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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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42 comments

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42 thoughts on “RBA targets ‘spillover’ from central banks for strong dollar

  1. Simon Mansfield

    So are you two actually going to admit you got it wrong on this issue? Or is that a bridge too far?

    It’s actually an issue for large sections of the community – the forex exposed sector of the economy is quite large. And the depressed revenues from exports is directly impacting tax receipts and ability of the government to return to surplus.

    There is plenty the RBA can do. But it’s now very late in the game and the damage to the food processing sector to name just one – is probably permanent. As is the damage to export focused businesses run by older employers in the IT sector and small scale manufacturers who have closed up shop and simply retired.

    Stephens should resign and the government should appoint an outsider from the RBA as the next governor – like that have done at the ATO.

    But that ain’t going to happen and instead it will be another year of the slow burn to the east coast economy. 30 years of painful economic adjustment wasted.

  2. Apollo

    My friend has a very good idea. Every rich Labor voter should invest in building a new house/property. That should stimulate the economy.

  3. Apollo

    I’ve got my own investments to live on, but I know that many self-funded retirees are upset about rate cuts. But I can’t see the RBA printing money.

  4. Jimmy

    I think the next few months will see the high water mark for the dollar – over the course of 2013 I would think the RBS will cut rates by around 0.5% (maybe a little more) and the US will continue it’s recovery (the fiscal cliff won’t eventuate) – both of which will see a slight easing of the dollar (I am not expecting it to get much below parity but it will dip).
    China’s growth rate has also bottomed out and it rise will increase commodity prices again (although this could slow the AUD’s fall).
    As long as Europe doesn’t completely self destruct (German figures were encouraging) 2013 should see economic conditins improving globally, whterh it is qucik enough to save the surplus is debatablebut economically and small deficit won’t be the end of the world.

  5. Apollo

    I’m told that maybe businesses should form co-ops and have a good currency strategist to trade the money, by buying into a variety of other currencies before returning to Australian dollar when it is profitable instead of waiting for a long time for the dollar to fall.

  6. Gavin Moodie

    Would a Tobin tax slow the flow of funds into Australia and raise revenue?

  7. Hamis Hill

    But surely the economy is already being deliberately slowed by Campbell, O’Farrell and Baillieu, partly in order to deprive Federal Labour of their much promised Surplus?
    If Australian wages were higher to the point where savings markedly increased then the interest to be gained would fall and the Australian dollar would fall.
    The overall value of the wages would stay the same since the rise in numbers would be accompanied by a fall in value which would preserve some of those industries adversely affected by the high dollar.
    Those unconvinced might wish to actually read Adam Smith on interest rates and wages.
    Which led to his claim that the “Idle Rich”, who live of their debtors, had an interest to deceive and oppress the public, especially seeking to deprive the public of the benefit of any substantial savings which might deliver them from the oppressive clutches of the “Idle Rich”.
    Bringing us, through the medium of the specialised idiocy of “economists”, to the inevitable Abbott, Austerity- induced, Recession that Australians will just have to have owing to the employment of conservative politicians by said Idle Rich.
    All in pursuit of a high Australian Dollar (as owned by the said Idle Rich).
    Industry, the real source of National Wealth to be driven into bankruptcy and sold off, at a fee to the agents of the Idle Rich, to wealthy “extra-nationals”.
    This would be the chickens of the $TRILLION Howard Golden Era mortgage debt coming home to roost.
    Strangely, those $1million bungalows would assume a more reasonable price should the dollar lose its comparative value, a 50% reduction?.
    But reading Adam Smith has always been just too hard, especially for those highly “evolved” economists, so let’s just destroy the national economy instead.
    Perhaps the new MCMansion owners can keep the present mortgagees on as caretakers.
    Australia’s economic geniuses have already arranged for the McMansioneers to be caretakers for the real owners the banks; is is that the idle rich?
    In any recession there are always bargain basement prices to be had by those whose wealth is not at risk.
    This is only really a “perverse” incentive for those who must live by their labour, and who at he same time seem quite prepared to vote against their own best interests next year by putting Abbottt into power.
    Only possible, as Adam Smith argued, if these same voters are deprived of the education( which grants them an understanding of their own best interests) upon which the true operation of a Free Market exists.
    Did anyone notice a large diminution of public spending on education during the “Times which suited” Howard’s politics?
    Pearls before swine.
    A good country roo-ted by a conga line of numberdunce, middle-class suckh-les, now formed into a circle and dreaming of the day when they can become “Idle Rich” aswell.
    Can we han a parliamentary inquiry into the nature and causes of the wealth of the Australian nation?

  8. Jimmy

    Interesting ana l ysis from Michael Pascoe to on consumer confidence – ALP voters are rating at about 120 (20 points to the positive) while Lib voters are rating at about 84 (16 points to the negative).

  9. Simon Mansfield

    If Labor was not in office – my fellow Labor voters would be in the streets demanding the government save Australian industry from Dutch Disease – instead we have the ludicrous situation where the “left” is defending the only major free market left in the OECD. Pascoe like the dynamic duo that authored the above article have been wrong on the dollar and interest rates for the past two years. But don’t expect any of these characters to admit they got it wrong. Maybe even you got admit you were wrong as well Jimmy. It might even start a trend.

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