Australia’s Needless Foreign Borrowing

no telling where the money went
Creative Commons License photo credit: Adam_T4


Michael Hudson and Shann Turnbull*


           
Confronted by the global financial crisis that is burying foreign economies deeper in debt deflation each month, Australia needs to protect itself – indeed, to liberate itself from as many costs and risks as it can. Fortunately, many of its costs and risks are unnecessary, merely a result of the inertia of old ways of thinking.


Australia has the means to protect its growth and to keep more of its income at home. But if it is to remain immune to the GFC meltdown, it must escape from the risky environment of foreign financial dependency. This requires new arrangements to take account of the rapidly changing character of credit.


Foreign credit is the most obvious yet also most needless form of Australian dependency today. It is created without cost on computer keyboards in Japan, the United States and Britain and lent out at LIBOR rates as low as 1% to arbitrageurs buying Australian securities yielding at least 4.50% and rising. The 2 or 3% arbitrage gain is a free ride for speculators – at Australia’s expense.

Over and above being a domestic expense, it must be paid in foreign exchange. This repayment will cause future pressure to drive the A$ back down, perpetuating Australia’s roller-coaster exchange rate cycle.


There is a widespread impression that if Australia created a similar amount of credit at home, this would be inflationary. That may be true – but it is more inflationary to allow foreigners to manufacture credit and add an interest charge that domestic credit creation could avoid.


More immediately, the flow of foreign credit creation into Australian securities and loans to Australian banks pushes up the exchange rate. This makes Australian labor, products and services more costly in world markets. The strong dollar already has prompted companies to warn of lower earnings and employment in the immediate future.

Australia requires investment for nation building. Some people believe that this investment requires saving out of current earnings. The national saving rate has indeed turned up recently, but this statistic is deceptive. It is the result of Australian banks cutting back their lending, requiring home owners to consume less and save more to pay off their loans.

            
Does this mean that Australia needs to turn to foreigners to supply “savings”?

Not at all because foreign economies are in the same boat, paying off the enormous debts that the global real estate bubble has obliged homebuyers and others to take on in order to obtain access to housing.


Where then does the foreign lending come from, if not saving? The answer is hard for many people to believe, but it is new electronic “free lunch” credit creation.


Australia can create credit itself just as easily as foreigners. It is merely a policy choice to let foreigners perform this task and extract income from Australia with its higher interest rates.

Meanwhile, the balance of payments makes its manufactured exports less competitive, and even eats into the earnings of its mining industry. (Mineral prices are set in U.S. dollars or other foreign currency, which yields fewer Australian dollars as the latter’s exchange rate rises.)


No nation need borrow in a foreign currency for spending in its domestic currency. Whether loans are created in Australia or at home, only Australia itself can create Australian money and credit.

The problem is that Australia runs a chronic current account deficit that needs to be financed with inward foreign investment if the exchange rate is to be held stable. Rather than “selling off the farm” and/or becoming indebted to foreigners, Australia should only spend as much foreign currency as it earns.


Market forces can achieve this result if exporters are not forced to gift the foreign currencies they earn to a national pool. Instead, exporters would obtain a second income by selling their foreign exchange to importers.


Without allowing market forces to keep current account transactions in balance, Australia is paying a high price for the self-imposed, old-fashioned view that it needs foreign money to invest at home. What the nation needs more than foreign credit is a more modern understanding that credit can be created without cost regardless of where it is created.

            

To avoid inflation – and to give value to this credit – the government needs to levy taxes. In view of the statement by the Reserve Bank of Australia that the reason it is raising interest rates is to slow the property bubble, a tax on land values, with which Australia (unlike the U.S.) is already familiar, would address the problem without creating a rise in the A$, without pricing its manufacturing out of foreign and domestic markets, and without giving international arbitrageurs a free lunch.

*Michael Hudson is Distinguished Research Professor of Economics at the University of Missouri and Dr Shann Turnbull is Principal of the International Institute for Self-governance based in Sydney.

7 Comments

  1. John Cole08-06-2010

    With a fully floating exchange rate there will be no affect on the domestic economy’s money supply of an inflow of financial capital.

  2. David14-09-2010

    You seem to lack even a basic understanding of how fixed income and fx markets work:
    1) “The 2 or 3% arbitrage gain is a free ride for speculators” errr, no – they take fx risk (if they borrow, say € to buy AUD

    2) “Over and above being a domestic expense, it must be paid in foreign exchange” errr, no if the debt is denominated in AUD (which to earn the carry it must) it is repaid in AUD by the Australian borrower. Again, it is the carry-trader who assumes the fx risk.

    Other than than, protectionism seemed to work well for North korea, Sri Lanka and Cuba and we certainly don’t want to become impoverished backwaters like Hong Kong, Singapore or South Korea.

  3. Bruce29-09-2010

    “With a fully floating exchange rate there will be no affect on the domestic economy’s money supply of an inflow of financial capital.”

    Cr@p John. When Australian banks borrow foreign wholesale funds, and lend to Australians to bid up housing, others take out lines of credit to buy assets and consume. Asset prices are raised beyond what they would be if we weren’t so reliant on foreign credit.

    Meanwhile the primary income account continues to overwhelm any trade surplus we can manage, as we continue to pay interest on growing net foreign debt.

    Why do continue to run CADs decade after decade, when nations like Germany, Switzerland, and Sth Korea don’t? Because we can’t blow our wealth on housing and imports, rather than investing in the means of production.

    This BS about the carry trade not hurting Australia is perpetuated by economic naives who are ignorant of where the funds come from to pay the interest. The fact that our interest rates are significantly higher than the rest of the oecd is indicative we don’t invest in the means of production adequately.

    How else could credit growth supercede gdp growth by 3-4x for the last 15 years?

  4. valerie yule10-02-2012

    You could make something out of this:-
    A use for pokies
    All this money from poker machines, taken from the peple of Australia! Well, why not let all the income from pokies, at present going to owners and government, go instead into a fund from which banks can borrow, in order to reduce their reliance on overseas money? Then banks can have less need to say they must charge highly in order to pay forign lenders?
    Only the winners and the administrative costs need be taken from this fund.
    Australian money spent on pokies is staggering. It is money that could be used.
    Australia has more than 200,000 pokies — 21% of all gambling machines on the planet. http://www.greenleft.org.au/node/49849
    A glance at the 2010 annual report of one of Australia’s largest clubs, the Panthers Group, shows how hollow the argument about community benefits really is. Panthers raked in $91.7 million from gaming in 2010, Rooty Hill RSL, also in Sydney’s western suburbs. Its 2010 annual report features a prominent drop quote from none other than Donald Trump: “As long as you’re going to be thinking anyway, think big.” The club is certainly thinking big when it comes to poker machines: it enjoys “Australia’s largest non-casino installation of electronic gaming machines” with an amazing 726 gaming machine licences. Poker machines raked in $43.2 millionhttp://www.crikey.com.au/2011/09/27/clubs-australia-campaignand-pokies-revenue/?wpmp_switcher=mobile The largest Australian operator of pokies is Woolworths, which owns about 13,500 machines.
    Add in what governments take from pokies

    “Pokies or Poker Machines are an Australian pastime that is getting more popular as time goes by. Pokies are everywhere you turn here in Australia, whether you’re in a local pub, sports club or casino, you can’t get away from them. Pokies are very similar to their online cousins, in that they use electronic, virtual reels instead of real mechanical reels. Pokies are the biggest form of gambling in Australia – for every Aussie dollar that is spent betting on the horses there are five pumped into the pokies. Pokies also generate a huge amount of revenue for the Australian government, so while pokies are sometimes the cause of gambling problems amongst Aussie citizens, the revenue they generate is put back into worthwhile community and federal projects.” http://onlinepokies4u.com/ http://www.google.com.au/
    Over 70% of Australian casino revenue is generated from slots play http://www.onlinepokiesaustralia.org/
    Pokie revenues in Victoria more than $600 per person http://www.onlinecasinos-au.com/pokie-revenues-in-victoria-more-than-60...

    Clubs Australia waged a $20 million advertising drive that called the proposed reforms “un-Australian” and harmful to community organizations it supports.
    Yet Clubs Australia admits that just 2.7% of the billions made from poker machines reaches community organizations and charities.
    Ask, how do sports and clubs in the rest of the world, including Western Australia survive without pokies income?

  5. Bryan Kavanagh14-02-2012

    Hello, Valerie, Bryan Kavanagh here. You might remember, you gave me a great photo of your father, Sir Ronald East, straddling the Murray in his early engineering daysduring a drought?

    I’d not seen that Australia has more than one-fifth of the world’s poker machines. Absolutely incredible!

    I agree with your sentiments as to what should happen with the proceeds of poker machines, but I believe the interests associated with their running are as antithetical to your ideas as those who are opposed to greater capture of land rent– instead of taxes on labour and capital–for our revenue.

    Both the extent of poker machines in Australian and of privatised land rent are proving to be a blight on the nation.

  6. David Brooks14-02-2012

    It is not surprising that we have in Oz 21% of all pokie machines. After all the largest manufacturer of Pokies in the world is a Sydney company called Aristocrat. That the various clubs are making money out of them, as well as the manufacturer, is not news.

    It would seem that many people, who do not use pokies want to tell many people who do use them, not to. The extent of so called “addiction” is grossly exaggerated. To interfere is simply a violation of people freedom. And where there is no harm to third parties the state should butt out. However, it is recognised that this is not the whole story.

    There was a time when the finest medical services in the country were available free (repeat FREE) in the state of Queensland. The hospitals and services were funded from peoples propensity for gambling. However Mr. Hawke managed to destroy that with the introduction of “medicare.” Now the revenue from gambling (there were no pokies in Queensland in those days) all goes to general revenue. And with pressure from the people of each state the pokie franchise became legal and a good money grab for the government who are always chary of raising revenue from legitimate sources.

    Gambling per se, does no harm; we hear very little criticism of betting around the Horse racing fraternity or the Tatts Lotto, or the footy pools in the UK (popular here) or of the two flies crawling up a wall. The screams come from the do gooders who want to control others. One of todays biggest crimes.

    If you really want to make a dent in those who make a living from the weaknesses of others then you must surely ensure that in the first instance there is an equitable and just distribution of the nations wealth. And that would cover much more than just the gambling fraternity.

  7. mark31-01-2016

    Can anyone show me who we borrow precisely ?
    why would a monetary sovereign govt that issues and creates its own wealth need to borrow ?

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