Business Week: Santa Hockey
The Treasurer gave the RBA an early Christmas present in the shape of a $8.8 billion capital injection. Michael Pascoe comments.PT5M31S http://www.canberratimes.com.au/action/externalEmbeddedPlayer?id=d-2w6ew 620 349 October 25, 2013
Here's another thing pointing to the cunning plan behind Joe Hockey's $8.8 billion gift to the Reserve Bank this week: the Reserve board wasn't asking for it, didn't think there was any urgent need for it.
As deputy governor Philip Lowe told a Melbourne conference yesterday: “The lack of capital had not been keeping me up at night.”
Oh, it was very nice of the Treasurer to write the big cheque (and blow out this year's “Labor” deficit to nigh on $40 billion). Lowe thought it “a prudent, sensible decision” and the Reserve was in a much better position to deal with unpredictable events that might occur, yet it seems the Reserve didn't share the Treasurer's sense of urgency.
Playing the odds: Treasurer Joe Hockey. Photo: Alex Ellinghausen
But the Reserve board probably isn't as interested as the Treasurer is in playing the foreign exchange market effectively to make “his” budgets of the next couple of years look better.
Hockey is betting on the Australian dollar weakening over the next couple of years, which would mean big, fat Reserve profits from the value of its foreign reserve appreciating.
By stumping up $8.8 billion now, Hockey will be able to take nearly all of those profits as dividends. As previously suggested here, it's a classic piece of deck clearing designed to make the previous administration look as bad as possible and the new mob look good. And the odds are that Trader Joe has made a very good bet.
Lowe spelt out the Reserve's position while answering questions after his prepared speech. The rapid rise of the Australian dollar had resulted in valuation losses of more than $5 billion.
“We had been saying publicly for some time (that) it was the board's intention, desire, to rebuild that capital over time.”
Former treasurer Wayne Swan clearly wasn't listening when he forced the Reserve to hand over a $500 million dividend last financial year against the explicit wishes of the governor. Lowe observed that that distribution “was subject to quite a lot of attention”.
“The current government has decided to move quickly to the desired level of capital to make sure the bank's balance sheet is of unquestionable quality and I think that's in our collective interest because you want the central bank to have unquestioned ability to deal with a whole range of situations. The board had wanted to get to that position over time and what we're doing now is moving directly to that position.”
So the Reserve felt no particular urgency about rebuilding the reserve fund to 15 per cent of assets. It had averaged 11.8 per cent over the last term of the Howard-Costello government and had been held quite steady in dollar terms for many a year until the dollar's rapid appreciation smacked it down in 2010-11 and 2011-12.
Maybe the Reserve heavies weren't losing sleep about it because they, too, were content to bet on the Aussie dollar weakening.
Lowe reiterated the Reserve's position that it doesn't cut interest rates to try to weaken the currency, but to ameliorate the effects of a strong currency.
It's an important distinction that seems to escape much of the commentariat. Perhaps the Reserve has a more realistic view of the ability – or inability – of a cash rate nudge to move forex markets for long. As Lowe said in answer to another question:
“What's much more important for the value of the Australian dollar is US monetary policy, not Australian monetary policy. The value of the dollar moves very much in line with changing expectations about whether the Fed is going to taper its asset purchases.”
In other words, it's not about us, it's about them.
If there is any rationality left in US institutions, it's a matter of when, not if, the Fed will start tapering. When the US stops debasing its currency by $US85 billion a month, the greenback will strengthen and the Aussie will weaken against it.
That will reverse the losses suffered from the previous currency appreciation – and most of the Reserve's profit will be able to flow through to the treasurer of the day.
By how much has Hockey needlessly increased this year's deficit by giving the Reserve more than it wanted? It's possible the bank would have been content if it had just been allowed to retain all profits until the reserve level was back to 15 per cent. After all, if there was an emergency, a government with one of only five AAA-stable credit ratings across all four main ratings agencies could write a cheque just as quickly as it has done this week.
Let's err on the side of generosity and suppose that injecting a couple of billion now is wise and prudent. That would mean the Treasurer is incurring interest charges on $6.6 billion in unnecessary borrowings. With the 10-year bond rate close to 4 per cent, that means an extra interest bill of about $260 million a year – the sort of thing that used to concern Hockey, back in opposition days.
But for Trader Joe, it's a nice play. For the cost of a couple of hundred million a year that he can blame on his predecessor, it will look like he's picking up several billion dollars over the next few years. A very nice play indeed.
Michael Pascoe is a BusinessDay contributing editor.