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If the conservative faction of the Liberal Party prevails in the leadership vote on Tuesday by installing its own candidate, Tony Abbott, or a compromised candidate, Joe Hockey, then what should the liberal wing of the Liberal Party do about that? 

They could remain and fight to take back control of the party.  It is the party with their name on it after all.  But they would still have to continually accommodate the ideology of the conservative faction.   It is not obvious that they could every marry liberal and conservative ideas again in the party.  The differences that the liberal and conservative factions have over climate change and the republican question are not aberrations; they are expressions of the profound difference in the liberal and conservative visions of society. 

Liberals and conservatives are not natural allies.  They are different to the core.  They have been at odds for centuries.   Liberals are progressives.  They are children of The Enlightenment.  Conservatives have the oldest ideological position.  They have through history been a sea-anchor against progress, and put more store in tradition, status quo and the wisdom of those have gone before.    So with little chance of reconciliation, why not make some good from the climate change rupture  and start a new party? Read more

Homer’s Iliad is the epic story of the infinite anger of the great Greek warrior Achilles.  The story begins with Achilles remaining in his camp and refusing to fight the Trojans, despite the imminent collapse of Greek forces.  After ten years of besieging the city of Troy, the tide of battle has turned.  Now, without Achilles, the Greeks have been forced back onto the beaches and with their backs to the sea are facing annihilation.  Only Achilles can carry the day, but he seethes with anger. 

Achilles was slighted by King Agamemnon, the leader of the Greeks.  Agamemnon was forced to relinquish his war prize — a woman named Chryseis — to end a plague on his forces sent by her father.  Agamemnon then insists that Achilles hand over his own captive — a woman named Briseis.  Archilles decends into a state of anger that knows no bounds and admits no reason, as a result of the dishonour done him by Agamemnon.  Read more

Well, not completely wrong (he is right that in principle taxes and caps achieve similar economic outcomes if implemented) but let me explain. In the FT today, Tim Harford argues that at Copenhagen negotiators should be focused on getting agreement on a tax rate on emissions to levied at the G20.

Cameron Hepburn, co-editor of The Economics and Politics of Climate Change, points out that quantity regulation puts knotty issues of distribution and compensation at the heart of the international negotiations. Harmonised carbon taxes put these questions to one side. They could be – and would have to be – discussed separately.

The problem with this is illustrated neatly by the Australian case. Suppose that this is agreed to. Then would Australia ratify this agreement? It is unclear. Who would it apply to? Surely more than the top 1000 emitters and likely to involve consumers and agriculture. If we trust that the current CPRS represents what is a possible coalition, that alone might be enough to kill the whole deal in Australia. Instead, an agreed emissions cap for Australia lets it sort out its own way of achieving it. By giving that flexibility, surely more countries are likely to sign on.

Put simply, caps mean that distributional issues that are inter-country have to be resolved at an international level while local ones can be resolved locally. A broad tax leaves inter-country distributional issues until later but ties them to local resolutions in order to get an agreement. Our experience to date suggests that right now, local issues dominate the G20.

It is hard to remember, although we should, that just over two years ago, Australia had held out for the better part of a decade being one of only two countries not to sign to Kyoto protocol. That was after the negotiators bent over backwards to cut a deal in our favour (allowing higher emissions than 1990). And for that same time the US, who similarly held out, could point to us as an partner on the outside. That shocked my 7 year old daughter more than anything at the time. That ended two years ago.

I’ve been distrustful of spurious arguments to pass the ETS legislation quickly. With the US likely to be cooperative, our role one way or the other in how we handle international negotiations is less important. But we could do one thing: we could become an example that it is possible — despite the diabolical nature of the problem — to generate the political coalition and negotiate the special interests to pass a widespread emission trading regime and begin the work of adjusting to carbon pricing. This isn’t a move that is likely going to be decisive in saving the Great Barrier Reef but given the inevitability of all this, it is a move that moves us from a position of laggards to leaders and for little cost. All our commitments are postponed but we can bring to the table political will.

That is why the beginning of next week is critical. The Government have done their part by providing an ETS that moves to the right. I hate the compensation but if we get a carbon price and some institutions out of it, I’m happy to live with it. The issue now is whether the Coalition looks at themselves over the weekend and says “no we want to Australia to remain the hold-out and in the international wilderness” or, as their leader has said, “such attitudes cannot stand and we need to be part of the global community.” And if you are thinking of the former, you had better think quickly about how you explain it to a young child.

Those early risers would have noticed that this website was hacked this morning. They had managed to replace two key WordPress files with their own code. It took myself and Kwang a good four hours to identify the problem and you can see we are back in business now.

It isn’t clear where the point of hacking occurred but the about 20 sites hosted by Bluehost and running WordPress were hacked today by the same people. Bluehost, of course, is my hosting provider offering 24/7 support. Alas when I called today they said they were off for the holiday. Me thinks, our hackers knew that. Anyhow, if others out there are searching and find this you need to restore your index.php and home.php files.

On another note: many professional media outlet who wants to purchase this blog, I’m receptive.

Some things seem to need no explanation, but are not obvious at all on reflection and, if you wonder about them, suggest something of interest about the economic system. Consider the question of why the informal economy is so small, leading to the question of how much more productive the formal economy must be than the informal economy to make sense of how little informal economic activityy there is. See over the fold for the full argument.

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If you attempted to upgrade from XP to Windows 7 recently, you probably went through Upgrade Hell along with me and many others.  In the process I learnt a couple of things about Microsoft. Firstly, Microsoft doesn’t understand how to sell software as downloads. If like me, you tried to buy a downloadable version of Windows 7, you would have ended up paying for it dearly, ending up with three files (an exe plus two bin files) delivered to you but with no instruction on what to do with them. The exe file failed to work properly on XP in my case, and searching online eventually yielded command line instructions on how to create a bootable ISO file from these, but that failed to work properly either. Why didn’t Microsoft just sell me an ISO file directly? It shows that Microsoft does not know how to sell software as downloads, perhaps being only familiar with selling software on DVDs or preinstalled on new computers. Ironically, it is now easier to download and install linux than it is to install Windows 7.

The second lesson I learnt is that Microsoft does not understand how to price an upgrade. It is clear enough that one should pay a lower price if you one is upgrading from an earlier version of Windows than if one is not. But in addition, Microsoft charges a different upgrade price depending on whether the installation wipes your original Windows installation before overwriting it. This is plainly wrong because the Utility of Windows 7 minus Utility of your earlier version is the same regardless of how you did the install. Case in point: after failing to compete the earlier install, I ended up getting the DVD for Windows 7 Professional Upgrade. That happily wiped out my XP hard disk and installed with no warning about future activation problems, but several days later asked me for an activation key. When I typed in the activation key I had earlier paid for, it didn’t work, generating an error message that the key was for an upgrade, not a clean install. So I ended up with Windows 7 that refused to activate, but installed within it was software (such as Office) that had already been activated, which were now unusable. Microsoft’s website suggested that I reinstall the previous operating system (which had already been wiped out) and try upgrading again. Really! it is clear that the installer did not check for a valid XP installation, and at that point enabled the activation key to work. It turns out that this is a common problem, and so if you plan to upgrade keep these tips handy and follow Workaround 3.

If you went through all this and ended up with Windows 7 installed, you will find that it is a pretty good operating system, but the process leaves a very bad initial impression.

If there is one thing I value in political leaders above all else is that they stand their ground on fundamental values when it is crunch time. There are very few political leaders who I have seen this quality in. Yesterday, we saw Malcolm Turnbull rise to that status. After months of trying to push the Coalition towards supporting some form of climate change legislation, he called an end to the internal debate and pushed ahead with their negotiated outcome with the Government.

The political conventional wisdom is that he has killed his career over this. I am not so sure but I am sure of one thing: if the legislation passes the Senate today, Turnbull will have ensured his place in history. More so than the Government, he is moved to action when he himself was pivotal. Had he caved or resigned, there would be no ETS anytime soon. This is the very definition of historical significance.

Alongside that, his press conference explaining this was concise and important. First, he believes in taking action and in the policy he is supporting as it is one that he pushed for. Second, for those who are sceptics, the policy is an appropriate form of insurance. Finally, his party made a deal and agree to it and has to stick by those agreements if they are going to have a meaningful role. It seems incredible to me that others in the past faced with so compelling a set of reasons to make a choice have failed to do so. But kudos to Turnbull for taking a stand and not being afraid to air dissent.

Again, the political conventional wisdom is that he will suffer for this. I wonder if that is so and whether the Australian people might actually support the values we have seen expressed here. We will see.

Here is the text of my opinion piece in The Age today. 

The events of the GFC have snookered the Rudd Government.  The RBA is now raising interest rates to suppress resurgent inflation, but most the Government’s $95 billion stimulus package is still in the pipeline and cannot easily be reversed.  The Prime Minister and Treasurer have lost control of events, as monetary policy (interest rates) and fiscal policy (government spending) pull in opposite directions.  But they are not completely trapped – there is a way out. Read more

I had intended to review Superfreakonomics chapter by chapter but only managed Five, One and Two. Chapter 3 was perhaps the most satisfying of the book dealing with John List’s research on altruism (or that lack of it). It is a bit triumphant but otherwise informative. Chapter 4, in contrast, with pithy and unsatisfying. It was a prelude to Chapter 5 (on global warming) and dealt with how often there are simple solutions so long as you are willing to look for them. They again talk lots about hand washing and they also introduce a plan to rid the US (at least) of category 5 hurricanes. All interesting but it didn’t seem much like economics to me. The book ends by moving to the truly freaky: monkeys are rational economic actors too describing the experiments of Yale’s Keith Chen who managed to introduce currency and prostitution into the monkey economy. Ironically, Levitt and Dubner appear to be saying that for the environment prices don’t matter although for monkeys they’ll do lots in response to small price changes. This highlights what essentially is a lack of a theme throughout the book.

The theme for the book should have been: it is good to look dispassionately at data. And there are ripples at this. But it is obscured by continual digs at government, non-economists and, of course, climate science. Perhaps to be entertaining, it just went too far off message and so the message was lost. Moreover, that entertainment aspect doesn’t look like it is going to translate into book sales. If you are college-aged are you really going to give a book with ‘global cooling’ and ‘prostitution’ in the subtitle to your friends? Last time around it was the rouge economist and that has a certain appeal with its questioning of the unintended side effects of monetary incentives (after all, the Sumo wrestlers cheated because of the gambling). This time around it is more the stereo-typical Chicago-style economist where it is government action that is potentially the evil. And for a book that doubts altruism, hard to say if that says ‘gift me’ this year.

There are two extreme views going around regarding where US inflation is headed. Those who subscribe to the view that the US is in for a long period of insufficient demand see the risk as being a Japanese style decade long deflation. On the other side are those who see the only way out of the US problem with unsustainable debt being to inflate it away. For those of that view, there is an extraordinary debate going on in the US House Financial Services Committee, which could lead to the Fed being a lot less independent (leading to the risk of higher inflation, among other problems). It will be very interesting to see how this pans out, but to follow the debate go to the Wall Street Journal article here.

I updated the piece that I posted last week relating to the value of the RMB and the US trade deficit - the new piece appears in todays AFR, and follows below. There’s a nice piece in The Economist magazine with similar themes – if you’re a subscriber you should be able to access this link. Follows is my piece…

During the 1992 US Presidential debates candidate Ross Perot famously declared that passing the North American Free Trade Agreement (NAFTA) would lead to the “giant sucking sound” of manufacturing jobs being sucked down to Mexico. Bill Clinton won that election and passed NAFTA, yet the US unemployment rate fell from over 7 percent at the time of the Presidential debates to below 4 percent when Clinton left office. A lot of lesser skilled manufacturing jobs did go to Mexico, but the US created many more jobs in the higher skilled sectors of the economy.

 Read more

I was asked to contribute a few words to a feature in The Age about how Australia has fared two years into the Rudd government. My bit dealt with the economy.

One thing is for sure, if there ever were a time when one can’t distinguish the soundness of economic management from things beyond control, the last two years would be it. A year ago, I could easily have imagined writing this assessment with the conclusion, “what’s the government of a small open economy to do?” Our expectation was for plummeting investment, high unemployment and a Government desperately trying to get things going again. Instead, the economy is strained but otherwise fine. The GFC has left hardly a dint. The Rudd government deserves considerable kudos for that.

But this also makes me nervous for the coming two years. There was and is much that still needs reform. We have proposals to deal with core issues like climate change, higher education and broadband but real implementation issues. And meanwhile there are challenges for general education, innovation and health care that remain without plans. Not to mention that the underpinnings of our system of financial regulation remain decidedly pre-GFC and need of far-reaching review. The Government’s job as economic manager remains unfinished.

The last time we found ourselves in a sound economic position, we also found ourselves with a government content to grow itself without growing its services. Surplus loving but without thinking long-term about the fundamentals. The next two years will tell us whether the Rudd Government is really something different.

Here is a basic economic principle: don’t sell an asset unless you have verified that someone actually places a higher value (at least financially) on it than you do. This is a principle that the Queensland government has apparently forgotten and is articulated nicely in a letter published today [over the fold] and signed by every economist you can think of. Well, actually, I had agreed to be on it too but am not listed (due to an error which also left off Stephen King) but that is understandable given the sheer volume of names. Let me assure you that I agree with every word and echoed much of it when I wrote about NSW’s moves in this direction.

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The Henry tax review has posted an interesting paper on its website.

Behavioural economics and complex decision making: implications for the Australian tax and transfer system by Andrew Reeson and Simon Dunstall, CSIRO
This paper summarises the relevant literature (from behavioural economics and psychology) on how individuals make simple and complex decisions; considers how these findings can provide a basis for designing policies adapted to these human behaviours; and concludes by considering some implications of these findings for the tax and transfer system (such as the decision making consequences of removing the burden of complexity from individuals)

The paper is a very nice review of behavioural economics, and neatly grounds the case for simplification in the psychology/economics experiments that largely originated with Kahneman and Tversky. My only quibble is that the paper misses the latest wave of US research around behavioural public finance being done by Raj Chetty, Emmanuel Saez, etc (for a discussion, see this op-ed). That research actually has even more fundamental implications for much of what public economists do (eg. EMTRs might not matter if they’re not perceived, legal incidence might matter after all).

(HT: Rosanna Scutella)

I wrote an op-ed a few months ago about David Galenson’s work on creative life cycles in art, poetry, novel-writing, movie-making and architecture. Now he’s turned his hand to pop music. Abstract below.

Innovators: Songwriters (gated link, sorry)
David Galenson
Irving Berlin and Cole Porter were two of the great experimental songwriters of the Golden Era. They aimed to create songs that were clear and universal. Their ability to do this improved throughout much of their careers, as their skill in using language to create simple and poignant images improved with experience, and their greatest achievements came in their 40s and 50s. During the 1960s, Bob Dylan and the team of John Lennon and Paul McCartney created a conceptual revolution in popular music. Their goal was to express their own ideas and emotions in novel ways. Their creativity declined with age, as increasing experience produced habits of thought that destroyed their ability to formulate radical new departures from existing practices, so their most innovative contributions appeared early in their careers.

With Obama in China this week many have been calling again for the need for greater Yuan flexibility to address the problem of global imbalances – big US trade deficits and big Chinese trade surpluses in particular.  The problem is that a flexible RMB will not solve the US trade deficit – the US trade deficit is not about a lack of competitiveness with China, but rather about excessive demand inside the US. This excess of demand has been reduced due to the GFC, but is still the main game. I published the following piece in the Age in April 2005 – I will try to update in the next few days. Of course the numbers and facts have changed in 4 1/2 years – in particular the Yuan has depreciated by about 20% against the USD, and the US trade deficit has widened. As I say below, even another 20-30% appreciation of the RMB is likely to do little to close the US trade deficit…Read more

John Quiggin has an op ed in the AFR today (not yet online) asking the Coalition to think of the Great Barrier Reef and to pass the CPRS. He points out (correctly) that the Great Barrier Reef is in grave danger from climate change. So what may save it is a global agreement on carbon emissions and you can add that to the list of compelling reasons to get that agreement. But the problem is that it is only a symbolic and not a real factor in whether Australia passes the CPRS now or not.

First of all, the CPRS itself doesn’t target sufficient emissions reduction in the absence of a global agreement. Second, while passing the CPRS would be a good thing for Australia to have done to show some level of commitment, it is not at all clear that it will, by any stretch, lead itself (even in more than a very marginal way) to that agreement and so ’cause’ the saving of the Great Barrier Reef. We see these ad hoc political arguments from climate change scientists and they annoy me. I was surprised to see John taking the same line.

Look the reasons to pass the CPRS are more straightforward. First, we need to get working on implementation so we can ramp up when the time comes. Second, business needs some certainty over what the operation of the scheme is going to look like. Third, it is useful to overcome the political hurdles of compensation. Finally, this will allow us to get cracking on innovation. Saving the Great Barrier Reef — while something we want to do — has little to do with our short-term debate.

My Wryside Economics segment on Life Matters this morning was about the effects of gender and money on happiness, essentially riffing off two important papers that Betsey Stevenson and Justin Wolfers presented at my happiness conference last week (the research is on their websites). The audio from my chat with Richard Aedy will be online here shortly.

My AFR oped today is on prison reform. You can’t put acknowledgements in an opinion piece, but the piece owes a substantial debt to Justin Wolfers, who first suggested the idea of smarter prison contracts about 7 years ago, when we were strolling the streets of San Francisco together. I’m also very grateful to a senior criminologist who took the time to discuss the contents, but who probably doesn’t want to be named here. ANU PhD student Daniel Suryadarma did a great job tracking down all the relevant statistics for me.

Full text over the fold.

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Ariel Kalil is a Professor of Public Policy at the Harris School, University of Chicago. She is a developmental psychologist by training, and her work links developmental psychology with economics, e.g., the effect of parental job loss on child development. I had a conversation with Ariel about her work and thought it would be of great interest to our readers.

Kwang: Congrats on the NY Times feature last week. Not many social scientists make it to the front page. How do you feel about that?

Ariel: It was very exciting! It was fun having friends e-mail to tell me they’d read the article on their train ride that morning. What I was especially happy about was that the reporter got the story right. He was a very curious and thorough guy, and we spent a lot of time on the phone and exchanging e-mails over the past few weeks. He read all of my original papers carefully, and came up with some very good questions for me. And the families that he interviewed had stories to offer that really illuminated some of the quantitative findings from my work.

Kwang: Tell me a little more about your work. What are main themes you’ve researched and what motivates you to pursue these questions?

Ariel: I’m interested in how socio-economic conditions are associated with families’ well-being and children’s development. So, I’m interested in parents’ mental health and their interactions with one another and their children, and I’m interested in children’s behavior and academic performance. In many instances, there is a link between, say, family income or families’ employment experiences and these outcomes. I care, as all economists do, about whether these links are causal. But, in thinking more like a developmental psychologist, I am also interested in “getting inside the black box” to understand why these links exist, and what kinds of individual differences shape how strong these links are for different types of children and families. I’ve always been interested in applying social science to real world problems. The idea that my work might someday shape public policy that could help improve the lives of families and children is very motivating!

Kwang: In the paper featured last week by the NY Times, you show that young people are badly affected when their parents lose their jobs, and that this is true in single parent and dual parent families [paper]. Could you tell us more about these effects and what you think drives the differences between single mothers and dual-parent families? Between male and female parents becoming unemployed?

Ariel: I think there are likely different factors at play for single parent vs. dual-parent households when jobs are lost. First, these families look a lot different from one another in terms of a whole set of demographic characteristics. So, in some sense, it’s a bit difficult to compare the two kinds of families. One of the biggest and most obvious differences is that when a single mother loses a job, the family has typically lost its only breadwinner. These families are likely to already be strained economically, and to have few (if any) people in their set of friends and relatives who can help them out. In many cases, a job loss sets off a cascade of adverse events that can be hard to stop, such as getting evicted or having to move in with others to save housing expenses, and this might disrupt child care arrangements or where kids go to school, and so on. There is just a lot more instability in these families related to the families’ economic circumstances.

In dual-parent families, I think the situation is a little different, and, at least in the short term, I think the impact on well-being and child outcomes has less to do with the economic impact of the job loss than the psychological one; for instance, in the way that parents relate to one another and to their children. For example, most dual-parent families have two earners, and so the family hasn’t lost all of its income at once. And many of these families also have some resources they can draw on, either savings or help from other family members. The immediate economic threat may not be quite as great. Also, in the families from whom I’ve collected data, I’ve found that parents will typically try to cut back on other things before they cut back on spending for their children, so the kids are often spared disruptions in their daily lives. In these families I think the adverse impacts that we see have a lot more to do with stress and anxiety, which we know can be very damaging to family relationships and ultimately to children’s development. And I think a big factor in the current recession is how long it’s taking people to find new jobs. The number of “long-term unemployed” is at an all-time high, and parents are very worried. We may eventually see more of these families exhausting their savings, losing their homes and encountering the same kinds of hardships that single-parent families have been more likely to face.

The different impact when fathers and mothers lose jobs is a really interesting one. In our work, we have consistently found that the negative impact of fathers’ job losses is greater. And this is not simply because fathers’ earnings losses are greater than mothers’ (in fact, in the US, in 40% of dual-earner households women are the primary earners). This is an interesting puzzle that I’d like to try to figure out; unfortunately the data are not readily available on this particular issue!

First, I think that “stereotypical” gender roles are still alive and well in many families and that the idea of being the “breadwinner” is still very important to many men and that is may be a bigger psychological blow to them when they lose their job.  Second, working women occupy a variety of roles – we see in time use data that women still do the lion’s share of caring for children and tasks around the house (cooking, cleaning, etc), even when they are employed full-time.  It turns out that working mothers cut back on their sleep and leisure time to do all of these things. So it may be that during periods of unemployment these women spend their time at home more effectively than a similarly unemployed man – because they were already occupying those roles anyway. Also, in the families from whom I’ve collected data, there seems to be more strife over figuring out what fathers’ “roles” are going to be during a period of unemployment. Many fathers viewed spending 40 hours per week in an outplacement office or a networking group searching for a new job as a full-time job, whereas many of their working wives thought they could usefully be spending more of that time helping out around the house or with the children. And that created a lot of conflict, which I think is rooted at least in part in “societal” or individual views about how the responsibilities of running a family should be divided between mothers and fathers.

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At lunchtime today I heard a part of Prime Minister Rudd’s public apology to people who were abused whilst wards of the state.  The so-called “forgotten Australians”.  Previously, Mr Rudd apologised to the “stolen generation”, again for their mistreatment by the state. 

There is something that these apologies say about Mr Rudd himself — he believes that he has the authority to apologise on behalf of all Australians.  There are two problems with this belief.  First, the “forgotten Australians” and the “stolen generation” have suffered at the hands of the State.  For the egregious actions of its representatives, the State should apologise to the victims, and the apology should come from the head of the State.  But Mr Rudd is not the head of state in Australia.  He obviously thinks of himself as being first citizen of the nation; however, in the our “Washminster” system the Prime Minister can only give advice to the head of state and cannot assume that role.  Rudd should have asked the Governor General to give the apology.  Read more

Last week, Rupert Murdoch gave an interview with Sky News where he repeated his claim that aggregators like Google and Microsoft were ‘stealing’ his content and that putting up a paywall will limit that. This resulted in an blogosphere frenzy as to his craziness. After all, if Google and Microsoft are driving traffic to your site why would you want to limit that?

I listened to the full interview today and while that opinion is expressed Murdoch clearly understands the implications of it. Moreover, he bends over backwards to point out that Google and others are respecting his copyright and that he has a choice as to whether his sites turn up in Google or not.

What was more interesting was his rationale for why he might want to throttle that traffic. His view was that those visitors pushed up count numbers but were not as valuable as loyal readers. He did not go into much more detail but in my recent work on this industry, I think that he might just have a point. Read more

I have a new paper out, looking at the impact of stamp duty on the housing market. Methodologically, the question turns out to be slightly tricky – because stamp duty is a mechanical function of house prices, a regression of turnover or prices on average stamp duty in a neighbourhood would return a positive coefficient. To get the behavioural impact, it’s necessary to form a measure of the predicted stamp duty in an area, and run this either as a reduced-form or instrumental variables regression. When you do this, the standard predictions of economic theory are borne out: places with higher predicted stamp duty rates tend to have lower housing turnover and lower house prices. Abstract below (click on the title for the full paper).

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On Wednesday I wrote that people who advocate a Tobin tax are revealing that their understanding of risk is at the level of static risk management rather than higher level of dynamic risk management.  Let me use an example to explain what I mean.  

Australian banks make more loans than they can fund by raising deposits or purchasing funds in Australia.  So, to make up the difference,  they issue a lot of foreign currency bonds into global debt markets.  The total volume of extant off-shore bonds issued by Aussie banks is about $A320 billion, mostly in Euros and USD.  The banks convert the funds borrowed off-shore into $A (without paying a Tobin tax) and lend it into the Australian economy.  Off-shore borrowing by Australia’s the four big banks finances most of Australia’s current account deficit.

The Australian banks then have $A assets and USD and Euro liabilities.   They face the obvious risk that the $A will depreciate against those currencies.  The banks have to hedge that risk.  The capital adequacy rules for commercial banks (the Basel II agreement) make it infeasible for banks to hold large amounts of forex risk on their balance sheets.  So instead, the banks pass the forex risk of their liabilities into the risk markets, where it is sliced up and distributed to the parties who can bear it at a lower cost.  Read more

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