ric battellino : will australia catch a us cold? address by mr ric battellino, deputy governor of the reserve bank of australia, to the euromoney forum, new york, 21 september 2011. * * * it is a great pleasure to be taking part in this conference, and in particular to be here in new york again. i have been visiting new york regularly for a large part of my career at the reserve bank. i have always very much enjoyed these visits, but that, of course, was not their purpose. the point of my visits was to find out what was going on in the us economy because, for a long time, this had a major bearing on the australian economy. through the 1980s and into the 1990s, developments in the australian economy showed a close correlation with those in the us economy. it was particularly striking that the recessions of the early 1970s, early 1980s and early 1990s were highly synchronised between the two countries and had many similarities in their nature and origins. as a result, it was common in the 1980s and 1990s to hear the phrase “ when the us sneezes, australia catches a cold ”. australian economists, including those in the reserve bank, spent a lot of time researching the question of why growth in the australian economy was so highly correlated with that in the us. we were intrigued by the closeness of the relationship because the trade flows between the two economies were not particularly large. the united states has always been only a moderately important export destination for australia. the research unearthed various channels that contributed to the close relationship, but two factors seemed particularly important : first, the economic shocks faced by the two countries in the lead up to the recessions of the 1980s and 1990s were similar, as were the policy responses. it was understandable, therefore, that the economies would follow similar paths. second, the financial and cultural links between the two countries have always been very strong. the united states is a large investor in australia and many australian companies have operations in the us. us economic news receives very wide coverage in the australian media. this, in turn, has often promoted very similar movements in financial prices, business sentiment, and even household behaviour. scrutiny of this close relation between the two economies reached its peak around the mid 1990s. ironically, this was around the time when the relationship began to change. certainly, by the first decade of this century, the paths of the economies had clearly diverged. whereas the united states experienced

are executed in the market. the aim here was to reduce the incentives and opportunity for misbehavior generated by the market structure. the fxbg report documented the concentration of activity through the fixing window. it noted that trading volume at that time was up to 10 times larger than at other times in the trading day. a major source of the large volume of these trades is likely to be asset managers seeking to rebalance their portfolios in line with the indices they track that incorporate the london fix in their calculation. one way to minimise this tracking error between their portfolio and the foreign exchange component of the index they are tracking is obviously to execute at the fixing price itself. orders for these trades and other fixing trades are provided by the client to the fx dealers ahead of the fix ( often this time is quite short ). importantly, the dealer typically agrees to execute these orders at the, as yet unknown, fix price and often does not charge either a fee or spread on the trade. these arrangements differ from standard principal - based risk transfer services offered by dealers, where the risk to the dealer is mitigated by using the current market price and applying a spread. the arrangements for fix - related orders mean that the price risk on the transaction is transferred entirely from the client to the dealer without any compensation. the dealers then have to manage the risk associated with this flow. the trades conducted as a result of this process can generate optics of dealers trading ahead of the fix, even if the dealer is simply seeking to manage the risk. but these dynamics can also create an incentive for dealers to manipulate the fix rate to generate profit from what would otherwise be potentially a loss - making exercise. to address this problem, the fxbg supported the development of industry initiatives to create independent netting and execution facilities for transacting fix orders. a number of such products have been launched on the market in recent months. they generally have the feature of maximising netting opportunities and then executing the order in a way that delineates the separation between the dealer trading on its own account and the dealer transacting on behalf of the customer. it remains to be seen how much traction these products will get. in our preliminary report, the group had sought market feedback on the development of a central netting utility to maximise netting opportunities and reduce the need for customers to provide orders in advance of the fix to dealers. while some of the feedback was supportive, others confirmed some of the potential practical problems that such a