Monday, November 17, 2008

The Australian Dollar

As you can see from the chart, the Australian Dollar has also lost a third of it's value against the US dollar since August (and dropped precipitously against the yen too). This despite the Aussies running budget surpluses. The Australians were due to have a budget surplus of 1.8% of GDP in this tax year, it will be less than that as they are increasing spending to offset the downturn - but they will be in a fiscally sounder position than both the Americans and Japanese.

So why are they having a downturn and why is their currency falling? Hint: it's nothing at all to do with Gordon Brown! There is a global recession going on that is effecting every country on earth. As for currency movements, hot money tends to overwhelm movements due to trade or government borrowing. (If you doubt this, ponder on the fact that the pound's value against the dollar is exactly what it was in 2002, when the Labour government was running the biggest budget surpluses since the 1940's).

Since 2002, hedge funds and other traders have borrowed in dollars and yen (which had very low interest rates) and invested in Europe, Australia, New Zealand, and the emerging economies (Brazil, South Africa etc). These loans are being called in, money is also being withdrawn from hedge funds by investors, so they are selling assets abroad (causing falls in the world markets), and then repatriating the money to pay off their loans - which is why the dollar and yen are rising.

Now, every world finance minister and their opposition counterparts know this, apart from George Osborne, who is under the impression that the forex markets can actually be controlled by governments!

No one can control the forex market, it's too big, there is too much money in it and too many players. Those who direct fiscal and monetary policy with an aim to target a certain exchange rate are doomed to failure, as Nigel Lawson and John Major proved so expensively.

If exchange rate movements make you queasy, you can always take refuge within a fixed rate system like the euro. But if you want a floating currency, you need to accept that it will move all over the place, you need to accept that you will have no control over it and you need to have enough nerve to not intervene or panic about it.

The trouble is Tories hate Europe, so don't want the euro. But they are also the biggest panic merchants out there! We saw that with Lawson and John Major, and now with Osborne. But panic and intervention combined with a floating currency system is the worst of all worlds. Intervening in currency markets doesn't work. Crafting fiscal and monetary policy with the aim to target the exchange rate instead of domestic consumption, destabalises economies.

The Tories have clearly learnt nothing from the disasters of Lawson shadowing the D-mark and John Major's ERM experiment. But we should be grateful to Osborne for letting us see now, before the general election, how clueless he is.


Anonymous said...

Since when was the Australian dollar a major currency,evermore desperate attempts to try and salvage some credibilty for this hopeless government.

Any ideas for what to do next when Brown's unfunded tax cuts don't make any difference to our recession?

snowflake5 said...

Broncodelsey - a) the point is that every currency is falling except dollars and yen (and the US and Japan have huge government debts) and b) Osborne's thesis that fiscal policy prevents your currency from falling is clearly disproved by the Australian case.

But we knew Osborne was talking out of his bottom, didn't we?

P.S. Interesting that Tories are now opposed to tax cuts for the poor. I can just see your election ads...

Anonymous said...

In case you hadn't noticed the Aussie economy is dependent on commodities, which have tanked in price. You aren't making a sensible comparison here. Yes the dollar has risen, but not by 25% against most other currencies, and more importantly you are not addressing the fact sterling is dropping against the Euro, which is our most important trading area.

Anonymous said...

After 11 years of New Labour we have poor people in our country?

So what happens when the unfunded tax bribe gets used to pay off the massive debt that most people seem to have acquired in the last 11 years and is not spent on consumption?

snowflake5 said...

devonchap - I agree the Aussie economy is slowing - but no more than the American or Japanese economies. So all things being equal, if fiscal policy was all that currencies were based on, the Aussie dollar would have held it's value. It hasn't, because the carry trade is unwinding - and the same thing is affecting sterling.

Broncodelsey - yes, there are still some poor people, though fewer than in 1997. 11 years just isn't enough to eliminate the effects of the previous hundred years. Ask me about it again in 2066.

As for debt - we haven't got a "massive debt". Indeed, even with Northern Rock's liabilities on the books, debt is less than in 1997. Given that John Major managed to double the national debt in just seven years, Tories are in no position to talk about debt.

Secondly every non-cretin knows that in a downturn private sector spending slows and govt spending is needed to pull the private sector up. Only after private sector activity is revived can the govt stimulus be withdrawn.

Cameron is proposing cutting govt spending at the same time as private spending is sinking - the same policy that idiot Tories put in place in the 1930's, which caused the Great Depression. And last week's idiot Tory idea was to use fiscal policy to target an exchange rate with the euro - something last done by Nigel Lawson with the D-mark, with disastrous consequences.

This is what the Tories have been reduced to - reviving discredited policies from the 1930's and 1980's. There is a reason that in most businesses the PR guy never makes chief executive - and that's because these presentational types find policy and strategy terribly difficult to get their heads around, as Cameron is proving.

Anonymous said...

If it is all down to the carry trade unwinding, why is sterling down against the Euro? That has nothing to do with the carry trade and more to do with the markets concerns that Britain is taking on lots of liabilities when it already has a structural deficit of 3% GDP. There is a risk that the UK could turn out to be a larger version of Iceland, as we have an overly large banking sector which is in deep trouble and the government has underwritten. If we have 1-2% GDP stimulus package and the banks come back for more money (which could happen) then that could tip sterling over the edge as the markets might not believe we will be able to pay back those debts and risk a soverign default. That woudl be game set and match for the British economy.

snowflake5 said...

Devonchap: "why is sterling down against the Euro?"

Because the euro is a (minor) reserve currency, and sterling isn't. The carry trade unwinding has also caused the euro to fall against the dollar and yen, but the fact that some people are holding it as a reserve currency means it hasn't fallen as much as sterling. But you knew that already, right?

Anonymous said...

You think that 25% of the value of Sterling was solely down to the carry trade? The fall is nothing to do with the economic fundamentals like the fact that because Britain has a financial service sector that is large in relation it economy and the credit crunch has hit that sector hardest that the British economy will grow more slowly in future. Or the high levels of personal debt in the economy (high than the US as % of disposable income) which means consumer spending will be depressed (another major part of our growth in the last 5 years), or that given the need to balance the government budget after the debt increased with the bank bail-out and fiscal stimulus government spending will have to slow dramatically after 2010-11 (the third motor of growth in the economy for the last 5 years)?
Despite what you might think currency speculators don’t depart from the economic fundamentals, they might overshoot but you can’t name one currency crisis that didn’t have an underlying economic problem with the country in question.
Osborne was never saying that the pound had to be propped up, rather than saying sterling is failing we must stop it, he was saying sterling is falling because of the economic mess we are in. Fix the mess and sterling’s slide will slow. Was some of Sterling’s slide down to the unwinding of the carry trade? Yes. Was all or most of it? No. You claim to know a bit about economics. In which case you will know that one thing is never the cause of everything. Not the carry trade, not the bank bail out, not the interest rate cut, not the recession. But together they make a dangerous environment. Britain is too much like a giant Iceland for my liking.

Anonymous said...

A nice article today in the Guardian, less pessimistic about the pound than I am yet doesn't even mention the carry trade as a reason for its decline

Are you still going to say it is all down to the carry trade?

Anonymous said...

I'm assuming that you either didn't get my previous comments or that you haven't had a chance to post them up. Anyway, more weight to my arguemnt that the Sterling is weak as the markets eye the risk of the British economy becoming a bigger version of Iceland. UK Government Credit default swaps are at an all time high, meaning the market is pricing in an increased risk of a UK sovereign default. Nothing what so ever to do with the carry trade.

Are you going to follow the PM and admit you are wrong?

snowflake5 said...

Devon chap - there is massive deleveraging going on. Massive! The fall in the value of the pound against the dollar and yen (and similar falls in the euro, aussie dollar, swiss franc and other assorted currencies against the dollar and yen) is down to that.

It's not to do with things like "high personal debt" (why then has the euro fallen against the dollar when high personal debt in the USA is a bigger problem than in the euro-zone?). It's not to do with govt borrowing either, else why would the aussie dollar have fallen against the dollar?

The currency markets are awash with hot-money, and it moves faster than money based on trade. The moves we are seeing are similar to those we saw in the commodity markets in the summer when speculators bid up prices insanely despite clear evidence that the global economy was slowing. Consumption of oil in the USA dropped 6%, but these daft speculators bid the price up from $100 per barrel in Jan to $147 in July!

The main point to accept is that THE MARKETS ARE NOT EFFICIENT!!! The best way to judge what is going on in the economy is through traditional indicators - unemployment, retail sales, manufacturing output etc etc. It's a waste of time trying to draw conclusions from the stock market, currency market or commodity markets, because the volume of speculation is so huge it overwhelms movements due to fundamentals. Those market guys are not rational, they suffer from an excess of hormones and mood fluctuations between greed and fear (they are mainly men afterall! :-)).

Osborne (and Tories) demean themselves when they use markets (which have been proven to be stocked with fools) to criticise the govt, instead of talking about economic fundamentals and traditional indicators. Osborne has a penchant for using "wild" indicators though. I recall once he used graphology to criticise the govt (or it could have been astrology, I forget).

Anonymous said...

So it was the carry trade, now it is deleveraging.

You coast over the fact the pound is down against a basket of currencies, not just the Yen and dollar.

While the markets do overshoot you don't bet against the fundamentals. If ultimately you aren't rational you won't be doing that job for long. You still can't name a currency crisis where the fault was speculators, not the country in questions fundamentals.

snowflake5 said...

"So it was the carry trade, now it is deleveraging"

The carry trade and deleveraging are connected, you doofus!

The carry trade was about leverage - borrowing in yen and dollars and investing in Europe and the developing world. The carry-trade is unwinding - deleveraging is taking place in other words! People are selling their investments in Europe and the developing world, and repatriating the money to the dollar and yen zone and repaying loans. The repayment of loans is the "deleveraging".

And yes, it's down to speculators - the same people who built the bubble in oil, built a bubble in sterling and the euro. The banks won't continue to finance their speculation any longer however.

Also, we are not experiencing a "currency crisis" - you can only experience one if you are in a fixed mechanism. And there is no evidence that the pound is too low - it's merely where it was in 1997, and hasn't really budged much for a few weeks. There wasn't really a currency crisis when sterling fell to $1.10 under Thatcher either, as sterling wasn't in a fixed mechanism then either.

Anonymous said...

I'm well aware that the carry trade is leveraged, so its unwinding is part of the deleveraging that is going on. My point is deleveraging is wider than just the carry trade, so your saying it is down to deleveraging is a wider statement than it is down to the carry trade solely. So you moved your position. As I pointed out, the weakness of the pound now isn't down to the carry trade, but our relative exposure to the economic downturn. And you can't blame speculators for that (unless it is the ones the Government encouraged in the City for the last 11 years). Talking of bubbles, how about the housing bubble this government oversaw? That isn't helping the pound right now.
A failing pound will hurt our ability to borrow to fund the deficit since the value of the repayments will decline relative to the elnders currency, so the lender makes a loss. Short term gilts are up, since the currency risk is less for them, 10 year gilts are down, since the risk is higher with them.
Of course you can explain to thr Icelanders that the collapse of the Kronur is not a currency crisis since they have a floating exchnage rate, but I think you might get short shrift.