Market, not intervention, put dollar right

THE recent decline in the Australian dollar happened without significant government or central bank intervention.

THE recent decline in the Australian dollar, which important sectors of the country had long sought, happened without significant government or central bank intervention, noted Standard & Poor's chief global economist Paul Sheard in Melbourne yesterday.

This demonstrated the key role of markets in achieving adjustments, he said.

"There's a very big currency market out there. And I don't think the Reserve Bank wanted to intervene any time soon."

He said Australia, a medium-sized country with an open economy and with an appropriate focus on maintaining its international credibility, had rightly refrained from taking action although its exchange rate was perceived to be in the "wrong" direction.

Mr Sheard also awarded the US "a good A" for its management since the financial crisis.

Five years later, he said, its outlook was relatively positive because "it did what Japan and to an extent Europe didn't do. It tackled it head-on rather than kicking the can down the road. Yet much of the public discourse in the US frowned on what it did."

The focus on the Federal Reserve "printing money" and on its "tapering" was half-baked, he said.

More generally, he said, there was "a disproportionate amount of attention" on central banks. That is in part because they tend to be transparent, they hold meetings, release minutes, make policy decisions and employ large research departments that publish papers, and their leaders give speeches.

"So, naturally, everybody focuses on what central banks are saying. But it also blows their importance out of proportion because monetary policy works through the financial markets.

"(Federal Reserve chairman) Ben Bernanke says something, and investors hang on his every word. Even if what central bankers are saying is just incremental, it gets amplified as investors take action at the same time, based on it.

"I am coming to the conclusion that although central banks are trying to reduce volatility, it is almost built into the framework" of how they themselves operate, Mr Sheard said.

"So the volatility tail wags the monetary policy dog."

The name of the game in investing, he said, was trying to get an edge on markets. Thus in June, when Mr Bernanke had indicated the prospect of winding down the central bank's quantitative easing, "there was a lot of second-guessing as to whether this was the right signal to be sending".

He said that last year the Federal Reserve had been "pretty radical and innovative and positive" by announcing its QE was open-ended, continuing until the labour market improved substantially.

On interest rates, the bank said that it was watching for unemployment to come down to at least 6.5 per cent, with inflation not above 2.5 per cent.

He said: "It was radical to tie forward guidance to a specific number on unemployment. And what Bernanke was doing in June was to give more specificity to that forward guidance.

"But the very act of communicating this induced the volatility" that swept through world markets, with portfolio investors pulling cash out of emerging economies in particular.

"There was no way they could tiptoe towards the exit" from QE, he said. "But in fact Bernanke was saying there would be incremental expansion in QE for the next year," not that there would be any sudden wind-back.

"It's dependent on continuing good results in the economy. So there won't be an exogenous shock if and when they exit QE. It's just that QE is uncharted territory."

But it was not the same as "printing money", as its detractors claimed, with liquidity flowing into emerging markets as if from a tap. "The Fed is underwriting recovery by changing the composition of the aggregate portfolio held by the private sector."

Now, he said, the world was seeing a return to a form of normality, with the largest economy, the first hit by the crisis, starting to grow again, without being burdened by some of the issues from which the Europeans and Japanese were suffering, and with the US energy boom also changing the calculus.

It's no surprise then, he said, that investors should look to put some of their money back to work in the US.

Mr Sheard said that he had long been arguing for the Japanese government to act as forcefully as it had done through Prime Minister Shinzo Abe's "Abenomics", which included massive QE.

But he was concerned about the fiscal policy element of Abenomics, which involves doubling the GST from 5 per cent to 10 per cent in two years.

Combining monetary easing with fiscal tightening "holds a lot of risks", he said, although overall, he believed Japan was heading in the right direction at last, after decades of stagnation.