March 23rd 2002

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Articles from this issue:

COVER STORY: The US steel decision

Ansett's collapse highlights failure of deregulation

Government's currency gamble goes bad

Straws in the Wind: All you need is love / What's in a name?

NSW Anglican Bishops support stem cell research ... but not at the cost of human life

Media: Courageously un-PC / Sudden 'enthusiasm' for Crean

Captive market (letter)

Misdirected (letter)

US steel (letter)

Show trials (letter)

Adult stem cells: the better option

Comment: Enron's collapse - the net widens

ASIA: How should the West respond to the terrorist threat?

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Government's currency gamble goes bad

by News Weekly

News Weekly, March 23, 2002

There comes a time in the life cycle of governments when it becomes impossible to blame things that go wrong on the previous administration. That point has been reached for Treasurer Peter Costello who has tried to shift the blame for up to $4.6 billion in foreign exchange losses over the past four years on to the Keating Government.

The money was blown by the Federal Treasury, and while they are "paper losses" at present it is unlikely that the money will be recovered.

There are of course some government policies which do reverberate down the decades, and Lionel Murphy's 1975 Family Law Act is one that readily comes to mind.

But in general, the major political parties have assiduously adopted the Treasury line for the past two or more decades, developing policies which are barely distinguishable from one another.

In the broad, both parties have agreed to open slather globalisation, the sale of public enterprises and assets, the deindustrialisation of Australia, deregulation of markets, and a blind belief that totally free market forces will ultimately work to the good of the nation.

Yet each newly-elected government persist with the ruse of claiming all the credit for good news and blaming any woes on its predecessors. It is not only tiresome, but dishonest.

For Peter Costello it was convenient to blame "13 years of Labor" for every conceivable economic problem the new Coalition Government encountered when it came to office in March 1996.

And while Costello can be given credit for cutting into Labor's accumulated public debt ("Labor's $8 billion black hole") in his early budgets, figures show he has presided over as big a spending government as any that has gone before him.

Meanwhile the national debt has kept growing exponentially under his stewardship and, as at last Christmas, was $326 billion.

Now, after almost six years as Treasurer, Costello wants to blame the Keating Labor Government for the disastrous currency swap losses his pals in the Treasury concocted.

The currency swap scandal, which has been overshadowed by other issues mainly because it is complicated for journalists to explain, was revealed during Senate Estimates Committee hearings on February 20, by Victorian Labor Senator Stephen Conroy.

The brash young Senator, who is Labor's new finance spokesman, chided Treasury officials, asking: "Have you guys been taking advice from Nick Leeson from Barings?"

How on earth did it happen?

Currency swaps

Without going into a complicated explanation of the derivative markets and "cross-currency swaps" the most simple parallel is that the Treasury did exactly the same thing as all those naive farmers did with Westpac's disastrous foreign exchange loans during the 1980s.

Those farmers were encouraged to borrow money in Japan where interest rates were next to nothing compared with Australia's high rates, but found themselves practically wiped out when the Australian dollar suddenly lost value against the yen.

In the case of the Commonwealth's unhappy gamble with the currency markets, the former Labor Government, under advice from Treasury, thought it prudent to use these currency swap arrangements, as a way of controlling the cost of the government's debt.

It was meant to be a carefully controlled mechanism - only 15 per cent of total debt could be placed in $US.

And there was supposed to be very little risk, according to research undertaken by merchant banks employed as consultants to the Government. The research showed that for a couple of decades US interest rates were on average 0.5 per cent lower than Australian rates, and significantly higher when Australia's budget went into deficit.

Not only that, but there was long-term stability between the two currencies - the Australian dollar had traded in a band between US65 and 85 cents for many years.

Reality knocked over both assumptions.

For a while the strategy worked - with some good years and some bad. However, eventually "the spread" or the difference between US and Australian interest rates narrowed, particularly after the Howard Government came to power.

And there was a massive depreciation of the $A against the Greenback again almost coinciding with the election of the Howard Government. In May, 1996 the $A was worth just under US80 cents, today it is worth just US52 cents.

Banana Republic

The currency fell to levels more than 10 per cent below the infamous days when Paul Keating warned that Australia could become a Banana Republic. The potential losses from the Treasury's currency swaps began to balloon early in 2000 as the $US soared against other currencies including our own.

According to the Treasury's own figures, the depreciation of the $A generated $1.1 billion in unrealised net foreign exchanged losses in 1999-2000. The following year, 2000-2001, the loss was $1.9 billion.

Costello's explanation?

First of all the whole scheme was started by Labor in 1989 to manage its own debt, and would not have occurred at all if Labor had not been such a profligate government.

He then went on to say that it was wrong to pick out two bad years when the overall policy has resulted in an average $100 million saving each year since 1989.

Costello says the only "realised" losses in the past two years has been $200 million.

However, the complete set of figures from 1989 to 2001 tell a different story (see box on previous page).

While there have been some positive years, particularly early in the piece, the total losses from the scheme has been in the order of $2.5 billion.

Why no intervention?

The key question for Costello is why he did not intervene when problems were clearly starting to arise in 1998, and particularly two years later when the Treasury was found breaching its own 15 per cent limits?

Again refusing to take any of the blame, Costello says he was directed by the Governor of the Reserve Bank, Ian Macfarlane, specifically not to unwind the currency swaps in October 2000 because this would have placed even more pressure on an already plummeting Australian dollar.

This, Costello said, was the cause of the Treasury breaching its own set limits.

Treasury reviewed the strategy in June last year after haemorrhaging $4.785 billion in just four years, and is now letting the swap agreements expire over time to zero.

Incidentally this will realise all those so-called "paper losses".

Mr Costello cannot have it both ways. If it was Labor's poor policy why didn't he review it? And if it was successful, why is the Treasury now winding the whole thing down?

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