During those first few weeks after the election, as over half a nation sat there in shock contemplating what had just happened, presumably flushed with joy at having the keys to the safe, Joe Hockey made the astonishing decision to borrow $8.8 billion to give to the Reserve Bank.
Hockey tried to sell this as crucial to our economy in giving the Reserve Bank a buffer zone to address future crises. What a load of hooey.
The RBA deputy governor, Philip Lowe, ‘said the level of the bank’s capital reserves had not been keeping him awake at night’. The board had wanted to rebuild the capital level over time but the government wanted to do it immediately.
In a speech at a Sydney investment conference in October, Reserve Bank governor Glenn Stevens backed up comments by the RBA deputy governor that the bank was happy to rebuild its capital reserves over time. The RBA certainly didn’t ask for Hockey’s $8.8 billion capital injection and didn’t think it was necessary.
At the current five-year commonwealth bond yield of nearly 3.4 per cent, the borrowed $8.8 billion will cost taxpayers about $300 million a year.
There were two reasons that Hockey did this and they have nothing to do with stability.
Hockey is making a shrewd political gamble. Any near-term budget deficit – made worse initially by the $300 million in interest accruing on these borrowed funds – will be blamed on the former Government’s proflicacy as perceived economic mis-management. It added a great deal to the deficit over the forward estimates which Hockey then blamed on the previous government. Approximately $68 billion of the deterioration in the deficit between PEFO and MYEFO is due to policy decisions made by the Coalition.
Secondly, this was a blatant gamble in the hope the Aussie dollar would go down. Then as the Australian dollar falls, and dividends from the RBA reserve fund flow to the Government, Hockey will be better placed to show improvement in the budget bottom-line and claim himself as a fiscal super hero. The last time the Aussie had a sharp fall, the RBA paid the government a dividend of more than $5 billion. Trader Joe is playing the forex market with borrowed money hoping for a windfall just before the next election.
Fairfax’s Michael Pascoe suggested that perhaps Hockey was acting on “in-house advice from the former head of foreign exchange and global finance at Deutsche Bank, Melissa Babbage. Hockey is Ms Babbage’s husband.”
Unfortunately, that gamble isn’t going so well so far as the dollar remains persistently high.
The Reserve Bank of Australia’s move to a “neutral bias” on monetary policy has angered the Abbott government, which believes any upward pressure on the dollar will make it harder to manage the economy and Treasurer Joe Hockey’s displeasure was made known to the RBA directly.
The government has become uncomfortable with the Australian dollar’s upward move since the RBA dropped its explicit easing bias, paving the way for the currency to rise on the expectation that the central bank’s next move will be up.
RBA Board member, Dr John Edwards, responded by saying Australia was in the grip of a “bountiful” mining and energy export-driven revenue surge.
“It’s very difficult to expect rhetoric to have an impact on economic forces which are running in the opposite direction. If you’ve got a mood going on in the currency, then rhetoric alone is not going change it. The currency argument is that a fall in the terms of trade should see lower exports and therefore less demand for the Australian dollar. It’s not working out like that. In fact US dollar revenues have increased [for local mining companies]. And the balance of trade has for several months been positive, once again. And that means, in terms of what happens in foreign exchange markets, you wouldn’t necessarily expect to see a weaker dollar if it’s associated with, effectively, a boom in exports.”
An article called Swaggering unarmed in the global currency war in Macrobusiness suggests that the dollar has turned for a number of reasons. The US recovery has again disappointed, pushing back rate hike expectations. China has hit the stimulus accelerator again (albeit mildly), the EU is clearly in the process of entering the money printing race as deflation looms, and Japan’s Abenomics burst is slowing and requires more money printing to get going again.
In short, we’re traversing an echo period of competitive monetary devaluation in which the US dollar is held down, commodity-intensive emerging markets are seen as the growth driver and real assets are seen as value protection. This is putting upwards pressure on all of the commodity currencies, and gold, not just the Australian dollar. We aren’t losing competitiveness against commodity competitors, for the most part. It’s against the manufacturing and service economies that we’re losing production.
Even before the Reserve Bank indicated it was disinclined to cut rates again, and more likely to keep them steady, the Aussie dollar had begun to climb.
Despite pointed references by Reserve officials about an “uncomfortably high” dollar, financial markets continued on their merry way, pushing the dollar higher. Regardless of the Reserve’s rhetoric, currency buyers continued to prefer to buy Aussie dollars and pay a higher price for them.
That’s not surprising when you remember that the return on many currencies around the world is exactly zero.
The Reserve Bank’s current assessment is that, with signs emerging that the economy is strengthening, the argument to reduce interest rates again from already record lows is weak.
The RBA indicated in February that it had finished its easing cycle, supported by strong inflation readings and finally a rebound in jobs growth. Most economists now expect rates will be on hold at 2.5 per cent – a record low – until at least later this year. The RBA is not just battling with the impact of an Australian dollar trading above fair value. It is concerned with trying to keep house prices under control and ward off an asset bubble fuelled by low interest rates.
When it began slashing interest rates two and half years ago, the RBA explicitly targeted a housing boom. Now it has a growing bubble on its hands and hence interest rate markets are pricing interest rate rises in the next twelve months, long before the real economy is ready for them given the long unwind ahead in mining investment. That has global hot money flows pursuing the carry trade into the Australian dollar as the interest rate spread has climbed a long way off last year’s lows.
Some suggest that the RBA should have introduced macroprudential tools, which would have insured that housing credit was controlled in this recovery cycle and interest rates could be another 50-100 bps lower. The recovery we should have had is in tradables with support from housing construction, not the other way around.
It could still be done and would have an effect. But the risk now is that it would work too well and cause a housing bust, just as we head off the mining capex cliff.
Likewise, Joe Hockey need not wait for the RBA. If Hockey really wants to push the Reserve back to cut interest rates and lower the exchange rate, he could trash the economy with irresponsible policy making. He could slash and burn in the Budget and force interest rates and the dollar lower.
Or he could shift negative gearing to new dwellings only. That would stall house prices and offer the opportunity for rate cuts to close the carry trade spread. He could install Tobin taxes on hot money inflows, a tax on all spot conversions of one currency into another to put a penalty on short-term financial round-trip excursions into another currency, which would help take the edge off and raise extra revenue.
As we have seen with the Coalition, they can find money for things they want – Operation Sovereign Borders, fighter jets, paid parental leave, roads, bribes to polluters, Tim Wilson, private jet travel for politicians, businessmen and journalists, tax concessions for the wealthy – so it is hard to buy the ‘need for austerity’ line. I think Hockey is sweating bullets because his gamble isn’t working out so well and he desperately needs to do something to make the dollar go lower.