Fariborz Moshirian

Last week’s Franco-German summit provided a foundation for deeper fiscal convergence amongst the Euro zone countries in the medium term. However, it failed to satisfy the expectations of the market which wanted to see much bolder action immediately.

The QE 2 provided ample US dollars to maintain liquidity in the market and now that this source of funds has disappeared, there are signs that European banks are seeking greater access to dollar market funds and requesting that the ECB provide them with US dollars.

The request made by the New York Federal Reserve to major banks in Europe asking them to ensure that they have adequate cash to deal with their day to day obligations in the US, in the wake of further financial turmoil in Europe, has created greater sensitivity in the market. This process has made the market nervous about the health of European banks and hence the market will focus on European banks in the coming days and weeks. This may well increase the interbank lending rate and create liquidity problems in the banking system. While some may argue that the ECB will be ready, as the lender of last resort, to ensure liquidity is not frozen, there is a limit to how much intervention the ECB can make in the market.

Indeed, there is some concern about the ability of the ECB to be able to continue purchasing government bonds from Italy and Spain over time. The ECB is acting as a de-facto Government or Treasury for the Euro zone. The ECB may continue this role if all the national parliaments of the Euro zone area do not ratify the European Financial Stability Fund’s (EFSF) mission by the end of September. However this role is unsustainable in the long term.

Both Germany and France have flagged that they do not intend to increase the funding of the EFSF from its current 440 billion Euro, as they are fearful that if they increase the amount now, the market will demand more. However, the idea of turning the EFSF into a bank and use this as a way of financing the needs of the member countries may not address the current concerns of the market. Only six European countries are still triple A rated to could ensure that the EFSF will remain a triple A fund. However, further transfers of funds from countries such as France into the EFSF may lead to France losing its triple A rating. Furthermore, the market is looking for bolder action. Merely allowing small economies such as Greece or Ireland access to the EFSF or Italy and Spain to roll over their debt in the next few years are no longer the only concerns for the market.

The Euro zone has lost its steam for generating economic growth. Greece’s economy is now expected to shrink by 4.5 this year. The German economy has slowed down. As the market is now nervous about European banks, the Euro zone leaders may have to take bolder action to either save the Euro and the Euro zone or prepare for a break down of the current monetary union.

Given Germany’s commitment to the Euro, the market is keen to see the Euro zone embrace full fiscal union and in this process allow the formation of Euro zone bonds that will be supported by all member countries. The concern is that small nations will over use euro bonds without any scrutiny, in the way they used the low interest rates of the ECB associated with monetary union, to borrow too much. However, similar to the US Federal system, Euro bonds should emerge as part of a full package that includes requiring small economies to forgo their fiscal independence and be subject to scrutiny by the EC and have a clear cap as to the amount of Euro bonds that they can use. On the other hand, larger economies may see their support and guarantee of the Euro zone bonds as a more effective way to contribute to the current financial turmoil in Europe than being forced by the market to pay more to rescue their large banks which have been exposed to the sovereign debt crisis, to provide more capital for investment, as foreign capital is fleeing the Euro zone rapidly, to spend more to stimulate the Euro zone’s sluggish economy, to spend more to stimulate their export market within Europe and be prepared to pay for a rise in the cost of capital.

The emergence of Euro bonds will create a unique opportunity for Europe to directly compete with US treasury bonds and attract much needed foreign capital to its shores. Large demand for euro-bonds may well bring its yield lower than the current German bond yield and allow for stronger economies in Europe to access cheaper capital and more investment opportunities.

German demands for an increase in the competitiveness of other member countries may not mean that they all become like the German economy. However, competitiveness could increase, if foreign capital moves back to small member countries in Europe and complement the austerity measures that are now in place in more than five countries there.

One of the underlying causes of the financial turmoil is a leadership crisis in Europe. Bold leadership on the part of Germany and France would not only address the current sovereign debt and banking crises but would also ensure that both Germany and France emerge economically stronger, and that capital will flow back into smaller economies. This will result in more consumption and spending in the Euro zone which will ultimately benefit Germany’s exports and German workers’ jobs over time.

Professor Fariborz Moshirian  is a Professor of Finance and Director of the Insitute of Global Finance at UNSW.

A version of this opinion piece appeared in the Australian Financial Review on the 25 August 2011.

Professor James Morley

The high Australian dollar certainly plays a role, however when you consider why Bluescope shut their blast furnace at this particular point of time, it isn’t just a high dollar – there are other more basic economic factors at play.

BlueScope Steel yesterday announced it was axing 1000 jobs because it had become unprofitable to export steel with the historically high levels of the Australian Dollar, and unions have urged the government to move to change this.

There is just a lot of steel being produced globally at the moment relative to expected demand, suggesting prices will be low in the future. I note the phrase ‘global steel glut’ cited by Bluescope in their announcement, which I translate as a prediction by them that they expect steel prices to be low for the next few years. The high dollar is only a small part of the story. I think the bigger bet for Bluescope is that demand from Asia (presumably China in particular) is not going to be as robust in the future, perhaps due to the recent financial market wobbles, including in China.

Bluescope are closing some parts of the operation, and mothballing others, such as the galvanising line at Hastings. It can make sense to mothball some operations and hold off on steel production until prices are predicted to be higher again. There’s no sense in producing at a predicted loss, but at the same time it cost a lot of money to build to plant to make steel, so if the plant can mothballed, production may start again quickly if there is a sudden uptick in demand.The Federal Government says it will announce further measures this week to help promote Australian products, as unions fear that thousands more jobs will be lost because of the high Australian dollar. This has reignited calls for government intervention and a cut in interest rates or a sovereign wealth fund to rein in the exchange rate. This would be a national fund to save more from the mining boom received backing from the Greens, and the Australian Industry Group.

The high dollar is partly driven by interest rates. But I doubt a cut in rates by the RBA would trigger any imminent reopening of a steel plant. Interest rates are set by the RBA who look at all market conditions – including inflation pressures. Broader economic developments for the whole country would be much more of a concern for the RBA than the closing of a section of a steel plant, even if it is painful for the local economy.

James Morley is a Professor of Economics at the Australian School of Business.

Michael Aitken

The Australian Securities & Investments Commission has extended its crackdown on the security of confidential information held by advisory firms. ASIC has also issued a consultation paper (CP145) examining Australian equity markets

Following the transfer of market supervision from the Australian Securities Exchange to ASIC, the watchdog says ‘insider’ lists obtained from advisers during investigations have revealed hundreds of people with access to confidential, market-sensitive information. A report on its market supervision function has revealed there were 35 referrals to the regulator’s deterrence team, up from 17 in the five months to December last year.

While the point is that the process is clearly more effective with the regulator operating both the surveillance technology and the investigations, the hard part in the sense of the number of false positive technology alerts that has to be investigated is doing ASIC no favours.

ASIC is working with one hand behind its back, and quite possibly two.

One hand is tied up – because there is no disclosure of client information in the trade records. This would make it much easier to profile clients and therefore spot unusual activity, and by comparison with the current means of operating would be like shooting fish in a barrel.

Secondly, another matter of prime concern is front running. This is another form of insider trading where the inside information is client trading activity. Besides insider trading (on corporate information) and market manipulation, broker-client conflict (of which front-running is the prime example) is one of three key prohibited trading behaviours.

ASIC is again working with one hand behind their back.

If brokers are not required to say if the are acting as principle or agent on the trading records, there is no prima facie way that a piece of technology can identify possible breaches which places ASIC in a worse position than with insider trading. There at least they can use the technology to give them a clue.

This all means Front Running – one of the three key prohibited trading behaviours – is not being monitored.

It would be good if Treasury took this into account when they make changes to the way the market operates such as are being contemplated under CP145.

Michael Aitken is the Chair of Capital Market Technologies at the Australian School of Business.

Jerry Parwada

There has been a mass of negative information over the past few days, and investors can’t just ignore it.

Even though Australian shares have staged a strong rally, it follows Wall Street’s sixth biggest points drop on record. Investors have dumped riskier assets on fears the US is headed back into recession and after the US was stripped of its triple-A credit rating.

Market players are looking for any signs as to the conditions they are going to face in the markets in the short term, and maybe the medium term as well. Uncertainty is stalking the market, even though there isn’t a logical reason for the markets to melt down, as the US debt downgrade had been widely anticipated. However there is a lot of uncertainty about what is going to happen in Europe, and although there are reports that the European Central Bank bought Italian and Spanish government bonds yesterday to try and stem the crisis, there is real fear. While Italy is too big to fail, it is also too big to bail out, and unless there is more belt tightening in Europe, we could see defaults there.

Overnight the Moody’s ratings agency has presented a more hopeful perspective than S&P on last week’s debt-reduction deal, which will cut more than US$2 trillion (S$2.44 trillion) from US government spending over the next decade. Moody’s says that the United States remains on a fiscal footing that is as solid as other AAA-rated countries.

The US debt downgrade will have little practical impact as the US remains the world’s biggest economy and Europe provides no alternative to US bonds as a safe haven. A rating is a measure of probability of a lender getting their money back. In this case it is an estimate that a government is going to ignore its borrowings, but there is little question of that with the US. People will still lend to the US. China will continue to buy US debts. The markets have tanked, but it is just a knee-jerk reaction to the need for information. And all the information is negative, so it has a negative effect on market sentiment.

The Australian dollar has dipped below parity, losing nearly 10 per cent against the US greenback in just two weeks. Meanwhile Chinese data shows consumer prices rose at the fastest pace in more than three years, stoking concern China will not be able to respond to weak global growth by dropping interest rates.

With all this going on, it might mean that a country such as Australia will not be immune to this unfolding crisis after all, particularly in markets for liquid assets such as equities.

Associate Professor Jerry Parwada is Head of the School of Banking & Finance at the Australian School of Business.

Jonathan Reeves

As it tries to find a way out of its debt ceiling crisis and the economic doldrums, a consequence of US policy is that inflation is being exported to the world, and that includes Australia.

Unlike the European Union, or indeed any other enterprise in the world, the US Federal Reserve has the unique ability to print more US dollars if it – and the US Treasury – deems that this is in the US economic interest.

We have had QE1, we have had QE2, and as a result of the debt ceiling compromise we may well also have QE3. The US debt deal includes major fiscal cut-backs, increasing the likelihood that the US will continue to rely on heavy monetary stimulus in its post GFC recovery phase.

It is a policy which is keeping the value of the greenback down and contributing to the record high values for the Australian dollar, a factor which is not necessarily good for our economy. Just ask the Australian education, tourism and manufacturing sectors how they are faring right now.

Inflation is a global issue and the Americans are only one, albeit large, factor in fuelling its momentum. Energy costs are rising, as is the cost of food around the world.

The reality is that US policy has intentionally devalued the $US through the mass printing of money, putting substantial pressure on the AUD$ exchange rate and the Reserve Bank’s inflation and interest rate policy.

Currently, the RBA has an inflation target of between 2 and 3 percent. Referring to this target has been a major reason why the RBA’s official cash rate have progressively risen to 4.75 percent. With a widening interest rate differential it is no surprise that the $AUD has climbed so high against the greenback, as speculators pile into a currency which – like the Brazilian real – is one of the hottest in the world right now.

All this calls into question the wisdom of the RBA’s target inflation numbers. The 2 to 3 percent per annum target is far too low in the current economic climate, and adhering to it can only exacerbate the developing exchange rate, interest rate and export issues we are currently experiencing.

Instead, the RBA should raise its inflation target to 4 percent, a move which would help us avoid some of the economic problems we have seen internationally. Raising the target would certainly take some of the pressure off the RBA to raise interest rates, and it would also take some momentum out of the $AUD’s strength.

Mining magnates may be sitting on unprecedented wealth, but a look at the rest of the economy shows that personal debt levels are at record levels – comparable to struggling economies such as Ireland. Raising rates to fight inflation would create significant financial distress and prompt sharp falls in property values, further dampening already fragile consumer and business sentiment.

Inflation at 4 percent would assist in reducing debt levels, as it did in World War II following the Great Depression.

It seems that the RBA may be mindful of this, despite maintaining its current inflation targets. Earlier this month RBA Governor Glenn Stevens said the board believed “it was prudent to maintain the current setting of monetary policy” in view of the “acute sense of uncertainty in global financial markets over recent weeks.”

The RBA has not raised rates since November 2010, and inflation has been creeping upwards and currently sits at 3.6 percent. Officially amending the inflation target would take the wind out of ongoing expectations of a rate rise and could prompt some easing in the value of the $AUD.

At 3.6 percent, Australian inflation is not high by current international comparisons and does not pose as much of a threat to our economy as record highs for the currency. Given two “evils” – inflation or an appreciating currency – it is clear that our current level of inflation is by far the lesser evil of the two.

In fact, tolerating a higher level of inflation could be the key to helping Australia navigate the turbulence of the global economy.

Dr Jonathan Reeves is a financial economist at the Australian School of Business at the University of New South Wales.

A version of this opinion piece appeared in the Australian Financial Review on the 9 August 2011.

Professor Neal Stoughton

Bad economic news over the past week has led some analysts to worry that the United States and hence the world is on the brink of a new economic downturn.

However the downgrade will have little practical impact as the US remained the world’s biggest economy and Europe provides no alternative to US bonds as a safe haven.

The downgrade of the US credit ratings on Friday by S&P is mostly cosmetic.  US bonds were already on ‘credit watch’ status, which has now actually been removed, although that has received little attention. The prospect of a real default by the US on its debt is remote.

There is still some room for manoeuvre, by engaging in yet more Quantitative Easing – or printing more money to ease an ongoing credit crunch. Unlike the European Union, or indeed any other enterprise in the world, the US Federal Reserve still has the unique ability to print more US dollars if it – and the US Treasury – deems that this is in the US economic interest.

The G7 group of major industrial powers has pledged to take whatever action is needed to stabilise the market, including a third version of Quantitative easing, or QE3.

It is far easier to simply inflate the money supply which results in a ‘soft default’ whereupon US dollars are devalued.  Given that yields on long term treasuries are still extremely low by historical standards – despite the ratings downgrade – the impact of having to borrow at slightly higher interest rates is very small.

Consider the comparison with Italy which is now having to borrow at around 6% yields which causes much more pain on its fiscal budgets. Therefore the upshot of this S&P ratings downgrade is not that significant in the scheme of things, especially when compared with the real crisis going on in Europe, which has comparatively greater issues.

Professor Neal Stoughton is the inaugural Macquarie Group Chair in Financial Services at the Australian School of Business.

Professor Fariborz Moshirian

The politicised handling of the US debt ceiling cap has highlighted its implications for global financial stability, the US interest rate and the pace of economic growth. This  is contributing to the gradual emergence of a new global financial landscape in which the US dollar may no longer remain the key world reserve currency in the medium term. In addition the US dollar could decline in value, and less foreign capital move to the US. Euro zone countries and some Asian countries, particularly China, appear to be the main beneficiaries of this gradual change in the structure of the International Financial System.

Given the slower than expected US economic growth and the high level of unemployment, investors are aware that US government revenue may not increase fast enough to tackle the size of the US government debt in the medium term. Some of the current investors may well move away from US denominated assets over time. One scenario could be an increase in US bond yields, as a way of encouraging more investors to hold US treasury bonds. However, this in turn may reduce the pace of economic growth in the medium term. On the other hand, if investors shy away from US assets, another scenario could be that the US dollar should substantially decline to ensure that the US can significantly increase her exports and reduce her imports as part of repairing her budget deficit in the medium term.

China is the largest US bondholder. She has kept purchasing US bonds, partly because this will keep US interest rates lower and ensure stronger economic activity. This in turn will assist China’s exports to the US and also ensure that China’s largest debtor maintains her capacity to repay her loans.  However, China is no longer buying US treasury bonds (ie with 10 years or more maturity) but has been investing in US treasury bills and notes with short term maturity instead, as China diversifies her international portfolio and allows for greater flexibility to exit from US denominated assets.

In the short term, there is no alternative to the US dollar as the most important world reserve currency. Nevertheless, investors have already refocused their attention to short and medium term assets of emerging countries such as Brazil, China, India that appear to be secured at least in the foreseeable future. In the meantime, the debt ceiling crisis in the US has provided an incentive to both the European and Chinese leaders to create a more secured investment environment for foreign governments, companies and large private investors to redirect some of their US denominated assets into European and Chinese denominated assets. The Euro and China’s Yuan, in the medium term, may well take away a portion of the current 61 percent share of the US dollar foreign exchange reserves and also calve into the current 84 percent of foreign exchange transactions that are generally trades of national currencies for the US dollar.

BRIC (Brazil, Russia, India, China) promoted a global currency away from the US during the recent GFC. However, in the process of negotiations within the G20 for “ strong, sustained and balanced” economic growth, such an idea was not pursued. However, the recent US debt ceiling crisis has highlighted the potential for the IMF Special Drawing Rights (a basket of four major currencies) as one of the mechanisms to diversify the current world currency reserves. BRIC and South Africa have entered into a swap agreement amongst themselves so that they can settle some of their major trades without the use of the US dollar.

While China’s Yuan is not yet a major international currency, the way the debt ceiling cap in the US has been handled may encourage China to fast track the process of converting Yuan into a trading currency, an investment currency and finally a world major reserve currency. The Bank of China is active in accepting Yuan-deposit accounts in the US. Thousands of Chinese companies are using Yuan for their cross border settlements. The Yuan denominated “dim sum” in Hong Kong is used by and increasing number of foreign firms.

The recent sovereign debt crisis within the Euro-zone has been used as an opportunity for Euro-zone leaders to tackle the mismatch between a European monetary policy and  nationally based fiscal policies. Undoubtedly, a number of financial challenges still need to be resolved in Europe.  The recent support by Germany to finance the European Financial Stability Fund generously and make this fund an active source of credit for the various needs of the member countries, has provided a new impetus for the Euro as a credible currency and may well accelerate the process of the emergence of Euro bonds, supported by all Euro-zone governments, as secured and effective assets that can directly compete with US treasury bonds.

The current political debate in the US regarding the debt ceiling cap has created a new global financial landscape that will gradually lead to a more diversified world currency reserve, away from the US dollar as the dominant one. Depending on the way US economic growth and unemployment rates evolve in the medium term, foreign investors may move away from US denominated assets and pave the way for the gradual emergence of a new international financial system with a world currency that is independent from any national government’s  fiscal, monetary and political policies.

Fariborz Moshirian is Director of the Institute of Global Finance and Professor of Finance at the Australian School of Business, UNSW.

A version of this opinion piece first appeared in the Australian Financial Review on 3 August 2011.

– Professor James Morley

Maintaining the policy interest rate at 4.75% appears to be more appropriate than raising or lowering the rates. However, there is currently an unusual amount of uncertainty about the most appropriate level for interest rates.

The Reserve Bank of Australia is due to hold its monthly board meeting today, amid conflicting economic indicators. Business and consumer confidence have dropped while inflation accelerated last quarter to the fastest annual pace in three years.

Because there are lags between the implementation of a monetary policy and its effects on real economic activity and inflation, policy should be forward looking and consider all possible scenarios for future economic conditions. The forecasts for these conditions are currently very mixed.

Last week the ABS showed that consumer prices gained 3.2 percent in the year, however a gauge of Australian manufacturing released today dropped to a two-year low in July.

I put the highest weight on maintaining the current rate, but also place more weight on an increase than a decrease in rates.

The near-term outlook for inflation is mixed. Headline inflation is running above the target range, but should be expected to fall back into range within the next year as the large increases in food prices due to the Queensland floods ease. Also, the large increase in world oil prices has eased somewhat in recent months. At the same time, the low unemployment rate suggests limited slack in labour markets and only a small downside risk for underlying inflation.

The near-term outlook for real economic activity is dominated by the strong growth of exports to fast-growing Asian economies and the concomitant investment boom in the mining sector. The high Australian dollar somewhat mitigates the overall upside risk of an export-led boom. Also, consumer sentiment and retail sales have shown some recent weakness, which can be expected to persist over the near term. There is also a small, but non-negligible risk that debt crises in the United States and Europe will have contagious effects for the entire world economy, including for Australia. A recent rise in unit labour costs of wages relative to productivity suggests some upside risks for the impact of real-economic activity on inflation.

James Morley is a Professor of Economics at the Australian School of Business, UNSW.
He is also a member of the newly-established Shadow RBA Board. Made up of senior Australian economists, the shadow RBA board pilot project runs from August until October with each round occurring on the Thursday before the decision by Reserve Bank of Australia board. Each Shadow Board member reports percentage weights on what he or she believes to be the most appropriate interest rate.

Gordon Mackenzie

When planning for one’s own death, it isn’t wise to depend on handing over superannuation funds to beneficiaries.

Spouses and children face the prospect of significant tax bills upon the death of a parent or partner following a ruling by the Australian Taxation Office.

The ATO ruling clarifies the manner in which pension assets will be treated following a death, and mean that private pensions are no longer tax-free upon the death of a pensioner and that any beneficiaries will have to pay capital gains and income tax on the assets.

What we are seeing with this ruling is the view that super funds should not be used for estate planning purposes.

If a death benefit is paid to someone other than a spouse or dependent child, the taxes in the fund and when the benefit is paid reverse the tax concessions that the deceased got for using a super fund in the first place.

What that means is that benefits paid to non-dependant adult children, say, will be taxed at an effective tax rate of 31.5%, (or 16.5% on capital gains). That rate is, broadly, the tax rate that most Australians would have paid had they not used a super fund on that account balance. So, in that way the tax concessions for using a super fund are recaptured.

Gordon Mackenzie is a Senior Lecturer and Program Convenor at the Australian School of Taxation and Business Law at the Australian School of Business. Gordon Mackenzie has given submissions to Henry Tax Review Panel on Resolving the Tax Inefficiency of Losses, and the Cooper Review on Tax Governance of Superannuation Funds, into the structure and operation of Australia’s superannuation system.

Professor Fariborz Moshirian

There is a lot of concern about the deadlock in Washington’s debt negotiations – and it is really uncertain whether the US can hold on to its triple-A credit rating.

Until this week there was confidence that a US debt-ceiling compromise could be reached in time to stave off a US credit downgrade or other damaging outcomes, however talks to resolve this have now dragged on, amid political posturing on the US budget debate, and it is possible the world’s largest economy would default and lose its prized triple-A rating.

The International Monetary Fund has called on US politicians to urgently raise America’s debt ceiling, as both parties dig in and the August 2^nd deadline for a possible default on the nation’s debt looms. With only a week left to reach agreement on a plan to raise the debt ceiling, the parties appear as far apart as ever, with each offering competing budget proposals in Congress to cut spending.

However, the US has no choice but to compromise. A default would be catastrophic for the world’s financial markets. The US dollar was once the world’s safe haven currency. Now that is looking ever more uncertain.

Looking at the other worldwide debt crisis in Europe, there is a leadership crisis within the euro zone. Germany and France now are showing more determination to address the underlying causes of financial crisis and they realise that their economic prosperity lies in prosperities of other euro zone member countries. The leadership and political process has been very difficult simply because the eurozone, unlike the United States or Australia, doesn’t have a federal government.

There is though, some reassurance for those in Australia. While we should be concerned about the position in the US and Europe, our investment banks are in a better position, but the future here is still dependent on the US economy. We need the US to come to a resolution in the debt negotiations.

Fariborz Moshirian is a professor of finance at the Australian School of Business, University of New South Wales.