Australian dollar still a reserve currency

Global_Reserve_Currencies

From The Australian this morning comes an important story about the Aussie:

THE dollar’s coming of age as a global reserve currency has resulted in a $200 billion buying spree by central banks and sovereign wealth funds since the global financial crisis, adding an estimated US6c-US8c to the dollar’s value, according to new analysis. And senior executives at US investment bank JP Morgan say the new structural allocations to cash and fixed-income assets, such as bonds, meant there was a natural flow of buying when the currency weakened in order to maintain portfolio weightings. This may mean the old adage that the Australian dollar climbs the stairs and goes down in an elevator may not hold as much weight as previously. “This has important implications for monetary policy,” JP Morgan interest rate strategist Sally Auld said. “If the currency remains resilient despite a weakening in the external environment, then this places a greater burden on monetary policy to facilitate trend growth and inflation outcomes.”Advertisement …JP Morgan’s head of fixed income for Australia and New Zealand Jeff Herbert-Smith said there were about 70 central banks and sovereign wealth funds participating in the local bond market.

If we accept this at face value the immediate impact is lower interest rates for longer. You can’t run your economy on an uncompetitive exchange rate so to maintain a rate at which the economy can actually grow you will need to shift down your interest rate structure. That’s pretty much what we’ve seen to date. Along with that, we should get on with building some new tools, like macro-prudential and/or money printing for foreign reserve banks.

I’m not sure we need to take this at face value, however. Portfolio flows are one thing  but not even a reserve manager with a constitution is going deliberately set about losing money. As the economy weakens, the flows will dry up. The dollar may get more support as it happens but it will still happen.

But we shouldn’t altogether look this gift horse in the mouth. If the world wants to offer us currency at ludicrous rates then let’s take some of it and build productivity boosting infrastructure to the extent that we can without blowing up our AAA rating, especially as we go over the mining investment cliff.

Comments

  1. ” If the world wants to offer us currency at ludicrous rates then let’s take some of it …….”

    They are not offering us currency – they are buying claims on our future income and our assets. Buying $AUS financial assets (govt securities etc, covered bonds and other securities etc) real assets and bidding up the $AUS in the process.

    If the $AUS reflected our trade performance it would be a lot lower.

    There is nothing wrong with foreign investment provided the foreign investor is at risk for poor investment decisions. In most cases the foreign investors are attracted because they know the taxpayers is providing a direct ( govt bonds) or implicit guarantee (bank bonds and wholesale borrowing.

    Restrict the sale of financial assets to foreigners to assets where the foreigner investor is actually taking the risk if the investment proves a dud ( for example direct lending to the ultimate borrower – real estate, factories, infrastructure) and then see where the dollars sits and the ‘rates’ the foreigners will consider appropriate to the risk.

    • Of course but it is cheap debt I’m sure you’ll agree. And made cheapre by the desire to hold $A.

      As you know I believe the dollar is the key. But a little quality infrastructure spend would be useful too.

      • Yes – there is nothing wrong with taking advantage of the saving habits of foreigners – even though their apparent enthusiasm for low rates of return with currency risk often reflects financial repression at home more than any special genetic saving ability.

        The important thing is to ensure that what looks like ‘cheap’ debt is actually cheap debt.

        It is hardly cheap if it is being subsidized by taxpayer guarantees.

        For example:

        If foreigners want ‘exposure’ to domestic real estate – let them buy new housing directly or lend to locals directly via securitisation. Wholesale lending to the banking sector who then distributes mortgages to home buyers involves a govt subsidy (as MB have so frequently noted).

        Without a local banking middleman – misjudged foreign investment in local housing is less likely to damage the local financial system.

        As for govt securities, the quantity that can be sold to foreign investors should be strictly limited if for no other reason than if a government chooses to finance its expenditure by issuing debt – limiting sales to domestic market creates a natural limit as the price of the debt will rise as the amount of debt starts to exceed the capacity of the local market to absorb it.

        I don’t think it is a good idea to encourage governments to develop a taste for ‘cheap debt’ – bonds sold to foreigners. They don’t need any encouragement on that front.

        Limit the quantity of government debt that can be sold to and held by foreigners and let the central banks and overseas investors squabble over that quantity. Any excess in govt debt is only to be sold to domestic investors.

        And PF’s point is good one about ensuring that whatever infrastructure projects are considered are actually income producing or income enabling. That is not asking to much of our ‘big picture’ and ‘vision’ crowd who think the solution is more snowy mountain schemes.

        It is important to keep in mind that the biggest employer is small business and the solution to any possible recession is encouraging existing enterprises and as many people as possible to start new ones. Someone who can employ themselves is someone who may employ someone else tomorrow.

    • “As I pointed out last week, the high dollar has made Australian producers dramatically less competitive in global and domestic markets. The International Monetary Fund estimates that it costs 55 per cent more to produce goods and services here than it does in the US. The miracle is not that manufacturers such as Ford are pulling out, but that so many have found ways to survive.
      But, once they go, they won’t return. The overvaluation of the dollar is temporary, but it changes the economy permanently.”

      Labor is not being punished for its leader – it’s being punished for not having the talent and the bottle to act in the country’s interests against the global finance houses and the foreign corporates that control our policy direction.

      • Assuming that’s true (and I have my doubts), do people expect that the Coalition will be any better in that regard?

      • “Labor is not being punished for its leader – it’s being punished for not having the talent and the bottle to act in the country’s interests against the global finance houses and the foreign corporates that control our policy direction.”

        Sorry aj, but this I believe is quite incorrect. The punishment Labor is receiving (I assume you mean in the polls?)is entirely self inflicted. It stems primarily from 2 sources. The first is Labor’s now distorted and perverted internal processes that have allowed the Unions to dominate all the important levels of ALP operations. The second is a follow on from the first- whereby the total lack of talent thrown up by the first source of ALP’s woes has thrown it into chaos and conveniently, denial.

        I’m not saying the condition you mentioned does not exist, but this Govt will never be able to address that, and many other important issues, while it remains a talentless rabble looking for a cause other than remaining in power.

      • GunnamattaMEMBER

        ‘Labor is not being punished for its leader – it’s being punished for not having the talent and the bottle to act in the country’s interests against the global finance houses and the foreign corporates that control our policy direction.’

        That is it in a nutshell chief – and I think GSM agrees with you too – he just lacks the ability to either think about what you have written or to clearly articulate his thinking processes (such as they are).

        The ALParatchiks have simply coughed up the ability to think about the economy over the longer term and to act. They have replaced this with polls and short term palliative policy. They have ignored clear warnings about where the economy is heading and why it is held to ransom by real estate speculators, banksters and the like, and kept touting the short term upside.

        The leadership issue is a side order of fries on that plate – though a lot of punters like their fries.

  2. “Labor’s now distorted and perverted internal processes that have allowed the Unions to dominate all the important levels of ALP operations.”

    Labor has always been run by the unions.

    But that aside, why do Liberals hate unions so much? Anytime I talk to a Lib – mercifully, that doesn’t happen a lot – they quickly start mouthing off about unions. This is totally mystifying and comes across as a form of hate – as a form of bigotry.

    Unions have such a small role in the economy these days, and an even smaller one in the private sector, that they can have very little effect on things. Yet Liberals obsess about them, as if this were 1913, not 2013.

    Perhaps someone with some insight into the Liberal world-view would like to explain this, because I don’t understand it at all.

    • GunnamattaMEMBER

      You arent alone there chief.

      I spent yonks in IR arguing with Unions, but when all was said and done they were rarely the real issue.

      Sure an up themselves Union offical could turn up in a workplace, or some workplace delegate might raise a union flag and try and create hassle. But it wasnt often, and never in such a way as couldnt actually be managed properly (and was usually managed just fine by management letting people know what was going on in the first place).

      The bigger issue was almost always the actual management (my side) which was all too often bullshitting, politicking amongst itself, treating the average employee as a chattel, and invariably incapable of any sort of management discipline and best practice.

      GSM will be around somewhere banging on about unions and ALP. But I doubt you will get any sense out of him.

      • Gunna…

        All the research and analysis that has gone into enterprise management suggests you are completely correct.

        I suppose what I am reacting to – and it is an emotional response, for sure – is the language of denunciation and contempt. I am well and truly over it. We all sail in this economy in each others company, and will have a fair voyage or founder on the shoals together.

        It is naive to think we might have a uniformly common sense of purpose in a pluralist democracy. But just the same, we should be able to have frank and informed discussions – and be able to disagree – without seeing toxic insults deployed for the emptiest of partisan purposes.

        There are many reasons why we have such a barren discourse in this country. The tendency to treat ideas and those who argue them in the same way as we treat cricket or football – as forms of ideological team-sport – is surely one of them.

    • drsmithyMEMBER

      But that aside, why do Liberals hate unions so much?
      Because Unions can even up the power imbalance between (most) employees and their employers.

      Perhaps someone with some insight into the Liberal world-view would like to explain this, because I don’t understand it at all.
      That’s because you probably believe in win-win scenarios and compromise, which are anathemas to the conservative mind.

  3. “..the new structural allocations to cash and fixed-income assets, such as bonds, meant there was a natural flow of buying when the currency weakened in order to maintain portfolio weightings. This may mean the old adage that the Australian dollar climbs the stairs and goes down in an elevator may not hold as much weight as previously.”

    If this really is now the case, then we have to be prepared to create new reserves for foreigners on an ongoing basis, and, likewise, be willing to accept foreign capital inflows beyond the needs of our own economic circumstances.

    This means that an assertive approach to reserve management will have to become a central feature of economic policy, and we should revisit the suggestion of Warwick McKibbon – that is, the RBA should issue currency directly to reserve buyers. At the same time, we should use the relevant inflows to increase our own holdings of foreign assets.

    This would enable us to improve our own financial resilience and stability while adding diversity to the global reserve system and still run monetary policy to suit our domestic objectives.

    • GunnamattaMEMBER

      Well a few of us have floated the idea of Australian Government infrastructure specific bonds. Alan Kohler raised the idea more than a year ago and I thought it worth a look. But nobody else has really picked up the idea.

      • This is a great idea, and will hopefully be picked up by the next Government. We can then formally separate recurrent fiscal flows from capital flows, and subject our public capital spending to rigorous economic analysis.

        But in addition, we should manage foreign inflows (reserve purchases) by increasing reciprocal holdings of foreign assets. This would be another form of Sovereign Wealth Fund – a fund financed by foreigners, in effect – and would mean foreign inflows would not exert such a high influence on the exchange rate.

        We would be developing another form of competitive advantage in the global financial system too – one based on the strength of our sovereign position.