Stephen Grenville, who retired from the RBA in 2001 to make way for present governor Glenn Stevens, has broken with economic orthodoxy to call on governments to discourage foreign speculators from parking their cash wherever short-term returns are highest.

In a paper published by the Lowy Institute, Dr Grenville takes aim at the ”carry trade”, in which foreign investors borrow cheaply where interest rates are low and invest the money where rates are high.

A classic example is companies borrowing in Japan to invest in Australia.

Dr Grenville said that while this could bring big profits to investors – 100 per cent profit for Japanese who parked their money in Australia from 2003 and 2007 – it could produce serious downsides for countries swamped with unwanted cash.

Among other things, he argues, it provides fuel for asset bubbles, undercuts monetary policy goals and pushes up the exchange rate. Such investors are also prone to abandoning ship abruptly, causing a foreign exchange crisis and adding to investment uncertainty, he says.

Brazil has imposed a 2 per cent tax on short-term capital inflows, primarily to stop them pushing up its exchange rate.

A higher exchange rate hurts local producers by making their products more expensive to foreign buyers, while making imports cheaper on domestic markets.

Australia, by contrast, has made itself a haven for such inflows, which help finance the current account deficit, allowing the nation to spend more than it earns.

But Dr Grenville warns that the problem is set to get worse. ”Now we have not just Japan, but low interest rates in the United States, United Kingdom and Europe”, he says. ”Those interest rates are not just low now, but are likely to stay low for some years, with the prospect of a slow US recovery.”

He urges governments to consider a ”Tobin tax” – a small levy on capital inflows to deter excessive flows – first proposed by US economist James Tobin to put ”sand in the wheels” of financial speculation.

The impact in Australia would be to lower the exchange rate, easing pressure on manufacturers, tourism operators and farmers, while making imports slightly more expensive.

It would benefit areas of the economy being put under most strain by the minerals boom.”~~~

Tobin tax in Riski,,,