The Carry Trade Demystified: Opportunities Abound

September 9, 2010


“The currency carry trade involves taking advantage of interest rate differences (that is, borrowing costs) between various countries. Each country’s central bank sets a key short-term interest rate target, which can differ greatly. Investors or traders will borrow currency at a lower rate, convert to a currency yielding a higher rate, and then lend it. To unwind the trade, they would convert the currency back. Traders around the world execute this strategy in a variety of ways to capture interest rate differential between economies. This causes cash to flow from economies with low interest rates into economies with higher rates, and that is what’s known as the currency carry trade.”
One of the biggest carry trades is between the Japanese yen and the Australian dollar. Japanese interest rates have been near zero for over a decade while Australian rates have been higher, often much higher. Investors have thus found it potentially profitable to borrow in Japanese markets, in yen at low interest rates, and then re-invest that borrowed money in Australia, in Australian dollars, at higher interest rates. The interest rate differential between the borrowing and investing rates allow for steady and easy profit.
“This strategy is not without risk. The most serious risk when you borrow money in one currency, convert it into another currency and then lend it in the higher rate currency is that the exchange rate will change to your detriment. For example, if you borrow yen, convert the currency into U.S. dollars, and then lend them at a higher U.S. interest rate, your risk is that the value of the yen will increase. That’s because you will have to reconvert U.S. dollars back to yen to unwind the trade. You might not have enough cash to pay out the loan if the currency appreciates too much. So you need both interest rates, and the currency’s value, working in your favor.”
1. How do differences in one nation’s central bank monetary policy versus another’s (e.g. Japan and Australia) lead to the ‘carry trade’?
2. What would happen to the demand for Japanese yen if Japan’s interest rates suddenly became equal to Australia’s? How would this shift likely affect the Yen/Dollar exchange rate?
3. How might the Yen/Dollar carry trade be affecting Australia’s balance-of-payments?
4. Does the carry trade have any economic purposes other than profit-making? What might they be?


WTO condemns Australian ban on New Zealand apples

September 9, 2010


“Australia’s decades-old restrictions on imports of New Zealand apples break international trade laws and should be amended, the World Trade Organization said on Monday. The WTO panel ruling should open the way for New Zealand to resume sales of apples to its biggest trading partner after nearly 90 years, and holds out the possibility of access to other Asian markets where its apples are banned for similar reasons.”

Australia banned New Zealand apples in 1921 because New Zealand had fire blight, a disease that attacks apple and pear trees and rose bushes which Australia did not and does not currently have. New Zealand began arguing in 1986 for lifting the ban and launched its WTO challenge in 2007.

The WTO did not claim that Australia’s quarantine was arbitrary but argued that the current rules and Australian safety checks on New Zealand apples were unscientific and disrupted trade more than necessary.

Australia is in the process of appealing the ruling.

1. Do you agree with the WTO that Australia’s quarantine of New Zealand’s apples is a ‘restraint of trade’?
2. What will be the ‘gains from trade’ if New Zealand apples finally enter the Australian market? Will be there economic losses as well?
3. How would Australian ‘consumer surplus’ be affected by freer trade in New Zealand apples?
4. What are the noneconomic costs and benefits of the current Australian apple ban? Do you think the noneconomic factors outweigh the economic factors in this case?


Can the NBN ‘save’ our cities?

September 9, 2010


New England Independent Member of Parliament, Tony Windsor, has argued that the National Broadband Network could be a key driver of economic decentralization in the country. He has been quoted as saying: “If there’s been a piece of infrastructure (if it’s done correctly) that negates distance as being a disadvantage of living in country Australia, this is it …If we get the broadband system right it could revolutionise country living and solve some of the city-based problems.”

Could this be true? The author of this article thinks not. Canberra is used an example. That city has good transport and internet connections, high income and levels of human capital. Yet it remains relatively small, with a population of 352,000 and growing only relatively slowly compared to the major cities of Sydney and Melbourne.

Distance from major cities seems to be the major constraint to Canberra’s growth. This indicates the importance of large, dense cities. Such cities offer bigger markets, bigger supplies of specialized skilled labour and better social and cultural amenities.

The author concludes that: “the fact is that moving large quantities of data at high speed isn’t a key determinant of where most firms locate.” “So I can’t see the NBN having a major impact on the relative shares of population growth in regional centres and our two largest cities. But I do see it having a positive effect on life in the regions.”

1. In what ways is the NBN a long-term growth policy? In what ways might it be a macroeconomic stimulus policy?
2. “The NBN will simply redistribute economic growth in Australia, not increase it.” Critically evaluate this statement. Would the author agree with it?
3. How might the NBN fit into ‘endogenous growth theory”?
4. Which do you think is the greater benefit of the NBN: regional economic growth or regional quality-of-life improvements?


Stay alert to inflation risks, warns deputy RBA governor

September 9, 2010


“THE economy is now operating at close to full capacity and policymakers need to be alert to inflation risks, a hawkish RBA official says. The highest terms of trade in 60 years was fuelling an income surge and would keep unemployment trending lower, Reserve Bank deputy governor Ric Battellino told an audience in Brisbane today.”

Battellino pointed to a number of factors, especially a big increase in mining and non-mining investment and government plans for future infrastructure spending that would create inflationary pressures for the Australian economy in the future. For this year the RBA expects inflation to remain within the RBA’s 2-3 per cent target band. It is future years where the concerns lie.

The RBA has hiked rates six times between October 2009 and May of 2010, taking the cash rate target to 4.5 per cent but has held rates steady since then. “Nevertheless, the hawkish speech could shake some investors out of their complacency.” Future rate increases seem likely.

1. List the factors that the RBA says are putting Australia at risk of future inflation. Which of these are ‘demand-pull’ and which are ‘cost-push’?
2. What is the meaning of ‘capacity’ and what does it have to do with inflation?
3. Why do some regions of Australia have inflation rates below the national average and others above? How does this complicate RBA anti-inflation policy?
4. How should Australian fiscal policy support monetary policy to keep inflation contained?


Commonwealth Bank FY Net Rises To Record; Margins Pinched

August 16, 2010


Australia’s big four banks have been posting record profits.  “Commonwealth Bank of Australia (CBA.AU), the country’s biggest bank by market capitalization, on Wednesday posted a 20% rise in full year net profit to a record A$5.66 billion.”  This is line with results being posted by the bank’s domestic competitors.

Yet banking shares in Australia have not done well lately, despite these record profits.  The banks themselves, Commonwealth included, have been cautious about future profits, saying that “fragile global sentiment and rising funding costs will continue to drag on margins.”

Australian banks are also finding less domestic demand for loans, especially in home mortgages, partly because government programs subsidising first time home buyers have now expired.  Additionally, business borrowing has remained relatively flat.

The fact that there is lower demand for bank loans and that it simultaneously costs more for banks to raise money to fund those loans is putting a longer-term squeeze on bank profit margins.  One solution for banks is to increase lending costs to borrowers, even if the rates set by Australia’s central bank, The Reserve Bank of Australia (RBA), do not move.  Politically, though, this would not be popular and the market might not bear it either.

  1. How are Australian bank profit margins linked to the interest rate on loans they make to consumers and businesses?
  2. Do bank loan interest rates always follow official ‘cash rates’ set by the RBA?  Why or why not?
  3. Assess the following statement, using economic theory: “High banking profits are good for the Australian economy.”
  4. How would you describe the near-term outlook for the Australian banking sectors’ supply and demand for funds?

In praise of stimulus

August 16, 2010


Joseph Stiglitz, a Nobel Prize winning economist, has noted that when the global financial crisis (GFC) hit in 2008, Australia was one of the few countries to avoid the recession that hit most other developed economies.

“Kevin Rudd, who was prime minister when the crisis struck, put in place one of the best-designed Keynesian stimulus packages of any country. He realised it was important to act early, with money that would be spent quickly….Rudd’s stimulus worked: Australia had the shortest and shallowest of recessions of the advanced industrial countries.”

Stiglitz goes on to claim that critics of this stimulus package, who argue that the stimulus money was not spent as well as it should have been and that government deficits and debt increased, have got it wrong. “While the focus for the moment is on public-sector waste, that waste pales in comparison to the waste of resources resulting from a malfunctioning private financial sector, which in America already amounts to trillions of dollars.”   And Australia’s deficit as a percentage of GDP and gross national debt are much smaller than in the US and many other developed countries and thus much easier to correct over the coming years.

Stiglitz also touches on the issues of the mining tax and environmental policy as they relate to the longer-term Australian economy.  The use of stimulus to avoid a long and deep recession; the appropriate taxation of mineral resource that are effectively owned by the country at large and not just single companies; and the environmental legacy left behind to future generations are all matters, at least in part, of economic efficiency, and policies dealing with these areas are thus of critical economic concern.

  1. How was Australia’s response to the GFC “Keynesian” and why does the author argue that it was effective?
  2. Why does the author argue that “waste” in Australia’s stimulus program was relatively unimportant economically?
  3. What is “deficit fetishism” and how is this concept meant to refute the notion of “Real Business Cycles” as described in Chapter 11?
  4. How does the mining tax and environmental policy relate to macroeconomics, as opposed to microeconomics?

Asian boom will support our long-term picture

August 16, 2010


Australia has a dominant export: commodities.  And this places the country in a powerful position for strong economic growth in the years ahead.  The Asian Development Bank forecasts 7.9 per cent growth for developing Asia in 2010 and the Asian countries will continue to have strong demand for the commodities that Australia produces.

Much attention continues to be paid to the strong growth in China.  But “even if China should choke economically, a most unlikely event, then India will be there, and Indonesia as well, each growing by 7 per cent or so a year.”

Why is Asian growth so strong?  Put simply these countries are growing in population and maturing in terms of economic development and these phenomena require consumption of lots of raw materials, especially steel which is a basic component in all sorts of private and public infrastructure. “World Bank economist Shane Streifel says that the growth in demand from China and India ‘presents a large challenge to the metals industry, to almost double output over the next two decades’.”

These conditions will drive up prices “for iron ore and coking coal, the core components of steel” and Australia, one of the closest sources of Asian supply for these and other mineral resources, will likely benefit the most from this trend, as opposed to other more distant sources of supply such as Africa and Latin America.

However, there is one key challenge.  “The chief variables that could still let this great opportunity for sustained prosperity slip from Australia’s grasp are investment, ensuring that demand is reliably met, and infrastructure, enabling the commodities to make their way efficiently to their markets.”

  1. What factors does the article identify as important to the future growth of Australian GDP?
  2. What are the differences and similarities between the factors driving Australian economic development and those affecting developing world economies?
  3. What role does Australian government policy play in ensuring macroeconomic progress?
  4. If the economic picture for Australia, as portrayed in the article, comes to pass, how might Australian inflation be affected?