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Kohler: trouble in a carry trade paradise

Keynesian purists are all clutching their foreheads, but actually it’s pretty fabulous that Australia’s politicians are competing with each other to promise budget surpluses: it’s so much better than the appalling tax cut and spending competition of the past decade led by J.W. Howard.

Politicians can really only be trusted with emergency fiscal policy, such as when they flooded the world, and Australia, with blind government spending in late 2008. Otherwise borrow only in recession please, and at other times make outgoings less than incomings.

Central banks are running the global economy now, not finance ministers and bureaucrats. Elected governments are either tapped out or, in the case of Australia, splendidly sidelined by the potent political symbolism of surplus budgeting.

The European Central Bank and the US Federal Reserve are using the rather novel strategy of printing money for financial speculators to play with to try and avoid another collapse and recession. Quantitative easing in the US’ and the ECB’s LTRO strategy involve flooding the system with cheap money knowing that it won’t be lent but gambled on carry trades and asset punts.

The result, as we begin 2012, is rising asset markets. In the US it’s shares and property, in Europe all-important sovereign bonds, specifically in Italy and Spain. This morning’s contraction in German industrial production, however, as well as the continuing weakness in US employment (highlighted by Fed chairman Ben Bernanke this morning) suggests that the transmission of this plan to the real economy is muffled.

The problem for the Australian central bank is that the speculators thus financed are keen on Australian assets, and why not? It’s a AAA country paying 4% on 10-year bonds and a dividend yield of 8% on Telstra shares that is underpinned by government cash.

Australia is a carry trade paradise and to prove it the dollar is at, or close to, $US1.08, moving higher.

So does the RBA cut rates to bring down the currency, as some suggest? No, that won’t work. The capital inflow is not investing in cash.

Far better, according to the RBA, to just watch the inflation rate, watch unemployment, try to ignore warnings about hardship and layoffs in the real world, and read up with what’s happening in Europe.

On that basis there was a solid case for leaving rates on hold yesterday because, in theory and looking only at the stats, the economy is in equilibrium (moderate inflation, moderate to low unemployment) and Europe is looking a bit better thanks to the ECB’s employment of the “good bacteria” of carry trade speculators keep the sovereign bond market afloat.

But as we have suggested previously in these columns, unemployment on the Australian east coast, and perhaps in the national statistics, is heading higher because retailers, manufacturers and banks are all cutting costs, because penalty rates are capping employment in hospitality and the currency is cutting tourism and exports.

In addition there seems a fair chance the banks will break cover and raise mortgage rates over the next month, starting with ANZ on Friday, which won’t be great for the property market.

But at least Australia’s RBA still has “sea-room”, to quote Wayne Swan, to use normal monetary policy to impose a pay cut on the nation’s bank depositors, thus lowering at least some of the banks’ funding costs.

Other central banks can’t do that since rates are at or close to zero. All they can do is print money for speculators to play with and hope that one day actual businesses will want to start borrowing to invest.

*This article was first published at Business Spectator

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  • 1
    Jimmy
    Posted Wednesday, 8 February 2012 at 1:36 pm | Permalink

    Good article Alan - the olny issue is “so much better than the appalling tax cut and spending competition of the past decade led by J.W. Howard.” but isn’t that what Abbott has said he wants to go back to? And isn’t that what his policies actually add up to?

  • 2
    Wallace Scott
    Posted Wednesday, 8 February 2012 at 3:42 pm | Permalink

    moderate to low unemployment”. The target for full employment should be four per cent unemployment now instead of five per cent. This is because consumer spending patterns have changed and Australians are saving now so lower interest rate will not drive up inflation and we do need more employment to create a bit more demand while increasing government revenue as well as less welfare payment to get back to surplus quicker.

    The correlation in the movement of interest rate raised by the Reserve Bank and the Australian dollar is five cents for every one hundred basis points raised. When the dollar is above a dollar and five cent USD it hurt exports and dampen employments.

  • 3
    Zarathrusta
    Posted Wednesday, 8 February 2012 at 6:31 pm | Permalink

    It would seem to me that all this printed cheap money is yet another excellent reason to have a Tobin tax. A tax on speculation is a great way to help balance the books.

  • 4
    Steve Gardner
    Posted Wednesday, 8 February 2012 at 9:30 pm | Permalink

    It’s disappointing to read Kohler repeating the canard that penalty rates are keeping employment capped in the hospitality industry. That claim has been debunked here: http://mattcowgill.wordpress.com/

  • 5
    Wallace Scott
    Posted Wednesday, 8 February 2012 at 9:37 pm | Permalink

    There is also a tourism deficit caused by the high Australian dollar. $9 billions last year because Australians travelled overseas and spent there instead of locally which could have helped employments in retails, hotel and hospitality, travel and tourism here; and overseas visitors dropped due to the high dollar.

  • 6
    Wallace Scott
    Posted Wednesday, 8 February 2012 at 10:26 pm | Permalink

    STEVE GARDNER

    The problem is not all employers are tight*ss, many employers do pay generous wages above award level and if you add Sunday penalty as a percentage of what they normally get it becomes a huge amount. Now employers don’t want to cut the wages during the weekdays to subsidise the weekends or so that when adding the penalty percentage on it does not become too high, my friends own business and they like to pay good rate to people.

    They could have a capped Sunday wage unless the employer is willing to pay more or special penalty rate specifically for the restaurant industry. I don’t see why they can’t since there are different work cover rates for different industry. Restaurant industry is quite different, more over it is most labour intensive, they employ most number of workers per dollar generated

  • 7
    Apollo
    Posted Thursday, 9 February 2012 at 7:08 am | Permalink

    S.G.

    It also depends on location if you are lucky. My friend has two restaurants one does extremely well one the other went into decline since developments surrounding it. Some lunch times are hardly worth open, occasionally at nights it is so quiet staff stand around trying to find things to do. In winter he can’t cover the rent he has to take money from the other business to help the slow one.

  • 8
    jeebus
    Posted Thursday, 9 February 2012 at 3:11 pm | Permalink

    Let’s be clear, our grossly overvalued dollar is a symptom of two things. One, the monumental amount of resource extraction, and two, the massive inflows of money hot off the printing presses of Japan, the US, and the EU.

    And why is that a problem? Because 5 years ago the dollar was worth 40% less. When foreign producers and exporters are given a 40% price advantage by brazen currency manipulation, how is the average Aussie business expected to compete with that?

    Simply, we can’t. Anyone who is not a miner is hurting. And when we look at why the service industries are also suffering, that is completely obvious. Service jobs do not pop out of thin air. They are created to support the jobs that produce and export things.

    My own niche export industry has shed over 1,000 high paying jobs in the last 4 years, and they will not be coming back even if the dollar swings back the other way. Reason being, most of these people have packed up their lives and moved overseas.

    The value adding parts of our economy are being progressively hollowed out like the dirt we stand on, and once the mining boom is over, our economy will be reduced to a service jobs ponzi scheme with ever diminishing returns.

    America is going through the same hollowing out crisis, but at least they now recognize the problem and are taking steps to bring production jobs back again.

  • 9
    Apollo
    Posted Thursday, 9 February 2012 at 3:54 pm | Permalink

    Jeebus

    Yup, and they want more QE. Good lord, I betta start subsistence farming.

  • 10
    Peter Ormonde
    Posted Friday, 10 February 2012 at 7:09 am | Permalink

    Apollo …

    Thoroughly recommend the subsistence farming … any time I feel the need for another bout of QE I just go and pick another bucket of strawberries. My fruit trees seem to be spectacularly indifferent to the screaming value of the AUD while the watermelons regard the funding costs problems facing the banks with at best a casual contempt.

    The hard part is finding enough dirt to grow something that won’t attract the attention of a mining company.

    Don’t we make life difficult?

  • 11
    Apollo
    Posted Friday, 10 February 2012 at 12:27 pm | Permalink

    Haha my asparagus and hens are very productive at the moment. Quite interesting seeing alliance forged between farmers & greens against mining at the moment.

  • 12
    Peter Ormonde
    Posted Friday, 10 February 2012 at 1:33 pm | Permalink

    Yes.. interesting and hopefully it marks at least the start of a generational change in farming ideology and attitudes to the land. But I doubt it.

    The sort of money being offered by CSG outfits will always turn heads in the bush. They will simply buy the land. Like Chinese coal companies. So much for locked gates and local opposition.

    Traditionally, at the end of the exercise, a farm is an investment. It is your superannuation. Your retirement. The kids’ future.

    The relationship with the land is primarily, fundamentally commercial, moreso than cultural. At some point - almost everyone on the land faces this dilemma: sell it… or give it to the kids (if they want it) … and move to the Gold Coast. That has at least been the historical attitude and life cycle here. It has been a fit young man’s (sic) business. Less so now.

    But for the old timers, old schoolers, those looking at too much hard work, wanting to retire …they’ll buckle. They always buckle. Their political leaders buckle. Alan Jones buckles. It’s all just a matter of price. We’ll see. But history is not kind to farmers with only a thin attachment to the land. They don’t really care.

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