Australia is a basket case!

Well not quite...but a toy kangaroo is certainly in the frame - for the royal baby soon to be born to Duchess of Cambridge Kate Middleton (and Prince William of England)!

For those unaware of Australia's odd constitutional arrangements, the head of state currently is English Queen Elizabeth II and through their shared history Australians maintain a strong connection to events in old Blighty.

That doesn't explain the whole stunt though.  Due to massive party infighting ahead of the September general election, Julia Gillard is trying all manner of things to regain the initiative and garner lost popularity, amidst infighting with former also-ran Kevin Rudd.  One such step was to announce a return to her traditional side by commencing a knitting of a soft toy for the English royal baby (while having only engaged in a sexist tirade at fellow male parliamentarians the week before).  Quite daft really.

But there is a serious point here - the political sideshow is distracting from serious economic headwinds.  As Warwick McKibben notes at MacroBusiness, problems lie ahead:

The biggest risk Australia faces is the political uncertainty which is undermining consumer and business confidence.
It won’t be until the end of 2013 that there is a clear indication of the direction of government policy. The good news is that the portfolio shift into Australian assets has probably passed, partly due to this political uncertainty. A weaker exchange rate is to be expected. This will be a two-edged sword. It will help with the profitability of trade-exposed companies but it will also add to imported goods inflation which will likely push inflation outside the RBA comfort zone.

Farewell good times

Colebatch in the Sydney Morning Herald with a firm take down on the Australian economy's growth aspirations.  Building on Ross Garnaut's recent assessment which was profiled in this blog, it makes for a really shocking read - the China bust, uncompetitive currency and interest rates, falling tax revenue, unfunded commitments and an aging society.  Ouch.  Is this the opening of a door into the bad old days of the recession we had to have?

Our economy is poised to go bust and only tax rises and spending cuts can save us.... One of Australia's most respected economists, Ross Garnaut, of the University of Melbourne, warns that when the mining boom busts, the economy is likely to bust with it. History is on his side. Since 2005, mining investment has reared up like a tidal wave, from 2 per cent of GDP to more than 8 per cent. If it breaks like a tidal wave, it will swamp the economy.... 

The bottom line is that something's got to give. Australia cannot continue this level of spending with this level of revenue.....

The end of the mining boom, however, could throw all this out. Garnaut, a former ambassador to China, says we underestimate the seriousness of China's rulers in planning to shift its economy to a more gradual, less resource-intensive growth path...But every mining boom since the war has ended in a bust, and there is no reason to think this time will be different. It was a very big boom, so it could be a very big bust. (here) 

More on RBA reticence

It has been noted on this blog that the RBA is clinging to its mining first policy and failing to engage with the rest of the world's central banks as they battle the nascent currency war.  Following its comments seeking to reassure earlier in the week, there has been some decent commentary on Macrobusiness.com.au about comments of the RBA and APRA on the difficult policy reform environment and how out of step the two bodies are with the rest of planet earth.

As noted RBA Governor Stevens decried reform fatigue:

....a point in the financial regulatory sphere where the G20 should be looking for careful and sustained efforts at implementation of the regulatory reforms that have already been broadly agreed, but being wary of adding further reforms to the work program....(here)

Macrobusiness notes the underlying concern could stem from a number of concerns - the amount of reform already, concerns about a change of government with new policies and the capacity of banks to comply more or even "that the RBA is more worried about the approaching mining investment cliff than they are letting on".

All true but this blog has a slightly different view.  Macrobusiness also talk about recent speeches at a meeting of central bankers in London this week, in particular from Fed Chairman Bernanke which it seems he is basically justifying the total debasement of the US Dollar via money printing programs:

....Regarding the effects of monetary easing on exchange rates and exports, I would note that trade-weighted real exchange rates of emerging market economies, with some exceptions, have not changed much from their values shortly before the intensification of the financial crisis in late 2008. Moreover, even if the expansionary policies of the advanced economies were to lead to significant currency appreciation in emerging markets, the resulting drag on their competitiveness would have to be balanced against the positive effects of stronger advanced-economy demand..... (here)

At a time of recurrent flagging demand! It goes on...

...It is true that interest rate differentials associated with differences in national monetary policies can promote cross-border capital flows as investors seek higher returns. But my reading of recent research makes me skeptical that these policy differences are the dominant force behind capital flows to emerging market economies; differences in growth prospects across countries and swings in investor risk sentiment seem to have played a larger role...

If this were true then the record high run of the Australian dollar would be simply down to the country's economic opportunities and not because Australian government bonds pay rates far higher than nearly most of the world!

So there you have it - Macrobusiness interprets this positively and mildly - positively in the sense that the Fed's actions are innovative policies and the actions by the RBA are failure to get with the program. This blog broadly agrees but comes to a different conclusion.  There is a currency war going on the the Fed's policies are especially provocative.  It is not that the RBA is not following - so far the RBA seems to be ignoring the situation completely and hoping it will go away..!  It will not and Australia is vulnerable...

What's wrong with the RBA

A well written piece looking at the short-sightedness of the RBA revealed by Philip Lowe in his speech this week.  While there was a logic to Lowe's statements, it is argued that they were unbalanced, skewed by bias and importantly not based on sound assumptions.  Couldn't agree more!

..., had macroprudential tools been used then the RBA would never have had to fear a blowoff in credit associated with the boom, rates wold have been much lower and the dollar too. We would not have had to embrace Dutch disease as a way of managing surging mining investment...

...Lowe’s internal balance (note it is not “external” balance leaving him an out later on) of course did have its casualties. The major ones being Australia’s non-mining tradable goods sectors: tourism, education, services generally and manufacturing especially. As we know, the last ABS private capex report showed manufacturing investment in outright collapse, running at 1989 levels before inflation adjustment: 

..The truth is it’s a punt and in this context it is hardly fair to describe Australia’s growth as  enjoying “internal balance”. If China does revert to mean, we’ll have nothing but under priced dirt to sell overseas...(here)

and that's not to mention the currency war!!

The Financial Times has a more sober analysis, focussing on the yield curve returning to normal (with its suggestion of a return to normal interest rate expectations).  As above, expectations of lower short term yields probably rests on assumptions which may simply not be true...wait and see.

RBA fighting a phoney war

Well certainly not a currency war.  As twitter posts have been appearing with news that Malaysia has joined the currency war, RBA board members are now talking about the possibility of joining - following other nations to lower their interest rates....Roger Corbett got a mention (here) as did Guy Debelle...

...‘To date in Australia, we have been able to counter the effects of the higher Australian dollar with lower interest rates,’’ he said in a speech to the University of Adelaide Business School. ‘‘We still, obviously, retain scope to lower interest rates further, should the need arise, including to counterbalance the pressures of an elevated exchange rate.’’....But Mr Debelle warned that cutting interest rates too far could also create problems for the economy - forcing up the price of assets and causing people to borrow more than they could afford....(here).

This is for an economy where there is already a bursting property bubble and asset price trend.

Meanwhile even the RBA is admitting the Aussie dollar is overvalued, but not by much they say!

....THE Australian dollar was overvalued by as much as 15 per cent late last year according to modelling released by the country's central bank....The local currency was between 4 per cent and 15 per cent over valued in September and about 7 per cent above fair value in December, papers released by the Reserve Bank of Australia under the Freedom of Information Act showed....Even so, the central bank papers said the currency wasn't having a "highly contractionary" affect on the economy...(here)

(the Economist calculated the overvaluation at 60% recently).

Cost of funding - cheap and risky?

More on Oz banks' low cost of funding - it's due to nice instruments called covered bonds, invented in the former European state of Prussia in the 18th Centure and rolled out globally in the 2007-8 financial crisis:

....Now the evidence is in. Covered bonds have brought down bank costs even further. In a confidential note to its institutional clients, Westpac describes the fall in wholesale funding costs over the past year as ''extraordinary''.....No longer can the banks rely on that hoary old chestnut of ''high funding costs'' to pass off their failure to match the successive cuts in the official cash rate....Margins are fatter than ever, veritably bulging, and there is scant proof that borrowers are getting their grimy fingers on a single cent of it. It's a good thing for shareholders though, some cautious at the listless growth in credit....(here).

But like all good things in banking, risks are appearing...

....BlackRock Inc. said using loans to small- and medium-sized companies, or SMEs, to back the securities rather than safer real estate or public-sector debt may devalue the asset class. Pacific Investment Management Co. said the first European deal, being marketed now by Commerzbank AG, may call into question SME issues as true covered bonds if it fails to qualify for indexes benchmarking performance....(here)

The elusive banking culture

Watchers of the UK financial system will have noted the new head of global giant Barclays Bank in London recently attempting to draw a line under all of the recent scandals by launching the bank's renovated set of values (here).  Its peer HSBC, was more pragmatic in the US when confronted with money laundering charges and was able to argue it was too systemically important, or too big to fail (here).

Throughout the various scandals of the last few years has been the understanding that not only were banks and their stakeholders let down by individuals, but there was a systematic culture which favoured profit and criminality over ethical behaviour.

In comparison the last few years have been favourable to the Australian sector, with few scandals on an industry wide scale.  A recent case involving the Commonwealth Bank (here) has shed some light, but also attracting attention is perennial outperformer Macquarie (the millionaires' factory).  

Reviewing the recent press about the activities of the holey dollar's private wealth division show all the similar signs.  Not only were there compliance failures leading to the resignation of the head of division, but a flawed culture:

....this is a big deal. Macquarie Private Wealth is the largest full-service stockbroker in Australia. The findings of the internal audit by the adviser services unit were that some 365 advisers of the 420-strong team coast to coast were in breach of compliance....Though the number itself is big, the bigger deal is what the regulator's investigations say about that elusive yet critical aspect of the corporation, culture....In contrast to previous ASIC ''enforceable undertakings'' penalties - which mostly pertained to individual rogue activities - the Macquarie action is squarely aimed at management....

...Macquarie Private Wealth is a marginal proposition economically. If deal-flow rises and capital markets return to full swing, this regulatory nightmare may drift away.....(here)

The bankers will be hoping for rising deal flow, but so far no encouraging signs on the deeper issues.

Rules of engagement

An RBA/Glenn Stevens defence piece by Michael Pascoe in the SMH.  A fair point but for how long will either Australia's policy makers blame the markets for inaction. New Zealand showed a much more assertive stance last week (here).  And while it is true that Australia is a small market that can get flattened by the FX monster, Australia will be in the unenviable position of being the only country not to engage in the currency war.  Brave?

....“You could argue we would be better off with some different configuration: a lower exchange rate and higher interest rates - or more normal level of interest rates - but, given the configuration of the global economy, I just do not think that is possible at the moment. The weakness in the North Atlantic and their money creation is leading to their currencies wanting to depreciate, and someone has to be high.”...(here).

Sounds like "the exchange rate we had to have"... (heard something similar before? here).

 Australia really is the lucky country...!

More evidence of bank gouging...

...The country's big four lenders now generate about 88 basis points of net profit on each new mortgage they sell--the highest rate since UBS began keeping records in 2004, analyst Jonathan Mott said Monday. As recently as a year ago, the nation's lenders were losing money on new mortgages....

...."Writing a new wholesale funded home loan has never been more profitable," he said in a note to clients. "If the conditions in debt and deposit markets continue to improve the banks will be in a position to pass through out-of-cycle rate cuts. If the banks do not follow suit, then the risk of 'political interference' in the sector is large."... (here)

Profitable certainly, but not without risks.  If Britain's banking sector's recent history is anything to go buy, gouging and profiteering will not protect from the coming downturn...

Australian mortgage stress - the high AUD bites?

Interesting take on mortgage delinquencies - not only are they continuing but indicating impacts of the high Australian dollar are noticeable, with stress in areas reliant on tourism (and sensitive to the exchange rate) - with mentions of the Sunshine Coast are we seeing a repeat of Florida-style stress in the US subprime crisis?

....RBA's easing of interest rates over the last few months have helped ease the number of mortgage delinquencies across Australia, but many postcodes remain on the repayment blacklist....According to a list released by credit ratings agency Fitch Ratings, overall mortgage delinquencies across Australia decreased to 1.2 per cent in September 2012, down from 1.6 per cent at end of March 2012 (here).

...Australia’s tourist and coastal areas had some of the highest levels of mortgage delinquencies, while city centers had the lowest rates, Fitch Ratings said.... A cash rate matching a half-century low helped boost home prices by 1.8 percent in January from a year earlier, after a 0.4 percent decline in 2012, according to the RP Data-Rismark home value index. The central bank yesterday held the benchmark interest rate at 3 percent, while signaling it has room to cut further, as the local currency remains elevated....“Coastal regions that rely on tourism are less affected by monetary policy and more by the high Australian dollar,” James Zanesi, Sydney-based associate director at Fitch, said in the e- mailed statement (here).

Flipside of depositholder gouging

The Reserve Bank of Australia has continued its campaign to shame Australia's large banks to pass on interest rate cuts by pointing out that the banks' argument of rising funding costs is baloney.  On the flipside however, it is interesting to note that wholesale funding costs are not getting cheaper and that this only highlights the dependence Australian banks have on overseas funding - not a great position to be in entering a currency crisis.

...The big four banks, ANZ Bank (ASX: ANZ), Commonwealth Bank (ASX: CBA), Westpac Banking Corporation (ASX: WBC) and National Australia Bank (ASX: NAB) have repeatedly cited wholesale funding costs as one of the prime reasons for not being able to full pass on the RBA’s cuts to the official cash rate....Additionally, in an election year, the banks may come under sustained pressure to pass on in full the RBA’s cuts to mortgage borrowers. RateCity estimates the banks have passed on 1.33% of the RBA’s 1.75% cuts to the cash rate since November 2011 (here).

....There has been speculation in recent months that a recent slide in wholesale funding costs would give Australian banks room to cut mortgage lending rates in 2013.....But, in its quarterly Statement on Monetary Policy, released on Friday, the RBA said bank's overall funding costs were relatively unchanged, compared to late 2012....The RBA said although the cost of unsecured and covered bonds had fallen in recent months, making it cheaper for banks to source funding though those avenues, banks were still paying higher rates for previously issued bonds (here).