Putting the politicians on notice

October 18th, 2009

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Over the weekend, the Reserve Bank of Australia (RBA) governor, Glenn Stevens, surprised the financial markets with his unusually hawkish stand on interest rates. In response, as this news article reported,

Financial markets responded by pricing in the most rapid series of interest rate rises Australia has seen for 15 years. Markets now predict that the Reserve board will raise rates at seven consecutive meetings, lifting its cash rate from 3 per cent 10 days ago to 4.75 per cent by May and 5 per cent by July.

As we wrote back in July (see How are central bankers going to deal with asset bubbles?), under the influence of William White of the Bank for International Settlements (which is dubbed as the central bankers’ central bank), there’s a sea-change in central bankers’ thinking. Glenn Steven’s aggressiveness is the result of such a sea-change. Our long-time readers should not be caught by surprise at this, unlike the financial markets.

Economists like Professor Steve Keen reckons that if the RBA really carry through its threat that way, it will be a big mistake. The problem with monetary policy is that it is an extremely blunt instrument. Though rising interest rates can put a brake onto the growth of dangerous debt-fuelled asset bubbles, it will also constrict other sectors of the productive economy as well. The risk is that the productive sectors of the economy may be crippled, bringing down the rest of the economy along with it, and as a result, burst the existing asset bubbles in a spectacular way.

Therefore, what is needed is a very precise tool that can target asset bubbles specifically while leaving the rest of the economy alone. Unfortunately, the RBA do not have the power to to enact such a precise policy tool- they can only change the interest rates lever. On the other hand, the arm of the government that are controlled by politicians has the power to formulate such a tool. Very unfortunately, we have politicians who are unwilling to attack asset price bubbles (and worse still, inflate the bubble even more), due in part to control of vested interests and fear of losing elections.

The outcome is that we will have politicians (both at the State and Federal level) and the central bank engaging in policies that are uncoordinated and mutually incompatible. Unless that change, there’s a significant risk of loss of control of the economy by the government. Should this happen, the most convenient scapegoat will be Glenn Stevens as he will be accused as the man who bust up the Australian economy. But for us, we will point the finger at the Rudd government because they understood what the root cause of the GFC (see the essay written by Kevin Rudd here) but instead, not only did nothing to deal with Australia’s towering debt levels, but also introduced policies that increase the risk of a home-grown credit crisis in Australia (the most notorious is the FHOG). The State governments are not any better either.

The politicians must be put on notice.

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  • sheridan

    “On the other hand, the arm of the government that are controlled by politicians has the power to formulate such a tool.”

    What would you suggest that Rudd & co. to do?

  • sheridan

    “On the other hand, the arm of the government that are controlled by politicians has the power to formulate such a tool.”

    What would you suggest that Rudd & co. to do?

  • Examples of questionable policies include: negative gearing (see Henry flags business tax reform), FHOG (see What goes in the mind of the Rudd government as it extends FHOG?), etc. Also, the corrupt State Labor governments makes things worse.

  • Examples of questionable policies include: negative gearing (see Henry flags business tax reform), FHOG (see What goes in the mind of the Rudd government as it extends FHOG?), etc. Also, the corrupt State Labor governments makes things worse.

  • Pete

    sheridan:

    It isn’t so much what they should do but rather what they should not have done.

    Going back to 2008, many different policies could have been enacted that would not have exacerbated the problems we have today. But, those policies are not popular with the mainstream and were therefore intentionally overlooked.

    If the Gov. is to try and manage the economy whilst the RBA is acting against its wishes – it will probably have to try some more targeted policies, such as bailouts for businesses.

    But every stimulus package or bailout distorts the economy. Capital is being injected into areas that will likely not produce the best value for money. The free market becomes a ‘some-parts-are-free’ market and the distortions get worse until…a crisis.

    Unfortunately I believe that everything the Gov. will do now will cause even more harm. Some things I expect to see:
    – more bank bailouts
    – more home owner bailouts
    – more pressure on banks to drop interest rates
    – some type of ‘mortgage relief’ package
    – more stimulus to save jobs/business*

    * This isn’t sustainable. Higher interest rates will hurt business badly. Poor old Harvey Norman (actually, I have no sympathy for their marketing/sales practices) is going to suffer even more as less purchases are made (because people with mortgages have less cash to spend) and because interest rates for the business are much higher than the mortgage rate. Has anyone else noticed how many advertisements Harvey Norman and Domayne (owned by Harvey’s wife) have put on TV lately? Every week there is some new “interest free” special on. I believe this was to get sales in quickly, to a) boost the books for quarterly reporting, and b) get in some sales (repayment plans?) before x-mas hits and the post x-mas slump kills the industry.

  • Pete

    sheridan:

    It isn’t so much what they should do but rather what they should not have done.

    Going back to 2008, many different policies could have been enacted that would not have exacerbated the problems we have today. But, those policies are not popular with the mainstream and were therefore intentionally overlooked.

    If the Gov. is to try and manage the economy whilst the RBA is acting against its wishes – it will probably have to try some more targeted policies, such as bailouts for businesses.

    But every stimulus package or bailout distorts the economy. Capital is being injected into areas that will likely not produce the best value for money. The free market becomes a ‘some-parts-are-free’ market and the distortions get worse until…a crisis.

    Unfortunately I believe that everything the Gov. will do now will cause even more harm. Some things I expect to see:
    – more bank bailouts
    – more home owner bailouts
    – more pressure on banks to drop interest rates
    – some type of ‘mortgage relief’ package
    – more stimulus to save jobs/business*

    * This isn’t sustainable. Higher interest rates will hurt business badly. Poor old Harvey Norman (actually, I have no sympathy for their marketing/sales practices) is going to suffer even more as less purchases are made (because people with mortgages have less cash to spend) and because interest rates for the business are much higher than the mortgage rate. Has anyone else noticed how many advertisements Harvey Norman and Domayne (owned by Harvey’s wife) have put on TV lately? Every week there is some new “interest free” special on. I believe this was to get sales in quickly, to a) boost the books for quarterly reporting, and b) get in some sales (repayment plans?) before x-mas hits and the post x-mas slump kills the industry.

  • light

    I think you’re wrong about Harvey Norman, they’re one of the industries that will benefit from rate rises, because a high A$ makes imports much cheaper – they’re probably trying to clear their inventories so they can import more cheaper goods.

    Other export industries like mining will suffer a double whamming – higher A$ and higher interest rates.

  • light

    I think you’re wrong about Harvey Norman, they’re one of the industries that will benefit from rate rises, because a high A$ makes imports much cheaper – they’re probably trying to clear their inventories so they can import more cheaper goods.

    Other export industries like mining will suffer a double whamming – higher A$ and higher interest rates.

  • Anon

    “I think you?re wrong about Harvey Norman, they?re one of the industries that will benefit from rate rises, because a high A$ makes imports much cheaper ? they?re probably trying to clear their inventories so they can import more cheaper goods.”

    Cheaper imports is abit useless if consumers have weakness in household income growth, and like Pete said — lots of people are in debt to their eyeballs so Harvey will likely be affected eventually.
    With real wages unlikely to keep up with inflation and debt levels of the consumer gigantic the retail industry is unlikely to grow much (if any). So if JBHifi or Harvey gain market share it will be at the sacrifice of others. Margin loss and aggressive pricing will be a hallmark of this industry for years to come.
    Think about why Myer is floating now? They just had an artificial sales prop up from the stimulus packages. Its abit like all the savvy people who floated in 2007 to take advantage of sheep.

    Hey just a side issue ? above not advice, only for debating ? pls see a financial advisor for decision making and advice.

  • Anon

    “I think you?re wrong about Harvey Norman, they?re one of the industries that will benefit from rate rises, because a high A$ makes imports much cheaper ? they?re probably trying to clear their inventories so they can import more cheaper goods.”

    Cheaper imports is abit useless if consumers have weakness in household income growth, and like Pete said — lots of people are in debt to their eyeballs so Harvey will likely be affected eventually.
    With real wages unlikely to keep up with inflation and debt levels of the consumer gigantic the retail industry is unlikely to grow much (if any). So if JBHifi or Harvey gain market share it will be at the sacrifice of others. Margin loss and aggressive pricing will be a hallmark of this industry for years to come.
    Think about why Myer is floating now? They just had an artificial sales prop up from the stimulus packages. Its abit like all the savvy people who floated in 2007 to take advantage of sheep.

    Hey just a side issue ? above not advice, only for debating ? pls see a financial advisor for decision making and advice.

  • Anon

    Important to note — I just bght something from my usual US retailer…and they are telling me its very slow at the moment and they are struggling to stay afloat.
    Be interesting if this is happening across the board.

  • Anon

    Important to note — I just bght something from my usual US retailer…and they are telling me its very slow at the moment and they are struggling to stay afloat.
    Be interesting if this is happening across the board.

  • Anon

    Producer Price Index falls – looks like weak demand across the board:

    “The government?s Producer Price Index fell 0.6 percent in September after rising by 1.7 percent a month earlier, the Labor Department reported Tuesday. The figures show that, despite a weakening dollar, inflation remains a remote concern as the American economy struggles to pull itself out of a deep recession.

    ?The demand for goods is still very soft; the United States economy is just barely recovering,? said Allen Sinai, president of Decision Economics. ?In a weak economy where consumer spending is weak, businesses have been slashing left and right. This surprisingly deflationary result reflects that.?

  • Anon

    Producer Price Index falls – looks like weak demand across the board:

    “The government?s Producer Price Index fell 0.6 percent in September after rising by 1.7 percent a month earlier, the Labor Department reported Tuesday. The figures show that, despite a weakening dollar, inflation remains a remote concern as the American economy struggles to pull itself out of a deep recession.

    ?The demand for goods is still very soft; the United States economy is just barely recovering,? said Allen Sinai, president of Decision Economics. ?In a weak economy where consumer spending is weak, businesses have been slashing left and right. This surprisingly deflationary result reflects that.?