Another spike would trigger a sell-off around the world, which could leave markets back where they were a year ago – unhappy and nervous, and with banks and other financial institutions facing huge potential losses, especially in Europe.
“The damage to the value of the Australian dollar and domestic interest rates from any change among Japanese investors could halt the economy.”
But the way the Fed is gradually softening up markets for the change seems to say that a panic won’t happen (hopefully). Of greater immediate importance to Australia is the sudden credit crunch in Chinese financial markets this week as the country’s central bank attempts to control lending and the unchecked growth in short-term financial products.
For Australia, the continued health of the financial system of our biggest trading partner and major buyer of our biggest export, iron ore, is of greatest importance. Any misstep by the Chinese authorities which causes a credit crunch would affect us. The central bank has refused to provide liquidity to the country’s financial markets, forcing short-term interest rates to around 8% in what is seen as an attempt to slow the pace of credit expansion and house price rises (much of which seems to be financed by a plethora of new, short-term wealth management products, as they are called in China). It’s high-risk.
The Reserve Bank is also concerned about Japan’s attempts to quickly reflate itself out of its deflationary rut, saying in the June minutes:
“In Japan, financial market participants had been weighing up two competing forces: the direct, downward pressure on yields from bond purchases by the Bank of Japan versus the upward pressure from expectations that these purchases would succeed in reflating the economy. The net result had been a marked increase in volatility and higher bond yields in Japan. Members noted that, while Japanese investors had shifted out of bonds and into equities, there had been little evidence to date of a shift into foreign bonds. Nonetheless, if it occurred, such a shift had the potential to affect Australian foreign exchange and debt markets. Despite Japanese investors allocating a relatively small share of their holdings of foreign debt securities to Australia, the absolute value of this allocation was large relative to the size of both Australian debt markets and capital inflows.”
The RBA never expressed so openly similar fears about the impact of the Fed’s three quantitative easings since 2008. It fears Australia could be collateral damage if the Japanese get their reflation attempt wrong. Already there are fears that it will mis-manage it – that’s partly the reason for the 20% plunge in the Japanese sharemarket since mid-May and the sharp rebound in the value of the yen.
Of the three challenges, Japan is the most worrying for the RBA because of greater uncertainty and unpredictability. The damage to the value of the Australian dollar and domestic interest rates from any change among Japanese investors could halt the economy. If that was to occur with the tapering in the US and tight credit conditions in China, then the new Australian government’s ability to ride out these shocks would be sorely tested at the start of its term.
This article was first published on LeadingCompany’s sister site, Crikey.
