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May 31, 2012 7:44 PM Subscribe
Interest rates for US certificates of deposit: 1%, if you're lucky. Interest rates for Australian term deposits: 4-5%. What gives?
I mean, I get that the Reserve Bank of Australia is keeping interest rates high-ish while the Fed is keeping them low, but why? Is this question a whole can of worms? Will there be references to the Chicago School? WILL THERE BE A TEST?
I mean, I get that the Reserve Bank of Australia is keeping interest rates high-ish while the Fed is keeping them low, but why? Is this question a whole can of worms? Will there be references to the Chicago School? WILL THERE BE A TEST?
The US Fed keeps them low to encourage borrowing for investment in the economy during our recession. Is Australia not suffering badly from the recession? That is at least a partial explanation.
posted by imagineerit at 7:48 PM on May 31, 2012 [1 favorite]
posted by imagineerit at 7:48 PM on May 31, 2012 [1 favorite]
The Australian economy is a whole different thing than the US and Europe. It's doing very well comparitively thanks to exports to China, mostly natural resources mined from Western Australia. So the government isn't playing games making rates low to stimulate growth. The risk as an American is if you buy those bonds you are now taking on Australian dollar risk. If the AUD gets weaker over time against the USD you may lose out. There may also be some structural risk, like if Australian banks go bankrupt. No idea how realistic that concern is.
posted by Nelson at 8:20 PM on May 31, 2012 [1 favorite]
posted by Nelson at 8:20 PM on May 31, 2012 [1 favorite]
Is Australia not suffering badly from the recession?
No, we're holding up quite well. Apparently a lot of this is because China is still keen to buy up whatever we dig out of the ground.
For whatever reason, the Reserve Bank of Australia never seems to lower the cash rate below 3%, and since 1992 it's hovered between 5-7%.
(that's an amazingly clunky graph for the freaking Reserve Bank to be publishing!)
posted by UbuRoivas at 8:24 PM on May 31, 2012
No, we're holding up quite well. Apparently a lot of this is because China is still keen to buy up whatever we dig out of the ground.
For whatever reason, the Reserve Bank of Australia never seems to lower the cash rate below 3%, and since 1992 it's hovered between 5-7%.
(that's an amazingly clunky graph for the freaking Reserve Bank to be publishing!)
posted by UbuRoivas at 8:24 PM on May 31, 2012
There may also be some structural risk, like if Australian banks go bankrupt. No idea how realistic that concern is.
They continue to make record profits in the midst of a global recession, mostly by skimming off a tidy percentage between the rates at which they borrow vs the rates at which they lend.
posted by UbuRoivas at 8:26 PM on May 31, 2012
They continue to make record profits in the midst of a global recession, mostly by skimming off a tidy percentage between the rates at which they borrow vs the rates at which they lend.
posted by UbuRoivas at 8:26 PM on May 31, 2012
Is a side effect of this that borrowing money in Australia is also much more expensive?
posted by smackfu at 8:28 PM on May 31, 2012
posted by smackfu at 8:28 PM on May 31, 2012
Yes. Banks won't lend money for less than their rate for deposits.
Also, that link I posted to the RBA graph...you'll need to click on "Australian cash rate", one down from the top. Other graphs in there show handy comparisons between countries regarding their interest rate policies.
posted by UbuRoivas at 8:31 PM on May 31, 2012
Also, that link I posted to the RBA graph...you'll need to click on "Australian cash rate", one down from the top. Other graphs in there show handy comparisons between countries regarding their interest rate policies.
posted by UbuRoivas at 8:31 PM on May 31, 2012
Inflation or anticipated inflation in Australia.
posted by miyabo at 8:36 PM on May 31, 2012 [1 favorite]
posted by miyabo at 8:36 PM on May 31, 2012 [1 favorite]
Congratulations, you've discovered the Carry Trade:
1. Borrow money in currency A (USD) from a country with low interest rates (1% from USA, using your example).
2. Convert to currency B (AUD), and make high return investments in that currency (4%-5% in AUD, again using your example) for the same duration.
3. When your investments mature, cash out and convert back to currency A (USD), to pay off the original loan.
4. If the investment return is greater than the loan rate AND the currency exchange losses, then: Profit!
Googling "carry trade" will give you a world of info. This sort of thing is best left to risk seeking hedge funds with deep pockets, since a large amount of foreign investment can significantly influence, you guessed it, national inflation rates and currency exchange rates.
posted by ceribus peribus at 9:19 PM on May 31, 2012 [6 favorites]
1. Borrow money in currency A (USD) from a country with low interest rates (1% from USA, using your example).
2. Convert to currency B (AUD), and make high return investments in that currency (4%-5% in AUD, again using your example) for the same duration.
3. When your investments mature, cash out and convert back to currency A (USD), to pay off the original loan.
4. If the investment return is greater than the loan rate AND the currency exchange losses, then: Profit!
Googling "carry trade" will give you a world of info. This sort of thing is best left to risk seeking hedge funds with deep pockets, since a large amount of foreign investment can significantly influence, you guessed it, national inflation rates and currency exchange rates.
posted by ceribus peribus at 9:19 PM on May 31, 2012 [6 favorites]
"I get that the Reserve Bank of Australia is keeping interest rates high-ish while the Fed is keeping them low, but why?"
The short and (over)simplified version is that the US Fed leans towards keeping cash rates low in order to encourage spending, while the Australian Reserve Bank leans towards keeping home loan rates low in order to encourage home buying.
Keep in mind that the $AU is traditionally somewhat more volatile than the $US, so you'd be trading return for risk. 4%~5% return in $AU stops looking good the moment the $AU drops to 95c US…
Ubu: "that's an amazingly clunky graph for the freaking Reserve Bank to be publishing!"
Because the Reserve Bank typically adjusts cash rates quarterly - if they smoothed the cash rate to look pretty it wouldn't be accurate - while the real cash rate is based on a daily figure (the overnight unsecured rate) adjusted for inflation.
posted by Pinback at 9:21 PM on May 31, 2012
The short and (over)simplified version is that the US Fed leans towards keeping cash rates low in order to encourage spending, while the Australian Reserve Bank leans towards keeping home loan rates low in order to encourage home buying.
Keep in mind that the $AU is traditionally somewhat more volatile than the $US, so you'd be trading return for risk. 4%~5% return in $AU stops looking good the moment the $AU drops to 95c US…
Ubu: "that's an amazingly clunky graph for the freaking Reserve Bank to be publishing!"
Because the Reserve Bank typically adjusts cash rates quarterly - if they smoothed the cash rate to look pretty it wouldn't be accurate - while the real cash rate is based on a daily figure (the overnight unsecured rate) adjusted for inflation.
posted by Pinback at 9:21 PM on May 31, 2012
Best answer: Don't forget you need to look at this net of the fx hedging costs.
This is one of the fundamentally borked things about the global economy. The monetarist approach to rate policy is not about risk, directly, it's about manipulating the appetite for risk. Basically, it's about controlling credit creation. Unfortunately, the rest of the economy is set up on the idea that rates reflect risk (and time). This disconnect has really weird effects on the global economy.
Like, if I want you to invest in my insane moonshot startup, you need a pretty high rate of return to make it worth the risk. If I just ask you to let me hold $10 till tomorrow and I give you $10 worth of collectible baseball cards to hold in the meantime, you'll take a super low rate. That is the basis of everything in the universe.
But central banks don't change their rate policies solely on the basis of risk. They change it based on economic policy goals. Japan has a savings glut in the early '00s and wants to get capital invested in riskier, more useful projects? It holds rates low, forcing savers into riskier investments in search of yield (although in the case of Japan, not really.) The USA is worried that there is too much credit being created through the tech VC/IPO pipeline in the '90s? Raise rates. You make that low risk pay better, so theoretically higher-risk activities need to do even better to be worth it (you also slow down borrowing, which creates credit itself, and increasing the time value of money makes things like long receivables chains more expensive for their holders and so discourages them. There's a lot of complex effects but this is the basic idea).
The critical difference here is that neither of these things reflect a change in the likelihood of Japan or the USA to default on their respective debts. The 'risk', in the sense of a default, is the same as it was before. So why not borrow in one currency and lend in the other? This is known slangily as the carry trade. There are all sorts of times when the spread between New Zealand sovereign debt and some borrowing in Japan becomes huge, for reasons that have nothing to do with credit risk, and everything to do with monetary policy.
So the real issue becomes, "what happens to the value of these to currencies relative to some other numéraire like my base currency, purchasing power parity basket of goods-wise, big macs, or what have you?" The issue is that fiddling with these parameters affects the money supply, which in turn affects inflation, which affects the purchasing power of the currency. In addition, especially with smaller economies, this opportunity attracts hot money flows.
Normally, in situations like this, which are mistakenly called "arbitrage opportunities" but are really types of spread trade, the attraction of people into the trade closes the opportunity. It gets "arbed out". Unfortunately, in this case, the opposite happens. The influx of hot money into the high-yield currency further inflates the value of that currency and is likely to contribute to further inflation of that economy's money supply, which leads bankers to raise rates even more. The money needs to be parked somewhere which contributes to asset price bubbles. The already overhot economy that was trying to use monetary policy to cool things is suffering the opposite sequence of events. Meanwhile, in the low-yield currency's economy, let's say the monetary policy is extremely accommodative because they've just suffered a financial crisis and are dealing with a drop in aggregate demand. Now capital is fleeing the country. The currency is being sold, further depressing its value (not necessarily terrible, this is going to get really complicated if we keep going this way). My point is just that, instead of encouraging the bought and sold currencies to converge, additional people getting into the trade can cause the currencies to diverge further, until the whole thing catastrophically unwinds. I mean, even in the simplest case, the low-yield currency should be the one suffering from rising inflation (in a "normal" case), right? So PPP-adjusted, it should cost you increasingly less to pay back your debts in the currency you borrowed in, effectively juicing your returns.
This is a huge, huge problem for smaller economies and is one of the main engineering flaws in the global financial system, in my opinion. There is no good way for small economies to deal with hot money flows. It's like a big fuel truck careening down a twisty road. The money in the tank oscillates and continually threatens to overturn the tanker, but any system of internal antislosh baffles we come up with looks like a trade restraint.
Another thing to keep in mind here is that central banks are not perfectly rational actors. They have their own sets of biases based on their experiences. For example, the ECB/Euro Area bankers are way more inflation-phobic than say the USA's bankers, because they have examples of incredibly destructive hyperinflation in living memory, and they can remember how hard that was to tamp down. The USA is way more afraid of unemployment, particularly the risk of cyclical unemployment becoming structural unemployment (this may also be related to the relative lack of a social safety net in the USA). In the specific case of Australia, the Australian central bankers are mindful of the relative value of the Australian Dollar. Remember, it wasn't that long ago that the Australian Dollar had been trading at low values for so long that it was derisively called "the Pacific Peso".
Anyway, yeah, borrow money in the US, invest in Australia, and buy AUSUSD futures. The above is a lot of background to your question but I guess the simple answer is that "Australian central bankers need to keep inflation and the real estate bubble in check which is being propped up by the seemingly insatiable demand of China for Australian natural resources. The US, by comparison, can't give away a house and has huge amounts of skilled labor sitting idle waiting to be put to productive economic use. Aus situation = high rate policy. US situation = low rate policy."
posted by jeb at 9:42 PM on May 31, 2012 [26 favorites]
This is one of the fundamentally borked things about the global economy. The monetarist approach to rate policy is not about risk, directly, it's about manipulating the appetite for risk. Basically, it's about controlling credit creation. Unfortunately, the rest of the economy is set up on the idea that rates reflect risk (and time). This disconnect has really weird effects on the global economy.
Like, if I want you to invest in my insane moonshot startup, you need a pretty high rate of return to make it worth the risk. If I just ask you to let me hold $10 till tomorrow and I give you $10 worth of collectible baseball cards to hold in the meantime, you'll take a super low rate. That is the basis of everything in the universe.
But central banks don't change their rate policies solely on the basis of risk. They change it based on economic policy goals. Japan has a savings glut in the early '00s and wants to get capital invested in riskier, more useful projects? It holds rates low, forcing savers into riskier investments in search of yield (although in the case of Japan, not really.) The USA is worried that there is too much credit being created through the tech VC/IPO pipeline in the '90s? Raise rates. You make that low risk pay better, so theoretically higher-risk activities need to do even better to be worth it (you also slow down borrowing, which creates credit itself, and increasing the time value of money makes things like long receivables chains more expensive for their holders and so discourages them. There's a lot of complex effects but this is the basic idea).
The critical difference here is that neither of these things reflect a change in the likelihood of Japan or the USA to default on their respective debts. The 'risk', in the sense of a default, is the same as it was before. So why not borrow in one currency and lend in the other? This is known slangily as the carry trade. There are all sorts of times when the spread between New Zealand sovereign debt and some borrowing in Japan becomes huge, for reasons that have nothing to do with credit risk, and everything to do with monetary policy.
So the real issue becomes, "what happens to the value of these to currencies relative to some other numéraire like my base currency, purchasing power parity basket of goods-wise, big macs, or what have you?" The issue is that fiddling with these parameters affects the money supply, which in turn affects inflation, which affects the purchasing power of the currency. In addition, especially with smaller economies, this opportunity attracts hot money flows.
Normally, in situations like this, which are mistakenly called "arbitrage opportunities" but are really types of spread trade, the attraction of people into the trade closes the opportunity. It gets "arbed out". Unfortunately, in this case, the opposite happens. The influx of hot money into the high-yield currency further inflates the value of that currency and is likely to contribute to further inflation of that economy's money supply, which leads bankers to raise rates even more. The money needs to be parked somewhere which contributes to asset price bubbles. The already overhot economy that was trying to use monetary policy to cool things is suffering the opposite sequence of events. Meanwhile, in the low-yield currency's economy, let's say the monetary policy is extremely accommodative because they've just suffered a financial crisis and are dealing with a drop in aggregate demand. Now capital is fleeing the country. The currency is being sold, further depressing its value (not necessarily terrible, this is going to get really complicated if we keep going this way). My point is just that, instead of encouraging the bought and sold currencies to converge, additional people getting into the trade can cause the currencies to diverge further, until the whole thing catastrophically unwinds. I mean, even in the simplest case, the low-yield currency should be the one suffering from rising inflation (in a "normal" case), right? So PPP-adjusted, it should cost you increasingly less to pay back your debts in the currency you borrowed in, effectively juicing your returns.
This is a huge, huge problem for smaller economies and is one of the main engineering flaws in the global financial system, in my opinion. There is no good way for small economies to deal with hot money flows. It's like a big fuel truck careening down a twisty road. The money in the tank oscillates and continually threatens to overturn the tanker, but any system of internal antislosh baffles we come up with looks like a trade restraint.
Another thing to keep in mind here is that central banks are not perfectly rational actors. They have their own sets of biases based on their experiences. For example, the ECB/Euro Area bankers are way more inflation-phobic than say the USA's bankers, because they have examples of incredibly destructive hyperinflation in living memory, and they can remember how hard that was to tamp down. The USA is way more afraid of unemployment, particularly the risk of cyclical unemployment becoming structural unemployment (this may also be related to the relative lack of a social safety net in the USA). In the specific case of Australia, the Australian central bankers are mindful of the relative value of the Australian Dollar. Remember, it wasn't that long ago that the Australian Dollar had been trading at low values for so long that it was derisively called "the Pacific Peso".
Anyway, yeah, borrow money in the US, invest in Australia, and buy AUSUSD futures. The above is a lot of background to your question but I guess the simple answer is that "Australian central bankers need to keep inflation and the real estate bubble in check which is being propped up by the seemingly insatiable demand of China for Australian natural resources. The US, by comparison, can't give away a house and has huge amounts of skilled labor sitting idle waiting to be put to productive economic use. Aus situation = high rate policy. US situation = low rate policy."
posted by jeb at 9:42 PM on May 31, 2012 [26 favorites]
Ubu: "that's an amazingly clunky graph for the freaking Reserve Bank to be publishing!"
Because the Reserve Bank typically adjusts cash rates quarterly - if they smoothed the cash rate to look pretty it wouldn't be accurate - while the real cash rate is based on a daily figure (the overnight unsecured rate) adjusted for inflation.
Slight derail, but I meant that it's not clear which points on the X-axis the marked years line up with. At least they could put a larger | for the marked years to make it clear. They Y axis is also very poorly marked. At the very least, you'd expect gridlines for every full percentage point. Also, why can't I specify the interval to report on? It's not as if they'd be short of IT resources.
posted by UbuRoivas at 9:53 PM on May 31, 2012
Because the Reserve Bank typically adjusts cash rates quarterly - if they smoothed the cash rate to look pretty it wouldn't be accurate - while the real cash rate is based on a daily figure (the overnight unsecured rate) adjusted for inflation.
Slight derail, but I meant that it's not clear which points on the X-axis the marked years line up with. At least they could put a larger | for the marked years to make it clear. They Y axis is also very poorly marked. At the very least, you'd expect gridlines for every full percentage point. Also, why can't I specify the interval to report on? It's not as if they'd be short of IT resources.
posted by UbuRoivas at 9:53 PM on May 31, 2012
The Reserve Bank of Australia adjust the rates quarterly but the big four banks, who act quite independently of RBA, are adjusting their rates every month, these are CBA, ANZ, NAB, Westpac.
Sometimes, some of the smaller banks offer higher long-term fixed interest (ING, Bendigo, Credit unions etc).
"Australian central bankers need to keep inflation and the real estate bubble in check which is being propped up by the seemingly insatiable demand of China for Australian natural resources. The US, by comparison, can't give away a house and has huge amounts of skilled labor sitting idle waiting to be put to productive economic use. Aus situation = high rate policy. US situation = low rate policy." - yep!
posted by Under the Sea at 10:37 PM on May 31, 2012
Sometimes, some of the smaller banks offer higher long-term fixed interest (ING, Bendigo, Credit unions etc).
"Australian central bankers need to keep inflation and the real estate bubble in check which is being propped up by the seemingly insatiable demand of China for Australian natural resources. The US, by comparison, can't give away a house and has huge amounts of skilled labor sitting idle waiting to be put to productive economic use. Aus situation = high rate policy. US situation = low rate policy." - yep!
posted by Under the Sea at 10:37 PM on May 31, 2012
the austrailian dollar seems really high at the moment. i suppose it could stay high forever, but given that that america is at the tail end of a recession and europe in the middle of one, while austrailia is showing all the signs of a traditional boom, i reckon it's gonna drop at some point. so, what you have is:
100usd -> converts to 102.81aud at todays rate (0.97aud for 1 usd) -> 5 years compound interest at 5% = 131.21aud -> converts to.... ???
the big variable is the exchange rate. after 30 years of traveling, living overseas etc, these things seem cyclical to me. lets conjecture the rate 5 years from now is going to be the same as it was 5 years ago, just for arguments sake. in may of 2007 that would be 0.82514 aud for each usd, so
131.21aud -> converts to 108.27usd.
however, in january of 2007 the rate is at 0.782835, giving you 102.71usd. in may of 2002, it was 0.549823, which would give you usd 72.14.
basically, fluctuations in the exchange rate are going to make a much bigger effect on your rate of return than interest rates, so it's more of a gamble than it looks on the surface. and given historical exchange rates between the us and australia, i'd venture to guess it's not really a particularly good gamble.
caveat: ianypo (i am not your precognizant oracle), obviously. ymmv
posted by messiahwannabe at 2:23 AM on June 1, 2012
100usd -> converts to 102.81aud at todays rate (0.97aud for 1 usd) -> 5 years compound interest at 5% = 131.21aud -> converts to.... ???
the big variable is the exchange rate. after 30 years of traveling, living overseas etc, these things seem cyclical to me. lets conjecture the rate 5 years from now is going to be the same as it was 5 years ago, just for arguments sake. in may of 2007 that would be 0.82514 aud for each usd, so
131.21aud -> converts to 108.27usd.
however, in january of 2007 the rate is at 0.782835, giving you 102.71usd. in may of 2002, it was 0.549823, which would give you usd 72.14.
basically, fluctuations in the exchange rate are going to make a much bigger effect on your rate of return than interest rates, so it's more of a gamble than it looks on the surface. and given historical exchange rates between the us and australia, i'd venture to guess it's not really a particularly good gamble.
caveat: ianypo (i am not your precognizant oracle), obviously. ymmv
posted by messiahwannabe at 2:23 AM on June 1, 2012
Nelson: There may also be some structural risk, like if Australian banks go bankrupt. No idea how realistic that concern is.
The Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding (the Guarantee Scheme) guarantees deposits up to $250,000 per individual at Australian deposit-taking institutions. Full list of guaranteed institutions on the APRA website.
I can't remember an Australian bank ever going bankrupt, so if it's happened, it's certainly not commonplace. There's pretty strict banking regulations here.
posted by Georgina at 2:24 AM on June 1, 2012
The Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding (the Guarantee Scheme) guarantees deposits up to $250,000 per individual at Australian deposit-taking institutions. Full list of guaranteed institutions on the APRA website.
I can't remember an Australian bank ever going bankrupt, so if it's happened, it's certainly not commonplace. There's pretty strict banking regulations here.
posted by Georgina at 2:24 AM on June 1, 2012
Keep in mind that the $AU is traditionally somewhat more volatile than the $US, so you'd be trading return for risk. 4%~5% return in $AU stops looking good the moment the $AU drops to 95c US…
Yeah, I think that's your risk. Plus just the costs of conversion- money is not technically convertible/fungible. When you need AUD, you need to find someone with AUD who is willing to buy your USD, and then vice versa at the other end. They will want to be paid for the trade, so the rate you get is just a little bit lower than the actual exchange rate.
(Plus any income taxes that might be charged on your income earnings?)
If you had a lot of money and investing like this was what you wanted to do, you'd set up savings accounts in the various countries, and then shift the money around as the exchange rates fluctuate.
The macro level of why some banks offer different rates is that they offer the rate that is necessary to get the money they need to lend out. The more they want your money, the more they will pay for it.
posted by gjc at 6:36 AM on June 1, 2012
Yeah, I think that's your risk. Plus just the costs of conversion- money is not technically convertible/fungible. When you need AUD, you need to find someone with AUD who is willing to buy your USD, and then vice versa at the other end. They will want to be paid for the trade, so the rate you get is just a little bit lower than the actual exchange rate.
(Plus any income taxes that might be charged on your income earnings?)
If you had a lot of money and investing like this was what you wanted to do, you'd set up savings accounts in the various countries, and then shift the money around as the exchange rates fluctuate.
The macro level of why some banks offer different rates is that they offer the rate that is necessary to get the money they need to lend out. The more they want your money, the more they will pay for it.
posted by gjc at 6:36 AM on June 1, 2012
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Good, that's just what the Australian government wants!
posted by kindall at 7:48 PM on May 31, 2012 [12 favorites]