Goldman Sachs gave up on its rate cut call for this year last night, beating me to it after the Glenn Stevens testimony yesterday which clearly showed the RBA is waiting for Godot. I no longer expect a rate cut before Christmas either given my outlook for iron ore isn’t too dour until next year. However, MB is not lifting its easing bias, and still expects the next rate move to be down given the terms of trade shock will roll on and the risks presented in China are growing not receding.
It’s worth revisiting the key statements from yesterday by Captain Glenn:
The low returns on offer on safe investments in Australia, and the ultra-low returns on such assets internationally, are certainly having an effect by prompting investors to ‘search for yield’. Not only are returns on financial instruments low, but yields on the existing stock of physical assets – houses, commercial property, infrastructure assets – are being bid down. Some of that search is of course coming from offshore.
That’s a big part of how accommodative monetary policy works. It prompts substitution towards higher-risk assets; it raises asset prices, which increases collateral values and makes credit extension more viable; it improves the cash flows of debtors; and so on. All those things have been happening in Australia. Admittedly, the exchange rate, another channel through which monetary policy usually has an effect, is probably not doing as much as it might usually be expected to do in achieving balanced growth.
But the thing that is most needed now is something monetary policy can’t directly cause: more of the sort of ‘animal spirits’ needed to support an expansion of the stock of existing assets (outside the mining sector), not just a re-pricing of existing assets. There are some encouraging signs here. Nonetheless, if reports are to be believed, many businesses remain intent on sustaining a flow of dividends and returning capital to shareholders, and less focused on implementing plans for growth. Any plans for growth that might be in the top drawer remain hostage to uncertainty about the future pace of demand.
That’s actually nothing new. It’s pretty normal at this point of the cycle. There is always a period in which people can see that many of the conditions for expansion are in place but aren’t yet fully confident it will happen. Nor is it confined to Australia. The gap between financial risk taking and ‘real economy’ risk taking is seen globally at present.
And bosun Lowe:
“At the end of the day, monetary policy can’t be the engine of growth in the economy. We can help smooth out the fluctuations, we can’t in the end drive the overall growth in the economy.”
“It’s clearly structural issues that do that… Australia is going to be a high wages, high-productivity, high-value added economy – that’s where we want to be, that’s where we could be, that’s where we should be. If we’re going to find ourselves in that position and sustain ourselves there, then people need to be able to take risks, they need to be able to be rewarded for risks and we need to innovate to find new ways of doing things better.
“So I think it’s somehow enlivening the entrepreneurial and risk-taking culture, innovation culture, so that we can be the type of country that has high value-added, high wages and high productivity. I think culture’s important .
“In my perspective, I think our society is becoming too risk adverse, the way we think about risk has got distorted and we’re not paying enough attention to returns and we’re paying too much attention to risk.
“I think if we invest more and more effectively in education, in human capital accumulation and infrastructure, so it’s risk taking, education, infrastructure, they’re the things that are going to help us be a high wage, high productivity, high value added economy.
“But the details here aren’t things the central bank are expert in, but they’re the ingredients to be a successful economy in the next 20 years.”
The RBA is talking about competitiveness, albeit obliquely. Very obviously, however, it sees itself as having no role in delivering such via a lower currency, which is quite possible to do, so long as one is prepared to put a lid on the housing bubble, which it is not. It’s worth noting in passing that this flies in the face of its own research about what it should be doing in our current circumstances:
Historically, for several years following a peak in the terms of trade, growth in investment and output per capita tends to be below average. As we have emphasised, the real exchange rate and the terms of trade generally move together. Consequently, the expected easing in the terms of trade, reflecting growth in the global supply of the bulk commodities, may be accompanied by falls in the real exchange rate. More generally, an increase in Australia’s competitiveness would help facilitate the macroeconomic adjustments necessary during the transition from the investment to production phase by providing support to sectors outside of the resources sector, thereby helping to rebalance growth in the economy. Reflecting the unparalleled magnitude of the expansion, the transition necessary is considerable and is likely to pose challenges to both firms and policymakers. The current policy frameworks and institutional structures, which were important in facilitating better macroeconomic outcomes during the upswing than occurred historically, may also assist this transition.
Note the emphasis on the real exchange rate. Terms of trade booms are great but everyone knows such also robs the economy of competitiveness outside of the endowment sector, that is, gives you Dutch disease. To fix it, therefore, one needs policies that undo the real exchange rate appreciation, according to some dill who is no doubt serving the tea now at the RBA.
In short, the RBA is beaten on the currency. And to this we can add a change in rhetoric by the Government. From the AFR:
In a rhetorical shift, the government stressed that almost 99 per cent of expense measures in the budget have been passed by Parliament.
Prime Minister Tony Abbott stressed that the government remained committed to implementing the structural savings in the budget but, when pressed, would not acknowledge there was a crisis, or an emergency, terms the government has used repeatedly over the past year.
…Treasurer Joe Hockey used a similar analogy to say the situation was not yet dire.
The government confirmed the shift in rhetoric when Finance Minister Mathias Cormann told the Sydney Institute on Tuesday night that the media was to blame for the sense of crisis an that “somehow we are running late’’.
“A significant part of the budget had gone through both Houses of Parliament by the end of June,” he said, and there was ample to time to methodically deal with the outstanding measures.
It’s the triumph of Pasconomics and the implications are:
- the Australian dollar will fall more slowly than any other inflated global currency (though it will still fall). When it does eventually crack it will crash;
- the Government is beaten at the margins on its austerity agenda. Given the terms of trade are already far below forecast, the forthcoming misses in deficit reduction are going to be tricky but the Government is clearly going to plump for confidence now as well;
- judging by the rhetoric of the major banks, the APRA macroprudential guide to lending is having some impact in preventing banks competing via lower lending standards. We can therefore expect out-of-cycle mortgage rate reductions (so far they haven’t actually amounted to anything) to keep the party going, and
- housing is set for one final great inflation straight into the capex cliff and the next external shock.
It’s a ship of fools cheering wildly into a storm but the spinnaker is set and bulging, the will for change is absent and the rudder is broken.