Budget emergency or a gambler in trouble?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
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
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
prolificacy 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
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
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
“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.