What an eclectic bunch has now assembled beneath the standard of RBA currency manipulation. Hitherto a rallying point for the likes of Paul Howes and the AWU, last week the unlikely figure of Warwick McKibbin, former RBA board member and serial Labor critic, joined them. This week, Stephen Koukoulas, a former adviser to Julia Gillard, has joined as well. Overnight, AIG’s Innes Willox joined in. Morgan Stanley’s Gerard Minack (with a reputation for being a Permabear in financial markets) joined as well.
Thus we have unions, industry, academic economists and market economists all calling for the RBA to emulate the Swiss National Bank.
It’s not just Australia that faces this dilemma. The Canadian dollar hit a three-month high overnight and the Norwegian krona hit a two-month high. Demand for their currencies is being driven in part by the same force driving our dollar up: central banks around the world diversifying out of euros and the greenback. These are irresistible forces at the moment.
But beyond all others, Australia is now paying the price for its economic management. We are being penalised, if you like, for being a successfully run and regulated economy and financial system compared with others in Europe, Asia and the US. We’re one of only seven “super AAA rated” economies — a AAA rating and stable outlook — which is driving our “safe haven status”. That status, remember, has been regained at considerable cost over the past two decades or more since Paul Keating’s “banana republic” comments in 1986: by our politicians who have (mostly) been fiscally restrained; by the independent RBA that has successfully targeted inflation; by our regulators who ensured a (mostly) stable financial system, by the hundreds of thousands of workers who sacrificed jobs and careers as we’ve transitioned to a more open economy.
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When interventionists complain that the dollar has diverged from economic fundamentals, they’re missing the long-term fundamental that is behind our “safe haven” status.
But where the case for intervention really comes a cropper is on the practicalities.
McKibbin suggested the RBA could do direct deals with foreign official buyers such as the Swiss National Bank. But to what end? Is it to defend a certain level of the dollar, and if so what rate would that be? Seeing the pressure is greatest on the Aussie dollar-euro rate because of the buying coming out of Europe (trading in that currency “pair” jumped 22% in the first half of the year), should the defence be conducted in euros? Or should it be in the Aussie-US dollar rate, which is the most popular currency pair? And at what rate? Parity at $US1? Ninety cents?
Nor have interventionists considered the interest rate differential between Australia and Europe, Japan and the US. Our 3.50% official cash rate is a great buy. Even if we cut rates to a dangerously inflationary level of 1%, rates in the US, Japan, Europe and the UK will still be lower. Official Swiss interest rates are 0% to 0.25%.
And oddly for someone who wants to see the dollar fall, McKibbin this week actually called for the RBA to raise rates. What does he think a further increase in the interest rate differential will do to the dollar?
A closer look at the experience of the Swiss National Bank should also give interventionists pause.
The SNB is defending a target rate of 1.20 francs to the euro because of the flood of money into the country from the unsettled eurozone. That has seen a surge in the amount of euros the SNB has purchased. Last week Crikey reported on the first-half surge of 41% in the bank’s euro holdings and how it was trying to reduce that level (61% of total reserves) by buying foreign currencies such as Aussie dollars.
Last night, the SNB released the monthly figures and they make grim reading. The SNB’s holding of foreign currencies jumped by 41 billion francs in July alone to SFr406 billion ($US419.7 billion) last month. Those holdings have leapt 71% from April. At the end of July, Switzerland’s foreign reserves are also equal to 71% of the entire economy. That is an increasingly dangerous position. So far it has kept the franc at the 1.20 rate, but the result has been an increasingly unstable rise in its holdings of foreign currencies. This means the SNB will continue buying billions of Australia dollars and other currencies in coming weeks as it seeks to cut the level of euros in its reserves to 50% or lower. That means more upward pressure on the Aussie dollar in coming months.
The best solution to an overvalued Australian dollar is out of our hands. A move by the European Central Bank to support economies such as Spain and Italy and their bonds, plus help the zone’s banks through another injection of cash would do more to lower the value of the Aussie dollar than anything we could do. All the ECB has to do is to convince markets that their money will be safe. Simple, but a big ask.
That’s why Glenn Stevens devoted far more space to Europe than to the dollar in yesterday’s statement:
“The most significant area of weakness continues to be Europe, where economic activity has been contracting and policymakers confront the very difficult task of seeking to put both bank and sovereign balance sheets onto a sound footing, while promoting conditions for improved long-term growth.
“Financial markets have responded positively to signs of progress, but Europe will remain a potential source of adverse shocks for some time. Low appetite for risk has seen long-term interest rates faced by highly rated sovereigns, including Australia, decline to exceptionally low levels. Nonetheless, capital markets remain open to corporations and well-rated banks and Australian banks have had no difficulty accessing funding, including on an unsecured basis. Share markets have remained volatile, though in net terms they have generally risen over the past couple of months
“As a result of the sequence of earlier decisions, monetary policy is easier than it was for most of 2011, with interest rates for borrowers a little below their medium-term averages. While it is too soon to see the full impact of those changes, dwelling prices have firmed a little over the past couple of months, and business credit has over the past six months recorded its strongest growth for several years. The exchange rate, however, has remained high, despite the observed decline in the terms of trade and the weaker global outlook.”
In those comments, the value of the Australian dollar seems to be almost an afterthought. The RBA knows it should be lower. But the factors behind its strength are much greater than anything the RBA can do.