Crikey

Today’s Reserve Bank statistics contain grim news. Since May 2007, Australia’s Official Reserve Assets have fallen 64% - down from $84bn to $30bn in December. They now cover a mere eight months of our chronic current account deficit.

On the five occasions since 1984 that Australia’s reserves have fallen to this coverage level, private banks filled the funding gap by overseas borrowing. However, this safety valve is now more difficult to tap. By January 2007 Australian private banks had borrowed $342bn abroad to fund their domestic operations, providing an all time high of 22% of their domestic funding needs. Little new overseas borrowing was undertaken during 2007 and by November, reflecting the turmoil in overseas markets, overseas funding provided only 18% of their total domestic needs.

In overseas credit markets, banks no longer trust each other. All are caught in a liquidity vice and are cutting interbank lines. Credit spreads have widened and rising currency volatility has increased the cost of hedging overseas sourced funds. With Australian banks unwilling or perhaps even unable to increase their overseas borrowings, there are few other mechanisms to balance the current account deficit, presently running at about $50 bn annually.

Selling assets to foreign investors has become subdued by falling base metal prices, rising interest rates, falling asset prices, and turbulence in foreign debt markets. Today’s figures show the Reserve Bank can no longer run down Official Reserve Assets. Clearly the Federal Government must now take strong spending and taxation measures to rein in excess domestic demand.

For the first time in 35 years, the Government might also be forced to provide the necessary stopgap funding. While it does not need to raise debt to support its own spending, the Federal Government might need to borrow abroad simply to fund excess domestic private spending.

Indirectly, via the Reserve Bank, it will be funding the domestic banks. What quid pro quo might Treasurer Swan demand from them, and how would he explain such borrowing to a sceptical public conditioned to the Costello/Howard mantra that any Government borrowing for any purpose is suspect ?