Reserve Bank Governor, Glenn Stevens last night ruled out, for the time being, intervening to sell the dollar to help drive the currency’s value lower.
He again said the Australian dollar was "currently above levels we would expect to see in the medium term", a remark he has made at least half a dozen times in recent months. But this time around it was linked to discussion of intervention (buying or selling the currency to affect its value).
In a much anticipated address in Sydney, he did confirm that the question of whether to intervene "remains part of the toolkit" of the central bank.
His speech, just after 8pm Sydney time, helped knock the dollar’s value against the US currency down by around a cent to around 92.20 US cents this morning as traders realised it was the most open and direct discussion of intervention from the RBA and its Governor for years.
"Overall, in this episode so far, the bank has not been convinced that large-scale intervention clearly passed the test of effectiveness versus cost," Mr Stevens told the annual dinner of the Australian Business Economists.
"But that doesn’t mean we will always eschew intervention. In fact we remain open-minded on the issue. It remains part of the toolkit."
But there were other factors in the market yesterday and last night impacting the dollar. There was the small easing in the pace of expansion in the Chinese manufacturing sector, reported in an early look at November’s survey from HSBC/Markit, weak sentiment in stockmarkets and a feeling the US federal Reserve is getting closer to starting to reduce its $US85 billion a month of bond buying.
Some economists, business people and lazy business leaders have called for the RBA to intervene to drive the dollar’s value lower. Those calls have continued as the dollar has resisted attempts by the RBA to talk the value lower (called ‘jawboning’).
The RBA has made the very valid point that the currency’s value at the moment is too high (it should be 80 – 85 US cents seems to be the consensus value in the market) for our weakening terms of trade, sluggish economy, rising unemployment and continuing weak budget position.
But offsetting that is our AAA stable credit rating from the world’s three major ratings group, solid economy (compared to Europe and the US), highish bond and share yields, liquid markets and currency and reasonable business laws and rules.
That was seen this week when there were bids for $5.86 billion from buyers here and offshore for the first 20 year Commonwealth Bond issue. The amount auctioned was $200 million, with a yield of 4.86%, which is a fat return for central banks and other AAA rated buyers (such as big global insurers) compared to Japan, the US, Eurozone and UK.
All these favourable points, plus the quantitative easing policies of the US Fed, the Bank of England and the Bank of Japan, and the very easy monetary policy of the European Central Bank, have made the Aussie dollar a global favourite, and held the value higher than fundamentals would suggest.
And then there’s China – Australia’s biggest trading partner and therefore for big global investors, the easiest way to get set in China (either going long if you are bullish, or short is you are negative or bearish). This is probably the biggest factor of them all.
For these various reasons, the dollar’s value has remained above where the RBA reckons it should be.
It peaked at $US1.05 late last year and hit a low mid year of 88.48 when talk about the Fed cutting its spending first appeared. It then bounced back over 90 US cents and topped 95 cents earlier this month, further frustrating the RBA, which has stepped up the frequency of commentary about the currency’s value in the past month (at least half a dozen prominent.)
AUDUSD 5Y – Dollar falls after RBA reveals intervention options
Mr Stevens explained that perhaps the main reason why the bank hadn’t intervened a lot in recent years (and at all in the current period of a higher than wanted currency value) was the simple cost benefit analysis.
"A further factor relevant to intervention decisions has been cost. Intervening against the Australian dollar would have been involved selling Australian assets yielding, say, 3 per cent, and buying foreign assets yielding much less – in fact earning almost nothing over recent years at the areas of the yield curve where the Bank operates. This ‘negative carry’ would be a cost to the Bank’s earnings and therefore Commonwealth revenue.
"Now it might be argued that a negative carry for the Reserve Bank, and therefore the Commonwealth, and an acceptance of the associated very large valuation risks, would be a price worth paying, if it corrected a seriously misaligned exchange rate.
"If such a policy were effective, it could turn out to be profitable, if a fall in the exchange rate offset the negative carry. The point is simply that costs have to be considered alongside the likely effectiveness.
"Often those who argue for intervention don’t work through those costs, or they assume it would be entirely costless. That can’t be assumed and the idea should be considered in a cost-benefit setting."
And Mr Stevens made another important point – given the surge in our terms of trade in the past five years or so, what level is appropriate going forward?
"Notwithstanding that, in my view, the Australian dollar is probably above its longer-run equilibrium at present, it is far from clear that we can assume that the mean level we saw in the 1980s to the early 2000s will be the relevant one in the future.
"In evaluating the merits of intervention, the Bank has been cognisant that the current episode is unlike the experience of the first twenty or twenty-five years of the float. Some very powerful forces have been at work."
In an answer to a question after a speech made last month by Phil Lowe, Mr Stevens’ deputy, the point was made that Australian business would have to get used to the face that for the foreseeable future, the dollar could very well have a value well above its historical value.
"So we will have a higher currency, I suspect than we’ve had on average historically, and that means that Australian business needs to compete on the basis of technology, of human capital, of skills, of ideas, and so investment in education, in innovation, in infrastructure, they’re all incredibly important ingredients into that story," Mr Lowe told his audience.
"A kind of what specific policies encourage that, there are others who are better placed to do it, but the general point is a relatively higher currency than we’ve had historically means we need to compete on the basis of our minds and our ideas, not on the basis of producing standardised goods for the world market."
That’s as an important point as any Mr Stevens made last night – Like it our not the Australian economy has been changed for quite a long time by the China boom, and then the huge resources investment boom.
And, in another speech to the same conference yesterday, senior Federal treasury official, David Gruen warned that Australia faces a big drop in national income in coming years and has to find other ways of replacing it.
Dr Gruen, who is Treasury’s top forecaster, warned that Australians had to to expect income growth will halve over the coming decade to the weakest pace in half a century.
He said a combination of the weakening in the terms of trade, the accelerating pace of retirement of baby boomers and falling work force participation rates, will impact the economy and reduce growth in national income.
Getting the dollar lower will help soften the blow from that fall in income.
