How Australia funds the CAD determines our future

How many of you are aware that Australia has accumulated a total current account deficit of $1.217 Trillion since 1980? From the ABS data base:

With the above in mind, I want to challenge two memes that continue to be perpetuated by many on a daily basis and point to perhaps the largest threat to the Australian financial system. Often why things are the way they are, are misrepresented in order to disguise true reasons and push biased agendas.

Firstly, non-residents buying new Australian housing does not in isolation add to the housing stock that Australian residents need and arguably it misallocates resources and reduces both available and suitable housing for residents.

Secondly, whilst banks use the funds they borrow offshore to lend on residential mortgages, banks do not have to borrow offshore to fill the ever-increasing demand for residential mortgages from Australians. Offshore borrowing funds the current account deficit and the resulting loss of deposits.

It would seem to defy logic to suggest that foreigners buying new high-rise apartments or houses does not add to the housing stock. I define housing stock as housing that is required to house residents. It does not include empty boxes in the sky or vacant suburban homes that are meant to be a store of value for a non-resident that have their own motivations whether legal or not.

The point is that houses or apartments required to house residents can be built and funded entirely within Australia. A loan from an Australian bank to an owner occupier or investor creates its own funds for the mortgage whilst there are more than enough investment funds available in say, superannuation for the bank to fund the capital requirement and therefore the building of all housing if there is demand to live in that housing by owning or renting. Affordable social housing is a government responsibility that again can be funded solely by internal means.

Non-residents buying Australian existing and new housing as a store of wealth or as pure speculation distorts the allocation of Australian resources, drives up house prices and increases unaffordability. Clearly certain sections of Australia – notably the FIRE sector – benefit as do politicians and regulators in the short-term.

But why does Australia hurt the majority of existing residents to the benefit of peoples in other parts of the world? It’s simply one of the mechanisms to fund the current account deficit (CAD) in a way that appears not to lessen the credit risk of the country.

The current account is defined as the “Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).” The current account is our monetary balance (excluding “capital and financial account”) with the rest of the world and Australia has been raking up a current account deficit (CAD) since 1980 as follows from the ABS:

To repeat, an accumulated CAD of $1.217 Trillion since 1980!

To ensure that the Australian money supply is not decreased the CAD must be funded by Australia selling assets or borrowing offshore. The RBA could have printed/lent money to the government to spend to cover the monetary shortfall but that’s a controversial alternative.

Allowing non-residents to invest in new Australian housing is a very poor way to plug the hole in funding the CAD. Unnecessary, distorting and highly risky. What happens when these same non-residents sell en masse? A run on housing rather than a run on the banks?

There are better and less risky means to fund the CAD than selling real estate to foreigners, we just need to put some thought into it.

This provides a nice Segway into the second meme on banks borrowing offshore to meet mortgage funding requirements. I repeat, Australia can fund all its mortgage and housing requirements within Australia. However, Australia has built an international deficit (cumulative CAD deficit funded by debt) of close to $1 Trillion that must be serviced and, one can only speculate, repaid at some point.

The ABS quaintly refers to this debt as part of the “International Investment Position (IIP)” that is described as follows: “Australia’s net IIP liability position was $958.8b at 30 September 2017, an increase of $13.2b (1%) on the revised 30 June 2017 position of $945.7b. Australia’s net foreign debt liability increased $26.0b (3%) to $989.7b. Australia’s net foreign equity asset increased $12.8b (71%) to $30.8b at 30 September 2017.”

Historically, the balance is as follows from the ABS (series only starts in 1988):

So, Australia has a cumulative CAD of around $1.2 Trillion funded mostly by net debt of close to $1 Trillion, the balance being net asset sales.

The net foreign debt is funded via international holders of government debt or through private debt, but mostly through Australian Banks’ offshore borrowings. The ABS notes the growth in those borrowings to a total of over $750 Billion:

The Banks may inject the offshore borrowings into the housing market, but it’s to fund the ongoing CAD and not because there is a need for offshore borrowings to fund excess mortgage demand.

If the accumulated CAD is not funded by offshore borrowings or asset sales, it sucks funds out of the banking system which is a form of deleveraging, through a reduction of deposits and therefore the amount of funds available to lend. Whilst that deleveraging would mostly occur in mortgage markets, that’s as a consequence and not actually banks borrowing to directly fund mortgages. Rather it represents borrowing to plug the whole in the mortgage funding markets caused by deposits being used to fund the CAD.

Offshore borrowing to fund the CAD, not offshore borrowing to directly fund mortgages may seem like a moot point but it isn’t. It’s very important. I’m arguing that as a nation we’ve used the easiest route to live large off the back of international benefactors, but this has led us down the path of an unstoppable debt feedback loop and subsequent bust.

Australian governments and policy makers have purposely chosen for Australia to run continual CADs to fund life styles. If we/they had chosen to structure a system where Australia had a minimal to zero cumulative CAD, Australia would have little offshore debt and be much more in control of the $A through the trading and capital account. The consequences for wealth and lifestyle may be problematic but if we wanted to improve both we would have had to work for it and not borrow it. We would have needed to be much more innovative in creating and selling our goods offshore to buy the TVs, Iphones, SUVs and whatever fills Bunnings and every department store that we all enjoy now, rather than rack up debt.

But our GDP numbers look great as borrowed and spent money pumps GDP. The following, from the ABS, are our GDP numbers since 1980:

Unsurprisingly, as the data shows, Australia’s increase in GDP since 1980 is $1.2 Trillion, equal to the cumulative CAD with the CAD being funded by $1 Trillion of offshore borrowings mostly through the banking sector ($750 Billion).

What many in hindsight may find difficult to understand is why in the history of the world would other countries lend to a small 3rd world economy like Australia, to fund its population a 1st world life style, and presumably, not expect to be repaid? For a population of around $25 million, to have $1 Trillion of offshore debt with very little productive industry (except selling rocks) is remarkable.

The question must become do we ever have to pay the debt back and if yes how? The problem we have is that the debt funded consumption and asset/house trading are not real productive assets.

So, firstly, we are not creating offshore income producing assets to repay debt.

Secondly, the distribution of wealth or the benefits of the borrowing are distributed inequitably among the population and the generations.

The debt is on the external account and growing. Australia cannot do anything to diminish the size of existing debt either in $A or a foreign currency. It’s owed and if our benefactors come calling then we must pony up under their rules. How?

The Banks could simply be forced to repay offshore debt and decrease deposits and therefore deleverage. If even 20% or $200Bn of the debt is repaid what do we think that will do to the economy and house prices?

We could print or use the modern version of printing – aka Quantitative Easing (QE) – but this in itself could cause capital flight and destruction of the value of the $A severely exacerbating capital flight. But it would work as a debt reduction for future generations even if scorching those that benefitted over the last 35 years. The RBA has set up Australian Banks to be able to pull the trigger on Aussie QE at any time.

You could argue that our offshore benefactors, expected Australia, at some future point, to sell so many rocks and apartments to overseas buyers and or severely decrease our offshore purchase of goods that it would produce an external account excess and pay down the “net foreign debt”. Seriously, don’t laugh, its possible that back in the day the benefactors believed this delusion and perhaps do even now.

Or perhaps, something else is a foot. Once the Banks took on the role of funding the majority of the accumulated CAD some 20 years ago, pressure was eased on the federal government’s balance sheet but it mounted onto the Banks. The Banks’ reaction was to greatly expand its asset base into what they thought were the lowest risk assets possible in order to placate those offshore benefactors/lenders that the risk it was incurring was low. That is, residential mortgages.

So rather than run federal government deficits by increasing government spending that ultimately turns into bank deposits funded through offshore government borrowing, Australia chose the magic of increasing deposits by increasing credit to residential mortgages through the Banks using offshore borrowings to plug the CAD hole. As traditional economics ignores the effect of private debt, its both a bizarre and cunning plan.

On a simplistic basis, this does appear to be the same thing – i.e. a large portion of the tax paying population of Australia is still responsible for repaying the offshore debt, either through tax payments to governments or their mortgage payments. Unfortunately, the different methods produce strikingly different results. Over time, one method is a controlling negative feedback loop whilst the other creates a positive feedback loop with negative consequences.

Running continual federal government deficits to spend is transparent but against the austerity doctrine and would surely have forced the credit rating agencies to strip Australia of its AAA, or never get there in the first place. As the twin debt and deficit grows to fund the cumulative CAD, the poor effect kicks in and this negative feedback loop effectively forces governments to adopt policies to curb debt and offshore spending growth and even go into reverse. Although, this method of funding the CAD does have the benefit that a wise government could more equitably distribute its deficit spending – i.e. offshore borrowings – to the benefit of most working Australians.

The antithesis of that process is borrowing through banks and “low risk” residential mortgages where the ever-increasing debt to plug the CAD creates a wealth effect through house price increases, strong bank balance sheets and low funding costs creating a positive feedback loop that has severe negative consequences as it compounds on itself turning “low risk” mortgages into high risk time bombs and transferring responsibility for too much debt onto younger generations or speculators. Or to put it another way, we need to continue to borrow to fund the CAD because that props up the housing market which is backing Australia’s external liabilities. There is no solution to this where there is not a lot of pain. there is not even a will to have a solution to this calamitous feedback loop. It’ll run until it breaks.

One problem, two seemingly similar methods for dealing with it, but two very different outcomes.

However, we shouldn’t forget that Australian Dollars exist to repay the debt and therefore there are means by which the situation could be mitigated by transferring from the haves to the have nots and then to repay debt. Though I can’t imagine how this could occur by government initiative prior to a crisis.

I doubt that any politician in the country understands this dynamic and I have never met a financial regulator or banker that does either. They all believe in the delusions of the wealth effect and “low risk” lending. But you only need to understand that borrowing to fund the CAD using mortgages as security is just one delusional way to fund the CAD. That’s a strategy that can’t last no matter what the powers that be throw at it.

Comments

  1. Let’s start building weoponry and military hardware – tap that trillion dollar market! We’ve got all the red dirt we need to build it, and when the dollar tanks and labour is cheap (read:desperate) again, voila.

    I mean, I’ll do anything not to have to sell my HSV and jetski…

  2. the colonialMEMBER

    great post – i’m sure most assume that capital gains magic will take care of the whole box and dice. its interesting by comparison to see how willing canadian authorities have been to act, albeit too late and in an incremental fashion.

  3. 12 / Dec / 1983.

    That was when Hawke / Keating decided to join the neoliberal ideologues and float the currency, thereby eliminating what little power the RBA had left to control the CAD.

    Private bank lending erodes the ability of a central bank to manage the CAD under a managed currency. This is because local production is typically consumed first, excess credit (increasing money supply) will chase local prices higher then spill over into imports as foreign sellers are slow to adjust prices (up), being the last to appreciate the reality of credit conditions (delayed information / furthest distance from the source of money creation). The ratio of imports to exports will increase as credit is eased.

    Even so, an activist central bank with a strong hand at the helm can defend against this weakening ratio by aggressively governing credit conditions to protect declining foreign reserves. If that fails, a strong government can implement Mercantalistic policies to defend foreign currency reserves and control trade imbalances (tariffs, etc).

    But floating a currency divorces the current account completely from the status of the RBA’s foreign currency reserves. The valuation of the AUD then has nothing to do with the current account and is purely determined by international market sentiment. Feelings over facts. Central banks don’t mind because their precious foreign reserves are now completely shielded. They happily kick back and say “not my problem”.

    Neoliberal ideology demands that this be the case because “markets are better than managers”. They don’t want the RBA deciding how many USDs you get for your AUDs (based on how many USDs the RBA has in reserve), nope, they’d rather it be left up to international FOREX traders. Seemed like a good idea at the time, but decades of experience now demonstrate the flaw.

    Whilst it’s true that markets outperform managers in so many cases, hardcore neoliberals fanatically believe that markets outperform in ALL cases, rather spectacular evidence to the contrary be damned.

    The AUD is far too high, caused by exuberant FOREX sentiment that does not have long-term Australian economic interests at heart. Under a floating currency, the only power the RBA has to really change the AUD is to lower interest rates, an action that will then cause even greater misallocation of capital, rising inequality, economic erosion and expansion of the current account deficit. Hence the RBA is damned. Combined with a pathetically weak government, that lacks the balls to ever take away the credit-to-imports narcotics and pursue a more Mercantalistic economic model, we’re screwed.

    Were the currency still managed, the RBA could simply revalue the AUD pairs down to defend its foreign currency holdings as needed, thereby stemming the current account deficit without having to do anything to interest rates.

    Meanwhile, China rejects neoliberalism, runs a managed currency to maintain a perpetual trade surplus, and laughs all the way to the bank as our adherence to a flawed economic ideology runs us straight into the ground.

    • Absoloodle! Good one Med.
      Just a point – I think you’d find the squeeze on the Current Account by managing the currency WOULD have a pretty drastic effect on interest rates (particularly starting from here which we’d all rather not do!)

      • Yes, and if they have the balls to (re-)manage the currency, then they should let the rates go where they naturally need to go (UP!!). Mega pain for the specufestors and too bad. ‘;..;’

        This country needs to learn how to make stuff again. Real economies aren’t built out of people circle-jerking assets.

        Gives me the sh1ts flawsie, we’re a sovereign nation with our own currency and bucketloads of resources. We could be building our own cars, aircraft, satellites, hell we could have a space program. 20 million souls is more than enough to build any industry.

        All that’s lacking is the will to build it and protect it, a rejection of extreme globalism in favour of sensible localism.

        We glorify useless, parasitic asset speculation instead of boosting real production, innovation and creativity. Then we cry about Australia’s DOA innovation whilst flipping through the real estate liftouts at the coffee shop.

      • 50 years! I’m only at ~20 years of what I’d consider economic literacy and it has driven me batty.

  4. The current state of affairs is not a mystery.

    Modern politicians are very sophisticated. They understand that to be elected and re-elected they need to offer more than the other mob. Electoral failure is the reward for the joyless scolds who think people want high fibre policy options.

    The best thing a modern politician can offer is something for nothing that appears to be prudent.

    Howard and Costello were simply brilliant at this. They shamelessly promoted the ideas that cheap credit for residential housing was an entitlement and people should trust him to deliver.

    “Interest rates will always be lower”…..absolute genius.

    The method of delivering on the promise was brilliant as well because it was sufficiently removed from the juicy goodness that very few people understood the connection.

    A prefect policy “magic pudding”. Why not vote for more pudding? Especially when the other side are idiots and dont know what hit them.

    The method of delivery had a several components.

    1. Allow and encourage local banks to expand their external liabilities.

    By allowing foreigners to own deposits and selling bank securities to foreigners. Without this supply of ‘unproductive’ capital as a low cost funding source to hold down mortgage rates we would not have been able to have the amazing trifecta of CAD, low rates and high AUD. You dont get the triffecta just by having sunny beaches.

    2. Allow foreigners to buy more and more Australian assets in greater quantities. Demand for our assets translates into demand for the AUD. Upward pressure on the AUD hides a myriad of sins. The chief one being an asset price bubble that makes asset owners feel rich.

    What many don’t understand is that neoliberal ideas about capital flows are attractive because they allow politicians to offer current lifestyles paid for by the future.

    They are electorally popular for good reason not because of some dumb conspiracy in a Swiss Ski village.

    With these powerful drivers in place there was little need for the government to sell govt securities to foreigners though of course as the households have reached their limits – and banks external liabilities became to large to ignore – we have seen the govt increase bond sales to foreigners.

    Naturally, govt bonds sales have a bit of political whiff thus why the desperate urgency to sign up asset sell off agreements by Ciobo. Those free trade agreements are nothing of the sort. They are signed by Australian politicians for a single purpose – to attract faster and faster inflows of predatory capital.

    Those flows keep the game alive if the bank external liabilities are reaching limits and the govt is not keen on ever expanding bond sales to foreigners.

    If we are serious about doing something about this we need to explain to the general public that capital inflows to support residential mortgage lending and residential asset prices is not a Magic Pudding.

    The higher than otherwise level of the AUD associated with the inflows destroys export and import competing businesses and the jobs that go with them.

    The unproductive capital inflows are not free.

    They involve either the sale of assets or the sale of claims over future income.

    In policy terms the solution is simple.

    Zero capital inflows for existing property.

    Capital inflows for new property must involve no rights to immigration. Absent that carrot capital inflows for new housing are likely to dry up.

    Oh and in case it was not obvious a key part of this scam is the role of private banks in our monetary system as they allow the process to be easily concealed.

    The first privatisation – of the public power over public money – was the worst yet most dont even understand that is our ‘system’.

    • “The higher than otherwise level of the AUD associated with the inflows destroys export and import competing businesses and the jobs that go with them.”
      YUP!!! We’ve destroyed production in the cites but we have also destroyed whole communities in regional and rural Australia. Nobody gives a RA!
      NOW this contains within it an awful truth.
      If we are to correct the CAD it will involve running an A$ at a much lower rate (half?) than has been the practice for the last 60 years. This involves the lower value currency making EVERYTHING in cities more expensive by probably 60 to 70% even not counting the catch-up the powerful will demand. There would be a HUUUGE spike in IR’s. We would have to run significantly RAT positive IR’s – work out for yourself what that might be. Cities would become a wasteland
      Now as a result of this continuous stupidity over a very long period including, and especially, from morons like Keating, Howard, Costello, and ALL politicians of recent yeas, we now have 3/4 of the population of Australia live in the major capital cities and their near surrounds what are the chances of getting any reform? How? We will not get it voluntarily. Any government even contemplating any reform will be voted out. Eventually it will be forced on us and when it is it will be terrible!
      Vote Flawse for Dictator

  5. Thank you Deep T!!!! Flawse feels a lot less isolated.
    Just this
    “We could print or use the modern version of printing – aka Quantitative Easing (QE) – but this in itself could cause capital flight and destruction of the value of the $A severely exacerbating capital flight. But it would work as a debt reduction for future generations even if scorching those that benefitted over the last 35 years. The RBA has set up Australian Banks to be able to pull the trigger on Aussie QE at any time.
    Points
    1. The reduction in the A$ IS a charge on future generations. Everything for them will be more expensive. One way or another, as you point out elsewhere, this debt WILL be repaid by those who come after us.
    2. Printing does not JUST cause capital flight – although the effect of that would be pretty drastic. If we didn’t print, then the CAD results in a decrease in the Money Supply. Interest rates rise and in an economy run on SANE principles people save, imports fall and the CAD gets corrected. (In the current stupidity if IR’s rise we allow all the spec printed money in the world to flood here and drive the A$ up to extremely uncompetitive levels.) If we print to fund the CAD it never gets corrected. We continue on running CAD’s, which when the c..p has already hit the fan, will have disastrous consequences on the currency.
    Printing creates a circle that never closes i.e. a whirlpool going down forever.

  6. As Gunna pointed out on the we, much of the foreign money, chinese, is allocated here, and to many other islands of the pacific, with the intention it will secure citizenship rights in straya and the benefits which accrue from that.
    That money funding the deficit has zero to do with benefiting the hosting nation.
    if we are going to go into an arms race, first thing we should do is pay out the debt to everyone other than strayan nationals.
    Then lock up anyone here who is not a Strayan national.

    • UPDATE:A Company linked to Chinese political donor Huang Xiangmo scoops Circular Quay apartment project
      The son of controversial political donor Huang Xiangmo has emerged as the mystery buyer of a billion-dollar Circular Quay apartment project, which is under construction, and the Jewel project on the Gold Coast for the combined price of $312 million in cash and $807.1 million in debt repayment.
      They were once valued at $1 billion each.
      The announcement said the purchaser was AWH Investment Group.
      Huang Xiangmo, whose legal name is Huang Changran, ceased to be a shareholder of AWH Investment Group a fortnight ago,His 23-year-old son Huang Jiquan, residing in Mosman, replaced him on the share register as a director of AWH.
      AWH was formed in November, around the time Wanda, started searching for a buyer for its Australian assets. Seven days after AWH was registered as a company, Huang Xiangmo stood down as president of the Australian Council for the Promotion of the Peaceful Reunification of China.
      It has been embroiled in controversy amid claims the group lobbies on behalf of the Chinese government, Sam Dastayari received political donations from Mr Huang.
      Another director of AWH is Xiaozhi Luo,This is the same name as the signatory on a $10,000 political donation made to the Liberal Party in 2016 AWH’s company secretary is listed as Jian Huang
      This is the name of the political donor who donated $100,000 to the Liberal Party in 2015 and was reported to be linked to a major Guangzhou property developer, R&F Properties

      • AND
        Sydney businessman Huang Xiangmo, a “wealthy individual with close but hidden links to” Beijing and who has boasted that he selected former foreign minister Bob Carr as the institute’s director.
        Mr Xiangmo’s application to become an Australian citizen has stalled over security concerns held by ASIO.
        The dealings between Labor senator Sam Dastyari and Mr Huang, led to Mr Dastyari’s resignation last year. Dastyari warned Chinese donor his phone was bugged.
        WW Reds under the beds, reds in the highrise, reds everywhere

  7. Note that while, in recent years, the sale of RE to foreigners has been a great way to fund a portion the CAD, it is only recent. The Cad has not been running since 1980. It’s been running, bar a small surplus in 1971, since 1959! We’ve funded it with borrowings as pointed out here. HOWEVER we have also funded it with the sale of our mining resources, farms and economically core businesses. This year Lowy’s sell out. Toll was sold. Every few weeks we have to sell a major important company to keep this rot going. The CAD this year looks like being $50 to $60 BILLION. That’s a lot of assets we have to sell to foreigners.

    • Note from Stephen Granville and this is 2010-11!!!!
      ” 83% of mining profits accrued to foreigners in 2009-10. Looking at the three largest ‘Australian’ miners, foreign ownership accounts for three-quarters of BHP-Billiton, over 80% of Rio Tinto and 100% of Xstrata. ”
      I understand the latest figure for foreign ownership of our mining industry was over 90% but I am open to correction. There was a number of 85% but that was a few years ago.
      But who gives a RA I gotta get to me tattooist to get a brand on meself so I know who I am.

  8. Great post.

    Minor typo – segue, not Segway. Pronounced the same but one is an electric vehicle.

  9. In light of this paper from Deep T, Doug Noland’s article this week is quite important.
    e.g.
    “For better than three decades, the U.S. has been in an enviable position of trading new financial claims for foreign manufactured goods. The U.S. has literally flooded the world with dollar balances. In the process, the U.S. exported Credit Bubble Dynamics (including financial innovation and central bank doctrine) to the world. When the central bank to the world’s reserve currency actively inflates, the entire world is welcome to inflate. The resulting global monetary disorder ensured a world of fundamentally vulnerable currencies.”

    http://creditbubblebulletin.blogspot.com.au/2018/01/weekly-commentary-america-first-and.html

  10. Loved this post. Here is my list of lead indicators for trouble in-coming. Interbank rate (21 month ahead)
    Personal saving (21 month ahead) Business Confidence (18 month ahead) Employment change (6 month ahead) High yield bond spreads to Government bonds > 200 bps (6 months ahead). Then BANG.

      • It’s when Savings start to go up that it signals potential economic stress. That said, it is a noisy Metric as Savings will struggle to go up when the household interest payments are going up with banking sector interest rate rises. If you have more spare time than most of us, you could attempt to normalise for interest rate rises and give yourself a headache wondering about what the lag period may be. I have a dim memory of a website ‘who crashed the economy’ which may have data over a long time period.

      • Coming
        I understand where you are coming from and that certainly applies to our economy at the moment. However people CAN spend less on consumption goods! In our economy this would be reflected in a lower CAD.

  11. Really good post. It covers and explains so much of the delusion in the country.

    A small typo – “For a population of around $25 million…”

  12. Fascinating article Deep T. I have often wondered why the commentariat claims that banks have to use foreign funds to finance their domestic lending.
    Just one query – You state ‘To ensure that the Australian money supply is not decreased the CAD must be funded by Australia selling assets or borrowing offshore. The RBA could have printed/lent money to the government to spend to cover the monetary shortfall but that’s a controversial alternative.’ I thought that with a floating currency the domestic money supply is not influenced by the current account balance. The adjustment in the absence of capital inflows would be through the $A depreciating. Have I missed something?

    • davie
      Not that simple That’s proffered as some simple magical solution to all our problems. it isn’t!! You’ve still got the debt. Worse still, if all you do is let your currency fall you still have the underlying structural problems that created the CAD in the first place. if you print to plug the monetary hole filled created by the CAD you don’t close your loop. You create a vortex.

      Also note and I think Deep T tried to cover this and it was certainly covered in Mediocritas comment. If the Banks print that money goes into circulation and in THIS economy pretty much all of that eventually ends up as buying imports. It’s not saved and the government runs a deficit – although in rality maybe 20 percent odd (rough estimate/guess) ends up in government coffers.
      So we need to borrow foreign currency to pay for the imports created by the extra bank lending.
      In practice this is all happening at once – continuously. So to a person on the inside it looks like the banks are borrowing to lend for housing.

      • HI Flawse. It’s not a magical solution, as far as I know, with a floating exchange rate it’s a fact. There is no ‘monetary hole,’ just a lack of demand for $A compared to their supply on forex markets. The depreciation that would result may or may not help and could be especially problematic if a lot of our foreign debt is denominated in foreign currencies.

    • davie
      You HAVE to look at the money, where it goes and how it flows. If you print to fund the CAD then you just exacerbate your CAD. If you don’t print then the money supply contracts, interest rates rise and, in other than a modern economist’s irrational world, consumption is cut. Your fall in the currency, for the current status, will greatly exaggerate the effects. For this to work in any way you have to impose strict controls on the movement of capital. THEN you have top impose strict controls on the powerful in the economy who will compensate themselves for the fall in the currency leaving the powerless to suffer all the consequences. Indeed the greed, in our society and economy as now constituted, will nullify the value of any fall in the currency.
      If you print (without selling assets to foreigners) you promote the distortions in your economy that caused the chronic CAD in the first place. The hole is never filled – hence the vortex. More and more debt. more and more asset sales to fund the CAD till thee is NOTHING left that we own.
      Lastly a simple fall in the currency is not going to fix problems that at now three generations old. It isn’t going to redistribute the population to areas associated with real production. it isn’t going to fix our education system and it sure as hell isn’t going to result in factories and technology suddenly sprouting lie a sown wheat field across the country.

      The stuff you put forward is based on a fairy story. There is no Magic Pudding despite the best efforts of Bill Barnacle to insist that there is.

      P.S. Re how much is denominated in foreign currencies. We are assured not a lot. Essentially as long as our IR is higher than the funding source the Bank can effectively swap into A$ debt which means they are paying A$ interest rates – what it gives them is unlimted access to funds at the current rate so they can meet whatever demand is created by the RBA’s IR setting.
      As I understand it when we hit the big problem is if the currency falls significantly and/ or foreign interest rates rise. The cost of the SWAP gets very expensive.
      Sure we CAN print the debt but with the world already aflood unwanted A$ adding another deluge to the flood has disastrous currency consequences which are the problem of future generations.
      One way or another, foreign debt is REAL debt that has to be paid by people who come after us.

  13. Great post Deep T

    So, when does Australia turn into Argentina? How much further can the can be kicked?

  14. What our politician will tell their grand children in 60 years: “In our country—as in all the others—there were beggars ruined by drink (opioids in ’18) and play (sport in ’18?) or rather beggars innate—I say innate, and maintain my expression. Indeed, in our country, and in all classes, there are, and always will be, strange easy-going people whose destiny it is to remain always beggars. They are poor devils all their lives; quite broken down, they remain under the domination or guardianship of some one, generally a prodigal, or a man who has suddenly made his fortune. All initiative is for them an insupportable burden. They only exist on condition of undertaking nothing for themselves, and by serving, always living under the will of another. They are destined to act by and through others. Under no circumstances, even of the most unexpected kind, can they get rich; they are always beggars. I have met these persons in all classes of society, in all coteries, in all associations, including the literary world.” From chapter 28 of: http://www.online-literature.com/dostoevsky/house-of-the-dead/5/. ……. Shame Australia The County That Would Just Lay Down and Get Run Over …….

  15. Thanks as always DT.
    OT but tied in…….. Is this just a regurgitation of something that’s been settled? – https://hotcopper.com.au/threads/think-your-bank-deposits-are-guaranteed.3956189/#post-30216011 – Or does it have merit?

    A former principal researcher at bank regulator APRA has revealed in a submission to a Senate inquiry that, contrary to government reassurances, Australian bank deposits are not guaranteed.

    This explosive revelation shreds the government’s repeated assurances that its new bill to give crisis resolution powers to the Australian Prudential Regulation Authority (APRA) will not allow the “bail-in” (confiscation) of bank deposits, because they are guaranteed up to $250,000 by the Financial Claims Scheme (FCS).
    In the cover letter to his submission to the Senate Economics Legislation Committee’s inquiry into the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017, Dr Wilson Sy asks Committee chair Senator Jane Hume: “As a matter of urgency, I need to ask: are you prepared to have your savings in bank deposits confiscated to save insolvent banks? What about the millions of voters you represent? How would they react if you allow this to happen to them?”
    Dr Sy charges that the bill “gives the Government and APRA new discretionary powers to confiscate bank deposits”, and that it should be rejected.
    (Dr Sy’s submission, “Protect Deposits Not the Fraudulent System”, is the first submission posted on the Senate inquiry’s website, and can be accessed here.)
    As a Principal Researcher at APRA in 2004-10, during which time he was briefly acting Head of Research for a time, Dr Sy is one of the most qualified people to comment on APRA and the powers it will be given by this bill. Both the 2008 global financial crisis and introduction of the Financial Claims Scheme occurred while he was at APRA.

    FCS guarantee not activated
    The essential point that Dr Sy makes is that the FCS is not an absolute guarantee. He quotes the FCS website, which makes clear that the FCS will only take effect if the government activates it when an ADI (Authorised Deposit-taking Institution—a bank, credit union, building society etc.) fails. “That is, when a bank fails, i.e. becomes insolvent, the Australian Government or APRA then has the discretion to decide whether or not to activate the FCS”, he says. “Hence, it should be emphasised that:
    “Bank deposits are not protected or guaranteed at all.”
    Under the Banking Act 1959, Dr Sy explains, APRA is responsible for two potentially conflicting objectives: the protection of depositors AND the promotion of financial stability. This depositor protection is “illusory”, he asserts, because the Banking Act doesn’t state which objective has priority.
    Under the new bill, however, APRA will have the discretionary power to decide which objective has priority; alarmingly, it will be able to make such a decision “in secrecy”. Dr Sy references Subdivision D, Section 11CH (p.24) of the bill, which states that APRA may decide that its orders must be kept secret if it is “necessary to protect the depositors of any ADI OR to promote financial system stability”. (Emphasis added by Sy.) The replacement of “AND” with “OR” confirms that the objectives are in potential conflict. “Therefore”, Dr Sy continued, “it is important to recognise that the Bill allows APRA discretionary powers to decide secretly whether to protect depositors or to promote financial system stability.”
    Quoting a 2012 Reserve Bank of Australia paper, which stated that the priority of regulators, mandated under Commonwealth legislation, is to “pursue financial stability”, Dr Sy concludes:
    “Therefore, the evidence collected here strongly suggests that the Bill is designed to confiscate bank deposits to ‘bail in’ insolvent banks to save the financial system.”

    Can’t be funded
    Dr Sy’s revelation is further, damning evidence that the FCS is not a real guarantee. The Citizens Electoral Council had already exposed in 2014 that, by the regulators’ own admission, the FCS doesn’t have the money to guarantee deposits in any of the Big Four banks, which hold 80 per cent of all deposits! This was first acknowledged in a 19 June 2009 meeting of Australia’s Council of Financial Regulators, comprising APRA, ASIC and the Reserve Bank, which noted in its minutes that a failure of one of the Big Four banks would “exceed the scheme’s resources”. Later, the Financial Stability Board in Basel, Switzerland, which is in charge of imposing a bail-in regime worldwide, noted in its 21 September 2011 “Peer Review of Australia” that the government’s $20 billion provision per bank “would not be sufficient to cover the protected deposits of any of the four major banks”, which each have more than $400 billion in deposits. The CEC presented this evidence in its submission to the Senate committee inquiry.

    Defeat the APRA bill
    Most members of parliament are assuring their constituents that the APRA bill—which virtually none would have read—does not mean deposits will be able to be bailed in, because deposits are guaranteed under the FCS. Dr Sy’s revelation explodes that myth. This is not an academic question. With all signs pointing to a near-term collapse of the so-called “everything bubble” comprising property markets in Australia and elsewhere, the US stock market, Bitcoin, and the US$1.2 quadrillion global derivatives trade, a looming global financial crisis threatens Australia’s banking system. It is urgent, therefore, that Australians demand their MPs reject this bill outright, and go with the Glass-Steagall banking regulation instead, which guarantees deposits and financial stability by separating commercial banks with deposits from all forms of financial speculation. As Dr Sy says in his submission: “The global financial system needs fundamental structural reform which many countries believe is the restoration of the Glass-Steagall legislation which had worked well for many decades until it was corruptly or mistakenly repealed at the turn of this century.”
    What you can do
    Before Christmas, upwards of 800 everyday Australians flooded the Senate committee inquiry with submissions opposing the APRA bill and demanding Glass-Steagall. The Committee is expected to hold hearings in either late January or early February, by which time it is imperative that every MP and Senator is confronted with the truth about this bill.
    1. Forward this release, the CEC’s submission (download here) and Dr Sy’s submission (download here) to your local federal MP and Senators before the end of the month. If possible, print copies and deliver them in person.
    2. Sign and share the CEC’s latest petition: “Global crash coming—Australia needs Glass-Steagall and a National Bank”.

  16. Tom ConleyMEMBER

    This is a great article and highlights a key external vulnerability. I’ve been following and writing about the CAD for many years, but it has largely disappeared as an object of policy concern. Warnings have been a staple critique about the unsustainability of Australia’s growth model since at least 1986 (and of course before this under the more regulated system of capital flows etc) and of course the CAD has kept on growing.

    Now this doesn’t mean you (and I) are wrong about the CAD funding problem but it does explain why the CAD has disappeared as an object of policy after the failures of the J-curve and twin deficits theory. Increasingly policy-makers have adopted Pitchford’s ‘consenting adults’ thesis. But as you say significant foreign borrowing to fund the CAD spurred by bank lending to households to buy and sell houses to each other does make us vulnerable to changes in international financial settlement. Now that the mining boom is receding into the past, the profits of the 80 per cent foreign-owned mining sector are leaving the country with insufficient taxation. The household sector is increasingly vulnerable to a property market downturn or a normalisation of monetary policy, which will make debt servicing increasingly difficult.

    Another definition is CAD = saving – investment. Both the housing and mining booms created investment opportunities that couldn’t (or as you say wouldn’t) be funded by domestic saving. This is the result of a liberal regulatory regime for capital flows (so-called deregulation is still a regulatory regime). Australians have increased their level of overseas investment as well (including funds like Nucleus!) meaning that more foreign funding is required on a net basis for investment. What you are advocating re house funding is anathema to the current globalisation (neoliberal?) policy rhetoric and agenda and is part of the reason concerns about the CAD have largely disappeared. If you have faith in the model, ‘things will work themselves out’, as the market adjusts to changing circumstances. The absence of a proof of a crisis in Australia means that there will be no rejection of this model until there is a crisis. And as the United States shows, the clear failure of the model has not led to a new policy regime, although there has been tinkering. It is just as likely that advocates of the globalisation model will argue the problem was not enough liberalisation, rather than too much.

    Despite my worries about Australian vulnerabilities to changes to international financial sentiment, on the subject of the future of the CAD there is an interesting proposition, which might see the CAD reduced not by a change in policy, but by a wider economic/financial crisis in Australia Given that CAD = S – I, if a country reduces investment, ceteris paribus, the CAD will decline. This opens up the possibility that a decline in the housing market will lead to a lower CAD. An associated decline in consumption will also mean higher saving. (The real question is what drives what?).

    As you would know in this circumstance, the CAD won’t be the major issue. What will matter here will be the turnaround in the net financial position of households. This as Minsky points out is a largely domestic dynamic, wherein ‘Ponzi financing’ leads to a banking crisis, which extends to the economy through consumption and rising unemployment etc.

    Interested to hear your thoughts.

    • Hi Tom
      Welcome to the CAD awareness club!!! Flawse has been around many years in these sites, and before that, banging on about the implications of CAD’s and what they mean about what is happening inside the economy. You can cop a fair bit of abuse for pointing out the difficulties!!!

    • Nice one Tom.

      There is another path to reducing the CAD without a sovereign default and that is to induce a controlled recession and reduce imports. Government austerity can effectively achieve this which makes me wonder if that’s actually the plan behind the otherwise irrational obsession with ‘balancing the budget’

      • Balancing the budget is far from irrational. The government is a big part of the CAD problem. What is irrational is saying the budget deficit is the only thing that counts and that community over-consumption is really really good – part of the growing economy and all that!

  17. A very decent post which has also generated thoughtful comments. In regard to be latter, it’s been a while between drinks.