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.