Print or be damned, Capt’ Glenn

Yesterday Capt’ Glenn of the RBA got a lot of international press for his utterances blaming profligate central banks and their printing habits for undermining the division between fiscal and monetary policy and driving up the dollar. From Sober Look:

RBA’s Governor, Glenn Stevens today took a jab at the four major central banks (Fed, BOJ, EBK, BOE) without naming any names. Here are two key points summarized by Goldman:

1. The rapid expansion of the balance sheets of many central banks has “blurred the distinction between fiscal and monetary policy” and therefore the future exit from these policies which “provide cheap funding for governments may prove politically difficult”. Ultimately, while central bank actions have bought government’s time to put public finances back on track, central banks cannot solve these longer run challenges.

This is an excellent point. Central banks are called upon to fix structural problems, but all they can do is make sure governments have access to cheap funding for some period of time. At some point these central bank actions become counterproductive, yet any exit from these strategies may prove politically difficult (effectively creating a trap).

2. The expansion of central bank balance sheets has created disquiet in the global policymaking community as it has led to spillovers and distortions at the international level via an acceleration in cross-border flows of capital in search of higher returns. Although central banks are effectively factoring-in these flows into their policy decisions, there is not a consensus on how this should be done and there is an argument that central bank mandates would need to be changed to appropriately account for these spillovers. At the very least, increased global cooperation is optimal on this front.Here he is referring to the persistent strength in the Australian dollar, which is killing the nation’s export sector. He is attributing this strength to other central banks keeping incredibly high liquidity levels and near zero rates – forcing capital to flow to assets like the AUD.

All true and bravo for the jab to the schnoz.

Now, back to reality, where elegantly expressed theories of best-practice are about as meaningful as Lance Armstrong’s medals, other central banks are delivering the bitter truth straight to the RBA’s front door. From the AFR:

Some central bankers are encouraging the Reserve Bank of Australia to consider heavy intervention if it wants to bring down the value of the dollar, which is at its highest in months.

Reserve Bank assistant governor Guy Debelle is hosting officials from Asia’s central banks and possibly officials from the Bank of England, European Central Bank and US Federal Reserve this week in Sydney.

Some central bankers attending the meeting, which is private, believe the Reserve Bank should consider large-scale intervention to drive down the dollar rather than join the “race to zero” and cut officials interest rates more.

Meanwhile, the RBA’s monetary purity is no doubt a factor in why the Australian dollar remains persistently high despite a falling away of its peers interest in government debt. From the ANZ:

A new study from the IMF permits a comparison of foreign central bank holdings of Australian public debt with 23 other advanced economies. The results suggest that while the share of foreign public ownership of Australia public debt is high, it peaked sometime in 2011 in spite of rising shares in other economies

Newly released data from the IMF suggest:

The extent of foreign official ownership in Australian public debt is among the highest in “non-core” developed economies, a set that includes New Zealand, Canada, Korea and the Scandinavian countries

Australia has always had a higher level of foreign official ownership of public debt than the median developed economy, but this proportion of foreign official ownership has increased in the post-crisis world, consistent with the idea that Australia is a ‘safe haven’

The peak and decline in foreign official ownership of Australia government debt observed in 2011 has occurred despite the continued increase in foreign official ownership of government debt in the median developed economy.

…The decreasing share of foreign official holdings of Australian government debt is consistent with the increasing expense of investing in Australian dollardenominated public debt as a non-resident. The high level of the exchange rate and the low yield on government securities make such investment increasingly expensive. The moderation may also reflect a thawing in global financial markets in recent quarters, at least compared with what has been typical in the post-crisis environment. An associated decline in appetite for ‘safe haven’ assets may be the result.

The greater share of net FDI inflows in Australia’s balance of payments, which likely reflects foreign investment in large-scale LNG project currently underway, will continue to support the Australian dollar at high levels. It will also make it more resilient to destabilising events in overseas economies and financial markets, since FDI inflows are made on the basis of long term business decisions and are much more ‘sticky’. But since at some point these flows are expected to abate with the peak in mining and LNG investment, a new source of financing will need to step in.

We suspect that inflows to Australian bank and money market instruments may increase to fill the void, especially given the abundant liquidity available in core markets. We would also not rule out a reacceleration of foreign central bank demand for general Australian government debt should the global economic recovery falter in 2013, or the financial markets experience some systemic event (though this is not our central scenario).

In short, if you keep doing what your doing the dollar will not fall on rate cuts because banks will need to start soaking up offshore money to fund the renewed credit expansion and the end of the mining boom will demand more government debt issuance.

At some point this will come unstuck as markets won’t countenance another round of Australian housing inflation for long. But before then, you’ll hollow yourself out further.

The dollar will fall sooner or later, but as many an emerging market has discovered before us international capital flows can be destabilising and, by the time the currency does dump, the correction is far worse than it should have been.

A Peak in Central Bank Demand for the Australian Dollar (1)