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.