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.

AUD is not a reserve currency...

An interesting side issue from the currency war debate.  In talking up the likely devaluation of the Aussie dollar, Debelle mentioned its widespread holdings among central banks.  It is true that hot money, including from central banks has been attracted to Australian bonds, with Australia seen as a relative safe haven, having high interest rates and good metrics.  

First thing to note is that metrics are degrading.  Swan's budget is sinking into deficit like a dead dodo (estimates are sinking to $15 billion here).  This means less incentive to hold Aussie dollar bonds.

But more significantly, Australia is a very small economy.  The argument made previously for not intervening is that Australia's debt markets and central bank are too small to counteract global flows.  Overall, thanks to mining plays, Australia's dollar has the character of an emerging market currency, once hot and decoupled from atlantic turmoil, now facing outflows.

Unlike China, which cannot sell parts of its massive holding of treasuries for fear of wiping out its remaining holdings, there is no reason why all those central banks Debelle is talking about will feel inclined to keep their Aussie bonds.  Debelle said:

....There's no limit on our ability to supply Australian dollars...we have more Australian dollars than anyone else in the world because we print them," he added, pointing out that Switzerland had successfully capped the value of the Swiss franc against the euro since 2011....(here)

Firstly there is no comparison between Switerland and Australia in terms of the size of their fx markets or Switzerland's proximity to the Eurozone.  Secondly and more importantly, who will even want Aussie dollars in months and year's time? 

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).

Cash in the attic...

...will be better than cash in the bank after 3 years...

....HOUSEHOLDS face losing up to $109 million from their family savings as the Federal government moves to seize cash from inactive bank accounts....After legislation was rushed through parliament, the government will from May 31 be able to transfer all money from accounts that have not been used for three years into their own revenues....

"It is very hard to see why this needed to be rushed through but there have been suggestions it was done more for the government's own financial circumstances rather than customers needs," he said.....Mr Munchenberg warned that unaware customers face having accounts frozen and could face months of delays trying to reclaim their won money from ASIC.....This cash grab comes as economists warn the government is on track to hand down a $15 billion budget deficit in May as company tax receipts collapse....(here)

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...!