Should Australia Join the Currency War?

As the melt-up in global asset markets continues, today we ask the question: Are central bankers’ egotistic hooligans blinded by their own intellectual arrogance? You can probably guess the answer to that one.

We’ll also have a look at the bidding war going on around Warrnambool and show you why the ‘winning’ bidder could ultimately prove to be the biggest loser.

On the question of central banks, an article by David Bassanese in today’s Financial Review got us thinking about it. Here’s the introduction to the article:

‘It is time Australian policymakers took a stronger stand against the extremely loose monetary policies still being pursued across Europe, the United States and Japan. With the global economy gradually recovering, monetary policy is well behind the curve, which is already distorting both currency valuations, but risks soon distorting equity valuations also – not to mention local house prices.

‘Ostensibly, these global policies are in place to fight off the lingering risks of deflation – or falling prices.

‘…Australia has been caught in the crossfire of this stimulus war, with uncomfortably low interest rates and an uncomfortably high exchange rate – an unbalanced mix which risks leaving economic growth over the next few years overly reliant on only a few engines, such as the housing sector.’

There is no doubt that Australia is suffering the effects of the global currency war. But as a small, open economy, we have always been affected by the policies of the major economic powers. And it’s not as if we can do anything about it…or take a stronger stand as Bassanese suggests. Besides, it’s not all bad. China’s stimulus and credit boom saved us from the fallout of the GFC…or at least delayed Australia’s day of reckoning (take your pick).

At one point back in 2010, national income growth was running at an annual pace of around 10%! A natural consequence of such strong growth is a strong dollar. It helped to keep a lid on the pace of expansion in other sectors, which in turn kept inflation at bay.

The problem for Australia now though is that national income growth is extremely weak (and will turn negative if the terms of trade revert back to historical levels). That’s why interest rates have fallen so low. But our currency remains stubbornly high, thanks largely to the ongoing currency war between the major global powers the US (and via the currency peg) China, Europe and Japan.

We’ll get back to Australia in a moment. But first, let’s consider what’s behind the currency wars. As Bassanese says, ‘ostensibly, these global policies are in place to fight off the lingering risks of deflation – or falling prices.

Falling prices? What falling prices? As far as central bankers are concerned, the only prices that matter are consumer prices. They completely ignore asset prices in the inflation/deflation outlook.

Apparently, consumer price inflation is still weak in the US and Europe, raising ‘concerns’ about those economies slipping into outright deflation. Deflation is bad apparently because it magnifies an economy’s real debt burden. Inflationary economic growth is good because it reduces the debt burden.

But to encourage economic growth central bankers encourage people to go further into debt. To complete the idiocy, it’s this ever increasing debt pile that brings about the prospect of deflation which the central bankers are working so hard to avoid. 

Meanwhile, incoming Fed Chair Janet Yellen says QE will continue because the Federal Reserve has ‘more work to do‘. Which is an interesting way of looking at it. Because as far as we can tell, the ‘work’ done so far by the Fed and other central bankers has created  a huge amount of asset price inflation and little to no consumer price inflation.

In fact, you could argue that the Fed’s policy of QE has further undermined confidence in the economy and exacerbated deflationary risks. That’s because the Fed’s attempts to get money into the real economy are not working. Instead, the Fed’s debt monetisation program ensures that the newly created liquidity remains within the financial system and only leaks into the real economy via hugely inflated high end real estate prices in the financial centres of New York and London, not to mention off the scale prices for art works.

Now, if that were an experiment we were conducting, we would probably hesitate to say we needed to do more. On reflection, we might humbly concede we needed to do something different. But not so the egotists tinkering with their academic models.

–There’s nothing surer in life (apart from constantly rising Aussie property prices) than the fact that a central banker will claim more needs to be done to fight deflation. When more is not enough, well, it simply wasn’t enough. Do more.

What we find galling is that after such obvious evidence to the contrary, the mainstream financial press continues to treat these people with reverence. These central bankers believe you must spend your way to prosperity. They punish savers and reward speculators and debtors, yet still society collectively worships their profession.

Savings…as in excess production saved and not consumed…are the foundation of genuine economic growth. Without saving you cannot have investment. And without investment you cannot have sustainable economic growth.

With these hooligans at the helm, today you have too much saving and investment in some places (China) and not enough in others (the US). Central banks ‘manufacture’ savings by crediting commercial banks’ reserves and by monetising government debt. As a result, the economic imbalances that led to the GFC in 2008 are still there, made constantly worse by the need to always ‘do more’.

Meanwhile, in Australia we’re back to relying on swapping houses amongst each other to prop up economic growth. The currency wars and insane central banking dogma has got us to a point of relying on rising asset prices to stave off a recession.

Rising asset prices are a product of economic growth and prosperity, not a cause of it. Australia’s strong house price performance since 2008 is in some ways justified, thanks to the high rate of national income growth – a consequence of the China boom that is slowly turning to a bust.

But now we’re relying on rising house prices to attract investment, while national income growth stagnates. That’s about as insane as the Fed fighting consumer price deflation by causing asset price inflation. But when did insanity stop anyone from doing anything?

Never. So we’ll continue to watch as this thing plays out. But with central banker credibility still riding high, it seems like there’s plenty of damage still to be done. Great.

Speaking of damage, whoever wins the battle for Warrnambool Cheese and Butter Factory (ASX:WCB) is going to do some damage to their balance sheet and future returns. We’ll explain why tomorrow…


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Greg Canavan

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing.

He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’.

Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors.

Greg Canavan

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10 Comments on "Should Australia Join the Currency War?"

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Day after day we watch this slow motion train wreck and nothing will stop it. It is a derivative of our consistent behaviour as humans, particularly our aptitude for denying the things that we fear.

Our resident BoE comedian reckons we are charging down the highway of economic recovery,(my expression), notwithstanding the bleeding obvious, shops and factories closing, shipyards closing down layoffs and other sundry clues. Rolls Royce, (jet engines division) the icon of British industry has landed a good long term contract so everything is all right then. House prices in London are ballistic, due to Euro residents desperate to offload Euros before the banks confiscate them. In the provinces, real estate agents think they can profit from the London madness, together with greedy house owners, I suspect mostly ‘buy to let owners’, the… Read more »
slewie the pi-rat
about 40 years ago, a guy with whom i had matriculated through public school had a puppy which had gotten sick w/ distemper. she needed food and rest, but wasn’t getting much of either, since G. had another dog and both dogs screwed around together all day while he was at work. he only had one porch. the puppy, even though quite ill, was still so playful that the big dog was powerless to resist, and also ate almost all of the food, what with playing around all day, like that. co-play. we’ve all been through it. she was going… Read more »
Slew I have a stumpy tail red cattle dog with a little kelpie/bull terrier in the mix. Best dog I could wish for honestly. She sticks by me everywhere I go, in fact she’s a house dog but also a hard worker and travels with me on my work outings around the state. Any time now the neighbours cattle will cross the creek to raid our grain bins (have to complete a fence today) and she’ll run out, turn them back around and drive them home while leaving my bulls alone. Those big fellas and her have an understanding. A… Read more »
In another life, I lived in Deniliquin, a quaint little town where bits of green ‘stuff’ came out the shower head, from, I was told, the Edward river. There wandered Charlie, a Emu that owned the town and made sure everyone knew it. His residence I found out was my place of employment, the local courthouse, an imposing building with extensive grounds well worth a look if you happen that way. There is nothing of great import to relate but Lachlan,s link reminded me of it. It certainly beats reading of the shenanigans, yet again, of the Fed and a… Read more »
Origin of the idiom…. A guest who checked into an inn one night was warned to be quiet because the guest in the room next to his was a light sleeper. As he undressed for bed, he dropped one shoe, which, sure enough, awakened the other guest. He managed to get the other shoe off in silence, and got into bed. An hour later, he heard a pounding on the wall and a shout: “When are you going to drop the other shoe?” Thus the term “waiting for the other shoe to drop.” SC that boot dropping idiom was often… Read more »

SC, in mother England you may find this interesting. A six part series on money creation as it applies to the UK. I am not promoting/advocating anything in particular which is said therein the series or their organisation. Anyhow…

Fractional reserve banking I understand, Lachlan, but I was lost after the third part. The fact that economists and accountants do not is rather scary. On the the other hand Mrs. Sc is an accountant and she does know how it all works. I have this vision in my mind of a pimply faced nerd, hunched over a computer in a back room of some bank, thinking of some way to get back at those who call him a pimply faced youth. The result is the excruciating convoluted way of the banking system, designed to pull the wool over our… Read more »
I’d hazard a guess the banks will go tits up but eventually there will be no winners. Either they will quickly be reformed as the gov backed, exploitive monopoly they are or we’ll repeat the 1300’s crisis where a major chunk of the earth’s population died out. Little ray of sunshine eh. The only way for an across the board win in my view would depend on the people organising themselves, en masse, ideologically and practically. Realistically that would seem about as likely as the pope turning to Islam. Only a segment of the population have this determination at any… Read more »

Well at least SC, until somebody is helping themselves they have no way of helping another is what I mean.

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