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Another big trade deficit

April 5th, 2005

The trade deficit for February came in at $2.8 billion, which suggests an annualised trade deficit of about 3 per cent of GDP, and a current account deficit of maybe 7 per cent of GDP. All the export growth was in the rural sector (mostly coal I guess, though I haven’t checked yet.

There are two broad explanations of this. One is that foreignrs see huge investment opportunities that will enable us to expand exports greatly some time in the future. Given the stagnation of manufacturing exports and the fact that there’s no particular reason to think that we are getting drastically better in service areas like tourism, the only plausible growth area is yet more coal.

The alternative is that we’re relying on hot money that can be pulled out quite rapidly when sentiment about the English-speaking countries sours. At that point, we’ll need to turn the trade deficit into a surplus, pronto. As those who’ve experienced such adjustments can attest, this is likely to be a painful process.

I favour the second explanation, but we’ve maintained these deficits for a decade or more, with the obvious blowout confined to the past few years. So we’ll just have to wait and see.

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  1. Joseph Clark
    April 5th, 2005 at 19:51 | #1

    If you are right with your second explanation the solution is simple; we use 1 percent of government spending to buy put options in the Aussie dollar. If your prediction is true, and the twitchy investors pull out all together, we make a killing.

  2. John Quiggin
    April 5th, 2005 at 20:53 | #2

    As I recall, Treasury did something like this a while ago (betting on the dollar rather than against it). They came out OK in the end, but the whole thing created such a fuss that I doubt it will be repeated.

  3. April 6th, 2005 at 00:39 | #3

    Minor quibble: it’s $2.18 billion.

  4. Joseph Clark
    April 6th, 2005 at 11:04 | #4

    The RBA seems to do a fair bit of this. They make an absolute killing off forex, largely by betting against the Aussie when they know things are down.

    The prudential controls prevent the banks from taking reasonable positions (like the NAB’s against the $A). This leads to a persistent underpricing of the instruments. Taking the risks that the banks aren’t allowed can be a very profitable little business for governments with prudential regulators in place. I’m trying to figure out if this is correctly classified as Taxation or Seignorage.

  5. Homer Paxton
    April 7th, 2005 at 11:24 | #5

    JQ,
    I think you will find that Treasury hedged their position which is a lot different to taking a position on the dollar.
    The reason the RBA can make money is they are not playing with borrowed money and hence can go up or down with one basis point.
    They can sit on losses until the currencr changes course again.
    Indeed that is their rationale.
    They buy the $A when it is obviously well under its value level and sell it when it is vica versa.
    They could not do this with borrowed money which is what the investment banks have.

  6. Fyodor
    April 7th, 2005 at 12:05 | #6

    Joseph,

    There’s no regulation blocking the banks from speculating in forex – they do it all the time. The constraints are capital adequacy regulation, their own capital base and risk tolerance.

    The NAB forex scandal related to alleged fraud and unauthorised risk-taking, not that NAB was speculating in the first place.

    As Homer points out, the RBA doesn’t trade the AUD so much as moderate the extremes: buy low, sell high. And it doesn’t leverage its positions. As it turns out, this tends to produce profits which are neither seignorage or (direct) taxation. It is effectively government speculation using our (i.e. taxpayers’) capital, however. The benefit in a more stable exchange rate probably outweighs the risk to our capital, so on balance it’s probably a good thing.

  7. Fyodor
    April 7th, 2005 at 12:10 | #7

    JQ,

    I agree with you on your second rationale. The large gap between our money market rates and those of the US has provided considerable incentive for hot money investors to park their liquids in the AUD. Unfortunately, US interest rates are now closing on Aus. interest rates very rapidly, diminishing the attractiveness of this trade. This signals to me a potentially significant depreciation in the AUD relative to the USD over the next year, as US rates continue to climb and ours stabilise.

    In the medium-term, AUD depreciation would help our trade deficit, but not as much as a sharp lift in our savings rate [don't mention the "R" word].

  8. Joseph Clark
    April 7th, 2005 at 14:15 | #8

    Fyodor,

    If you believe a devaluation is likely, I suggest you buy some options in the $A quickly before the market prices it. You could become a very rich man indeed. I’m not convinced myself so I might sit this one out.

  9. Homer Paxton
    April 7th, 2005 at 14:35 | #9

    Stephen Kirchner writs about a RBA discussion paper which says the opposite Fyodor

  10. Fyodor
    April 7th, 2005 at 14:48 | #10

    Joseph,

    Thanks for your investment tip. Got any others?

  11. stephen bartos
    April 8th, 2005 at 18:43 | #11

    while I don’t have a view on the movements of the $US vs the $A, I do think that both currencies will fall against the rest of the world – because we in Australia are, like it or not, hostage to the US deficit and will tumble with their currency when the game of chicken (who pulls out of $US first….) comes to an end.

  12. April 9th, 2005 at 00:29 | #12

    SB, I like to use a three variable graph, two dimensional since one dimension is constrained. Take the A$ and two others, e.g. the US$ and the pound sterling. Take the log of each of their ratios. Plot them as distances from each side of an equilateral triangle. Then the trajectory of the points shows better (not perfectly) whether a change is coming from, say, the US or the Australian end. You have to use judgment to interpret what you see in these entrails, of course.

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