Lurking beneath Australia’s AAA economy…..

‘Since [Paul] Keating abandoned exchange controls, more than $A7,000 million has fled Australia every year.  A major industrial economy, like Britain’s, can sustain bleeding of this magnitude for some time.  A small economy cannot; and unless the flight of capital is stemmed, Australia will be left with an insoluble balance of payments’ deficit and is likely to join the ranks of Latin American states in permanent hock and bereft of their sovereignty.  Indeed in surrendering one of the few weapons with which a small country can defend its economic sovereignty, Keating has given away almost all that the Labor Government in the 1940s fought to preserve against extreme American pressure.  No Australian Government now can afford to stand up to the power of the international money markets or to major foreign investors.  If, for example, the Government wants to improve rather than further reduce its welfare provisions, the international banks almost certainly will ‘sell-down’ the Australian dollar, and bring intolerable pressure to forestall such a measure.  Brokers in New York have said as much when consulted by Australian politicians and by those Australian commentators who constantly seek Wall Street’s approval of Australian policies…  As part of his de-regulation policies, [Paul] Keating abolished the Federal Reserve Bank’s power to monitor money leaving the country, which allowed the very rich to practise ‘tax avoidance’ on a previously unheard of scale.  Moreover, the interest incurred on the huge amounts borrowed on world money markets in order to finance takeovers is tax deductible in Australia.  This has helped to give Australia a foreign debt which, under Keating’s stewardship, has risen to $A114 billion and is behind only that of Mexico and Brazil. The scandal of this is that Australia, with one of the smallest public debts in the world in relation to Gross National Product, has to bear two-thirds of the overall debt because of the private borrowing of corporations, banks and individuals…’

Journalist, author and film-maker John Pilger, in his book ‘A Secret Country’ published over 20 years ago


The official figures for Australia’s gross foreign liabilities (public and private debt) stands at $2.224 trillion and its gross foreign assets are $1.347 trillion which includes, rather amusingly, the “reputable” asset derivatives.

I’ve focussed on the gross rather than net foreign liabilities here because it is unlikely that investors would repatriate into a falling market if the proverbial hits the fan.

Australia has had a current account deficit since the 1980s. That means we are spending more than we are earning.  We’ve had to sell public assets to balance the current account deficit. Put simply, the surplus on the capital account is flogging off the sideboard to buy the fruit.

In other words, our net international financial position is not strong and gross foreign liabilities are alarming.  Banks are the intermediaries between foreign lenders and Australia’s big spenders. The banks have mediated the private household debt and as a result if there is a worldwide recession, banks could be called to pay up.

Our banks have borrowed short (internationally) and lent long (domestically, for mortgages etc.) which may explain why a US diplomatic cable dated 7 July 2009 published by WikiLeaks states, ‘…In late June, the IMF advised the Government to limit its borrowing in case it needs to bail out the major Australian banks, which must roll over short-term international debts which exceed A$500 billion…’

It may also explain why despite subsequent denials from the Australian Bankers’ Association, Economist Professor Ross Garnaut suggested in October 2009 that the big Australian banks were essentially insolvent at the time of the crash [in 2008] because “they were starting to have great difficulty in rolling over their huge external debt”.   He added, “This time, the banks were in trouble with their debt, and the Government stood behind them. That’s not a sustainable permanent thing because it would – now that it’s happened once, there will be an expectation that it will happen whenever banks get into trouble, and you no longer have appropriate levels of responsibility about private decision making, if people think there’s going to be a government bailout if they go wrong…..The consequence of private actors thinking they can take decisions and if those decisions turn out to be very profitable, they’ll keep the gains, but if they go wrong, the community will pick up the losses. That’s what moral hazard is, and the consequence of that is that you encourage risk-taking behaviour, you discourage prudence and I don’t think that a sound financial system can work for long on that basis.”

Turning to derivatives, in November 2008 it was reported that the official Reserve Bank figures, from APRA, showed that Australian banks’ off-balance sheet derivative exposures totalled $13.8 trillion (nearly ten times our Gross Domestic Product of 1.5 trillion USD, and probably understated). It was noted that 47.6% of the Big Four Banks’ off balance sheet derivative exposure was to interest rate swaps ($8 trillion gross), the remaining trillions in collateralised debt obligations (CDO), credit default swaps (CDS) and currency exposures.

Banks could either deem derivative exposures to be either “off-balance sheet” or use special-purpose entities to “house” the exposure in separate but related vehicles.  In their absence, banks would be “forced” to increase the capital adequacy reserves required by prudential regulators.

What remains a central issue is the fact that it was not made clear whether the Government’s guarantee package extends to offshore borrowings by banks to cover off-balance sheet derivatives, bad bets and the impact such exposures would have if forced onto banks’ balance sheets. Let’s pray that Complexity Theory is flawed.

Since then we’ve learned that the National Australia Bank and Westpac borrowed money from the US Federal Reserve at the height of the financial crisis but we don’t know if this has been paid back or whether it is included in our official gross foreign liabilities figures; that Australia has a sub-prime debt market but we don’t know the extent of it; that our banks have negligible (depends how you define it) direct exposures to the European sovereign debt crisis yet no one asks about our indirect exposure; that historical details of billions in government guaranteed loans have been taken off the Reserve Bank and Treasury websites so we are left to speculate about whether or not this may be because the Government doesn’t want Australians to know how much they’ve had to guarantee and/or they don’t want the world to know the extent of the derivative exposures; and finally , despite Professor Garnaut’s warnings, the Reserve Bank of Australia has set up a $380 billion bail-out fund called the Committed Liquidity Facility in the event that banks are insolvent or illiquid.

If the banks are hunky dory why is it necessary to set up a $380 billion emergency fund and, more importantly, is it enough in light of possible derivatives exposure?

Perhaps the Reserve Bank knows something that we don’t?

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