Of Interest Rates and Exit Strategies - Aus leads the way!

By MARTIN HUTCHINSON and NICHOLAS PAISNER
New York Times
Published: October 6, 2009

Australia is sometimes known as the “lucky country.” Its success in fiscal and monetary policy, though, has more to do with skill. If other countries had followed the Aussie way in the good times, the financial crisis would have been less bad. But it’s not too late to follow a good example.
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The Reserve Bank of Australia increased its target for overnight interest rates by 0.25 percentage point on Tuesday, to 3.25 percent. It was the first central bank among the G-20 nations to push rates up since the crisis began. But then Australian interest rates were generally relatively high before the crisis — the policy rate stayed above 5 percent from 2003 on, peaking at 7.25 percent in 2008.

Australia also followed a conservative fiscal policy, paying off almost all its public debt. That gave it more room for fiscal and monetary stimulus during the downturn. Technically, Australia avoided recession, growing in both the first two quarters of 2009. The global rise in mineral prices has further benefited its economy. It wasn’t too hard for the Reserve Bank to decide to tighten.

Other countries don’t have Australia’s advantages. But the current fashionable policy combination of heavy fiscal stimulus, extraordinary liquidity measures and interest rates below the level of inflation have caused sharp run-ups in global commodity, bond and stock prices. Such policies could eventually prove inflationary.

Other nations’ “exit strategies” shouldn’t start with a withdrawal of liquidity. The two worst recessions in United States history, those of 1837-43 and 1929-41, were both fueled by liquidity shortages that led to prolonged deflation. If central banks worldwide cut back liquidity now, without increasing rates, they would risk something similarly dismal.

But raising interest rate targets — without ending other liquidity programs — presents no such danger. Doing that would reduce the upward price pressure on financial assets. And weaker bond markets would force governments to get serious about budget deficits rather than borrowing more.

With asset bubbles deflating and deficits declining, liquidity could be withdrawn slowly, without starving the private-sector economy of necessary finance. Then the rest of the world would start to look a bit more like that lucky place down under.

Property Deals Return

Real estate deals are back — to a point. The British retailer Tesco and the European banks HSBC and BBVA have notched almost $3 billion of sale-and-leaseback deals in two weeks. The three are hardly distressed sellers. But a thawing in the commercial property market is giving them a chance to tidy up their balance sheets.

At first glance, HSBC seems to be selling its United States headquarters on Fifth Avenue cheaply to an Israeli conglomerate, IDB. The $330 million price tag puts a juicy 13 percent rental yield on this prime piece of Manhattan real estate in the first year. But IDB’s opportunistic move is a risky one. After 12 months, HSBC will vacate a third of the building.

For HSBC, the deal delivers only a modest profit. But it allows the bank to release capital tied up in property and redeploy it in its core operating business. The move is also consistent with HSBC’s stated belief that the world faces a double-dip recession. Similar deals may lie in store for its offices in London and Paris.

The Tesco and BBVA deals look richer for them. Tesco is selling £514 million ($817 million) of property at yields of 5 to 6 percent. For the buyers of 948 BBVA branches, yields will probably be closer to 6 percent, according to a person familiar with the situation. Again, the proceeds can be put to more profitable use in the companies’ operating businesses.

While they may not be getting bargains, the buyers in these cases are securing multi-decade leases offering inflation protection. That’s an attractive combination when the economic outlook remains uncertain and huge stimulus measures threaten inflation eventually.

Banks and other companies remain under pressure to tidy up their balance sheets. And while the short-term outlook for commercial real estate is far from assured, buyers are returning to the market.

The latest entrant is France’s BNP Paribas Real Estate, with a new £150 million ($238 million) fund meant for deals in Britain. The recent flurry of sale-and-leaseback deals looks set to continue.

MARTIN HUTCHINSON and NICHOLAS PAISNER

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