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.