@thekouk, the SNB, and Carry… (more on FX intervention)

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Chris Joye linked to our post on the cost of FX intervention: which got the readership up… It also got the ire of Mr Stephen Koukoulas of Market Economics.

So much so that he started his tweeting about it. I don’t follow twitter, but I found them amusing – so I’ve pasted a few below (for those like me that don’t watch this sort of thing).

What horse shit. No wonder the “senior” person wants to stay anonymous

500 billion is the starting point …too busy to deal with this nothing form a nobody.

30% of GDP selling AUD: cost $32b: Sell $1 trill loss $64; $640 b loss if RBA sold $20 tril! See the prob

I did a Barnaby: got numbers wrong before. Why not sell $5 trillion? The cost would be $112 bil per annum

Mr Ambivalence ignores: if RBA sells at 1.04; then marks to mkt at 95c, it will book $50 bil fx profit

At 85c, the profit is $100 billion… fund NDIS, Gonski for a decade!

Find them all @thekouk

Well, it’s true that I didn’t count the gains from the mark to market on the FX assets in the case that the foreign exchange value of the AUD declines.

First, that’s because they are highly speculative. The above chart shows the RBA’s valuation gains and losses over the past few years — this includes both interest rate risk and foreign exchange risk. It’s hard to make a buck in this game – the portfolio has been costing them money of late.

Clearly, they would have done well on their duration (they hold USD, EUR, JPY and CAD), however that has not been enough to overcome their FX losses.

Second, that’s because the RBA’s foreign exchange assets would have to be sold and AUD re-purchased if the RBA was to realise their mark to market gains and pass the profits across to the Federal Government (which is likely to increase the foreign exchange value of the AUD once again … doh!).

Again, the SNB’s experience is relevant.

The SNB started intervening to cap the strength of EURCHF in March 2009. At the time, they told the market that 1.50 was the line in the sand. They have since added ~300bn (~50% of CHF GDP) to their foreign exchange assets. Despite their initial interventions, EURCHF appreciated to cap out at 1.04.

The only reason it’s 1.20 now is that the SNB went Rambo on them, and said that they will do YOUR SIZE at 1.20 on EURCHF.

As a result of this all you can eat approach, they SNB grew their FX Assets by an incredible ~120bn (~20% of GDP) between April and June 2012. Now they own a lot of bonds at super low yields – and have oodles of duration risk (as well as FX risk if they have to let 1.20 break — which they would do if the EUR collapsed).

Australian Nominal GDP is ~1465bn, so an equivalent amount (as a % of GDP) is ~750bn. Current RBA FX assets are ~50bn, so let’s say that the RBA sell’s 700bn, to take FX Assets to 750bn, for an incremental carry cost of 2.25% of 700bn, or 15.75bn per year.

Holding all things constant, the RBA would need the AUD to depreciate by 2.25% per year, each and every year, to break even on this trade.

Basically, the AUD would have to follow the forwards. How likely is that?

Carry trades are typically profitable, so historical experience suggests that the RBA will lose money if they sell the AUD and buy lower yielding foreign currency denominated debt …

If yields were to increase sharply, the value of the RBA’s assets would decline, and this would make the required FX depreciation (to break-even) a little larger.

For the GDP data see: here for swiss GDP data, and here for Aussie GDP data. The RBA portfolio charts are from their 2011 annual report.


  1. Both you and Kouk are wrong wrong wrong!

    The RBA is a monopoly currency issuer and as such financial losses are irrelevant. Just like any individual who had the power to issue his / her own currency, a financial loss can be corrected with a couple of keystrokes on a computer.

    Your obsession with profits for a currency issuer is distroting the whole issue.

    By being a slave to “efficient markets”, the RBA is blithly standing by and watching Australia export production to other countries at the expense of its own citizens. And you think this is ok because otherwise the RBA may make a financial loss?

    Truely bizzare!

  2. The major reason the RBA ‘makes money’ on FX transactions was that it didn’t ( it didn’t used to) mark to market and so had the advantage of time and the rest.

    Has this changed?

    Moreover the RBA is not a FX player. It can ‘smooth’ out large falls and rises in the currency but that is all.

    now that i have criticized the kouk I can be called ‘even-handed’!!

    1. I will answer them – but i have a pretty full on work schedule this week so it may not be until the weekend. Thanks for good questions.

      1. Linked yr first FX post to Macrobusiness yesterday, nice to see Cameron with questions displaying his typical thoughtful style. Looking forward to the follow-through. Thanks.

        1. Thanks mate. You been on holiday? Hope you are well.

          I think this is a good topic. I am cleaning out a few cobwebs myself!

    2. This question is simple – though a full answer requires more careful explanation – but the simple answer is that yes, i think they will regret their current policy in due course. I expect that it will end up costing them a lot of money.

      1. Are you suggesting the SNB run the risk of going broke – ie: run out of Francs? I am very much looking forward to this post!

        1. Some disagree — former UBS CEO Oswald Grübel said: “When a relatively small, healthy economy with low public debt, such as Switzerland, couples its currency to a larger business network with an artificial currency transfers and high public debt, it also assumes the risks. In other words, the Swiss franc is now a euro. The economic base of the Swiss franc is fundamentally better than that of the euro and will not degrade themselves by the fixed exchange rate as fast. It is only a matter of time and of the speed of the development of the Euro crisis that this strategy must be abandoned. One thing we know for sure, is that the longer we hold on to it, the higher the price is we all pay for it. ”

  3. Yes, I agree, you are completely right here: it is not that simple to intervene at all. The risks are very high and intervention should be left only for very extreme situations. Now I also understand the reluctance of the RBA.

    The simple fact that K disagrees with you is a big plus for your argument. He’s the one that has been calling for rate cuts to weaken the AUD…. but hey, after 100bps+ of cuts, the AUD is still up there where it was last year. Hope he did not put his money behind that forecast (I bet he did not).

  4. …. and what if “markets” have a stronger hand? Is the RBA ready to go “all-in”? What happens if they lose?

    1. The “markets” are users of AUD. Therefore the “market” has limited firepower.

      The RBA is an issuer of AUD – they can never run out of AUD (operationally) and therefore has unlimited firepower. Just like Qantas can never run out of Frequent Flyer Miles.

      Therefore the RBA can not lose unless they choose so. It is for the same reason why no-one is willing to take on the Swiss Central Bank.

      1. If winning in the FX market is their only objective, you are of course correct – they cannot run out of ammo. However their willingness / ability to do this is constrained by their other targets – inflation at 2.5% and financial stability.

      2. You sure they can’t lose? Would like to see the RBA fight something like QE3, QE4, QE5 etc. and keep printing AUD while commodity prices are spiking. The “markets” know the RBA has an inflation mandate, and if inflation gets to 3%, they lose. That’s also why AUD is still high. Because no one expects rates to go to zero, like in most other countries.

        1. exactly. only IF they are willing to drop all other targets are they unconstrained in their FX firepower. I agree, it’s a risky policy – that’s why i’m against FX intervention at this level. risk-reward is all wrong.

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