Friday, September 18, 2009

The Reserve Bank Annual Report reads like a thriller

Let no-one tell you "it was never in doubt".

The global financial crisis has delivered the Rudd Government an unprecedented windfall in the form of massive Reserve Bank currency profits that will slash billions from the projected budget deficit and billions from government debt.

The Reserve Bank's annual report reveals that it handed Treasurer Wayne Swan a record $5.2 billion in August as a partial payment of its 2009/10 dividend, well up on the $1.4 billion in handed over as a full payment the year before.

The Reserve Bank's profit of $8.8 billion is far in excess of anything it has ever made in its 50 year history and came as a result of a decision to pour billions into supporting the Aussie dollar late last year as it slid even faster than it had during the "Banana Republic" crisis of the mid 1980s...

The Bank says that as Aussie touched 60 US cents in late October it became concerned that "the breakdown in market conditions itself had become a significant factor in the increasingly rapid depreciation".

In order to "break this dynamic" it bought $3.8 billion of Aussie dollars on foreign exchange markets helping drive the price up towards its present 87 US cents netting a cash profit of $4.4 billion as it sold dollars and an extra paper profit of $2.3 billion from revaluation of its assets.

It says in the process it had to break its own rules about the allocation of assets between currencies, rules it is now complying with again.

It'll transfer $557 million of the profit to its Reserve Bank Reserve Fund, and hand a total of $6 billion to the government, $5.2 billion to bolster its books during the current financial year, and at the request of the Treasurer a further $750 million to bolster its books during 2010/11.

The payouts will make a dent in the projected budget deficits for two financial years and will come on top of an expected budget boost of around $6 billion from better-than-forecast tax revenues as a result of the faster than expected recovery. The $57.6 billion deficit forecast by the Treasurer at Budget time is set to be revised down to somewhere between $40 and $50 when the forecasts are updated in December.

The Reserve Bank report also reveals a surge in demand for cash as Australians took money out of banks and stored it in physical form. A record 201 million $100 notes were in circulation at the end of June, up 24 million on the year before; The number of $50 notes was up 7 million. The Bank says it alerted Note Printing Australia to produce more but was able to meet to demand for previously printed supplies.

Published in today's SMH and Age

Crikey's Glenn Dyer adds:

For the first time we have been given an inkling of just how close the Australian financial system and economy came to freezing or imploding in the last quarter of 2008.

For all the confident talk from the government, the Opposition and others about how well we have done, we would not have been able to claim that if the economy had ground to a halt as credit froze over.

Prime Minister Kevin Rudd was the most accurate when he told the Queensland ALP conference earlier this year that Australia came very close to a serious crisis.

Overseas credit was cut off for everyone, including the federal government, the banks and companies, Australians panicked (there is no other word for it) and withdrew billions of dollars of cash from their banks to hide (presumably under the bed); banks could not raise money domestically from the markets so scared were they of one another, so they turned to the Reserve Bank in desperation.

So large was the demand for cash that the RBA ran out of $20, $50 and $100 bills and had to order more than $11 billion worth be printed to fill orders from the banks.

In fact everyone turned to the Reserve Bank in desperation for the three months to December, 2008 and into the early months of 2009.

All up the RBA boosted liquidity day-to-day in the markets by about $100 billion as the crisis intensified from October into early 2009. It was unprecedented.

Many of the moves, such as currency swaps with the Fed and rule changes to allow more and different types of securities to be dealt to the bank in liquidity management operations, were revealed during the year, but not the extent of activity as the RBA's balance sheet blew out to $165 billion at the height of the crisis in the last months of 2008 and early this year (now about $100 billion as conditions improved), still above normal.

The central bank's actions saved Australia (with help from treasury, the federal government and the US Fed) from joining other economies in deep freeze: The bank's senior executives were worth the pay rises they received during the year that some ignorant financial writers bagged this morning because they failed to comprehend the story that RBA laid out for them in its 2009 annual report.

Just how serious was it then?

Well, Australians were so worried about the financial crunch in the last three months of 2008 that they forced the Reserve Bank to boost supplies of cash to the economy by a massive $10 billion or 19% as they demanded cash.

The run on cash was part of a period of intense nervous crisis as the Reserve Bank found ways to boost the supply of liquid funds to the banks, individuals, businesses and even the government.

Financial institutions from credit unions to the biggest banks "self-securitised" their highest quality home-loan mortgages and sold $45 billion in the December quarter (now down to $20 billion) of them to the RBA in short-term deals called repos or repurchase agreements to raise cash to maintain liquidity during the worst months of the crisis. The RBA changed its rules to allow the exchange account balances the banks hold at the RBA to rise to a peak of $11 billion late in 2008 because financial institutions demanded instant availability of cash.