Aussie Banks Cling to Old World Order

–Today is one of those sad days in life. It’s sad because your own financial plan must take into account what the Reserve Bank of Australia (RBA) says about interest rates. We’ve been in Australia almost six years now. And it never fails to annoy us that the RBA’s plans have such a huge and immediate effect on the plans and actions of millions of people.

–The cost and value of money shouldn’t be so variable. But it’s the nature of the money system we have – a money system that’s infiltrated the entire economy – that unsound money leads to economic and monetary instability. So we wait on the next oracular statement from the central planners.


–In any event, later today the RBA will release the minutes of its monetary policy meeting earlier this month. Those minutes may contain clues that tell you where the cash rate is headed. If the RBA is super spooked about a Greek default – although recent events in Greece won’t be reflected in the September minutes – you might get the prospect of a rate cut from the current 4.75%.

–Language indicating a rate cut probably means a weaker Aussie dollar. This would be consistent with the “risk off” trade in which global speculative money flows out of assets like the Aussie and into the short-term US bond market. Exhibit A: two-year US Treasury Note yields traded at a record low of 0.12% before settling at 0.16%, which is still not exactly high.


–The only reason you’d want to be in two-year US Treasury notes yielding 0.16% is that it’s not a Greek government bond or a common stock. This is a fear and liquidity trade combined. It has reached a rather extreme level.

–Markets are reaching extremes more often, and then reversing course quickly. You might say Mr. Market has become manic-depressive. He goes from extremes of euphoric optimism to lows of despair. One day the Fed will save the world. The next day, we’re all doomed.

–Our mate Kris Sayce is taking a more clinical approach to the market. He’s looking to be a bit greedy while everyone else is a lot more fearful. Why? He’s of the view that everything you see happening in the financial world can be explained in terms of “creative destruction.”

–That’s the term coined by the Austrian economist Joseph Schumpeter. Schumpeter said the “gales of creative destruction” are always blowing through economy. They are the market forces that reward entrepreneurs and innovators with disruptive technologies, new ideas, new ways of organising things, or new products.

–But if entrepreneurs who offer the world better products and services are rewarded in Schumpeter’s capitalism, the incumbents are destroyed. The incumbents are the old firms who fail to keep up with the times or who are simply displaced by technological innovation and economic change.

–We’re hoping Kris is right. In fact we’re hoping the age of the financier is over. We’re hoping the whole system of the financier – the central bank, the money printed by government with no backing by gold, the fractional reserve banking – is headed for the trash heap of history. If bureaucratic government is a dead hand on the economy, the hand of the banksters is grasping and greedy. Lock them both up!

–If the RBA fails to reveal anything that spurs stocks higher, the Federal Reserve may do so later this week. The Fed holds a two-day meeting this week. And it’s become conventional wisdom that Fed President Ben Bernanke will at least indicate what shape a third round of Quantitative Easing may take. QE3 is supposed to give the market one more shot of adrenaline.

–Anything so widely expected is either already priced in to stocks or unlikely to happen. The fact of the matter is, the Fed has done about as much as it can with monetary policy. It’s committed to keeping interest rates low through mid-2013. About the only variation on this theme is if it keeps its total US bond holdings the same, but shifts from shorter maturities to 10-year and 30-year bonds.

–Shifting the composition of its bond holdings to the longer end of the yield curve would keep the size of the Fed’s bond portfolio the same AND keep interest rates low. Besides, so many people want to buy short-term US notes right now (to get out of the Euro) the Fed doesn’t need to support the bond market there. But this is a change in tactics. Not a change in strategy.

–A change in strategy would be the Fed announcing it’s going to buy stock futures, or gold mines, or corporate debt. That would be direct support of financial markets through expansion of its balance sheet. But we haven’t reached that level of crisis. Not yet anyway.

–In the meantime, Australian banks are quietly planning on doing without Europe for awhile. Fairfax’s Eric Johnston reports that Aussie banks are cutting back their exposure to Europe’s most troubled economies. Aside from actually limiting their exposure to a European credit crisis, this is the sort of move that’s also designed to reassure investors that Aussie banks won’t lose any money when Europe’s monetary union disintegrates.


–Every single business that depends on credit expansion for profit growth is at risk in this new financial era (the credit depression). Aussie banks are no exception. But they have been busy finding alternatives. That’s a good sign.

–For example, the chart below from the RBA shows that since the fall of Lehman Brothers in 2008, Australian banks have upped their domestic deposits and decreased their reliance on short-term debt sourced from big overseas lenders. This is an interesting change in the way Aussie banks fund their lending. You’d think, at least we’d think, it would mean lower overall credit growth in the Australian economy in the years ahead (with ominous tones for housing growth).

bank funding

–But the banks are already trying to turn those idle cash deposits into the basis for more borrowing. That is, the banks are trying to leverage their increased deposits by using them as collateral for bond issues. Yes, the covered bonds are back.

–We’ve written about covered bonds here, here, and here. It’s a new source of funding that Australian banks have been thus far prohibited from using. The reason? As we understand it, covered bonds give investors preference to collateral in the event of a bank liquidation.

–The collateral is actual bank deposits – as it is with covered bonds – this appears to put creditors ahead of depositors in line for…your deposits. Of course, that would only ever happen in the event of a bank collapse. And that would never happen.

–And besides, new rules proposed by the government would only allow Aussie banks to issue covered bonds as no more than 8% of the bank’s capital. Advocates say this change allows Aussie banks to do what foreign banks have been doing for years: tap a lower-cost source of funding for new lending without really exposing depositors.

–Hmm. The giant assumption behind the whole scheme is that no Aussie bank would ever actually fail. How could one? The banks have tremendous assets, many of which are residential and commercial property mortgages. There is hardly any precedent for bank capital being wiped by fallen asset values in residential and commercial property, is there?

–Well, of course there is. This is precisely what happened/is happening in America. But we are assured, for myriad reasons, it could never happen here. And just to be sure it never happens, the government and the banks are finding new ways to direct more borrowed money and more Australian savings into a single asset class: housing.

–What could possibly go wrong?

–The penny has clearly not dropped for some people. Policy makers and bankers are scrounging for ways to keep debt growing here in Australia. Meanwhile, Europe is showing us what happens when the financial system can no longer add any more productive debt: a great contraction.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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2 Comments on "Aussie Banks Cling to Old World Order"

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Great article. Now write it again without the technical jargon, in plain English, and in a mainstream forum.

Don’t forget the anecdotes covering the conniving pollyanna bankster, the lonely cassandra economist, and the bewildered chump consumer who is left holding the bag, once again. SMH op-ed?



Patrick Donnelly

I still see only a soft landing for Australian housing values and in terms of other currencies, small increases.

DW Journal TV today was hilarious, showing a German girl making $7000 from selling an apartment in Sao Paulo, not yet built to people who expect to flip in two years for 40% profit. Housing went up 80% last year ….. so everything is fine and there can’t be a bubble!!!! Quote from DWJ!!

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