Currency wars blur distinction between quantitative easing and MMT

Reserve Bank governor Philip Lowe: There is a fine but important distinction between defending the currency with QE and MMT. Picture: AFR photo LOUIE DOUVIS

In launching proper quantitative easing this week for the first time, the Reserve Bank has not thrown in the intellectual towel and joined the modern monetary theorists; it is simply engaging in old-fashioned currency warfare.

And the market’s immediate verdict? It wasn’t enough, especially after the result of the US election. The reflation trade has been unwound because the Republicans won the Senate and are likely to block further fiscal stimulus, which has seen American long bond yields and the US dollar fall sharply.

It’s a fine but important distinction between defending the currency with QE and MMT: in six months the RBA will own about half of the government bonds on issue and will probably keep buying them faster than they are issued, at least for a year or two, so it is MMT (or more precisely the monetisation of government debt) in all but name; it’s just that the bonds have been laundered in private ownership first.

But the idea that the RBA is like any other buyer of bonds — put forward by governor Philip Lowe on Tuesday — is simply ridiculous. The central bank is an arm of government.

The Australian government can sell virtually any amount of bonds it needs to at the moment and doesn’t need the RBA as the buyer of last resort, so QE is not needed to support fiscal policy. But the fact is that it will own about half of the government bonds on issue, and it is not credible for the RBA to pretend it’s just another bond investor, especially since it’s buying the bonds for policy reasons.

The RBA knew that whoever won the US election this week the US dollar would head south, especially against currencies that have the coronavirus under control, like Australia.

If it’s President Biden when the American electoral fire burns out, the US will have to go into enforced lockdown like Britain; if it’s President Trump it will more likely be voluntary lockdown: people staying indoors without being told to, in order to escape the virus. Either way more fiscal and monetary stimulus will be needed, producing downward pressure on the US dollar.

“Currency war” is the 2020 equivalent of the February 1987 Louvre Accord, in which the world’s finance ministers and central bankers met in Paris to stop their currencies appreciating against the US dollar, reversing the impact of the Plaza Accord two years earlier.

Both accords involved direct, co-ordinated intervention in foreign exchange markets as well as monetary policy, which is easy to do, and instantly effective, but no one has much stomach for direct intervention these days, apart from China, because the forex markets are so much larger and more dangerous.

The British experience only five years later, on September 16, 1992, when George Soros provoked a run on the pound that the Bank of England was powerless to prevent and forced Britain to pull out of European Exchange Rate Mechanism (ERM), taught all governments that currencies were no longer controllable.

By the way, the Louvre Accord led directly to 1987 stockmarket crash because the Federal Reserve’s role in the deal was to tighten monetary policy to halt the decline of the US dollar. Growth in US money supply fell by more than half from January to September, interest rates rose, and stock prices began to fall by the end of the third quarter of that year before collapsing on October 19.

No chance of monetary contraction or rate increases this time, and in fact the opposite is going on, and is certain to continue, so it’s every country for itself: it has to be a “war” this time, not an accord, because co-ordination would have to involve harmonisation of both pandemic responses and fiscal policies, and not even Biden could pull that off.

The Aussie central bank certainly couldn’t contemplate direct intervention in the foreign exchange market, even if it was inclined to do it. Daily foreign exchange market turnover is approaching $US7 trillion ($9.6 trillion), and the Australian dollar is the fifth most traded currency. The RBA would last five minutes trying to manipulate the Aussie dollar.

So even though the economy is improving, the real estate market has bottomed and coronavirus case numbers are minimal, the RBA has had to cut rates and print money — simply because the US is doing it, along with Europe and Britain.

And that’s because of the surging pandemic in those countries. Well not entirely because of that: underlying the events of 2020 is the profoundly deflationary impact of technology which has been building for 20 years and has meant central banks everywhere are spinning their wheels trying to get inflation up.

The RBA said this week it was for cutting interest rates and launching QE to get unemployment down, and of the three mechanism for achieving that cited by the RBA — “lowering financing costs for borrowers; contributing to a lower exchange rate than otherwise; and supporting asset prices and balance sheets” — only the one about the exchange rate has any substance. Financing costs were already low enough for those inclined to borrow and supporting asset prices is not necessarily a great idea, and won’t do much for employment. A rising exchange rate, however, would crush employment in export and import-competing industries as they emerge from the pandemic.

So Australia’s tremendous success in dealing with the virus could have the unintended consequence of producing a new housing boom, as negligible interest rates designed to stop the currency from rising combine with a recovering economy to bring out the real estate buyers.

At least the authorities now know how to bring down house prices without raising interest rates now: hello APRA, and macroprudential.

Alan Kohler is the editor in chief of Eureka Report.