Senator JOYCE—I have a question in regard to the managing of debt in the nation and the current international turmoils that we are seeing coming online with the increasing price of oil, the wild fluctuations in financial markets, the excessive pressures that have been placed on financial markets by derivatives and them flowing through now. My question is directed towards market dysfunctionality and transparency in stocks. Do you believe that we have the capacity to properly foresee what is the cost in financial stocks and what are the inherent risks in financial stocks? I will base this on the premise that I know this is a complicated subject. In the past I think Dr Paul Woolley pointed this out, that about 10 per cent of a company’s profits came from financial trading, from the purchase and sale of shares. Now we are looking at about 40 per cent and moving up, but this puts inherently excessive stresses on the financial market because of our over-reliance on a share trading system, a financial system, which lacks so many of the transparencies that we cannot actually see the exposures of what is going on there and basing that also on the problems we have had with the subprime fallout about which everybody said at the start: it will not affect us. Now our share market has gone down by 18 to 20 per cent because we did not have the transparencies to foresee what was happening there. In the management of the Australian economy, what are your views on that and what if any suggestions do you have?

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Mr Hyden—I must answer that from the point of view of my responsibilities for the Office of Financial Management in managing Australian government debt and financial assets. Financial markets have always been subject to uncertainty and it is part of the nature of the market. People are trading and investing and there are different views of where the markets should be. There is no doubt that the events in the US in particular, that is with the turmoil in financial markets there, have reflected significant lack of information in the markets and uncertainty as to just what the risks are and what the positions are, so that the downturn in the housing market there has put pressure on financial markets, particularly through the subprime mortgages. That has uncovered a lot of uncertainty about the positions of different houses and that has swept around the world and is affecting our markets as well.

Would better transparency have helped? Clearly there was a deficiency in the market which allowed people to trade and to build up positions without having a full understanding of them. It is not clear what regulatory changes might make a difference there, but I think the experience of the turmoil that we are now going through will clearly make market participants a lot more careful in the future and that we will benefit from that in the longer run.

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Senator JOYCE—You are basically in agreement, and it is not unusual that you are in agreement. You are not agreeing just with me you agreeing with a whole range of commentators and I give credit to Dr Paul Woolley, formerly of the IMF. With the Australian debt position and the inherent uncertainties that are currently present in the market, do you see Australia exposed to a recession in the US, which I would say is either with us or absolutely imminent, and the effect that will have as a flowthrough via Asia back to demand for our resource capacity? What will be the effect of our capacity to meet the excessive foreign debt that we have as a nation built up into the future if that becomes reality?

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Mr Hyden—In terms of the Australian government debt, none of that is issued in foreign currencies or held overseas, or apart from a very, very small remaining fragment. There are of course substantial holdings of the debt that we have issued in Australia by overseas investors, including overseas institutions, and the uncertainties in the US market and globally have added to the demand by foreign investors for the Australian government debt. That reflects both our high interest rates, or relative to the terms available elsewhere in the world, a strong exchange rate and a flight to safety in terms of the security of the debt that we have. So what we have seen is a very strong increase in demand for our debt.

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Senator JOYCE—So we are seen as a secure investment, is what you are saying basically?

Senator JOYCE—How are you going to manage that?

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Mr Hyden—It is a substantial reduction in our resources. We have over recent years been able to make some efficiency improvements or savings in costs in a variety of ways, but they are all sort of a small change here and a small change there, but they add up and they have allowed us to reduce our staff numbers a little. So we will continue to look for those sorts of opportunities.

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Senator JOYCE—So you have to look at staff numbers. With 13¼ per cent over four years, staff numbers would have to be part of that efficiency dividend and you would have to be certainly looking at the prospect of losing staff over that.

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Mr Hyden—The largest part of our costs is staff costs.

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CHAIR—Thank you. Are there any further questions for this group?

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Senator JOYCE—I have more questions.

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Senator Sherry—Has Senator Watson come in?

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CHAIR—He has no questions apparently, so we can move on.

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Senator JOYCE—How much debt does Australia need to hold to have an effective capacity to influence monetary policy?

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Mr Hyden—The Reserve Bank undertakes its market operations using particularly repurchase arrangements which use Commonwealth securities as one form of collateral but also now use a number of other securities including state government securities and some commercial securities, so that when the previous government undertook a review of whether it needed to maintain a Commonwealth government security market, my recollection is that the Reserve Bank felt that that was not essential for their monetary policy purposes. So I assume that would still be the case and that they would be able to devise other ways of operating monetary policy without a CGS market.

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Senator JOYCE—Do you have any oversight over state government debt management at all or liaise with them?

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Mr Hyden—I liaise and have contacts with the state authorities that manage their debt but we do not have any close operational involvement in their markets or their market activities. The Commonwealth has in the past issued debt on behalf of the states but those arrangements have now terminated. It was under the financial agreement and that debt has all been retired. There is only a small residual amount of state debt that we manage and we are looking to find ways of winding that up.

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Senator JOYCE—Does state government debt have an effect on the financial management of the nation? Does it affect the overall debt position and the terms of trade of how Australia as a nation federally deals with debt?

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Mr Hyden—It is an important part of the financial markets. I think the macro effects that you are looking at really depend on the overall operation of the markets and the demand and supply of funds. The state borrowings are one of those demands for funds.

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Senator JOYCE—So it could have an effect on the price of debt if the states have excessive deb