiss and Russians etc on exchanging AUD for their reserves is better than having them buy on the open market.

      I think the deals would take a lot of the sting out of the AUD, which for sure is creaming the local import competing/exporting sectors (anyone see the report on Tassie not exporting apples for the first time in 100 years because of the AUD?).

      I am not sure that cutting rates is actually the way to go simply becausee that would have great potential to set up unintended consequences (particularly reflate the housing bubble – but the car sales thing also indicates a lot of spending mentality out there).

      There does need to be a game plan for the longer term, because the competitive devaluation has been underway for a while now with major global currencies and it is likely to continue for a very long time. Australia is the odd man out here.

  12. First great article, we need more debate about this issue. The A$ needs to be in balance with our trading partners or industry and the economy stagnates. If our trading partners devalue, so should we.

    However, as we know the dollar is high, we should be printing and buying foreign assets so that when the A$ does pull back, we’re sitting with hard assets.

    The elephant in the room which nobody wants to talk about is of course GOLD. Gold can be used by the RBA, or by Treasury to manage the exchange rate.

    As WMcK stated, we could provide A$ to foreigners in exchange for their gold. Simple transaction and simple to unwind, A$ goes out, gold comes in, satisfying demand for A$, when the transaction is reversed the A$ comes back to Aus and Gold goes back to its country of origin. Simple but effective

    For Treasury its a bit harder as they need to work in tandem with the banks and RBA to get an effective policy in place for Gold swaps.

    I’ve only got one issue with the article

    “As a current account deficit nation, we need to attract capital to keep growing”

    This is actually not true, Australia is a sovereign country and money is whatever we say it is. We don’t need foreign capital to do anything other than manage a free floating exchange rate and buy our goods. If we decide that Seashells, Gold, Silver, or Iron Ore is money, thats fine as long as it is managed effectively by Treasury and the RBA

    Cheers

  13. A “Current Account Deficit” is not a condition you set for running your economy. It is a RESULT of the other conditions you set.

    Any problem with any ‘printing’ is that we are putting in the hands of foreign interests more money with which they are free to continue to buy our assets.

    So immediately the effect of the print is negated and we have sold another asset.

  14. Flawse I agree with your concerns. I might add that nothing makes my blood boil faster than to hear someone with a policy desk job mouthing on about how this is just a necessary “structural adjustment”. These are often people who have never spent a day in their lives building a business-and certainly they have never spent years doing so only to see it sacrificed on the alter of a floating exchange rate.Every policy maker should be required to invest half their savings in SMEs exposed to these realities.Then the textbooks might be left on the shelf.

    • Every policy maker should be required to invest half their savings in SMEs exposed to these realities

      Absobloodylutely!!!!!

      Note my business is a beneficiary of a high dollar and high consumer spending!!! So I don’t push my own pram around here. The future of the nation has worried me for a very long time.