Why the cumulative CAD and offshore debt are both the cause of our prosperity and the downfall of the nation?
Australia is locked into a debt feedback loop that can only stop with the end of the growth era and a system reset, and there’s nothing anyone in this country can do to stop it.
I’m returning to the effect of the cumulative Current Account Deficit and the debt that’s funded most of it for further analysis. Australia’s GDP has increased by $1.2 Trillion since 1980 and that is equal to the cumulative CAD of $1.2 Trillion over the same period. So the only growth in the Australian economy generated over the last 40 odd years is from either selling assets or borrowing funds from offshore to fund the CAD. Think about that for a while.
The following graphs were derived from the ABS data base.
Well, I’ve thought about CAD equal to GDP for quite some time. My thesis is that an open economy (freeish flow of trade and capital) that persistently generates a CAD and borrows to fund the CAD so distorts itself by the simple matching of the greed to have things with the need to sell or borrow to fund the greed, that any GDP growth must equal the cumulative CAD over time. This is not traditional economics rather it’s a form of behavioural economics where incentives, or decisions made by taking easy street today, create a positive feedback loop that inevitably locks an economy into a death spiral or at the very least a very painful readjustment.
Regardless of the correctness of my thesis, the facts are what they are. Australia has a $1.2 Trillion cumulative CAD funded by $1.0 Trillion of debt as per the ABS’s “External Liabilities” with the balance funded by selling assets.
The debt is the real issue for us now and the future generations. Around $750Bn of the debt is on bank balance sheets and $250Bn is mostly government debt.
Banks borrow offshore to fund the reduction in their deposits caused by paying for the CAD. All else being equal, if banks didn’t borrow offshore they would have a deficit of funds and the RBA would need to print or have a form of QE to maintain the funds in the system. Banks do not borrow offshore to fund lending to Australians or to lengthen duration or any other reason, that is a fallacy.
Now let’s look at the FX consequences of borrowing offshore to fund the CAD.
A CAD is caused by simply having an excess of payment obligations offshore over the payment receipts from offshore. So consequently $As are taken out of banks and used to meet foreign currency obligations. Ie selling $As. When a bank fills the deposit gap by borrowing offshore generally it borrows foreign currency and swaps that into $A. ie Buys $As. The buying and selling of $As balances and therefore the fall in the $A that would normally occur by using $As to fund the CAD is cancelled out.
Many point to the third leg of funding in a foreign currency, the currency hedge $As to pay back the foreign currency when the debt is due as countering the balance but that’s incorrect. That’s because the hedge is priced off the interest differential based on today’s spot price so it has little effect on actually changing the spot price of $As when the borrowing is made.
At this point we should be able to understand that borrowing offshore to fund the CAD inflates the value of the $A compared to the situation where no borrowing occurred, and the CAD was funded by taking $As out of the system or the RBA printed by QE or a computer.
Of course, the problem with offshore debt is that it does not go away without repayment, and the terms of rolling over the debt are in the hands of the lender.
When each offshore borrowing matures, the swaps ensure that the $As are there to repay the debt but that leaves a hole in bank deposits and the whole offshore borrowing process repeats itself but with one difference. This time there is not a selling of $As to balance the buying, remember the selling occurred in the swap the price for which was set by the previous spot price, only a buying to fill the deposit hole caused by debt repayment. Again the swap is priced off the spot so there is only a boost in demand for $A spot which keeps the $A inflated.
The federal and state governments issue $A bonds that are purchased by offshore borrowers, funds raised under this method to fund the CAD have the same effect. Except the lender does the swap, not the borrower. Same effect when issued to fund the CAD and on refinance. The result is boosting the value of the $A and distorting the productive exporting and importing businesses of Australia.
Funding the CAD by debt with no prospect of generating a surplus to repay the debt is an easy alternative to either printing, QE or reducing the money supply. The later would remove the capital transactions described above allowing the $A to reduce to its proper trading level, increasing the cost of offshore goods but stimulating innovative export businesses.
Continuing the stimulate the value of our so called stabiliser, the $A, through debt is to favour financialisation over productivity. Financialisation must be paid for, its not free and results in an ever increasing polarisation of the population from those with assets to those without.
The debt path is easiest to sell to the populace and fund current lifestyles, until it’s not. The vast majority of us are the proverbial turkeys being fattened and waiting for Christmas, happy with the status quo and delusional to the true state of affairs, so down that path we go.
If you’ve ever wondered why it’s so important for government and regulators to profoundly and loudly push our banks as “unquestionably strong” and vitally important to the economy, then funding the CAD is the reason. The problem is that our major banks are not unquestionably strong, they are demonstrably average. Our housing markets are not strong and never retreat, they are on the brink of a fundamental correction to affordable.
So where do we go from here?
- Repaying banks’ offshore debt by government borrowing will trash the federal government balance sheet to almost junk status, increasing borrowing costs and ensuring capital flight occurs. The irony is off course the country’s balance sheet (private and public) is the same. Damn those rating agencies!
- Repaying offshore debt through printing or QE will crash the $A, as per the reversal of the FX demand effect described above.
- The RBA decreasing the overnight cash rate will result in offshore lenders not refinancing unless inter-bank credit margins are significantly increased. Look at BBSW, we’re actually already there.
- Any action that the RBA takes on interest rates, QE or printing will not boost borrowing but only increase costs to the economy through increasing the costs of offshore debt or crashing the $A
- The banks’ offshore borrowings are all in effect secured against housing, so any drop in housing security values will increase borrowing costs and cause capital flight and then RBA printing or QE.
- Australia may have thought that selling iron ore, coal and gas to the world would repay its extravagant debt, it wont and we have nothing to sell (except the country). So unless the rest of the world continues to fund our life styles in effect for free, as we borrow to pay interest, the great reset will continue until its done.
- The Government in its desperation to stave off collapse will trash the superannuation system, of the poor if it’s the LNP and the rich if its Labor, to fund offshore debt repayment. But it won’t work, because the value of superannuation will have plummeted on its own.
- As Australia’s link to the rest of the world is both trade and debt, decreases in commodity prices, increases in interest rates and a re-rating of major banks, all of which are upon us, means the beginning of the end of Australian lifestyles funded by offshore debt has started.
Once I realised after the GFC that Australia had many means to delay the inevitable, if asked when the great reset would occur, I would say, “I don’t know when, but when it starts, I’ll know”.