Well, Merry Christmas and go to hell all you savers and pensioners. The Reserve Bank of Australia has delivered a giant lump of coal. They put it in a stocking and gave it to the Treasurer, who then swung it over his head with glee. The World’s Greatest Treasurer (Wayne Swan) said yesterday’s rate cut from the RBA is an ‘Early Christmas present that hardworking Aussies deserve…When you have an interest rate cut, that’s good news for families and good news for business.’
Let’s sum up the situation. Interest rates are back where they were at the peak of the financial crisis. Unemployment is apparently at 5.4%. Total debt in the Australian economy has expanded. Mining investment has peaked. Is it a crisis, or not? If not, why are interest rates now at ’emergency’ lows?
The stock market’s reaction to the news was swift and decisive. You can see it on the chart below. The ASX/S&P 200 closed at 4504, or 0.62% down for the day. Perhaps the rate cut was baked into the cake. Or maybe it was the fact that the RBA’s statement didn’t suggest there was more on the way. Without more monetary stimulus, there’s no easy boost to consumption, corporate profits, or stock prices.
But woe betide anyone who was short the Australian dollar before the announcement. The Aussie dollar actually rallied on the news that official interest rates were headed to 3%. If the RBA meant to kneecap the dollar, it needs a bigger lead pipe, or to aim higher. Not even the lowest interest rates in the last 60 years can stop the local currency.
By the way, here’s a riddle for you: how can the Australian dollar fall when every other major economy in the world already has lower interest rates? Japan, the US, and Europe have effective interest rates of zero (or less!) once you adjust for inflation. The short-hand term for it is ZIRP, or zero interest-rate-policy.
At 3%, the RBA has 300 basis points to go before it too gets to ZIRP. But you only go to ZIRP if you have an economy burdened by debt and unable to grow. That clearly isn’t the case…yet…in Australia. The RBA hopes the end of the investment boom in the mining sector will be followed by a boom in the non-mining sector.
Come to think of it, the debt part may be true. Australia’s net foreign debt is now $748 billion, according to figures published by the Australian Bureau of Statistics yesterday. Foreigners own a lot more of Australia than Australia owns of them. The ABS figures also show that the trade deficit jumped from $2.1 billion to $4.6 billion in the third quarter. The current account deficit reached a record of $14.5 billion.
Australia has run a current account deficit for 30 years. This is not news. But surely this structural feature of the economy would figure in whether the Aussie dollar is actually a safe haven. According to London-based fund manager Andy Seaman, the real measure of a country’s safety and creditworthiness is how much it relies on foreign capital to finance its growth.
Seaman says Australia’s net foreign assets-to-GDP ratio is negative 81%. This is basically a measure of a country’s net foreign liabilities. Foreigners are cleaning up on their ownership of Australian assets, or at least own more Aussie assets than vice versa. Seaman reckons this is a sign of weakness.
Part of the problem is that assets tend to be equities and liabilities tend to be debt. Australia’s economy has a high net foreign-debt-to-GDP ratio too. But it’s not earning enough on its foreign assets either. What makes it an even bigger problem is what the current account deficit really means.
If you’re running a current account deficit, the value of imports exceeds the value of exports. To make up the difference, the deficit, you have to bring in money. This is what it means to ‘finance’ a current account deficit. If you’re spending more than you’re bringing in, you have to make up the difference by borrowing.
The borrowing is called a ‘capital account’ surplus. At first, it looks like a strength. Foreign money is pouring into the country. But that money must continue to pour in to finance the current account deficit as long as you run it. And if it doesn’t?
If it doesn’t, you normally get a currency adjustment (a fall in the Australian dollar) and a second look at the creditworthiness of the country and its banking system. That’s an elaborate way of saying that instead of being seen as an attractive place for foreign capital and investment, you look a lot more like a country with a big spending problem. You look like a debtor, not a creditor.
The Aussie dollar is not valued as if the country were a debtor nation, at least not yet. But with the boom in mining investment at or past its peak, what will draw in the foreign dollars to finance the current account deficit and keep the Australian dollar high? Tourism? Another housing boom? Christmas? Pies and beer?
All this is kind of warming up to the idea that something is rotten, or rotting, in the land of the never ending boom. But that is a case for another man, and another day. Our mate Greg Canavan is just the man and the day is coming. Look for it tomorrow.
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From the Archives…
William Knox D’Arcy: The Greatest Australian You’ve Never Heard Of
30-11-2012 – Callum Newman
Credit and Credibility
29-11-2012 – Greg Canavan
Nothing More than Feelings… For the Aussie Dollar
28-11-2012 – Dan Denning
The Thanksgiving Gift from the Feds
27-11-2012 – Bill Bonner
The Aussie Dollar Dilemma
16-11-2012 – Dan Denning