Will there be an AUD currency crisis?

April 20th, 2010

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A few weeks ago, in Black Swans lurking around Australia?s banking system, we expressed our nervousness about Australia?s banking system:

We must confess, we are getting more and more nervous about the potential for a Black Swan hitting the Australian economy. Particularly, we are looking at a vulnerability in the banking system.

As we wrote in that article, the solvency of Australia?s highly leveraged banking system is concentrated too much on mortgages. It is bad enough for the entire banking system to be so highly leveraged. It is even worse for the leverage to be concentrated on a particular type of loan- mortgages.

In other words, any one of the Big 4 banks are too big to fail because if one fails, it is likely that the others will follow. That implies that the Australian government will have to act quickly to nationalise the entire banking system in such an event.

Will that be the end of the story?

No, our fear is that the biggest casualty in this story will be the Australian dollar.

Firstly, Australia?s gross foreign debt (at December 2009) is AU$1.2 trillion. Correspondingly, the net foreign debt is AU$648 billion. It is highly unlikely that foreigners will continue to lend money to an already highly indebted Australia with a broken banking system. In fact, it is likely that the great Aussie carry trade will reverse, causing a rapid depreciation of the AUD. Should the implosion of the Australian banking system cause a panic, we can easily see the Australian dollar crash.

Secondly, nationalisation of the entire banking system will be prohibitively expensive for the Australian government. The asset column of Commonwealth Bank?s balance sheet alone is around 60% of Australia?s GDP. In the context of a banking crisis, the Australian government will have to guarantee bank deposits. As we wrote in Australian government?s contingent liability to exceed AU$1 trillion, that is a contingent liability of over AU$1 trillion. That means Australia?s relatively small budget deficit can easily balloon to dangerous levels very quickly.

In short, we can?t see how the Australian dollar will retain value in a banking crisis. An AUD currency crisis may not happen, but as we get more and more nervous, we find it more and more imperative to be prepared. As we wrote in Protecting yourself against currency crisis,

Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF. If not, stock up some physical cash (both foreign and local), physical gold and silver (see our book, How to buy and invest in physical gold and silver) and supplies- these will tide you over while the sh*t is hitting the fan. For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).

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