Tag Archives: forex

Australian Dollar To 1.25 – Who Cares?

9 Mar

This article cross-posted from Lighthouse Securities, with kind permission of Greg McKenna. You can follow Greg on Twitter, and at MacroBusiness where he blogs as “Deus Forex Machina”.

Let me ask you a question.

Do you care if the Aussie Dollar heads toward 1.20 or 1.25 in the next 12 to 18 months as Australia’s alternative Treasurer Joe Hockey said the other day.

In the Sydney Morning Herald Mr Hockey was quoted as saying,

”it is not inconceivable for the Australian dollar to reach $US1.25 over the next 12 to 18 months”

I agree, it is not inconceivable that the Aussie heads to these levels not seen since the 1970′s its a low probability I think that one that has enough serious implications that we need to have a planned response for industry from government.

So I was encouraged that the SMH also reported Mr Hockey said,

It is time to carefully consider what a comparatively high Australian dollar means for key sectors of our economy.

Big tick Joe! Or at least I thought there was a big tick but then I saw that he also said,

In a warning to those in the Coalition advocating protectionism, Mr Hockey said it would not be propping up unsustainable industries.

While it was worth providing help to those industries facing short-to-medium-term pressures, such as the high dollar, industries which are proving unsustainable over the longer term for many reasons would not be saved.

While they could be eligible for such assistance as retraining or relocating workers, ”we should not, however, be in the business of propping up industries that for many reasons do not have a sustainable future in Australia”, he said.

He said the ”brutal truth” was that managers and consumers, not government, would determine the fate of individual businesses

Theoretically and politically I have probably always been to the right of centre, as I age and since I’ve become a dad I find myself moving to the left on social issues but in general I’d normally agree with the sentiment of what Mr hockey is saying above.

Certainly I welcome the fact that he is thinking about my oft mooted plan to assist companies and industries that are being buffeted by the high dollar  and in general why would you prop up other industries that are on the way out. Its my typewriter/iPad analogy I’ve used a few times now.

But what bothers me about the political class in Australia at the moment is that they take acceptable and plausible theoretical constructs and write them into stone as laws.

Take the Budget surplus at any cost pact between the two parties as an example – at a time of massive structural change in the economy, structural change that has the RBA on the back foot in managing this sports car/draft horse economy there may be, probably is a need for some support in some parts of the economy.

But no we can’t do that – Swanny and Hockey are too busy leading the war cry each morning.

SURPLUS, SURPLUS, SURPLUS, Oi, Oi, Oi.

Even if the Treasury Secretary Martin Parkinson says they are going to be “only wafer thin”

And so it is with the Aussie Dollar’s strength – we know its high because the central banks of Russia, Brazil, China and others are buying and have bought lots of Aussie. We know its high because in a moribund economic global outlook even a print of 0.4% GDP growth seems still ok. We know the Aussie Dollar is high because our interest rates are high and we know that unless or until China slows and lets their currency float the Aussie Dollar remains its proxy.

So nothing is going to be done it seems as RBA Deputy Governor Lowe pointed out the other day. Bloomberg quoted him the other day saying they are watching things,

“It is possible for exchange rates to overshoot,” Lowe said in his prepared remarks. “While the evidence of the past 30 years is that movements in the exchange rate have been an important stabilizing force for the Australian economy, the unusual nature of the current forces means that we need to watch things closely.”

But I’ve always got the sense they are glad the Aussie is as high as it is cause it reduces the pressure to smash households even further with interest rate increases. I think Lowe makes this point below,

“On the evidence to date, something like the current combination of exchange rates and interest rates appears to be what is needed to maintain overall macroeconomic stability,” Lowe told the AIG, whose members include manufacturers hurt by the currency. “The high exchange rate and the high interest rates relative to the rest of the world are both being driven by the fact that Australia is a major beneficiary of the change in world relative prices.”

Indeed Deputy Governor Lowe feels the Aussie is not misaligned fundamentally

“It’s difficult to make a strong case that the exchange rate is fundamentally misaligned,” Lowe said in response to a question from the audience after a speech today in Sydney, citing the nation’s solid economy. “That makes the hurdle for intervention quite high.”

But part of this argument I think is flawed and circular. The price of our commodity exports is largely denominated in US Dollars and the US is actively engaged in a policy of making the Greenback as weak as possible without cause it to crash. And they are succeeding in using this to increase exports as a total percentage of GDP, quite a few percentage points over the past few years.

So while they win, commodities are pushed higher in price than underlying demand warrants because the USD is weak and we just suck it up and continue the experiment all the while knowing that other nations are deliberately manipulating their currencies to their own best interests.

I even saw an article in the Atlantic last weekend arguing that currency wars are good . The author argues that beggar-thy-neighbour policies are good,

Rather than cooperating, countries are fighting over trade. But in this case, some fighting is good, and more fighting is better. Countries that lose exports want to get them back. And the best way to do that is to devalue their own currencies too. This, of course, causes more countries to lose exports. They also want to get their exports back, so they also push down their currencies. It’s devaluation all the way down. All thanks to economic peer pressure.

Nobody wins if everyone does it. But for those who are happy with their theoretical purity that seems to pervade Australia economic thinking its a death spiral for currency exposed industries.

At a time of massive structural change where, as Bill Evans said yesterday, the mining boom is simply eye watering but the rest of the economy is under intense pressure I would like to think that we wont be trying to pick winners but we might find some money to ensure that we at least give ourselves and our industry a chance for survival.

It is clear to me that the push back from the policy making and political class on this topic of the Aussie Dollar’s strength is such that they recognise there is an issue but it is also clear they are trying to manage the issue rather than deal with it.

We are a small open economy with a currency that trades far too much for our relevance in the global economy and thus there is little we can do to halt its strength. We just dont have the fire power unless we want to print lots and lots of Aussie Dollars.

So it’s not easy but it would be good if as Joe Hockey said we consider carefully what the impact is going to be on our industry, on our jobs and on the fabric of our society in the years ahead.

You’re probably sick of hearing this from me but I think at a time of structural change it is important we talk about the structure of the change and the structure that in the end results from the change. now, ex-ante not in the future, ex-poste.

Have a great day.

Gregory McKenna

Disclaimer: The views expressed in the above article are the author’s own. They should not be interpreted as reflecting any views held by Senator Barnaby Joyce or The Nationals.

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There’ll Be No EU Bailouts From China’s Empty Pockets

25 Nov

For weeks … months in fact … there’s been plenty of fevered speculative commentary about China sailing to Europe’s rescue, by using their vast foreign exchange reserves to buy up European sovereign debt that the markets increasingly distrust (thus, ever spiking interest rates).

Problem.

China’s vast foreign exchange reserves may not be so vast after all.

From Reuters via The China Post (h/t ZeroHedge):

Analysts suspect China’s forex may be weaker than perceived

Europeans searching for a bazooka to blast away eurozone debt problems might well eye China’s US$3.2 trillion foreign exchange arsenal with envy, but Beijing has far less firepower available than many assume.

Most of money in the world’s biggest store of foreign exchange reserves is prudently kept in near-cash instruments to fund import and debt service bills in the event of an unforeseen domestic emergency, or invested in long-term assets that, if sold in size to help Europe, would spark panic on global financial markets.

In fact, analysts reckon China’s armory has only about US$100 billion to spare.

“The sheer size of China’s foreign exchange reserves is massive, but the actual amount of money available for investing in Europe each year isn’t that big,” said Wang Jun, an economist at CCIEE, a top government think tank in Beijing.

A crucial constraint is China’s existing holdings of U.S. Treasury securities. Beijing is by far the biggest foreign owner, with an estimated 70 percent of the nation’s reserves held in U.S. government bills, bonds and other dollar assets.

Turn outright seller and the market value of the remaining holdings is likely to plunge.

That’s not a great investment strategy given the Chinese public’s unhappiness about the roughly 38 percent decline in the nominal value of the dollar in the last 10 years.

The government also may have to set aside some foreign exchange reserves to bailout the banking system if piles of loans to local governments and the property sector turn sour.

China injected nearly US$80 billion in reserves into its big state banks from 2003 to 2008 to help them clean up their balance sheets so they could float shares.

Shrinking Exports, Smaller Surplus

Meanwhile, China’s trade surplus, essentially the money it has to invest overseas, is shrinking as Beijing does what critics in the developed world have been urging for years and rebalances its economy away from exports.

Imports surged 28.7 percent year on year in October and the surplus of US$17 billion was well short of the US$24.9 billion forecast by economists.

Beijing holds an estimated one-quarter of its reserves in euro-denominated assets, so keeping that steady implies a US$117.5 billion increase this year if the country’s foreign exchange reserves grow by the US$470 billion estimated in 2011.

That’s roughly the amount economists expect China to invest in Europe in 2012.

“Assuming the FX reserve accumulation does not slow significantly, I think China will put at least US$80-100 billion in euro assets per year in the next two years,” said Wei Yao, China economist at Societe Generale in Hong Kong.

China recycles foreign exchange assets into overseas investments so outflows of cash roughly track inflows.

The build-up in FX reserves, a result of the central bank’s intervention to limit the yuan’s appreciation, tends to fuel inflation pressures even as the central bank issues bills to mop up the amount of local currency it pumps into the economy.

And it explains why foreign reserves cannot easily be used for domestic spending on infrastructure or shoring up pension systems, since simply converting the cash risks driving up both inflation and the value of the yuan currency.

This revelation comes hot on the heels of a similar one from a well-known Chinese economist and TV personality, who recently told a private audience that China is nearly bankrupt.

In his own words:

“Every province in China is Greece”

Our Banks Racing Towards A “Bigger Armageddon”

27 Jun

Many economists and commentators are focussed on the ongoing debt crises affecting the USA, UK, Europe, Japan, and indeed, virtually the entire globe.

But David Bloom of HSBC Foreign Exchange suggests that there is “a bigger Armageddon out there”.

And the latest RBA data shows that our banks are racing headlong into it.

From CNBC:

Investors are afraid of “Armageddon” in foreign exchange markets due to concerns beyond the Greek debt crisis and sluggish US growth, David Bloom global head of foreign exchange at HSBC told CNBC Thursday.

Bloom described the Greek sovereign debt crisis as “yesterday’s news” for foreign exchange markets, adding fresh worries were spooking investors following Federal Reserve chairman Ben Bernanke’s downgrade of US economic growth prospects for the year and his silence over further fiscal stimulus measures.

“Today’s news is will (the US) do (Quantitative Easing) and then is the UK falling apart? This is the problem that we’ve got… this is the problem that I’ve got with currencies, there’s no doubt about it that (the euro zone) is trying to cause a delay and people honestly believe in their hearts that at some stage they’re going to have to take a haircut on Greece, but is there a bigger Armageddon out there?” Bloom asked.

He added that in addition to persistent worries over the Greek crisis and the US economy, China was a fresh cause for concern.

“We’ve got the possibility of QE in the UK, there’s massive change in growth numbers in the US and now people are starting to worry about China,” he explained.

“You saw PMI numbers showing some weakness and actually Chinese interbank interest rates are going up quite substantially, so people are starting to get quite worried,” he added.

An “Armageddon” in foreign exchange markets – indeed, even just a serious bout of volatility – would spell doom for Australia’s banking system. And in turn, for our economy, given that our Government has guaranteed our banks using taxpayers future earnings as collateral.

There are a number of reasons why a forex “Armageddon” poses a critical threat to our banks.  Perhaps the primary one, is their staggeringly large exposure to Foreign Exchange and Interest Rate derivatives.

Derivatives are the exotic financial instruments at the very heart of the GFC.

Back in 2003, the world’s most well-known investor, Warren Buffet, famously called derivatives “a mega-catastrophic risk”, “financial weapons of mass destruction”, and a “time bomb”.

In essence, the type of derivatives held Off-Balance Sheet by our banks, are financial instruments used for “hedging” and betting on the direction of Interest rates, and Foreign Exchange rates. A large or unanticipated change in those rates, and our banks stand to lose.

And lose big time.

According to the RBA, our banks hold a combined $3.98 Trillion in Foreign Exchange derivatives. And a whopping $11.68 Trillion in Interest Rate derivatives.

To put that in some perspective, it is almost 15 times more than the value of Australia’s entire annual GDP:

Click to enlarge

In May ( “Tick Tick Tick – Aussie Banks’ $15 Trillion Time Bomb” ) we saw that Australia’s banks held almost $15 Trillion in Off-Balance Sheet “Business” (mostly derivatives) at December 2010.

The latest RBA figures are out, current to March 2011.

In just 3 months from December to March, our banks’ exposure to Off-Balance Sheet derivatives “Business” has blown out by a whopping $1.99 Trillion, to a new all-time record total of $16.83 Trillion.  That’s the biggest 3-month increase in our banks’ history.

By comparison, at March 2011 the banks have “only” $2.68 Trillion in On-Balance Sheet Assets. That’s an increase of “only” $19.9 Billion. In the same 3 months, their Off-Balance Sheet derivatives exposure blew out by 100 times that much ($1.99 Trillion):

Click to enlarge

You may be wondering how the banks could possibly manage to increase their “Assets” by $19.9 Billion in just 3 months. The answer? 96.4% of that increase ($19.19 Billion) is in new Residential loans.  That’s right – your loan is considered the bank’s “Asset”. Which really means, you are their asset.  Your signature on that loan document means they literally “own” you, your daily sweat and toil, for the next 30 years.

Now, does this suggest to you that our banks are becoming even more reckless? That near-parabolic rise in the chart of their derivatives exposure is approaching what looks just like the classic “blow off” phase of every trading bubble.

Certainly there is clear evidence of their becoming even more reckless when it comes to mortgage lending standards.  We saw this in data released just a couple of weeks ago – “Fresh Evidence Our Banks In ‘Race To The Bottom’ Means You Can Kiss Your Super Goodbye” (a must-read).

This is a classic sign of the near-end of a Ponzi scheme, a sign that was also seen near the end of the real estate bubbles that blew up in the USA, UK, Ireland, and Europe. The last mad rush by greedy banksters to rake in profits, before the bubble bursts.

And their losses are “socialised” by the government, on to the backs of the next X generations of taxpayers.

Now that we have learned that “Our Banking System Operates With Zero Reserves”, that Fitch Ratings considers “Australian Banks Most Vulnerable To Europe’s Debt Crisis”, and that our banks have just taken on an all-time record $1.99 Trillion in additional derivatives exposure in just 3 months, this new warning about “a bigger Armageddon” in foreign exchange markets should be considered another clear harbinger of an epic disaster to come Down Under.

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