Squeezing monetary policy

Nothing unusual in politicians seeking to pull the levers of supposedly independent monetary policy with some public comments and a coming election in mind.  Question is, in the midst of a currency war with central bankers from Japan, Cyprus, Europe, UK and US all feeling the politcal heat to abandon orthodoxy and print, will Julia begin a trend of greater pressure on the RBA?

...Prime Minister Julia Gillard says that the federal government’s ‘‘tight’’ fiscal stance leaves room for the central bank to cut interest rates as manufacturers try to cope with sustained currency strength....
...‘‘Our success as a resources economy, as an economy that’s emerged from the global financial crisis strong, has meant that our Australian dollar has been very high,’’ Ms Gillard said hours after meeting with business leaders advising the government on its 2014 presidency of the Group of 20 nations..... (here)

As has been posted, Garnaut and others have discounted the comfort such statements and assumptions propagate - the Asian mining boom is ending and income and growth will drop but FTAlphaville noted another reason why this is dangerous:

Hot Money

It turns out Australia is being funded by non-conventional sources, with the implication being it is "hot" and can be withdrawn very quickly in a crisis (and quick hot money withdrawal means currency crisis and/or collapse):

...At face value, given the share of foreign companies involved, the analysis implies that around half of the investment during the boom has been funded from offshore. However, the actual use of foreign sources of funds is much higher than that. This is because wherever companies are partly foreign owned, funding from internal sources is equivalent to partial funding from foreign sources. Consequently, since the Australian listed resources sector is around three-quarters foreign owned, the same large proportion of internal funding is attributable to foreign sources.... Taking all this together suggests that around four-fifths of the investment funding has been sourced from offshore (here).

The Cyprus connection...

Australia is not Cyprus.  Professor Ross Garnaut said as much during an interview with the ABC's Tony Jones this week (more on that later).  Of course Australia is not a small country tied into an unpalatable and unfunctioning monetary union like a Mediterranean peripheral country.  So why the headline.

Well Australia is tied strongly to China and... is very dependent on offshore financing.  Since the GFC started in 2007 Ozzie banks were exposed for the relatively small deposit bases - something they have been remedying in recent years (though not without using this as an excuse to gouge depositors).  This in itself is not particularly remarkable - the Aussie dollar and bond markets have swelled with surging inflows as worldwide investors have galloped in for healthy returns and interest rates in Australia's booming economy.

But therein lies the risk - should a sudden reversal of sentiment cause a 180 degree turn and a rush of money out of the country, how exposed will #Ozeconomy be? It's hard to say but one tweet by respected economist Stephen Koukoulas raised an eyebrow.  Though justifying the current strong position there does seem to be a hint of possible future vulnerability for Australia:

All is fine for now but worth remembering that confidence is precious...

UPDATE - Bloomberg has an article indicating that foreign interest in Australian bonds is falling:

...Banks held A$76.2 billion ($79.5 billion) of securities issued by regional borrowing authorities, or 37 percent of the outstanding debt, at the end of 2012, according to data from the statistics bureau. That’s up from A$71 billion, or 35 percent, at the end of the third quarter. The share of foreigners’ holdings fell to 32 percent, the lowest level since June 30, 2009....(here)

Where it all went wrong...

Nice piece in the Sydney Morning Herald which hits all the major factors.  No one cause and no simple solution.  In particular with he banking system - as elsewhere private sector risk is now sovereign risk.

...On one half of the pincer, government does not have any choice but to aim for surpluses. This is because the federal budget guarantees Australian banks’ offshore debts, which funds much of the service sector’s growth.....The other half of the pincer inhibits monetary policy.  The lower interest rates get, the greater the likelihood that the banks will need to resume borrowing offshore to fund renewed credit expansion as deposit growth falters and credit demand climbs (here)

...In short, whatever mix of monetary and fiscal policies Australia chooses, growth will be squeezed by the legacy of yesteryear’s offshore bank borrowing binge....The only way to grow out of this in the long run is via productivity gains and/or external demand. So far that has been gifted to us by China. But to keep growing as the mining boom ends we will need to be competitive at both the fundamental and currency levels....

....Basically, Australia’s entire macroeconomic structure is geared towards a dated growth model of borrowing offshore to fund excessive and unearned income inflation. The astute might also observe that this set-up is entrenched also in both political parties....