Category Archives: Currencies

Mosler on Reuters

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Round two. Constructive comments as well!

Mosler: The wrong standard

Reader Note: This is the second entry from Warren Mosler in a debate with Jim Rickards about how to fix the economy. More on the authors here. This is a response to Rickards first piece. Mosler’s first piece is here.

by Warren Mosler

Jim’s recommendations are “sound money, lower taxes, and light regulation.”

We do agree on lower taxes. My proposals include a full payroll tax holiday to support demand. And while Jim suggests a return to Glass-Steagall, my banking proposals are even more narrow and dramatically reduce the need for regulation. I also support price stability.

We also agree that the Monetarist concept of “velocity” is flawed, but our reasons differ. Jim’s derive from the long-dead gold standard where velocity is a calculation of how many times the given amount of money (gold) is used to buy and sell goods and services. Today, however, monetary expansion has nothing to do with money supply like it used to under the gold standard. The reason banks aren’t lending isn’t because they don’t have money to lend. Lending is constrained only by bank capital and the creditworthiness of willing borrowers, not by gold or any other concept of bank reserves. That’s why quantitative easing – i.e. the Fed printing money to buy securities – has no effect on bank lending.

Interest rate cuts transfer income from savers to banks, reducing overall spending. So while interest on savings dropped from over 5% to near 0%, borrower’s rates fell little if any. The wide yield spread means banks’ profit margins widened.

New Keynesian thought is also flawed, because it too presumes gold standard constraints. Today government never actually has nor doesn’t have dollars, and spends, taxes, and borrows simply by changing numbers in bank accounts at the Fed.

When it comes to the dollar, the US government is the scorekeeper. Unlike the gold standard days, the government can’t run out of money. Nor is it dependent on China to fund spending.

Under the old gold standard, taxes and borrowing did fund spending. Today taxes function only to regulate aggregate demand and to control prices. The federal deficit is merely the difference between the numbers changed upward when the government spends, and the numbers changed downward when it taxes. Taxes therefore function to regulate aggregate demand, not to raise revenue, per se. Tax cuts increase our spending power, tax hikes lower it. This is indisputable operational fact, not theory or philosophy.

Jim’s general warning is that too much spending or monetary stimulus might lead us to cross a “critical threshold where diverse actors reject dollars in a cascading collapse.” But this only applies to fixed exchange rate regimes such as the gold standard, where a weak currency results in gold outflows.

Today the dollar is a non-convertible currency. The exchange rate continually adjusts, always representing indifference levels with no gain or loss of gold reserves. I would note too that the U.S. is actively seeking to weaken the dollar vis-à-vis the Chinese yuan. Would Jim want the reverse?

Jim’s arguments are as good as gold. However, we are not on a gold standard, so they don’t apply. Today’s monetary arrangements call for my solutions to restore output, employment, and price stability.


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reuters post

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Mosler’s 11 steps to fix the economy

1. A full ‘payroll tax holiday’ where the US Treasury makes all FICA payments for us (15.3%). This will restore ’spending power’ and, by allowing households to make their mortgage payments, will fix banks from the bottom up. It may also keep prices down as competitive pressures may lead businesses to cut prices, passing on their tax savings to consumers even as sales increase.

2. A $500 per capita federal distribution to all the states to sustain employment in essential services, service debt, and reduce the need for state tax hikes. This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP would be restored.

3. A federally-funded $8/hr job and healthcare benefits for anyone willing and able to work. The economy will improve rapidly with my first two proposals and the private sector far more readily hires folks that are already employed. In 2001 Argentina implemented this proposal, putting to work 2 million people who had never held a ‘real’ job. Within 2 years, 750,000 of those 2 million were employed by the private sector.

4. Making banks utilities. The following are disruptive, serve no public purpose and should be done away with:

–Secondary market transactions
–Proprietary trading
–Lending against financial assets
–Business activities beyond approved lending and bank account services.
–Contracting in LIBOR. Fed funds should be used.
–Subsidiaries of any kind.
–Offshore lending.
–Contracting in credit default insurance.

5. Federal Reserve — The liability side of banking is the wrong place to impose market discipline.

The Fed should lend in the fed funds market to all member banks to ensure permanent liquidity. Demanding collateral from banks is disruptive and redundant, as the FDIC already regulates and supervises all bank assets.

6. The Treasury should issue nothing longer than 3 month bills. Longer term securities serve to keep long term rates higher than otherwise.

7. FDIC

–Remove the $250,000 cap on deposit insurance. Liquidity is no longer an issue when fed funds are available from the Fed.
–Don’t tax good banks for losses by bad banks. This serves only to raise interest rates.

8. The Treasury should directly fund the housing agencies to eliminate hedging needs while directly targeting mortgage rates at desired levels.

9. Homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the government at the lower of the mortgage balance or fair market value of the home.

10. Remove ’self imposed constraints’ that are disruptive to operations and serve no public purpose.

–Dump the debt ceiling – Congress already votes on spending and taxes.
–Allow Treasury ‘overdrafts’ at the Fed rather than forcing it to sell notes and bonds. This is left over from the gold standard days and is currently inapplicable.

11. Federal taxes function to regulate aggregate demand, not to raise revenue per se, and therefore should be increased only to cool down an overheating economy, and not to ‘pay for’ anything.


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Greece Sells 2 Billion Euros of 2015 Debt to Banks

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That spread for its own banks that it guarantees shows a serious funding issue.

During a period of euro weakness funding problems could become worse and spread to other euro nations.

When foreign govts. buy euros for their portfolio of fx reserves, they have to hold them in some kind of account or security. Most probably opt for eurozone national govt paper. Same with international institutional investors.

When they stop adding to their euro portfolios and/or reduce them, they stop buying and/or sell that paper.

The new holders of euro (those who buy the euros when portfolios sell them) may or may not buy that same govt paper, and the euros may instead wind up as excess reserves at the ECB in a member bank account, or even as cash in circulation as individuals who don’t trust the banks turn to actual cash. The banks with the excess reserves may or may not buy the National govt paper or even accept it as repo collateral, to keep their risk down, and instead simply hold excess reserves at the ECB.

Markets will clear via ever widening funding spreads as national govt paper competes for euros that are otherwise held as ‘cash reserves.’ The amount of reserves held at the ECB doesn’t actually change, apart from some going to actual cash.

What changes are the ‘indifference levels’- yield spreads- between having cash on your books and holding national govt paper risk. And the ability to repo national govt paper at the ECB doesn’t help much.

Would you buy Greek paper today if you were concerned it might default just because you could repo it at the ECB, for example?

Also, while Americans go to insured banks and Tsy secs when they get scared, Europeans exit the currency as they have a lot more history of hyper inflation.

That means a non virtuous cycle can set in with a falling euro making National govt funding problematic, which makes the euro continue to fall.

This happened a little over a year ago due to a dollar funding liquidity squeeze.

The Fed bailed them out with unlimited dollar swap lines and the euro bottomed at something less than 130 to the dollar.

This time it’s not about dollars so the Fed can’t help even if it wanted to.

And the ‘remedies’ of tax hikes and/or spending cuts Greece intends to pursue will only make it all worse, especially if undertaken by the rest of the eurozone as well. Fiscal tightening will only slow the economy and cause national govt. revenues to fall further, unless the taxes are on those taxpayers who will not reduce their spending (no marginal propensity to spend) and the spending cuts don’t reduce the spending of those who were receiving those funds.

And the treaty prevents ECB bailouts of the national govts. so any bailout from the ECB would require a unified Fin Min action and an abrupt ideological reversal of the core monetary values of the union towards a central fiscal authority.

This is somewhat analgous to what happened to the US when the original articles of confederation gave way to the current constitution in the late 1700’s..

Greece Sells 2 Billion Euros of 2015 Debt to Banks, Bankers Say

By Anna Rascouet and Christos Ziotis

Dec. 16 (Bloomberg) — Greece sold 2 billion euros ($2.9 billion) of floating-rate notes privately to banks, eight days after Fitch Ratings downgraded the nation’s debt as the government struggles to cut the European Union’s largest budget deficit, two bankers familiar with the transaction said.

The securities, which mature in February 2015, will yield 250 basis points, or 2.5 percentage points, more than the six- month euro interbank offered rate, or Euribor, they said. That’s 30 basis points higher than a similar-maturity Greek fixed-rate bond when converted into a floating rate of interest, according to data compiled by Bloomberg.

Greek bonds have fallen in the past week, with two-year note yields rising by the most in more than a decade on Dec. 8, when Fitch cut the nation’s credit rating to BBB+, the lowest in the euro region, citing the “vulnerability” of the nation’s finances. Prime Minister George Papandreou has been unable to convince investors he can reduce a deficit the government says will rise to 12.7 percent of gross domestic product this year, after the economy shrank 1.7 percent in the third quarter.

“Selling bonds via a private placement can be a double- edged sword at this point,” said Luca Cazzulani, a fixed-income strategist in Milan at UniCredit Markets & Investment Banking. “On the one hand, it shows that Greece can always find buyers for their bonds. But the market might take it as a sign that they only have this channel left.”

Widening Spread

Greek bonds rose snapped two days of declines today, with the yield on the 10-year note dropping 11 basis points to 5.62 percent as of 10:26 a.m. in London. It rose as much as 29 basis points yesterday to 5.76 percent, the highest since April 3.

Concern some countries may struggle to pay their debt was reignited after Dubai’s state-owned Dubai World said on Dec. 1 it wanted to restructure $26 billion of debt. The premium, or spread, investors demand to hold Greek 10-year bonds instead of German bunds, Europe’s benchmark government securities, rose as high as 250 basis points yesterday, the highest closing level since April 2. It narrowed to 239 basis points today.

The participating banks in yesterday’s private placement were National Bank of Greece SA, Alpha Bank AE, EFG Eurobank Ergasias SA, Piraeus Bank SA and Banca IMI SpA, the bankers familiar with the transaction said. Italy’s Banca IMI was the only foreign-based in the group.

Worst Performers

The government paid “generous” terms, said Wilson Chin, a fixed-income strategist in Amsterdam at ING Groep NV.

“I guess you have to pay some liquidity premium, given the sale was done at the end of the year,” he said. “I would be very surprised if they continue to use this method into the first quarter of next year. That would probably be taken as a sign the market isn’t working for them.”

Greek bonds are the worst performers after Ireland among the debt of so-called peripheral euro-region countries this year, handing investors a 3.5 percent return, according to Bloomberg/EFFAS indexes.

In a private placement, issuers offer securities directly to chosen private investors as opposed to selling them through an auction or via a group of banks.

Papandreou pledged in a speech two days ago to begin reducing the nation’s debt, set to exceed 100 percent of GDP this year, from 2012. The European Commission estimates the ratio at 112.6 percent of GDP this year, second only to Italy.

‘Painful Decisions’

“In the next three months we will take those decisions which weren’t taken for decades,” Papandreou said in Athens. He said many choices will be “painful,” though he promised to protect poorer and middle-income Greeks.

Credit-default swaps on Greece rose 1 basis point to 238.5, according to CMA DataVision, after surging 25.5 basis points yesterday. Such swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.


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oil supporting the dollar

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Crude oil below $69 is now offering even stronger fundamental support for the $US.

And it’s not impossible cash flow issues of member nations may be causing ‘cheating’ on OPEC quotas
that would ultimately show up in lower Saudi production as they try to hold price. The Saudis are currently
at about 8 million bpd, and the rest of opec could probably add 2 million bpd in production if it wanted to.
That would bring Saudi production down to a dangerously low 6 million bpd, where a drop in world crude
demand due to substitutions and output stagnation could be very difficult to match with production cuts.

The US is a large importer of crude- lower prices make dollars harder to get over seas.

And purchasing power parity already overwhelmingly favors the dollar, and there is no
domestic US inflation of consequence to reverse that, especially with now falling energy prices.

Yes, it is sometimes that simple.

Shifts in portfolio preferences can still push the dollar down but the ‘trade flows’ are the stronger force longer term.

Rising dollar = reduced S&P earnings due to translations of foreign profits and less competitive exports

The weak US consumer personal income kept low by the 0 rate policy and ‘over taxation)
will keep a lid on imports even with lower import prices.

Falling gold will quash the ‘Fed printing money’ inflation myth and reverse prices driven up by precautionary
‘inflation hedge’ allocations.


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bernanke

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Karim writes:

DOVISH-Focus largely on headwinds to growth; token paragraph (new) on the dollar; repeats the ‘2Es’ (exceptionally low for an extended period)

Excerpts

* Today, financial conditions are considerably better than they were then, but significant economic challenges remain. The flow of credit remains constrained, economic activity weak, and unemployment much too high. Future setbacks are possible.

* My own view is that the recent pickup reflects more than purely temporary factors and that continued growth next year is likely. However, some important headwinds–in particular, constrained bank lending and a weak job market–likely will prevent the expansion from being as robust as we would hope.

* access to credit remains strained for borrowers who are particularly dependent on banks, such as households and small businesses.. the fraction of small businesses reporting difficulty in obtaining credit is near a record high, and many of these businesses expect credit conditions to tighten further.

* With the job market so weak, businesses have been able to find or retain all the workers they need with minimal wage increases, or even with wage cuts. Indeed, standard measures of wages show significant slowing in wage gains over the past year. Together with the reduction in hours worked, slower wage growth has led to stagnation in labor income. Weak income growth, should it persist, will restrain household spending. The best thing we can say about the labor market right now is that it may be getting worse more slowly… a number of factors suggest that employment gains may be modest during the early stages of the expansion.

* I expect moderate economic growth to continue next year. Final demand shows signs of strengthening, supported by the broad improvement in financial conditions. Additionally, the beneficial influence of the inventory cycle on production should continue for somewhat longer. Housing faces important problems, including continuing high foreclosure rates, but residential investment should become a small positive for growth next year rather than a significant drag, as has been the case for the past several years. Prospects for nonresidential construction are poor, however, given weak fundamentals and tight financing conditions.

* The foreign exchange value of the dollar has moved over a wide range during the past year or so. When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely. We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.

* The Federal Open Market Committee continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.


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foreign dollar buying

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The possibility of announcing an exit from Afghanistan with the funds saved to pay down the deficit would be extremely popular short term and contribute to lower GDP and higher levels of unemployment over the medium term.

Those shorting dollars are selling them to foreign central banks who want their currencies weaker vs the dollar. This means it is unlikely they ever sell their dollars.

Float to lower crude prices and modestly declining us gasoline consumption would threaten the viability of the dollar shorts.

Much of this has been a reaction to the fed building its portfolio, which many presume to be an inflationary act of ‘printing money’ which it is, in fact, not.


Dollar Overwhelms Central Banks From Brazil to Korea

By Oliver Biggadike and Matthew Brown

Nov. 12 (Bloomberg) — Brazil, South Korea and Russia are losing the battle among developing nations to reduce gains in their currencies and keep exports competitive as the demand for their financial assets, driven by the slumping dollar, is proving more than central banks can handle.

South Korea Deputy Finance Minister Shin Je Yoon said yesterday the country will leave the level of its currency to market forces after adding about $63 billion to its foreign exchange reserves this year to slow the appreciation of the won. Chile Finance Minister Andres Velasco said the same day that lawmakers approved an increase in local debt sales to finance spending, a move that will allow the government to keep more of its dollar-based savings overseas and slow the peso’s rally.

Governments are amassing record foreign-exchange reserves as they direct central banks to buy dollars in an attempt to stem the greenback’s slide and keep their currencies from appreciating too fast and making their exports too expensive. Half of the 10-best performers in the currency market this year came from developing markets, gaining at least 14 percent on average, according to data compiled by Bloomberg.

“It looked for a while like the Bank of Korea was trying to defend 1,200, but it looks like they’ve given up and are just trying to slow the advance,” said Collin Crownover, head of currency management in London at State Street Global Advisors, which has $1.7 trillion under management.

The won, after falling 44 percent against the dollar in March 2009 from its 10-year high of 899.69 to the dollar in October 2007, is now headed for its biggest annual rally since a 15 percent gain in 2004. It traded today at 1,160.32, up 8.6 percent since the end of December.

‘Suffered Tremendously’

Brazil’s real is up 1.6 percent this month, even after imposing a tax in October on foreign stock and bond investments and increasing foreign reserves by $9.5 billion in October in an effort to curb the currency’s appreciation. The real has risen 33 percent this year.

“We have to be careful that our exchange rate doesn’t appreciate too much as to deindustrialize the country,” Marcos Verissimo, chief of staff at Brazil’s state development bank known as BNDES, said yesterday at a conference in Sao Paulo. “The capital goods industry has suffered tremendously.”

Russia’s Bank Rossii increased its foreign reserves by 15 percent since March 13 as it sold rubles in an attempt to cap the currency’s gain. Even so, the surge in commodities prices this year means Russia’s steps to fight a stronger ruble may “not be productive,” the International Monetary Fund said yesterday. Energy, including oil and natural gas, accounted for 69.5 percent of exports to countries outside the former Soviet Union and the Baltic states in the first nine months, according the Federal Customs Service.


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Canada ready to buy $US on weakness

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From: Mario Seccareccia
Date: Sat, Oct 24, 2009 at 10:58 AM
Subject: RE: *Canada ready to buy $US on weakness
To: Warren Mosler

Warren,


I was at a conference in Quebec City on the issue of financialisation and I just got back literally during the night because of a nasty storm that caused flight delays last night.

However, the Governor of the Bank of Canada is under a lot of pressure from the export sector to do something about the high Canadian dollar because of the Dutch disease effects on the Canadian manufacturing sector. In fact, I have been invited to participate in a conference organized by the Quebec Federation of Labour and various employers’ associations in Montreal right at the beginning of December on exactly this question of the Canadian dollar.

As you know I stand with the Bank of Canada in defending a floating exchange rate but the Bank is under a lot of pressures from both those on the Right and on the Left of the political spectrum to institute some Chinese-style low (Can) dollar pegged exchange rate! This has been an on-going battle over the last few years every time the Canadian dollar is approaching parity with the US dollar. My position has always been to advocate fiscal (and monetary) policy to keep the economy on its full-employment path and I have proposed interregional transfers to deal with the problem of the Dutch disease. But it is very difficult for them to think in those terms because of their fixation with deficit spending and also because of the high constitutional fragmentation of the country that makes a policy of interregional transfers via the taxation of provincial natural resource revenues a political hot potato in Canada. Indeed, there have been even supreme court challenges from Newfoundland and others over the system of equalization payments because of the inclusion of provincial oil revenues in the formula for calculating the current regional transfers.

In any case, as you can see, given the current downward evolution of the US dollar, this might trigger competitive devaluations much as in the style of the 1930s.

Best,

Mario


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Carney Says Intervention Needs Policy to Back It Up to Work

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CIBC Says Canada Should Consider ‘Bounded Float’ of Currency

This would help support exports. (But my first choice would instead be funding an $8/hr job for anyone willing and able to work and a tax cut to sustain domestic demand and optimize real terms of trade.)

Carney Says Intervention Needs Policy to Back It Up to Work

Oct. 27 (Bloomberg) — Bank of Canada Governor Mark Carney said today that central banks that try to affect the level of their currencies through market actions need to back the transactions with monetary policy to be effective.

Speaking to lawmakers, Carney said the bank could use tools, including quantitative easing, to implement policy with

the bank’s key interest rate as low as it can go.

Selling your own currency is the back up to your other, export oriented policy.

There is no limit to the amount of your own currency you can sell into a bid at that level.

The (operational) limit is how much the rest of world wants to buy at your selling price.

Quantitative easing has nothing to do with this.


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Roubini Says Carry Trades Fueling ‘Huge’ Asset Bubble

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Again, maybe right but for the wrong reason.

My take is the gold and commodity bubble is due to people (Roubini included) believing Fed policy is inherently inflationary – printing money and all that – when it’s not.

When those funds are done being committed, it can all end very badly in a deflationary tumble.

Roubini Says Carry Trades Fueling ‘Huge’ Asset Bubble

By Michael Patterson

Oct. 27 (Bloomberg) — Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

“We have the mother of all carry trades,” Roubini, who predicted the banking crisis that spurred more than $1.6 trillion of asset writedowns and credit losses at financial companies worldwide since 2007, said via satellite to a conference in Cape Town, South Africa. “Everybody’s playing the same game and this game is becoming dangerous.”


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Carry trade

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The article completely misses the point.

There is no ‘cash pouring into’ anything.

Nor is there a constraint on lending/deposits in any non convertible currency.

It is not a matter of taking funds from one currency and giving them to another.

There is no such thing.

Yes, the interest rate differential may be driving one currency high in the near term (not the long term) due to these portfolio shifts.

But the nation with the currency seeing the appreciation has the advantage, not the other way around.

Imports are the real benefits, exports the real costs, which the author of this piece has backwards.

The nation with the stronger currency is experiencing improving real terms of trade- more imports in exchange for fewer exports.

The most common way to realize this benefit is for the government to use the currency strength to accumulate foreign currency reserves by ‘pegging’ its currency to sustain it’s exports. This results in the same real terms of trade plus foreign exchange accumulation which can be of some undetermined future real benefit.

Better still, however, is cut taxes (or increase govt. spending, depending on your desired outcome) and sustain domestic demand, employment, and output, so now the domestic population has sufficient spending power to buy all that can be produced domestically at full employment, plus anything the rest of the world wants to net export to you.

Unfortunately those pesky deficit myths always seem to get in the way of anyone implementing that policy, as evidenced by this
article below and all of the others along the same lines. Comments in below:

>   
>   Steve Keen pointed me to it. Talks about the carry trade in US$ over to AUD$.
>   There are not Federal unsecured swap lines, would be interested in your take.
>   

Foreign speculation on our currency is a bubble set to burst

By Kenneth Davidson

Oct. 26 (National Times) — The pooh-bahs running US and British hedge funds and the banks supporting them are more than capable of reading the minutes of the Reserve Bank of Australia board meetings and coming to the conclusion that RBA Governor Glenn Stevens is committed to pushing up the cash rate from the present 3.25 per cent to 4 to 5 per cent if necessary.

And they are already betting tens of billions of dollars on what has so far been a sure bet.

But is always high risk, and not permitted for US banks by our regulators, though no doubt some gets by.

These foreign financial institutions are up to their old tricks. After getting trillions of dollars out of their respective governments to avoid GFC-induced bankruptcy – which was largely engineered by their criminal greed – because they are ”too big to fail”, they are already using their influence to maintain ”business as usual”.
Why funnel the money gouged out of American and British taxpayers into lending to their national economies to maintain employment when there are richer pickings elsewhere?

As above, these transactions directly risk shareholder equity. The govt. is not at risk until after private capital has been completely eliminated.

Two of those destinations are Brazil and Australia. Their resource-rich economies are still doing well compared with most other countries because they are riding in the slipstream of the strong demand for commodities from China and India.

Cash is pouring into these economies, not for development, but to speculate on the local currency and the sharemarket. The rising value of the Brazilian real and the Australian dollar against the US dollar has had a disastrous impact on both countries’ non-commodity export and import competing industries.

Yes, except to be able to export less and import more is a positive shift in real terms of trade, and a benefit to the real standard of living.

Brazil’s popular and largely economically successful left-wing Government led by President Lula da Silva is meeting the problem head on. It has decided to impose a 2 per cent tax on all capital inflows to stop the real appreciating further.

Instead, it could cut taxes to sustain full employment if that’s the risk they are worried about.

Arguably, the monetary strategy adopted by Stevens has compounded Australia’s lack of international competitiveness for our manufacturing and service industries, especially tourism. Since the end of 2008 our dollar has appreciated 27 per cent (as of last week). This means that financial institutions that invested money at the beginning of January are enjoying an annual rate of return on their investments of 35 per cent.

Tourism is an export industry. Instead of working caring for tourists a nation is better served taking care of its people’s needs.
And those profits are from foreign capital paying ever higher prices for the currency.

US and British commercial banks can borrow from their central banks at a rate less than 1 per cent. The equivalent RBA rate is 3.25 per cent and many pundits are forecasting the rate could go to 3.75 per cent before the end of 2009. This will increase the differential between Australian and British and US interest rates and make the scope for speculative profits even higher.

They are risking their shareholder’s capital if they do that, not their govt’s money, at least not until all the private equity is lost.
And the regulators are supposed to be on top of that.

Since the beginning of the year, $64 billion has poured into Australia in the form of direct and portfolio (share) investment and foreign lenders have switched $80 billion of foreign debt payable in foreign currencies to Australian currency. Most of the portfolio investment ($41 billion) has gone into bank shares. Banks now represent 40 per cent of the value of shares traded on the stock exchange, and while shares in the big four bank shares have increased by about 80 per cent (as measured by CBA shares), the Australian Stock Exchange Index has risen by only 30 per cent.

When anyone buys shares someone sells them. There are no net funds ‘going into’ anything.

Also, portfolio mangers do diversify globally, and I’d guess a lot of managers went to higher levels of cash last year, and much of this is the reversal. And it’s also likely, for example, that Australian managers have increased their holdings of foreign securities as well.

Foreigners have shifted out of Australian fixed interest debt and into equities because as interest rates go up, the capital value of fixed debt declines. By driving up interest rates to curb inflationary expectations and the prospect of a housing price bubble the RBA is in far greater danger of creating a stock exchange asset price bubble as well as an Australian dollar bubble. Once foreigners believe interest rates have peaked, the bubbles are likely to be pricked as financial speculators attempt to realise their gains. This could lead to a stampede out of Australian denominated securities.

Markets do fluctuate for all kinds of reasons, both short term and long term. The Australian dollar has probably reacted more to resource prices than anything else. But again, the issue is real terms of trade, and domestic output and employment.

With unemployment expected to continue to rise, and the level of unemployment disguised by growing numbers of workers being forced to work part-time, there is little chance of the underlying inflation rate, already below 2 per cent, increasing as a result of a wages break-out. The last wages breakout (leaving aside the explosive growth in executive salaries in the past three decades) occurred in 1979.

This gives the govt. cause to increase domestic demand with fiscal adjustments, including Professor Bill Mitchell’s ‘Job Guarantee’ proposal which is much like my federally funded $8/hr job for anyone willing and able to work proposal.

The world has moved on but the obsessive debate about wage inflation and union powers hasn’t. Since the beginning of the ’80s, the problem has been periodic bouts of asset price inflation. It is the biggest danger now.

Instead of controlling the unions, there should be control of financial institutions. The Australian dollar bubble and the incipient housing bubble should be micro-managed. Capital inflow could be dampened by a compulsory deposit of 1 to 2 per cent to be redeemed after a year to stop speculative inflow. Home ownership has become a tax shelter. The steam could be taken out of the rise in house prices if negative gearing was limited to new housing. This would obviate the need for higher interest rates that affect everyone.

The Job Guarantee offers a far superior price anchor vs our current use of unemployment as a price anchor. Also, I strongly suspect that the mainstream has it wrong, and that it is lower rates that are deflationary.


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