Benefits of economic deregulation come at a cost - SMH -

 

The deregulation of the economy, including the floating of the dollar, has created winners but also plenty of losers.     Opinion by Martin Feil

For  the past 25 years state and federal government economic policies have been driven by an unquestioning acceptance of the value of deregulating the Australian economy. There is no doubt that deregulation has made the economy (especially the financial sector) bigger.

Size is not everything. There have been some very large losers in the deregulation process, and some changes have had adverse social and economic effects on many Australians.

The industry and economic policies of governments have embraced free-market economics as an unquestionable article of faith during deregulation. The question is whether this approach has reformed or vandalised the economy.

Two steps to deregulation are excellent case studies for empirical evaluation of the question. They are the float of the dollar in December 1983, and the deregulation of the banking system that began in 1985. This article is about exchange rates and the consequences of the float of the dollar.

Exchange rates are simply the price of one currency expressed in terms of another. For example, at the present time you can exchange one dollar for US74.68 ¢ at most banks. If you travel overseas, your credit card will have the overseas currency amount spent but it will be converted to an Australian-dollar amount you have to pay.

The purpose of currency exchange is to enable people to buy and sell goods and services internationally. Our imports and exports trade requires about $300 billion of various foreign currency transactions.

This process has benefited considerably from deregulation. There is no longer a need to get Reserve Bank approval to obtain foreign currency. The apparatus of letters of credit and bank administration of funds transfers is much faster than previously, which has appreciably shortened the cross-border supply chain between Australia and the rest of the world.

Yet, this function and its benefits are immaterial to an evaluation of the benefits of floating the dollar. The view that floating the dollar will enable automatic corrections to the Australian economy to reflect its relative strength or weakness at a point in time is also immaterial.

This idea is based on the economic assumption that when the dollar falls against other currencies, imports are dearer and exports are cheaper. If it rises then exports are dearer and imports are cheaper. Imports and exports rise and fall accordingly. But there are holes in this theory that you could drive a truck through. For the purposes of the argument, I am happy to concede its validity.

Foreign currency needs for imports and exports of goods and services represent about one day's value of trade in the Australian dollar, or about a third of 1 per cent of annual trade. Deregulation has created a new, major financial function that is, fundamentally, speculation in the Australian dollar.

We are paired with the US dollar and the Japanese yen, and currency trade involves many trillion of dollars annually. The traders are experienced and use sophisticated models and techniques. They still win and lose because trading in currency is a zero sum game. For every profit there must be an equal loss or collection of losses.

The RBA is the only official punter on the exchange rate. From time to time it may buy or sell the Australian dollar based on its view of the appropriate position for the dollar. This, of course, contradicts the free-market forces argument advanced for floating the dollar in the first place.

A few years ago there was a major argument in Parliament because the RBA had lost some billions of dollars in trading.

The Minister for Finance's response was that at other times it had made a lot of money. This response presumes that the bank never ends up on the wrong side of an irreversible trend in the exchange rate.

In 2000, the Auditor-General recommended that Commonwealth departments should not manage their foreign exchange transactions. He said "foreign exchange risk was not effectively and prudently managed by the audited agencies because they did not have systems and procedures to identify their exposures, analyse the extent of those exposures, assess their impact and take steps to cost-effectively manage the resultant risks".

The Government stopped hedging by the departments but left the foreign exchange management of billions of dollars with them.

Major speculation in the exchange rate involves trade in a number of financial products. These include derivatives, which are financial contracts where you bet on the performance of an asset over a period of time; futures, where you agree to buy or sell currencies or options for currencies at a future date; and hedging, where you fix the exchange for a transaction at today's exchange rate.

In some circumstances, using these products is an essential part of good business practice. If you are buying or selling billions of dollars of imports or exports, that is your business.

Since the float we have had tragedies, scandals and a swag of lawsuits in relation to foreign exchange losses. In the 1980s, the banks sold Swiss franc loans to Australian farmers and small-business operators at 6 per cent when they had borrowed the francs at 2 per cent and then watched the franc rise from 2.5 to the Australian dollar to less than one to the dollar.

George Soros created a hedging fund that attacked the currencies of Thailand, Malaysia and Indonesia and caused major devaluations of those currencies. Warren Buffett called derivatives "financial weapons of mass destruction".

The message is plain. The float of the Australian dollar was, according to Paul Keating, a way to "de-spiv" the Australian economy. I think it has probably increased the number of spivs.

The financial markets are all about risk, adequate capital support and a return that is commensurate with the risk. The trick is to know and measure the risk and to have deep enough pockets to stay in the transaction.

It is sad to hear that retirees are opening trading accounts on the internet. They might as well go to the races or a casino. Some very good businesses have been gutted by exchange speculation.

My final point is about the exchange rate over time. It was floated at US91 ¢; it has been down to US49 ¢ and it is now at US75 ¢. These rates do not reflect the state of the Australian economy at those times. Speculation and technology have pushed economic theory about relative exchange rates out the window.

There is no doubt that the financial sector has benefited enormously from the float of the Australian dollar. I haven't seen a calculation from them for the debit side of the ledger.

Martin Feil is a tax and industry policy consultant and a former director of the Industries Assistance Commission.