Glenn Stevens’ “Draghi moment” calls time on Australia party

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You know Glenn Stevens is serious when he begins making dedicated media appearances. The last time was in 2010 when he warned Australians about debt and house prices, which then peaked and fell for two years.

Over the weekend he appeared at The Australian in along interview in which he took his jawboning of Australian housing and currency speculators to a whole new level.

The full interview is very long and very much worth reading but here are the several passages of greatest importance:

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The Australian: You mention the exchange rate; you might have hoped that, this year would have seen some lift in global interest rates, weaker commodity prices and easing of the currency back to mid-eighties. Global bond rates have remained pretty low and while current commodity prices have weakened, the net has been that the Australian dollar has not fallen. It fell but now it’s risen back and I’m just interested to get your sense of what some of the factors that play are. For example, a lot of people talk about Australia as a safe haven, that we’re starting to get safe haven flows that we never would have seen before. There’s also global QE, or the fact that we’ve got foreigners owning quarter of a trillion dollars’ worth of Australian government bonds….

Mr Stevens: Well all these things are at work. On the safe haven point, I would put that slightly differently. I think there is some portfolio reallocation-type flow. You have a phenomenon that particularly sovereign investors who want AAA quality assets, but the list of countries who’s got AAA ratings has gotten smaller, and I think we’re quite prominent on that list because of, basically a sound economy by global standards. We have strong banks, government finances – for all our current debates, actually, the government finances overall are in very good shape compared with the case in many other countries. So there’s some reallocation of official portfolios. Perhaps you could call that safe haven, though I think what safe haven normally means is that when there’s a sudden risk event, people run to the haven. I’m not sure whether I’d be willing to say that we’re going to be the recipient of those kind of flows in a kind of a major ‘risk-off’ event. I suspect we might well see the Australian dollar go down in such an event, time will tell. So those things are at work. Global interest rates are very low, that remains the case. I think the day is coming when we will see the Federal Reserve begin the process of, at least starting towards some normalisation. That’s a while away yet but by all accounts in a year from now, that path is going to be seriously in prospect. And at some point I expect people will start to focus on that and we could expect I think that when that day comes and starts to get closer even, the likelihood of some disruption in markets is probably pretty high because it always is when the Fed eventually changes course. And that will be the case even though they will be very careful and measured and signal and so on, as they’re doing. It continues to be my view that on most standard metrics that you could devise, it’s hard to see how most of those metrics would have the Aussie dollar quite this high. And that’s why we’ve said that our sense is that some of the investors are maybe underestimating the probability of a material decline at some point, but I can’t say when that might be.

On the miracle economy:

Mr Stevens: Well you see I don’t think it’s true that it’s a long time since we had a down turn. A long time since we had a…

The Australian: Recession.

Mr Stevens: And this is a thing I feel rather strongly about. We are creating a narrative here about the twenty-three years of no recession as though this is some miracle and, you know, we’ve sort of advanced smoothly without any setback, but that’s not really true. I mean we have had a few episodes of mid-cycle slow down, and we’ve had a couple of episodes where the economy contracted, but only briefly and they were shallow contractions and brief ones. We had one in the later part of 2000, and we had one as you’d well recall at the end of 2008 which could have turned out to be much deeper – and I actually thought it would be deeper at the time – but, we got back to growth quickly. So the down turns were shallow. We did see the rate of unemployment go up a percentage point or so,in both those episodes. The only reason they weren’t labelled recession is because the contraction happened to be all in one quarter, not spread across two, otherwise you guys would have written very different stories. But the way to think about this isn’t that we don’t have down turns and we haven’t had downs, we have had them. The way to think about it is that we’ve managed for twenty some odd years to only have little ones and short ones, and what we should be thinking about is, how was it we managed to do that. It isn’t because we’re a miracle economy and it’s not because we’re geniuses in government or the central bank. I do think though that good policy frameworks, careful policy development and implementation does make a difference. That’s the difference it can make. It doesn’t promise you that we can go another ten years without recession or without down turn. I would fully expect within, over that ten year period at some point, there will be a down turn for some reason of some depth. The question is, can we be in a position to do the things that would make it a shallow and short one, that’s really the issue. And having a strong fiscal position by the way, ahead of any such down turn, which stood us in very good stead in 2008, would be one such thing and sound monetary policy framework another obviously. So I want to fight against this narrative that’s built up.
It’s a myth really that this economy doesn’t have down turns, we do have them, we will have them. We happen by either good luck or good management, or both, to have had pretty shallow ones the last couple of times. Long may that be so, we should be doing what we can to give us the chance for the future down turns are short and shallow.

On foreign investment in housing:

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The Australian: Just darting back just briefly on to housing, your submission to the parliamentary inquiry that’s underway at the moment on foreign investment in housing. You downplayed the significance that it’s having in terms of housing demand and emphasised the role that foreign investment is having on housing supply. Nonetheless asset markets are becoming globalised, and we are seeing more foreign investment in property and in residential housing. Do we have to accept that the global investment will be an additional source of housing demand?

Mr Stevens: I think we probably have to accept to some extent that Sydney in particular and I would say Melbourne as well, these are cities that enough foreign people have been to and like the look of. There’s going to be some, we’re on the global radar to some extent. It isn’t London or Paris or New York, but I think certainly our larger cities are on the radar for international people more than they used to be. And so there’s going to be some demand on the part of some of those people for property here. It’s very hard to say quantitatively how much that has been or will be I think. But the issue for us is, whether that interest results in our own people not being able to housed at a reasonable price in our cities. I’m not sure we should assume that. I think surely it’s not beyond us to make sure that the supply capability particularly for new housing – and at least legally, its new housing that the foreigners are supposed to have the access to – can’t we do things that ensure that the supply responsiveness is adequate to meet both their demand and the demand of our own children and new families here, without excessive increases in price? If that’s the challenge to us, why can’t we meet that challenge? It seems to me we should set out to do so.

On the Fed tapering and the Aussie:

The Australian: But it’s not inevitable is it that there will be a financial market shake out at the end of tapering because there was a lot of volatility when the Fed, if you like, “false started” last year early and then they delayed the start, but since then it’s been a very smooth response every meeting to tapering.

Mr Stevens: It’s been remarkably smooth. I agree. I think that probably in terms of the tapering which they’ll finish before the end of the year by the look of it, one would expect that that will be now accomplished fairly smoothly. I would only observe that that’s not the same as actually starting to raise the cost of overnight money. Now at this point I think that that’s priced into the forward curve in the US so people in some sense have absorbed it and discounted it. Once it gets to be a few months away rather than twelve months or more away, perhaps that will be more of a test and I think one should not discount the possibility that there will be some disruption there and even when that disruption, if it happens…even when it occurs, well that’s part of these course changes pretty much every time.

The Australian: You mentioned that you know the Australian dollar could well fall in such an event, when the US normalises

Mr Stevens: Or some other set of events for that matter.

The Australian: Yes but are there other spill over’s that you anticipate for Australian that might follow once the US starts shifting rates?
Mr Stevens: Not necessarily particularly big ones. I think the atmosphere in international financial markets would be different in a world where the Fed is on a path however gradual to raise its rates. I think it would be no secret that our feeling is that we hope to see that for a bunch of reasons, not least of which is that’s a further sign of healing in the United States economy. I happen to think the US economy is going pretty well and it’s going to be just fine. But further confirmation of that would be when the Fed feels confident enough that they start to normalise the policy rate. I think overall that’s a good story. It’s a good news story. It’s simply that there’ll be some bumps along that road for some people. I wouldn’t anticipate serious problems for Australia in particular. And most people who are looking for potential problems for us I think will be more likely to think about China than the US at least over the next twelve months. I happen to think China’s probably okay too but most of the people that I talk to who want to think about what might go wrong, that’s where they’re looking.

On macroprudential:

The Australian: The longstanding position has been that monetary policy should not be used to prick asset levels or to deal with asset prices. In the Australian context is it still fair to say that also holds true here, that asset prices in your setting of policy are given nowhere near the weight say…of employment or inflation…?

Mr Stevens: I think asset values are given appropriate weight in our decision making and I think I made that fairly clear in a speech last week. Actually it’s the credit cycle that’s the really important thing. I think if we frame this in terms of ‘is it an asset price bubble or not?’ we haven’t quite framed the right question. The real question is, is there a credit event happening which is risky from the point of view of financial stability, and therefore ultimately for macro-economic stability? If the answer to that is yes, there’s still then a question of what you might do about it, but I think you have to start with thinking about leverage not just the asset price per say. And for example that is why, although some people have gotten more excited than I have so far about the house price rises we’ve seen, it’s important to ask how much credit is behind that. And the answer in most cases, the investor part is a bit different but for most occupiers, credit increases remain quite moderate so I’m not inclined to get on the soap box. That could change but that’s been the story to date. So I think you have to think about the leverage, and I personally think that it is useful to have so-called macroprudential tools. These are really regulatory tools, let’s be plain about what they are. They are useful to have as an adjunct, however I think that you always have to keep in mind that if you’re concerned about rising leverage and you have a very low rate of interest, sure it’s fine to use some regulatory tools to lean on that and that will probably help you in a very worthwhile way for a very short period of time, but it won’t really be a sustainable persistent state of affairs to say ‘I’m going to hold the rate at rock bottom and control everything with regulation.’ If you’re trying to do that for five years I very much doubt that will work out well.

The Australian: Is there any irony that we’re shifting back to more direct rules on banks that we shifted away from in the 1980’s and thereafter?

Mr Stevens: Well I think there is a bit of déjà vu. At least in some of the things one hears said. I think macroprudential tools are certainly worth having in the tool kit and in our case they would be deployed by APRA of course. And I, despite claims that we indicate a reluctance to use them, I’m quite happy to use them if they would be useful. My only broader point is, I think one should be wary of putting too much faith in them as an entirely independent suite of tools. I think that might be a little bit naive if that was to persist over quite a long time.

This is Glenn Stevens’ “Draghi moment” (the moment when a central banker declares he’ll do “whatever it takes”) in which he’s drawn a line in the sand for both higher house prices and a higher currency. If both persist then policy action is now a high probability. Be warned.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.