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Dec 13, 2012

RBA targets 'spillover' from central banks for strong dollar

The Reserve Bank has identified "spillover" from quantitative easing as a key concern as the Australian dollar climbs higher. Glenn Dyer and Bernard Keane report on the danger.


Reserve Bank of Australia

The Australian economy and policymakers face a prolonged period in 2013 with an overvalued dollar pressing down on the economy and activity, thanks of the actions of central banks around the world, and the RBA has few options to address it.

That’s the implication of important comments by RBA governor Glenn Stevens in Bangkok yesterday — one bolstered by this morning’s announcement by the US Federal Reserve of a new bond-buying program worth $US45 billion per month of longer-term Treasury bonds in another effort to reduce what the central bank calls an “elevated” unemployment rate.

The Fed also kept its existing program to buy $US40 billion a month in mortgage-backed securities, to try and boost the recovering housing sector and generate more jobs. It plans to keep interest rates exceptionally low until unemployment falls below 6.5% — the first time rates have been linked to the jobless rate (the current US jobless rate fell to 7.7% in November).

The announcement sent the greenback lower and pushed the value of the Aussie to a three-month high and well beyond $US1.05, adding extra pain to the biggest policy headache confronting the Reserve Bank — an overvalued currency. The strengthening Aussie dollar will bear down on export returns and profits, and will ensure the mining tax produces minimal income, unless there’s a significant slump in the next six months. Wayne Swan’s surplus is now looking very shaky.

As Crikey pointed out last week, Australia is feeling the full weight of the winners’ curse: we have been too successful in running our economy in a prudent fashion, keeping debt low, keeping growth going and employment solid. Our high AAA credit rating with a stable outlook and relatively high interest rates are adding to the problem.

Stevens and the RBA believe the expansionary monetary policies in the US, Japan, the eurozone and UK are behind the continuing strength in the value of the Aussie dollar. That strength is throttling our export sector and dampening demand and sentiment elsewhere. And judging by the Fed’s move (and the fact that Japan is back in recession and facing more spending in 2013), the upward pressure on the currency isn’t going to ease quickly. The result: economic growth in this country will continue to flag.

Stevens made his views known in a speech in Bangkok yesterday to a meeting of central bankers. His comments were the most pointed he has made on this subject so far. His observations related both to the dependence of governments on quantitative easing, and to the international impacts of that easing (note the third paragraph particularly):

“[T]he balance sheets of central banks in the major countries have expanded very significantly, in some cases approaching or even surpassing their war-time peaks. Further expansion may yet occur. It is no criticism of these actions — taken as they have been under the most pressing of circumstances — to observe that they raise some very important and difficult questions for central banks. There is discomfort in some quarters that central banks appear to be exercising an unprecedented degree of discretion, introducing new policies yielding uncertain benefits, and possible costs …

“The problem will be the exit from these policies, and the restoration of the distinction between fiscal and monetary policy with the appropriate disciplines. The problem isn’t a technical one: the central banks will be able to design appropriate technical modalities for reversing quantitative easing when needed. The real issue is more likely to be that ending a lengthy period of guaranteed cheap funding for governments may prove politically difficult. There is history to suggest so. It is no surprise that some worry that we are heading some way back towards the world of the 1920s to 1960s where central banks were ‘captured’ by the Government of the day.

“The expansion of central bank balance sheets has created disquiet in the global policymaking community as it has led to spillovers and distortions at the international level via an acceleration in cross-border flows of capital in search of higher returns. Although central banks are effectively factoring-in these flows into their policy decisions, there is not a consensus on how this should be done and there is an argument that central bank mandates would need to be changed to appropriately account for these spillovers. At the very least, increased global cooperation is optimal on this front.”

That is, for the first time, Stevens has confirmed the RBA believes Australia is being hit by these “spillover effects” from the extra liquidity flowing from these rounds of quantitative easing and other support measures in the US, Europe, Japan and the UK. It’s impacting Australia by driving demand for the dollar (and the value of the currency higher) and making the central bank’s handling of monetary policy much tougher than it has been for decades.

In effect Stevens attributed the dollar’s strength to other central banks keeping incredibly high liquidity levels and near zero rates — forcing capital to flow to assets like the Australian dollar. This has seen central banks from developed and developing countries, big global investors such as insurers (such as Berkshire Hathaway and Munich Re), and other conservative investors chase Australian dollar assets for the higher returns and safety of our stable credit rating.

This means lower economic growth and that the RBA’s primary tool, monetary policy, is significantly less effective than it otherwise might be in responding to that lower growth. It also means less revenue for the government.

The problem for policymakers, however, is that both sides of politics have turned their backs on fiscal policy as a tool of stimulus, preferring monetary policy to do all the work. Indeed, the Coalition actually wants a significantly tighter fiscal policy.

The problem is only one for the cognoscenti while the economy continues to travel at or near trend. Should it slow, it will become a problem for all us, and our politicians will need to reappraise their abandonment of fiscal policy in favour of a monetary policy severely hampered by the world’s biggest economies having made exactly the same decision.


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