Glenn Stevens

Reserve Bank governor Glenn Stevens is the latest to weigh in on the increasingly murky circumstances in which Treasurer Joe Hockey handed nearly $9 billion to top up the RBA’s Reserve Fund last week.

What we know so far is that the level of the Reserve Bank’s Reserve Fund isn’t keeping the bank’s deputy governor Phil Lowe awake at nights, and that after consulting with the RBA, Treasury in April told former treasurer Wayne Swan that there was no need to provide a top-up — and indeed it might damage the RBA’s credibility to do it in a rush.

Judging by the remarks by Stevens yesterday, it’s not clear the RBA wanted the increase so quickly either. His remarks on the issue (italics added) were:

“Moreover, the terms of trade are likely to fall, not rise, from here. So it seems quite likely that at some point in the future the Australian dollar will be materially lower than it is today. The high exchange rate has also had a significant impact on the Reserve Bank’s own balance sheet. It led to a decline in the value of the Bank’s foreign assets and hence a diminution in the Bank’s capital, to a level well below that judged by the Reserve Bank Board to be prudent. This has been a topic of some interest of late.

“Our annual reports have made quite clear over several years now that, while this rundown in capital in the face of a very large valuation loss was exactly what such reserves were designed for, we considered it prudent to rebuild the capital at the earliest opportunity. It has been clear that the Bank saw a strong case not to pay a dividend to the Commonwealth during this period, preferring instead to retain earnings, so far as possible, to increase the Bank’s capital.

That rebuilding could in fact have taken quite a few years, given the low level of earnings. That is the background to the recent decision by the Treasurer to act to strengthen the Bank’s balance sheet, in accordance with a commitment he made prior to the election.

“The effect of this is that instead of it taking many years to rebuild the capital, it will occur in the current year. This results in a stronger balance sheet on average, and makes it likely that a regular flow of dividends to the Commonwealth can be resumed at a much earlier date than would otherwise have been the case.”

So, the RBA fully expected a slow rebuilding of the fund from the declining value of the dollar. How did it feel about this? Much of the meaning hinges on Stevens’ use of the word “could”. Was he saying that rebuilding “could” have taken a long time and that this was undesirable, in which case it’s a subtle endorsement of the Treasurer’s decision, or was he saying it “could” have taken a long time and that was fine — in which case, Hockey’s decision looks precipitate? That was the interpretation Shadow Treasurer Chris Bowen and Fairfax’s business commentator Michael Pascoe went with. To us, it’s not quite as clear — as Pascoe said, Stevens’ remarks are rather subtle (in true central banker style).

But where Stevens’ comments get more interesting is on dividends. Stevens said the rebuilding of the Reserve Fund “makes it likely that a regular flow of dividends to the Commonwealth can be resumed at a much earlier date than would otherwise have been the case”.

That is, Hockey will be more likely in coming years to get a big payday back from the RBA — especially if the Aussie dollar falls, which will instantly lift the value of the RBA’s foreign currency holdings, particularly US dollars (as Pascoe correctly notes, however, the opposite applies if it rises).

That’s great news for Hockey because he can blame an extra $9 billion on his deficit (and yes, it is your deficit now, Joe, because you can fix it any time you like) on Labor and recoup billions in dividends from the RBA “much earlier”. Not a little earlier, not a fair bit earlier, but much earlier — that was Stevens’ deliberate wording.

For Hockey, it’s a political and fiscal winner. But it looks like a politically based Ponzi scheme, where the dividends to the government paid by the RBA will come wholly or in part from the government’s $8.8 billion boost in the Reserve Fund. Would ASIC allow an Australian company to market such an idea to the investing public?

Of course, if the RBA believes that the dollar is likely to trend lower rather than higher — which it appears to do — it begs the question of why it doesn’t rely more on that to restore the value of the Reserve Fund. Why does it need a capital injection if it expects the value of its holdings to go up? At the very least, doesn’t this mean the fund could have been built up gradually?

And there is a final point — as Treasury told Swan, central banks such as the RBA don’t really need reserve funds if a quick source of cash is needed. A central bank can quickly create the funds needed and inject them into whatever markets that need help — and they can do it via a sterilised operation where the amount is taken from elsewhere.

Or the RBA can do it via repurchase deals with banks and other groups, as it did in the last quarter of 2008 after the financial crisis erupted. The RBA bought an estimated $60 billion of bonds and self-securitised home mortgages from the major banks and others to keep liquidity flowing as offshore funding had been cut off.

The bank also printed around $8 billion in extra notes and sold them to the banks to meet a quiet run from their customers. The bank note data in the RBA’s 2012-13 annual report shows that over the course of 2008-09 more than $6 billion in extra notes, mostly $50 and $100 notes, were created and sold to the banks. The RBA got that money back from its bank customers, but the money was printed quickly to meet a need.

So Stevens’ rather allusive comments get us a little closer to understanding why Hockey gave the bank such a payday — and those comments don’t exactly fill us with confidence about the Treasurer’s motives.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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