While the two leaders of Australia’s political parties are busy stroking racist sentiment in Western Sydney, the RBA meets today and will very likely not cut interest rates despite a manufacturing capex reading last week first seen in 1989 (in nominal dollars, real dollars being FAR worse). It’s not that the RBA would not like to cut but as its various boffins have recently noted, the risks of an asset blowoff are too great.
Given the asset class in question – property – has so far rebounded almost exclusively on a charge by investors into the existing home market, we now face the very explicit national situation of being unable to rescue our dying industrial base from a well-overvalued dollar because a cabal of specufestors (apologies to more upstanding property investors) are busy bidding up pressure on interest rates.
Of course it’s not actually the fault of the specufestor. The issue is with our macroeconomic settings which encourage such behaviour. Two stories today underline the folly of this situation.
The first comes from Banking Day, which describes the moves by the RBNZ towards macroprudnetial tools, which enable the central bank to control mortgage issuance without using interest rates and thus can be used to lower a currency:
The Reserve Bank [of NZ] has asked for feedback by April 10 on a process that has recently been accelerated. Finance Minister Bill English said in a speech last week that the Government and the Reserve Bank planned to have the tools and their framework ready to use by mid-2013.
The Reserve Bank is increasingly worried about an over-heated housing market in Auckland and a surge in high loan-to-value ratio lending in the last six months.
The bank spelled out more detailed proposals for a counter-cyclical capital buffer, changes to the existing core funding ratio, sectoral capital requirements and limits on LVRs for home mortgages.
The second story offers another option for dealing with Australia’s current impasse too. Find below an eminently sensible suggestion today from Henry Thornton that Australia impose a Tobin tax in capital inflows. For those that don’t know, Henry Thornton is the nom de plume of PD Jonson, former head of research at the RBA.
THE Reserve Bank meets today and interest rates will remain on hold. This is because there is no compelling reason to change them. Inflation remains within the target range, unemployment (as measured by the ABS) is low and the dollar is strong. Share prices are rising strongly, company profits are growing and house prices seem to be reviving.
Looked at by people with secure, high-paid jobs and generous defined-benefit pensions, the macro picture of Australia seems glowing.
But come down to the grassroots and the picture quickly seems less rosy. Jobs are hard to get and companies are cutting costs largely by cutting jobs. The cost of living seems to be rising inexorably. Home ownership looks impossible for all but the lucky young people who get one of those precious jobs.
Look a little deeper, if you will. We learn from recent news reports that Australian peach growers are destroying their crops because canners are preferring cheaper imported peaches. Another iconic Australian business, Rosella, is closing its doors/being purchased by a foreign buyer. And Nelson’s Honey in Boggabri, NSW, has sold 900 of its 1000 hives because it is unable to compete with the high salaries offered by Whitehaven Mines.
Such stories are a constant part of the news cycle and who, pray tell, cares? Australian businesses, and in particular smaller businesses, are suffering. Competition at work? Yes it is.
But the heavily competitive, global economy, while offering expanded opportunities for gain, is also one where small economies (read Australia) may suffer longer-term negative effects, just as small businesses within Australia suffer from the greater efficiency of larger businesses.
The very strong Australian dollar is great for overseas travel but it is crushing Australian manufacturing and even parts of Australian primary production. There is an avoidable reason for lack of competitiveness of Australian industry, but this is not yet the subject of serious debate.
The powers, including to its credit the Reserve Bank, have at least conceded in public that the Australian dollar is overvalued. The dollar is slightly overvalued, so goes the story, with an implication that if necessary interest rates can be cut further.
The manipulation of interest rates within a deregulated financial system with a freely floating exchange rate is a tool that has been highly successful in achieving low and stable goods and services inflation in Australia. However, manipulation of interest rates cannot simultaneously be effective in both keeping inflation low and stable and controlling the level of the Australian dollar. As Milton Friedman said, “Monetary policy cannot serve two masters.”
The purest economists say the answer is renewed micro-economic reform, raising productivity and restraining wages. I strongly agree that such reform is highly desirable, but it is not going to happen and it is certainly not going to happen soon. In the meantime, more jobs will be lost and more businesses will close down or be sold to overseas buyers. And serious economic reform would not necessarily make industry more competitive, as the Aussie dollar might rise as the reforms took hold. This is because relevant and successful microeconomic reform would make Australia an even more attractive place to invest, driving the Australian dollar higher and killing more businesses that cannot make it in a global economy where Australia becomes an even more highly successful player.
I question whether the Australian dollar is only slightly overvalued at present. Australia’s productivity is perhaps 80 per cent that of the US. My crude logic says that perhaps the natural or equilibrium exchange rate is 80 per cent of the value of the US dollar. I may be challenged on this, but the standard view of “slight” overvaluation needs a rethink.
I am certain the Australian dollar is overvalued, and that if monetary policy is eased to help reduce the value of the dollar it will create other problems, as it did in the late 1980s, when such actions led directly to “the recession we had to have”. Monetary policy is not equipped to get the Australian dollar back to where it should more realistically be, whether this is $US1.00, US90c or US80c.
This is a problem for government. Governments are elected to work in the interests of Australian citizens and it is time for the Australian government to consider alternative options for controlling the Australian dollar.
The global economy remains mired in a growth recession that is likely to be prolonged, making global business increasingly competitive as it makes many of its people miserable.
Last week a mere report that the US Fed was debating how to exit from current super-easy monetary policy caused a mini-panic in which US stocks plunged. The US government has since failed to agree on sensible plans to cut its unsustainable fiscal position, leaving the crude and damaging “sequester” to cut spending across the board. The eurozone is still struggling in recession, China’s new government faces many challenges, and another global crunch is looking increasingly likely.
Australia will need to get many things right to do as well in the coming global crunch as it did in 2007-08. But we can do better than simply let market forces impose massive instability and uncertainty. The way to do better is to impose a variable tax on capital inflow. This should be implemented by the Reserve Bank, which would give it the power to maintain firm monetary policy without destroying large swathes of Australian industry.
Even more simple of course would be to tweak capital gains tax or negative gearing benefits for property. Of course, with our two leaders busy stroking racist sentiment in Western Sydney, ancestral home of the specufestor, none of these will be considered.