RBA takes the initiative sqeezes banks into gear?

This column has dwelt before on the RBA and the fundamental dilergence between the inflated Treasury information it is given and conditions in reality.  For some time now we have argued that the RBA was in denial about impending weakness in the economy, the banking system and the mining boom.

In case you missed it the contrarian view was that despite appearances, the economy is weak, the banking system is undercapitalised and the mining boom evaporating more quickly than most realised.

After previous speeches essentailly committing Australia to an ostrich policy of head in the sand isolationism, RBA Governor Glen Stevens, as this macrobusiness.com.au article explains performed an about turn and signalled accomodative monetary and fiscal policy.  Or to put it another way after denying the currency war and gathering global slump would affect Australia, Stevens now took aim:

This is a remarkable statement. Although its content is ambiguous about how effective the RBA sees its power to lower the exchange rate, the import of the analysis is that only a lower currency can deliver a ‘sustainable rebalancing’. Truly this is an epic volte-face by the central bank which was, until recently, still encouraging Australians to think of a high exchange rate as a historic boon that was here to stay. It’s not done for the central bank to say it was wrong but it sure is implicit.
...The point is it’s an economy operating at stall speed, with rising unemployment and falling business investment. Into this mix we must throw one more probable outcome....
There is a significant risk that the terms of trade will fall further and faster than Treasury forecasts (here)

And across town the banks are being squeezed hard.  Not only with a deposit levy (a form of negative interest rates to an extent, to encourage spending?) which will likely impact on capital, but also in a seeming prodding of banks to come good on interest rate cuts.  Unusually (and perhaps for the first time ever seen by this reviewer) one of the major banks has passed on and then exceeded a rate cut - could this even be too risky by the banks?  Who knows?  Certainly the dressing of the step us as "showing confidence" is absolute baloney! (here)

An optimist reassessed

It has been very interesting to read the changes in tone from respected Ross Gittins in his publications in the Sydney Morning Herald.  Gittins is a respected economist and long term contributor to the Herald and often takes an alternative viewpoint on issues.

So it was not surprising that as recently as June Gittins was still in the boom times camp (or boom times are coming again camp):

In other words, it's wrong to imagine the boom's about to leave us high and dry. Mining production and exports have a lot further to grow in coming years. Even the fall in imports (which constitutes a reduction in their negative contribution to growth) is linked to the boom: reduced investment in new mines means reduced imports of capital equipment (here)

An observer looking globally would conclude that in fact the boom is about to leave and right now is leaving all emerging economies high and dry as has been seen by the plunging currencies and poor statistics of high growth favourites like South Africa, India, Mongolia and Brazil being reported recently.

What a change then a couple of months makes:

Stevens warned that, in our efforts to get economic growth back to its trend rate of about 3 per cent a year - which is necessary to stop unemployment continuing to worsen - ''the challenges ahead are substantial''. What's more, those challenges will continue for ''the next few years''.

His speech explained those challenges. You know the basic problem: ensuring the rest of the economy takes up the slack as the stimulus from the mining investment boom tails off...

It turns out that, in our present circumstances, low interest rates don't pack the punch they used to, so we're not going to get as much increase in activity as usual.
Why not? Because, Stevens reminds us, we're not just coping with the aftermath of one boom, but two. The other is the end of the ''credit boom''.
… we should not expect a return to the sorts of growth seen in the 1995 to 2007 period' (here).

Now that's a turnaround!  If the Australian economy could rebound to such a degree (in the opposite direction), it would...oh no it won't!

Unintended Consequences

Not a phrase central bankers would like to associate with.  

Just this week, shrugging off questions about his time at the head of the Finance Ministry when it entered into the budget flattering derivatives which have now been revealed to have lost the Italian government about $8 billion, Mario Draghi was able to team up with fresh faced new Bank of England Governor Mark Carney to talk markets up and interest rates (and currencies) down.  So far, so forward guidance (link here, although the FT was more sceptical, feeling a short term effect before rising US rates markets took the stage again).

In complete contrast Australian central bank governor Glenn Stevens had a proverbial foot in mouth moment (exacerbated by his deputy) - telling a "joke" about how much the rates committee had deliberated about holding interest rates at their last meeting (although with the door left open for likely declines soon).

The Reserve Bank of Australia’s deputy governor has been speaking on Thursday. Sadly there were no jokes but Philip Lowe did attempt to explain his boss’s side-splitting gag. 

RTRS – RESERVE BANK OF AUSTRALIA DEPUTY GOV LOWE SAYS BOARD DID DELIBERATE FOR VERY LONG TIME, BUT ALWAYS DOES
RTRS – RBA’S LOWE SAYS GOVERNOR’S REMARKS WERE MEANT TO BE LIGHT HEARTED, WERE MISINTERPRETED 

But some people still don’t get the joke (which you can find on the RBA website).
Here’s a furious ANZ. 

"The Australian Financial Review reported an RBA spokesperson confirmed the RBA Governor’s comments yesterday that the Board deliberated for a very long time on Tuesday (before doing nothing) were meant as a “joke”, rather than a steer on policy. Presumably, however, the Governor would not be unhappy with the further fall in the Australian dollar to a new recent low that occurred partly as a result of this particular remark, but no doubt also as a result of the sober assessment of the challenges facing the economy in transitioning to other sources of growth amid considerably weaker mining investment over the next few years. 

The “joke” was important in our decision to add a further rate cut in August, changing the probabilities of an earlier move in our view (we had still been expecting a further cut later in the year). Given this information has been shown to be false, we should revert to our view of the day before yesterday that the RBA will cut rates again, but probably not until slightly later in the year as, for now, the currency is doing much of the easing work for the Bank and that the bias of risks for Australian official interest rates in 2014 is still assessed to be to the down side....(here)

Most would agree this has all gone a bit overboard.  But it raises a couple of points:

i) as noted in the quote Governor Stevens' statements were much more effective than many previous deliberatons in lowering the exchange rate (which has been a key objective with Australia finally entering the currency war of countries seeking to devalue their currencies).

ii) but central banker's main tool regarding market sentiment is their comments and misusing the tool could weaken it and cause adjustments by market participants (in the above quote ANZ is one example of such a participant).

iii) while the falling Aussie dollar is broadly welcome for Australia, it is not a fait accompli, if the dollar were to fall quickly, in adverse circumstances, it could trigger a loss of confidence which could exacerbate a crisis (such as might occur if there is a sudden withdrawal of hot money, or another meltdown in a big market nearby in Asia).  To lose control of the direction or tempo of currency policy would be a failure of the RBA (and currency management is a de facto remit of central banks in the era of currency wars).  High pitch fears of bears for the Aussie dollar (predicting future lows of US 75c are starting to resonate for some (here).

iv) even if there are no adverse outcomes, the overworking of the Governor's comments may blunt them as a tool in future (with market participants less responsive), making it harder for the central bank to steer policy in a crisis.  Which could be a big concern indeed..

A petition to Glenn Stevens

Rumoured at one point to be the highest paid central banker in the world, Glenn Stevens, has been reappointed as governor of the RBA.  As his second three year term commences, we would like to petition Governor Stevens in respect of the following items which we believe must be addressed urgently:

1. The mining boom is over.  Stop twisting monetary policy to suit this bloated sector and start to focus on the ailing real economy.

2.  Admit the obvious and stop ignoring the currency war.  It is foolish to maintain one's head above the parapet.  All central banks are engaged in debasing their currencies.  The textbook has been ripped up and it is now beggar-thy-neighbour policies.  Ignore this at your peril - the high AUD is hollowing out the economy.

3. Accept that Australia is flooded in hot money which will withdraw in a hurry when yields return to normal.  Reread point 2 in respect of the high AUD.

4. Prepare for vaporisation of the banking system.  The safety in conservatism of the banking system is a myth (and that means the liquidity facility will be used for solvency).

5. Taking account of conditions in Australia and observing overseas, true inflation is much higher than official figures and should be dealt with accordingly.  Australian's purchasing power is soon to erode and quickly.

That's five big points to tackle Glenn.  If you have others, please comment or send an email to feedbackformhere@googlemail.com

Liquidity v Solvency again

One man's assistance is another man's bailout...

In the world of bank recapitalisations little is clear and labels are important as substance.  Of the many banks which imploded or suffered from the ongoing implosion in Europe, a vast number had been given a clean bill of health by the European Banking Agency during post-2007 stress tests.  In fairness the tests were focussed on liquidity management (liquidity strain being identified as the immediate cause of failures of banks like Bear Stearns and Lehman which kicked off the crisis), while as many now know (except it seems the heads of the EU and the ECB, the crisis has morphed into one of solvency - banks just don't have enough capital in general (as opposed to immediate funds to hand and agreed credit lines to see off a sharp rise in demand for return of funds).

And so it is that the same debate is playing out in Australia in respect of its new bank liquidity facility.  As noted several times in this blog, this has been characterised as a backstop, a safety measure which should not have to be used, or if used, only to cover temporary liquidity demands.  Taking this at face value there are fair questions to answer, but interestingly Michael West had an article out where he disputes the purpose - that the facility is in fact, simply a bailout fund from the RBA - with the suggestion being that Australia's banks are much weaker than they represent.

Over to Michael:

...Glenn Stevens doesn't think it's a bailout fund. It's a Committed Liquidity Facility - the $380 billion in Reserve Bank rescue money, sorry ''liquidity'' that is, which the banks can access should they find themselves in strife....Under this thingamajig, one must select one's words with care, if you are a bank and you are about to bite the dust then you can forget about a bailout. If you are even tempted to whisper the word bailout, snap out of it!...

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...If, however, you encounter ''an acute stress scenario'', why not shimmy on down to Martin Place - but only if you need a little something to facilitate your liquidity in a committed kind of way - flop out the old paw for a spot of lazy taxpayer liquidity, say $20 billion, and Bob's your uncle. Or rather Glenn's your lender. This is no freebie. You will pay dearly - a heinous 40 basis points over the official cash rate....

...Yes, you can only access this exciting opportunity if you are a bank and you are ''illiquid'', but not ''insolvent''. It is beyond this mere chronicler to explore the fathomless schism between a bank that finds itself illiquid and one that finds itself insolvent....(here)

This is not too different from some schemes tried elsewhere and the main message from the crisis in other jurisdictions is that early recognition and writedown of bad banks is necessary (this is the difference between the US and EU response).  Given that thanks to the EU, we are now in a world of depositor bail-ins (with New Zealand and Canada indicating they are considering such contributions so that bondholders, depositors and all sorts of creditors likely to be hit if a bank fails), the strong suspicion is that, notwithstanding the arrangements discussed beforehand, any stress at a major Australian bank will be messy.

RBA in numbers

Interesting data out via a Bloomberg FOI request (via FT Alphaville).  Some detail of foreign holdings of AUD (in particular central banks) and the way RBA goes about determining the extent of overvaluation.

....The staff's preferred model is based on the long-run relationship between the real exchange rate and the terms of trade and the real policy rate differential with the G3 (US, euro area and Japan) over the post-float period. It suggests the exchange rate is around 5 per cent overvalued.......While the bank has signalled that the dollar has been a factor in deciding recent rate cuts, and there's been a bit of 'passive intervention' with a chunk of foreign currency, so far it does not seem to have done much....

...We have to wonder how much of the central bank's low-key response to the AUD's overvaluation is because officials genuinely think the Australian economy can cope, and how much of it is because doing anything about it is too damn difficult. The RBA is already in a cutting cycle but slashing rates very low would risk inflation. Going Swiss is not an attractive option for small economies that have inflationary pressures; as the New Zealand central bank governor outlined last week....(here)

Fair enough but what is likely disturbing is that there are well a couple of assumptions in play, particularly that i) the high AUD hasn't had an impact yet (arguably it has) and ii) the RBA still has control of its currency

...In that scenario, how long might it take before even a 'moderately' overvalued currency takes its toll? We also can't help noting that the central bank of New Zealand, a much smaller economy in a very similar predicament, has decided that despite the risks it is time to go a little harder by explicitly threatening intervention .... RBA governor Glenn Stevens says that if things get really bad, a strong Australian dollar probably would cease being a problem....

What if the AUD doesn't fall or falls very abruptly?  There is a currency war after all. And in case you are wondering whether imports (including outward tourism) are on expanding too rapidly, symptomatic of an overvalued currency, then read this.

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...!

RBA's Glen Stevens doesn't get it!

...Reserve Bank Governor Glenn Stevens does not think Australian house prices are unreasonably high and does not believe they will drop. Nor does he agree that we have a price bubble (here).

Using price-to-income ratios - a gauge of affordability - and price-to-rent ratios, The Economist suggests home prices are overvalued by about 25 per cent or more in Australia, Belgium, Canada, France, New Zealand, Britain, the Netherlands, Spain and Sweden (here).

“Property booms are never driven by supply and demand – they are driven by credit. And credit is the pretty hand-maiden of debt,” he told a room of about 300 people at the ticketed event....“It screams to me – running naked down Darling Harbour – that this property market is overvalued,” he said. (here)

The AUD at this very moment is hollowing out the economy – anyone not believing that should go have a chat with any exporting or import competing company and see if they are looking to take on more people and have more work, or are easing back.... .....Now cast your eyes to Australia’s banks. They are a significant factor in the overseas borrowings. They know that they can get overseas funds which are looking for a yield, and that they can place those funds in Australia. ............Bank lending, particularly for mortgages has helped inflate Australian housing prices to insane levels. The mortgages taken out by Australians have helped push their private debt levels to global highs. Current private debt to disposable income is circa 145%, mortgage debt to GDP is about 85% (here).

Australia in denial about currency war...

...THE entry of Japan into the global currency war -- a kind of echo of its bombing of Pearl Harbour in December 1941 to enter World War II -- presents a fresh challenge for policymakers everywhere, but especially in Australia......But it's against the Australian dollar that the yen has fallen the most. The Aussie has appreciated 19 per cent against the yen since October but only 3 per cent against the US dollar...(here).



...Australia's economy requires "active management" this year to offset the slowing mining boom and the high value of the Australian dollar, said a board member of the Reserve Bank of Australia, or RBA, in an interview Wednesday.... Heather Ridout, one of nine policy setters on the RBA's board was speaking ahead of the first meeting of the central bank this year scheduled for Feb. 5, when concerns over the persistent strength of the Aussie dollar above parity with the U.S. greenback will again be in focus. Some 1.75 percentage points of rate cuts since November 2011 have failed to ease ...(here).