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interest rates + foreign debt « Previous | |Next »
March 24, 2007

It was only a few weeks ago that the economic talk in Australia was about a reduction interest rates. It's suddenly been transformed into talk about interest rate increases this year. That is a rapid shift in market sentiment. Maybe it is the Reserve Bank---ie., it's assistant governor Malcolm Eddy--- jawboning.

Another interest rate hike would mean five rises since the 2004 election — and that means another $230 more a month on the average mortgage repayment. Ian Manning, at the National Institute of Economic and Industry Research, is quoted by Marc Moncrief in The Age as

"From an economic view, the exposure is worse. The general economic policy has been to drive economic activity by a continued consumer boom funded by debt — that, in turn, made tenable from the banks' point of view and from the borrowers' point of view from rising land values. But, of course, rising land values also come home to bite us because that comes into the housing affordability question."

Australian household debt is increasing and Sydney is the seventh least affordable city in the world in which to buy a home, and the least affordable anywhere outside of the US. (London was ninth). That is a consequence of inflationary pressure associated with an large expansion of credit that fosters asset price bubbles.

There is a fault line lying behind interest rates and it is foreign debt, which barely figures in the flow of economic statistics these days. Kenneth Davidson says in The Age that since 1996, net foreign debt has grown 170 per cent to $520 billion and is continuing to grow by nearly $50 billion a year despite the biggest export commodity price boom since the Korean War.These are large international liabilities. Davidson adds:

Most of the borrowings that aren't used to pay the interest on the existing stock of borrowings have been used by the banks to finance the housing bubble. We are assured by authorities that the growth in household debt doesn't matter because the debt burden has been reduced by low interest rates and rising house values.

But the housing bubble will pop if interest rates and/or unemployment rise as a result of foreigners deciding to withdraw the foreign needle. Our future is no longer in our hands. In the past decade we have frittered away the savings generated by accumulated budget surpluses and asset sales.


He says that long-awaited rebalancing of the economy, in which domestic demand contributes less to overall GDP growth while net external demand (net exports) swings from a negative to a positive contribution, has still not materialised. And this despite the continuing improvement in our terms of trade, which are now 32 per cent better than they were three years ago and the best we've had since 1959.

Doesn't this make Australia vulnerable to capital flight? Could not the Australian dollar be hit by surges in global volatility? Shouldn't the Reserve Bank of Australia ne looking beyond narrow inflation targeting to the broader issues of financial stability?

| Posted by Gary Sauer-Thompson at 9:10 AM | | Comments (1)
Comments

Comments

The generalized statement, by financial journalists refering to Australia's foreign debt as "the banks debt" is totally dishonest. Australia's current account deficit (not offset by foreign investment) has increased Australia's foreign debt to $520 billion, as in the Opinion Article above. The Reserve Bank borrows foreign currency to offset the current account deficit. Foreign exporters to Australia require foreign currency in payment for their goods (Mercedes cars etc.) Payment in Australian dollars is then exchanged for Reserve Bank's foreign currency loan borrowings. Reserve Bank debt is really Goverment debt. Foreign loans to Australia's Federal Government should be approved via Parliament. Current Account Deficit is a budget responsibility; which should not be a devious secret. The Swiss Bank Loans in the past were a disaster for borrowers. The major Banks would not be engaged in foreign currency speculation in such a massive way.