Australian Dollar: Resilience of a Country and Its Currency
Australia: The Early Years
New South Wales was founded in 1770 by British explorer Captain James Cook, given its formal name and established as a legal colony in 1788. Later in 1863, the British separated the land to form further British colonies of Tasmania, South Australia, New Zealand, Victoria, Queensland and the Northern Territory. Founded inside the borders of New South Wales is today’s capital, Canberra and most important city Sydney and would become vital components to Australia’s legal declaration as a nation in 1901, Australia’s central bank and AUD as a single free float currency. But the road for Australia to become the nation and currency we know today was not an easy journey.
Imagine the early explorers revelation when they found New South Wales and Australia in particular with an abundance of natural resources such as Coal, Iron Ore, Tin, Nickel, Bauxite, Copper and later Gold, Silver, Natural Gas and Petroleum. Iron Ore was the first suspected resource identified by Captain Cook when his compass failed in many locations. He also found “not sand but deep black soil capable of producing any type of grain.” The problem wasn’t the natural resources but the system of trade.
Early year complications included not only lack of banks and a central bank but a system of exchange and various currencies employed as a system of trade found severe shortages because currencies left the territory by way of merchant ships and residents spent currency only when the need arose. Various currencies deployed between 1780’s – 1814 was the Indian Rupee, Dutch Guilder, Spanish Real, British Sterlings (Silver Pennies as the formal name) and internal barter of natural resources: Copper and Rum. Early Notes of credit termed Police Fund Notes and backed by the English Treasury were issued by banks but fear was notes were subject to and found counterfeiters. Police Fund Notes were just one type of note issuance during this period and all found problems. Not until the Spanish Holey Dollar became the first ever minted and legislated coin did Australia enter a new period because confidence was instituted in a currency with not only Government backing but a fractional dimension was introduced to understand a currency value to formally trade goods.
The New South Wales government under then and well known Governor today, Lachlan Macquarie purchased 40,000 Spanish Reals due to the Real’s world dominance then and cut the center from the Reals to double the number of available coins. The coins were formally minted and known as Holey Dollars with official Australia backing and began circulating in 1814. The center of the coins became known as Colonial Dumps and were fixed at 15 Pence per Dump while the official Holey Dollar was Fixed at 5 Shillings per Holey Dollar. Again, shortages developed due to increased natural resource trade and growing populations so in came the British as they imposed the Sterling Standard throughout its vast empire.
The British relieved the shortage pressures and 40 year attempt to institute an exchange system by legislating a Sterling currency in 1825 although accounts specify brisk trade of Sterling occurred as early as 1822. As the British introduced a new Gold piece and imposed the Gold Standard in 1821, all nations under its vast empire were subject to the new Sterling Standard. Australia was a prime target so approximately, 30,000 Pounds Silver arrived and it was here that began Australia’s long, long history as the Australian Pound that would span about 150 years. The term “about” was stated because evident throughout Australia’s history, legislation was always late to actual currency and other market developments. Changes in early Australia occurred as people movements or from those market participants that wished for adjustment so all demanded corrections from Australia’s government.
Quite evident from modern day Reserve Bank Governor speeches from 1960 to present day is Australia is not only a very conservative government traditionally but market adjustments occurred slowly and gradually with a need for consensus from government representatives. Consensus took time particularly in Australia as spirited political debate was always the norm and dates its history from its early beginnings. Legislation was never forward, it was always a response to market developments that were already implemented. With formal recognition of RBA true independence by Australia’s government in 1996 and with full powers to fully implement monetary policy independently, the ties between the RBA and Australia’s Treasury Department was severed.
From 1825 until the 1966 decimal system was introduced and Australia’s end to the Pound Fix in 1967, the Australian currency was known as the Australian Pound. Official RBA accounts always addressed the Fix end as 1971 but 1967 began actual market trading with price swings from 1967 onwards. AUD/GBP would share a 150 year relationship. Two problems existed however, Australia wasn’t formally a nation and official adoption of a currency wasn’t legislated. The impetus in this relationship was Gold.
Gold was found in the 1850’s and prosperity came to Australia. Banks were formed, populations grew and Gold coins were minted backed by Gold in circulation. Australia’s Museum of Currency Notes reports the population tripled to 3 million between 1858 and 1889, and banks saw an explosive increase. In 1851, 8 trading banks (Commercial Banks, traditionally referred as trading banks by Australia) and 24 branches existed but by 1890, 33 new banks opened accompanied by branches that exceeded 1500. As depression occurred in the 1890’s due from credit booms, many banks failed but reopened later after Australia became a nation in 1901.
As Australia’s six self governing British colonies voted and approved Federation, a constitution ratified by the English Parliament in 1900, a new nation was born in January 1901 when Australia adopted and called the new nation: Commonwealth of Australia. The new Commonwealth would include New South Wales, Tasmania, South and Western Australia, Queensland and Victoria. The first Parliament would convene May 1901. The first acts of the new parliament were adoption and issue of a currency and notes with full government backing.
AUD History
From 1910 to the 1983 free float, AUD journeyed through first the Fix to AUD/GBP, Fixed to USD, Fixed to its TWI (Trade Weight Index) then Fixed as a Crawling Peg to the TWI basket. Finally in 1983, the free float began and the free float was purely a clean float.
Formal adoption of AUD – adopted but not Fixed to GBP – occurred with passage of the Australian Notes Act in September 1910 and the Australian Notes Tax Act in October 1910. The first ever official notes were issued in 1913 based on the British system where 12 Pence = 1 Shilling and 20 Shillings equates to 1 Pound. A 10% per annum or as the legislation states 10 Pounds per Centum tax was imposed on all bank notes issued or reissued by any bank in the Commonwealth. Consistent with Section 51, Subsection 12 of Australia’s constitution, the powers to coin and issue was placed under government Treasury Departments. No mention of a central bank and it is here why the RBA was not only slow to develop but slow to gain its independence once it was formed due from Treasury constitutional dominance.
AUD/GBP
AUD/GBP from March 31, 1919 to August 31, 2014, the historic trading range saw its lowest low at 0.3333 on December 31, 2001 and highest high on December 31, 1976 at 0.7824 with an opening price that day of 0.7458. Not only were both prices extreme rarities throughout AUD/GBP’s history but other Fix periods accounted for those price swings.
The formal AUD/GBP Fix occurred June 30, 1931 at 0.3846 with a more formalized Fix one year later June 30, 1932 at 0.4000. The original 0.3846 Fix during this period means opening, high, low and closes remained the same price at 0.3846. Breakdowns in the Fix first appeared March 31, 1932 as the market was moving towards the 0.4000 point. The 0.4000 point held as open, high, low and close from September 30,1932 until June 30, 1947, 15 years.
A new Fix then developed September 30, 1952 at 0.3984 and held until December 31, 1967, 15 years. AUD/GBP trading ranges in the interim period from 1947 – 1952 hardly saw a 10 pip move on any given day. From June 30, 1931 – December 31 1967, AUD/GBP didn’t move nor saw a 10 pip price change on any given day in 36 years. Responsibility for price movements was placed on Gold and Deflation.
AUD/GBP from March 31, 1919 – 1931 Fix saw trading days of 20, 50 pips and a rare day March 31, 1920 at 441 pips. June 30, 1924 was another rare 123 pip day. The exchange rate was very stable between 0.4900 – 0.5200 but it was obvious June 30, 1930 the market was moving towards another period when AUD/GBP broke its 0.4900 range and opened the next day at 0.4700’s and then moved steadily down towards the 1931 Fix at 0.3846. The conundrums during this period were many but all involved GBP and the UK rather than Australia.
If AUD/GBP traded between 0.4900 – 0.5200 then GBP/AUD ranged between 2.0408 – 1.9230. If AUD/GBP was moving towards the 0.3846 Fix then GBP/AUD was moving up to 2.6000.
The period from 1870’s until 1931 was characterized as the Gold Standard where currencies were valued based on Gold prices. GBP left the Gold Standard in 1914 and 1916, returned in 1925 and formally left permanently in 1931. The explanation to spikes in AUD/GBP was characterized as times when GBP suspended then reentered the Gold Standard. The 1925 event was an actual devaluation of GBP/USD to its pre war rate at 4.86 and was called for by Churchill. When GBP permanently left the Gold Standard in 1931, all currencies free floated with wide price swings on any given day that ranged between 500, 1000, 1500 and even 2000 pip trading days.
The UK saw higher exchange rates coming in times when serious deflation, deficits and debt was the order of the day for many nations due from World War 1. To retain the Gold Standard wasn’t the way to assist to alleviate its many economic problems due to small movements in exchange rates versus Gold.
What the UK didn’t see during this period was all nations suffered serious economic effects and had acceptable exchange rate prices for their currencies to export goods and regain economic health. This led to true currency wars where nations engaged in destruction of the next nation’s exchange rate to gain export advantage. The Tripartite Agreement was signed in 1936 by all nations and all agreed not to engage in “Competitive Devaluations” of the next nation’s exchange rate. The UK devalued twice more during Australia’s Fix period. In 1947, GBP/USD was devalued 30% from 4.03 – 2.80 while Australia revalued AUD/GBP higher to 0.4600’s. In 1967, GBP/USD devalued yet again and it was here where Australia ended its Fix to AUD/GBP in favor of its next period.
For Australia and the AUD/GBP Fix period, it can only be classified as smart, yet protective and possibly defensive. If a currency is Fixed, it means budgets are also fixed at specific levels. But just as GBP went through devaluations Vs USD, Australia was fighting another battle with USD because AUD was also fixed to the United States Dollar.
AUD/USD
Officially, AUD/USD was fixed to USD from 1945 – 1971 and became the center of RBA Monetary policy during this period because RBA policy was adjusted based on USD monetary policy to protect the exchange rate. The Fix period ended December 30, 1971 but the start date is questionable because more than one Fix price was observed throughout the early 1940’s. The key to understand the early and middle 1940’s is the Bretton Woods Fixed exchange rate to $35 per ounce Gold system was signed in July 1944 and implemented so the market possibly was pricing various peg adjustments. Consider as well Fix prices were only allowed a 1% deviation fluctuation above or below by Bretton Woods agreements.
From 1940 to 1943, the Fix price was 1.6100. 1943 – 1945 saw a Fix price of 1.6080. 1945 – 1949 experienced another 1.6100 Fix while 1949 – 1971 set the Fix at 1.1200. From 1949 until 1971, AUD/USD traded somewhere not far from 1.1200 but spent most of its life at 1.1100’s. Because of the Fix Pegged system beginning about 1940, exchange rate prices saw again 20 and 50 pip trading days for 31 years. To understand the context for Australia, the early years must be viewed.
From 1919 until June 30, 1931, AUD/USD ranged from 2.4300, 2.2200, 2.2300 and eventually winded its way down to 1.8000 by June 1931. Then the Fix prices at 1.6100’s began in the 1940’s. From 1919 to 1931, price swings of 500, 1000, 1500 even 2000 pips per day were common. If the 2.4300, 2.4000 highs are considered from 1919 and 1920, AUD/USD has embarked on a 95-year downtrend if today’s 0.9300 price is further considered.
AUD/USD and TWI
As the Gold Standard was lifted formally by the 1971 Smithsonian Agreement in December 1971 and officially in 1973 by United States President Richard Nixon, currencies again free floated after a 33 year hiatus. Nations then began adoption of Trade Weighted Indices to understand prices of their own currencies versus other nations for import and export and contractual purposes. AUD was fixed daily to the US Dollar based on its Trade Weight Index number then to the trade weight basket as their next experiments. But as a reminder from Australia’s early days when currency shortages occurred, Australia maintained an Exchange Control Policy. Limits were placed on a number of shares owned by foreigners, restrictions on foreign owned financial companies, import and export controls, registration of foreign banks, foreign currency amounts crossing borders. When AUD free floated in 1983, all Exchange Controls were lifted that derived primarily from the Banking and Foreign Exchange Regulation Act of 1959. The primary message to markets, investors and the world was capital controls were lifted and Australia was open for business.
AUD/USD was next Fixed daily to USD based on its Trade Weight Index from officially September 1974 – 1976. The Fix period began in 1974 at 1.4825 and saw lows of 1.0005 but when the time ended is unknown because of the massive swing in prices and because the period ended only to roll into the next TWI Fix period. End time speculation derives from the 1976 Fraser Government’s desire to devalue AUD against Treasurer Keating’s objections. A long fight ensued regarding devaluation with a win for Prime Minister Fraser but how much and when the devaluation occurred is not seen in the markets. A view of trading days during this period fails to reveal a sustained Fix price based on open, high, low and closing prices. What was seen only was large price swings daily. Part of the price swing reasons may be due to ending of Bretton Woods and abandonment of the Gold Fixed Peg system in 1973.
The TWI experiment ended in favor of the Fix to the larger TWI basket. This would be termed a variable or Crawling Peg. The Crawling Peg would become the mainstay system from 1976 until AUD/USD was formally free floated December 1983 at 0.8975. RBA head Glenn Stevens in a 2013 speech credits the free float price at 0.9000. The 1976 Fix saw price swings on any given day at about 500 pips.
From Pound to Dollar
Formal separation as the Australian Pound was completed in 1966, with passage of the Currency Act of 1965 from Pounds to the present name Australian Dollar. Shillings, Pounds and Pence were converted to a new 100 cent decimal system with a conversion rate at unofficial estimates of 2 AUD = 1 GBP. Since Australia’s Monetary Policy was closely tied to USD, it was also vital to Australia’s economic health to price AUD higher than USD.
AUD/USD The Free Float
After 203 years since Australia was founded in 1770, AUD free floated and allowed for the first time in history that monetary policy was not set by exchange rates. Early free float years however was characterized as holding AUD/USD’s values.
RBA Free Float Interventions
The early years of AUD/USD were characterized as interventions particularly 1989 and 1990 when the RBA intervened 145 and 111 times but serially spread over the years. In 1989 for example, the RBA intervened in 11 of 12 months and over a series of days. June 1989 saw 18 interventions, September 1989 saw 19 interventions. This pattern would repeat itself throughout 1990. Factor 253 United States trading days and 254 for Australia, the RBA was in the market over half of the trading days in 1989 and almost half of every trading day in 1990. The first intervention occurred in 1985.
Based again on the 2013 Stevens speech because RBA intervention data dates to 1989, the first major intervention occurred November 1985 then July 1986 “when AUD/USD fell 38% in 18 months and threatened to fall further”. The third intervention occurred the following year in January 1987.
The 1980’s were classified as volatile because the Plaza Accords were agreed and signed in September 1985 to depreciate the US Dollar, and Australia was neither a signatory nor invited to the talks because it wasn’t a member of the then G-7 nations. The G-7 nations reconvened two years later to sign the Louvre Accords in February 1987 to stop the decline of the US Dollar. The second volatility consequence happened when Australia’s government under Bob Hawke’s Australia Labor Party proposed in 1984 and implemented in 1985 to remove interest rate ceilings on loans and deposits as part of a larger financial deregulation of Australia’s finance and bank system introduced in the 1981 Campbell Report. Australia and AUD/USD suffered the effects as December 31,1984, AUD/USD opened at 0.8320, traded its lowest low December 31 1986 at 0.6308 and opened at 0.7105 December 31, 1987. AUD/GBP opened at 0.7125 March 31, 1985 and by December 31, 1987, opened at 0.4391. By the 1990’s, interventions would continue.
From 1991 – 1998, interventions progressively decreased from the 1991 high of 57 to the 1997 low of 2 and 12 in 1998.
Beginning in the 2000’s decade, 2000 saw 17 interventions while 2001 experienced 19. From 2001 to present day, the RBA intervened only as a result of the United States August 2008 Housing crisis. Then, the RBA intervened once in 2007 and nine times in October and November 2008. AUD/USD July 2007 experienced a market price of 0.9838 then saw a drop to 0.6021 by October 2008. Interventions since 2008 ended although three recent speeches by RBA head Stevens mentioned AUD/USD’s overvaluation and the July 2014 RBA Minutes revealed AUD/USD was not only overvalued based on “historical standards” but commodity prices were also low. The point regarding commodity prices is vitally important to understand AUD, its early free float and interventions.
A Commodity Currency
Along with the free float, a discussion originated in the 1984 -1985 Australian Parliament to understand AUD’s type of currency. An official Government report was released and revealed AUD moved in the markets based on its exports of Commodities. Then, Australia was exporting primary products of Wheat, Coal and Petroleum but importing less manufacturing products. The suggestion to smooth the exchange rate was import more manufacturing products. As time progressed, exports of commodities and various types grew exponentially to the point exports in the last 10 years comprise 55% of total exports and account for 11% of GDP.
From 1984 -1985 period is when work began to construct Australia’s Index of Commodity Prices but the overall discussions began as a result of the 11.07 billion Current Account deficit in 1984 – 1985 and 14.50 in 1985 – 1986. AUD then became known informally as a Commodity Currency and various commodities important to Australia began a close tracking of prices in relation to exchange rates because exports from free float beginnings were exported in either AUD, USD or Special Drawing Rights. Why the “informal” mention of AUD as a commodity currency is in its formal yet historic definition. A true commodity currency is money backed by gold as opposed to fiat money backed by the economy. While AUD was on the Gold Standard, it was truly a commodity currency but shifted to Fiat as the free float began.
Whether the RBA has an explicit intervention policy is unknown but the common theme throughout Australia’s years is interventions occur when Fundamentals are not aligned to the exchange rate. Part of the fundamentals concern commodity prices as much as balance of payments and other economic releases. A high exchange rate in light of low commodity prices is as much ground for intervention as much as an exchange rate misaligned to any economic release but the focus is primarily commodity prices. The historic assumption since the free float is a high exchange rate in AUD/USD occurs when Australia’s natural resources are demanded and a low exchange rate when commodity prices are low. Traditional RBA intervention practice is verbal warnings are issued directly to market participants then intervention follows.
A Commodity Currency
Along with the free float, a discussion originated in the 1984 -1985 Australian Parliament to understand AUD’s type of currency. An official Government report was released and revealed AUD moved in the markets based on its exports of Commodities. Then, Australia was exporting primary products of Wheat, Coal and Petroleum but importing less manufacturing products. The suggestion to smooth the exchange rate was import more manufacturing products. As time progressed, exports of commodities and various types grew exponentially to the point exports in the last 10 years comprise 55% of total exports and account for 11% of GDP.
From 1984 -1985 period is when work began to construct Australia’s Index of Commodity Prices but the overall discussions began as a result of the 11.07 billion Current Account deficit in 1984 – 1985 and 14.50 in 1985 – 1986. AUD then became known informally as a Commodity Currency and various commodities important to Australia began a close tracking of prices in relation to exchange rates because exports from free float beginnings were exported in either AUD, USD or Special Drawing Rights. Why the “informal” mention of AUD as a commodity currency is in its formal yet historic definition. A true commodity currency is money backed by gold as opposed to fiat money backed by the economy. While AUD was on the Gold Standard, it was truly a commodity currency but shifted to Fiat as the free float began.
Whether the RBA has an explicit intervention policy is unknown but the common theme throughout Australia’s years is interventions occur when Fundamentals are not aligned to the exchange rate. Part of the fundamentals concern commodity prices as much as balance of payments and other economic releases. A high exchange rate in light of low commodity prices is as much ground for intervention as much as an exchange rate misaligned to any economic release but the focus is primarily commodity prices. The historic assumption since the free float is a high exchange rate in AUD/USD occurs when Australia’s natural resources are demanded and a low exchange rate when commodity prices are low. Traditional RBA intervention practice is verbal warnings are issued directly to market participants then intervention follows.
AUD/USD Long Term Averages
If the December 1983 post float average at 0.7626 is considered, AUD/USD is not only not overvalued but the calculated target is 0.8928 and is well within the distribution between 1.1532 – 0.8503.
If averages from 1970 and 1971 at 0.8861 and 0.8802 are factored, AUD/USD is vastly oversold with targets at 1.1190 and 1.1125. Both average distributions lie within neutral zones between 0.8076 – 0.8645 and 0.8019 – 0.9584. The common theme among the three averages is bottoms are found at 0.8076, 0.8064 and 0.8019.
Between 25 and 20 year averages at 0.7643 and 0.7696, targets become 0.9226 and 0.9028 and neither average is oversold / overbought as prices trade middle range inside both distributions. Prices at 0.8109 and 0.8211 must break to see lower prices.
The 14 year average at 0.7990 targets 0.9680 and price lies inside a distribution between 0.9129 – 1.3060. The 10 year average at 0.8806 targets 0.9976 and price lies between the distribution at 0.9594 – 1.2315. A break of 0.9200 in the neutral zone reveals a new shorter term distribution would fall between 0.8806 -0.9200. The 5 year average at 0.9732 targets 0.9068 and prices are within a distribution between 0.9732 – 0.9284.
The common theme within a 5-55 year historic walk is all averages lie beneath present prices except the 5 year and all remaining averages are not threatened by breaks anytime soon. Further, all averages are either vastly oversold or approaching middle bounds between oversold and overbought. As the world regains its economic composure once again, AUD/USD has the potential to see far higher prices over time.
Monetary Policy
Australia’s Monetary Policy foundation began with passage of the 1911 Commonwealth Bank Act, a main bank in Australia today. The bank was established with 1 million Australian Pounds where bank profits were distributed between a Reserve and Redemption fund.
The RBA was born from early Commonwealth Bank beginnings and the relationship growth between Reserve and Redemption. Not until passage of the 1959 Commonwealth Bank and Reserve Bank Acts would the RBA receive official birth when the Commonwealth bank was split into the Commonwealth Banking Corporation and the RBA became a separate entity.
Issues regarding the Commonwealth Bank’s Reserve and Redemption Funds were seen in the 1920 Notes Act when issuance of Australia’s notes became the sole domain of the Commonwealth Bank from Australia’s Treasury Department’s origin as originator. A Note Issue Department was established and existed until 1924 when a Bank Board was created to issue Notes.
The Bank Board would exist to issue Notes for the next 35 years until the RBA would assume control in 1959 / 1960 under a formal Reserve Bank Board created by the Bank Act of 1959. The move would become the first formal powers toward an independent Central Bank despite calls dating to the 1920’s when questions arose regarding exchange rates, credit, size and scope of Notes issuance, budget amounts and Australia wasn’t on the Gold Standard then. Many problems existed in the early 1920’s but essentially the Commonwealth Bank was the Bank for the Australia Government from 1920 – 1960.
The 1945 Bank Act allowed Commonwealth Bank to pursue a monetary policy with goals to achieve currency stability, full employment and prosperity. Further, the 1945 Act allowed Commonwealth Bank to pursue a monetary policy “beyond Australia if necessary”. By passage of the 1951 Banking Act, monetary policy transferred to a board. The 1953 Bank Act not only affirmed rate of interest would remain the same but it was illegal for Gold to leave Australia. Monetary policy began due to the Reserve and Redemption funds however slow.
Monetary policy was again a slow and gradual process until 1976. The focus from the 1920’s – 1970’s regarded fixed exchange rates coupled with Fiscal policy. The 1930’s experienced depression and war, and GDP for example dropped 10% in 1931. The late 1930’s addressed questions of Macroeconomics in the Australian Parliament and resulted in a 1937 Royal Commission report. Over 200 economists testified regarding adoption of various macroeconomic policies prudent for Australia such as recommendations for Keynesian economic policies, high versus low taxes, free float versus fixed exchange rates, independent central bank, control interest rates, allowance of private sector growth vs government growth, regulation and non regulation of banks. Testimonies spanned a large spectrum of economic issues.
Budgets however were fluid over the years particularly during the early periods through various devaluations of GBP and its effects to Australia. The 1947 GBP devaluation was still seen in the 1950 Australian Parliament for example when the devaluation was prominent regarding Australia’s proposals to export wool and ability to obtain its proper price based on Australia’s exchange rate.
Fiscal policy and taxes in relation to fund government budgets became a mandatory tool particularly when Interest Rate Controls were placed on Australian Government Bonds. Monetary policy was first seen in the 1970’s when reform slowly began and for the RBA to obtain independence, it was first seen in removal of interest rate ceilings.
Interest Rates
Until September 1973 when interest rate ceilings were removed on Certificate of Deposits, interest rate controls were enforced on bank deposits, interest charged on loans and maturities on term deposits. By 1980, full interest rate ceilings and fixed deposits were removed but most important was banks entered the market fully to compete for overnight funds.
The overnight Cash Rate began trading in May 1976 with actual Cash Rate targets first seen in August 1990. Once removal of bank restrictions to raise funds less than 14 days was implemented in 1984, Australia’s interest rate markets were fully developing. For example, interest rate ceilings were removed on bank loans less than 100,000, interest was paid on large deposits held less than 14 days and small deposits less than 30 days. Term deposits increased longer than four years. Despite the transfer of power to set the overnight interest rate from the Bank Board to the RBA, responsibilities and independence would not implement fully due to the gradual process to trade Bank Bills.
Bank Bills are security investments ranging from 1 -180 days. Two forms exist, Bank Accepted Bills and Bank Endorsed Bills. A Bank Accepted Bill is a Bill of Exchange and accepted by banks where banks pay face value at maturity. A Bank Endorsed Bill is a Bill of Exchange endorsed by the bank. Simplistically, Bank Bills today are Bank Accepted Bills that comprise negotiable Certificates of Deposit that range from 30, 90 and 180 day terms and are by far the most important interest rates in Australia to understand the term structure of interest rate paths. The overnight rate is also vital but its a 1 day rate and assists in the daily view of interest rate paths.
Bank Bills are security investments ranging from 1 -180 days. Two forms exist, Bank Accepted Bills and Bank Endorsed Bills. A Bank Accepted Bill is a Bill of Exchange and accepted by banks where banks pay face value at maturity. A Bank Endorsed Bill is a Bill of Exchange endorsed by the bank. Simplistically, Bank Bills today are Bank Accepted Bills that comprise negotiable Certificates of Deposit that range from 30, 90 and 180 day terms and are by far the most important interest rates in Australia to understand the term structure of interest rate paths. The overnight rate is also vital but its a 1 day rate and assists in the daily view of interest rate paths.
When interest rate ceilings were removed, only the 90-day Bank Bill was available for trade and its trade data dates to 1969. The 30 and 180 day Bank Bills began to trade in July 1992 and the Cash Rate Target began trading August 1990. To understand Australia’s interest rate paths was only to view the Overnight Cash Rate and the 90-day Bank Bill. Viewed together, both contained wide variations.
Consistent with 1900’s Swedish economist Knut Wiksell and his Neutral Interest Rate viewed from 20 – 50 years to understand an economy’s economic context, Australia’s current 90-day Bank Bill rate is far below the Neutral interest rate. The 20-year average is found at 5.33, 25 year at 6.13, post 1983 free float at 7.67 and since 1969, 8.44. Targets range from 3.27 – 4.22 and price at 2.63 is approaching bottoms. If any wonder existed how AUD/USD would see far higher levels, it’s found in Bank Bills because Australia’s economy seen from interest rates is underperforming.
The point of reference is the RBA doesn’t disclose nor offers information regarding its Neutral Interest rate but not only does New Zealand employ the 90 day Bank Bill as its Neutral Interest Rate but its the rate suggested by Wiksell and employed by many nations today.
Monetary Policy and Inflation Targets
Australia’s Parliamentary authorities realized early in the 1970’s world economics as a whole was headed towards interdependence particularly under a free float exchange rate system where nations were most interested in protecting and properly aligning currency prices versus the next nation. Exchange rate markets journeyed full circle from the 1920’s volatility to fixed periods, Gold Standards and to outright destruction of another nation’s exchange rate.
Interdependence was an economic system where all nations would adopt the same policies as the next nation but accompanied with certain twists and tweaks in each nation. Economics in its own right also adopted a full circle approach from serious deflation in the 1930’s to exhorbitantly high inflation in the 1970’s. The 1930’s witnessed government controlled Keynesian policies while the 1970’s experienced monetarism to target and adjust money supplies. Australia was no different in this regard as they first adopted discretionary budgets.
Monetary Policy 1971 – 1985.
Monetary Policy from 1971 – 1976 was classified as discretionary budgets. If Real spending growth by CPI is a gauge, 1975 -1976 was the only negative cash balance year within the period.
From 1976 – 1985, Australia adopted a monetary policy titled Monetary Targets where the target was M3 money and set by the Treasury. In light of interdependence, the United States, Germany, England and Switzerland all adopted Monetary targets.
The goal was to reduce inflation but targets missed every year except 1981 so inflation rose, GDP dropped and large budget deficits were seen. Budget deficits would result in deficit spending to borrow monies by selling more bonds to cover the deficit gap. To borrow money while in deficit results in money printing and results in printing spirals as more and more bonds are sold with interest rate controls to cover increasing gaps. By 1985, M3 rose to 17.5%.
1993 – Present Inflation Targets
RBA head Ian Macfarlane’s 1998 speech highlights the next economic experiment termed Inflation Targets. New Zealand again took the lead in 1990 and led the world on the path to Inflation Targets followed by Canada in February 1991, the UK in 1992, Sweden, Finland and Australia in 1993.
The target is the “price path with the goal to maintain price stability by anchoring Inflation over time versus price changes”. The objective would become price Inflation or simply CPI, the Consumer Price Index. Why New Zealand is because New Zealand as a leading central bank was the first to revamp CPI indices so they adopted Inflation targets in line with newly revamped CPI Indices.
Australia defines and implements its Inflation Targets as an average rate of increase in CPI of 2% – 3% over a medium term. A medium term further defined in both Macfarlane and Stevens’ speeches is if Inflation has a 2 in front of it over time, Inflation is on track.
Real Spending Growth by CPI since 1993 experienced negative Cash Balances from 1993 to 1998 then positive from 1998 to 2001 and negative in 2002. From 2003 to 2008, cash balances were positive then began negative years between 2009 and 2014. Current CPI is 3% and at upper end of target.
Upon the formal adoption of Inflation Targets in 1996, the RBA was officially recognized as an independent central bank.
Since 1980, Australia as well as the United States experienced negative Current Accounts. Neither has been positive since 1980 and remained well below the all important 0 line. Over a longer horizon, Australia’s Current Account has been negative since 1959 and is now slowly approaching the 0 line.
Top four export nations in the last four years in order is China, Japan, South Korea and the United States. Top four import nations are China, United States, Japan and Singapore. Top five two way trade is found between China, Japan, United States, Korea and Singapore. Iron Ore is the number one export followed by Coal, Natural Gas and Gold. Iron Ore is employed to make Steel so its obvious exports head to growing nations to build buildings, tunnels and bridges. Only since 2010 has Australia’s trade shifted to Asian nations.
Australia 10 Year Yield
The most important Bond yield for Australia is the 10 year. The current 10 year average of the 10 year yield is 4.95 and its highest price seen in the last 10 years is 6.81 and lowest price was 2.68. Traditionally, as long as the 10 year Australia bond Yield is above the United States 10 year yield, AUD/USD is a long and short upon Australia yields below the United States. The current 10 year yield average for the United States 10 year bond yield is 2.72. The current Australia yield is 3.37 and 2.34 for the United States.
Budget Years
Australia’s Fiscal year begins July 1 – June 30. How and why budget years began in this time frame is unknown. The UK’s Fiscal year begins April 1 – March 31. One would note the many references to December throughout the text. December is almost the half-year point and a popular month historically to adjust interest rates.
FIX Price
A currency Fix price began under the early Gold Standards where a currency price was fixed by Government, bank or currency board to the Gold price. Generally the Spot rate was employed as the basis for any Fix price. Under free floating exchange rates, governments and central banks found creativity by fixing currency prices to Trade weight indices, another nation’s currency, a currency board, Trade weight baskets or free float but manage the price heavily as it trades. In Australia’s early years in the 1920’s free float, bank cartels in London negotiated the Fix price. Today, central banks employ and decide a Fix price daily based on Spot prices and usually in conjunction with its domestic banks. Australia releases its Fix price at 10:00 a.m. promptly Australia time.
AUD and Monetary Policy
The enemy of any central bank since 1970’s interdependence is the business or any cycle that deviates from economic projections. Inflation Targeting as a policy is here to stay for the foreseeable future because to control inflation controls GDP, employment and interest rates within small channels. It’s a top-down approach but one that has served central banks well since the high 1970’s inflationary periods.
If the yield curve is viewed as an inflation curve then Inflation Targeting has the effect to also control exchange rates within small ranges. As long as Inflation holds within projections, central banks can extend economic periods far into the future. They conquered what they sought to control since the industrial revolution and its not market friendly to volatility but it may ensure trends remain and more certain. But no policy last forever, its periodic.
A note on cycles. The United States 1982 Official Gold report reveals since the 1500’s, the gold versus paper currency standard reigns in each period about 50 years. Governments spend in excess and can’t repay paper currency debts so Gold periods reign. Once a need exists for governments to spend in excess of Gold to currency Fixes, paper currency floating becomes the order of the day. If 1971 is the beginning of floating exchange rates, 2014 marks the 43rd year.
Within 50 year periods derives market crashes such as the 1998 Russian Ruble crisis, 94 / 95 Mexican Peso and 1997 Thai Baht crisis. The 2008 United States housing collapse was a market crash.
Australia never causes nor will cause a crash rather they suffer the effects but they also are resiliently able to weather any storm. Australia’s dilemma is commodity cyclicality and negative balance of payments. Commodities cycle with economic growth and it is reflected in its balance of payments. Now that the RBA has true independence, they are capable of staying ahead of any curve.
AUD as a currency is equally resilient. Many view AUD as a cousin to NZD when, in fact, AUD is more a Euro than NZD. Its construction, trading ranges and possible deviations are more aligned to the Euro than NZD. As time progresses, AUD will be much more widely accepted as the currency that weathered every economic and currency storm over a 203 year period.
Despite quite a monetary, exchange rate and nationhood journey, Australia after 115 years since 1901 fought the hard fight and won.
Brian Twomey
