Matisse, Fillettes Jaune RougeHere is another perspective on the US dollar carry- trade, this time from the receiving end of the dollar flows in Australia. The article is written by Kenneth Davidson for ‘The Age’; thanks to Steve Keen:
Foreign speculation on our currency is a bubble set to burst
October 26, 2009The 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. 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? 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. 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.
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.
The flows of money heading toward high- rate countries don’t find themselves supporting innovation or relief from oil depletion but for speculation in finance. Here’s another take from Andy Xie:
Before the Asian Financial Crisis, the ASEAN region was touted as a “miracle” by international financial institutions for maintaining high GDP growth rates for more than two decades. But some of that growth was built on a bubble that diverted business away from production and toward asset speculation. This developed after credit expansion, driven by the pegging of regional currencies to the U.S. dollar, encouraged land speculation. ASEAN’s emerging economies absorbed massive cross-border capital due to a weak dollar, which slumped after the Federal Reserve responded to a U.S. banking crisis in the early 1990s by maintaining low interest rates.
Back then, I visited companies in the region that produced goods for export. I found that, despite all the talk of miracles, many were making money on financial games — not business. At that time, China was building an export sector that had started exerting downward pressure on tradable goods prices. Instead of focusing on competitiveness, the region hid behind a financial bubble and postponed a resolution. Indeed, ASEAN’s GDP was higher than China’s before the Asian financial crunch; now China’s GDP is three times ASEAN’s.
China today faces challenges similar to those confronting ASEAN before the crisis. While visiting manufacturers in China, I’ve often been discovering that their profits come from property development, lending or outright speculation. While asset prices rise, these practices are effectively subsidizing manufacturing operations – an asset game that can work wonderfully in the short term, as the U.S. experience demonstrates. When property and stock markets are worth more than twice GDP, 20 percent appreciation would be equivalent to four years of business profits in a normal economy. You can’t blame businesses for shifting their attention to the asset game in a bubbly environment. Yet as they focus on finance rather than manufacturing, their competitiveness erodes. And you know where that leads.
In China, the speculation bubble arises from sterilized hot- money flows lent into asset markets by the PBOC and large, government- run banks. In Australia, the bubble is inflated by cheap US dollars sold short with the funds driving a real estate bubble. The result is the same in both countries, investments of non- existent productive return. There is nothing gained on the dollar- or- yuan flows save hollow finance profits. With the passage of time, the bubbles deflate, leaving ordinary citizens holding the bag.
One investment opportunity neglected is renewable energy. As conventional supply decreases, the infrastructure that supports the oil platform becomes stranded. This represents a significant cost as the platform provides returns for the entire economy. What is needed is a new kind of platform that is not dependent upon conventional liquid fuels.
This investment in all its guises would provide real returns to capital as well as provide employment/spending/capital formation. “Non, non,” say the energy provocateurs shaking their heads. “We must focus on consumption growth and expanding marketplaces!“
Of all the follies that will return to bite us on the collective rear end, this must be the greatest of all. We need desperately a commercial life that is less energy- dependent. We know what to do and how much to invest but the investment initiative is never made.
Instead there are carry- and hot money- trades.
Davidson notes the Brazilian approach to the dollar carry; tax capital inflow!. Brazil knows it needs to develop commercial activities outside of resource extraction. Allowing hot- money flows to drive up the Brazilian Real relative to other currencies would make Brazilian products that much more expensive in outside markets Brazil needs.
The Fed raising funds rate 2% would do the same thing applied to the source. Of course, finance would lose the greater part of its profitability and banks would fail. Whether the banks deserve to fail is another matter, but the Fed has taken the position to support the banks regardless of cost to the rest of the country.
Andy Xie suggests a large, pan- Asia free trade zone. This would assist Japan which teeters on the edge of debt- deflation catastrophe. Both Japan and China have saturated their US customer base; at the same time China needs better technology to address its greenhouse gas and other pollution problems. A trade zone outside the reach of US Peak Oil- denying ideologues might have the benefit of directing more investment toward renewables somewhere on Planet Earth.
In reality, the carry is likely to continue until it cannot sustain itself and the ideologues will lead the rest of the US off the cliff. If this wasn’t so tragic it would be farcical …