Hold rates, tax hot money

Money Globe

Cross-posted from Henry Thornton.

THE Reserve Bank is widely expected to leave cash rates unchanged today, a judgment with which I agree.

Global conditions are looking better, though attempts to solve the Cyprus crisis involving theft of bank deposits has created a nasty precedent. Local economic conditions are looking better, but the labour market is far weaker than official statistics suggest.

Directors of the bank, mostly Labor appointees, must be watching with astonishment the foolish and outdated class war being waged by the failing Gillard government. It is time for the central bank to stand firm and provide a beacon of stability in a generally volatile environment. I am confident that this will be the case, except for the unresolved issue of the value of the Australian dollar.

The latest official forecasts of global prospects were presented late last week by Pier Carlo Padoan, OECD deputy secretary-general and chief economist. He said progress was generally positive, though risks remained high. The US economy has rebounded this year, and concerns about the “fiscal cliff” are receding, perhaps only until the next round of political head-butting. The proportion of Americans in jobs, however, has not risen by much, and there is the important problem of how the US Fed will restore a more normal monetary policy.

Japan has responded to new and more decisive political leadership and its central bank is now being run by a man committed to joining the global push for easy monetary policy. Moving forward will replace moving backward, at least for a time.

The venerable Bank of England has been deemed so incompetent that it has had to look outside to find a new governor. The outgoing governor Mervyn King advised an event at the London School of Economics (Henry’s alma mater): “Whichever crisis we are talking about it is far from over. There will surely be many unexpected twists and turns before we can truly say that the crisis is indeed over.”

US Fed chairman, Ben Bernanke, present at the same event, reportedly provided a robust defence of cheap money to promote recovery.

Within the troubled eurozone, there is a renewed divergence between growth in Germany, which is likely to pick up strongly over the first half of this year, and that of other countries, which will remain slow or negative.

Mr Padoan declined to say how the European ideal would survive the extreme divergence in economic outlooks. Growth in Germany, extreme austerity in Greece and Cyprus, very high rates of joblessness and underemployment in Spain and Italy, great uncertainty in France in my view is simply unsustainable.

The European Central Bank has joined the easy-money crusade of the US Fed (and now Japan) to do what it takes to encourage recovery.

Easy money is boosting global equity markets while ordinary (goods and services) inflation is “contained”.

History says that such an outcome should come as no surprise. There is, however, a major problem: how to exit from easy money without reversing the asset inflation, and reversing the positive impact of easy money and asset inflation.

The 1920s in the US was a time of rising asset prices and “contained” goods and services inflation. Many people, including prominent economists of the time, provided support for the equity boom and denied the need to do anything about it.

JK Galbraith, in his book The Great Crash, said the failure of the US Fed to end the equity boom of the 1920s was because, if the Fed had done this, it would have been blamed for the crash.

The modern version of this dilemma is likely to involve continued easy money, since significant tightening will not be generally acceptable.

An inexorable rise in goods and services inflation will eventually weaken the confidence of investors and so strangle the equity boom. With luck, so the argument will go, the Fed will not be blamed.

So far, and despite continued advice from many sources to keep easing monetary policy, the Reserve Bank has not joined the global rush to provide a highly easy monetary policy. This column has argued that easy money globally combined with responsible firm monetary policy here has kept the Australian dollar high despite lower (but still high) commodity prices.

But the high dollar is strangling various industries. The deputy governor of the Reserve Bank, Philip Lowe, perhaps influenced by his boss’s tendency to look on the bright side, has recently pointed out that the high dollar is encouraging (or forcing) companies to increase productivity.

No doubt there is some truth to this, but this is not an outcome available to every enterprise.

Despite Mr Lowe’s attempt to look on the bright side, I fear that, if the Australian dollar remains at current levels, or rises further (as it has been doing lately), the balance of help and hindrance to prosperity will worsen. Cutting rates further is not the right answer, just as tightening monetary policy gradually was not the right answer to the asset boom in the Roaring 20s US.

“Monetary policy cannot serve two masters” is a rule that cannot be ignored. The US Fed and other leading central banks are attempting to promote global economic recovery when they should be contributing to this task by keeping monetary policy firm and steady to provide a stable environment for households and businesses, rather than promoting a boom and inevitable bust in asset markets.

The Reserve Bank needs to maintain firm and stable monetary policy, while the problem of a high currency needs to be handled another way.

My proposal is to introduce a broad-based tax on capital inflow, applied to all inflows of capital so as to reduce the currently excessive and damaging currency to more sensible levels.

But evidence, rather than the feelings of senior RBA officials, is urgently needed. If Mr Lowe’s view that industry can handle current levels of the exchange rate is correct then the tax may not be needed, or the rate can initially be low.

But if the evidence is that a lower level of the Australian dollar would help enterprises in industries including manufacturing, tourism and education, indeed is urgently needed, then a moderate tax will be indicated.

Such a tax may prevent, or ameliorate, serious damage to much Australian business and by extension to many Australians.

David Llewellyn-Smith


  1. “…introduce a broad-based tax on capital inflow, applied to all inflows of capital…” Yep. Capital Controls. They always sound so much better than Trade Wars…. because that’s the front that they are implemented to fight on. Hello darkness, my old friend….

    • That’s the problem isn’t it? Got rates low enough to get assets moving but not low enough for dollar. You can’t cut. You can’t hike.

      HT is right right.

  2. Excellent article!

    Mad Adam is right about the 25bps though not for the endless sunshine reasons he usually relies on.

    25bps will assist the debt weaning that we are going to have to do at some point.

    But this will require the protective measures (or similar) prescribed by Mr Thornton.

    • GunnamattaMEMBER

      Yeah but what we are going to get today is no change on rates

      So the queue lines up with their tray for another serving of debt.

      House prices set themselves for the rarified heights

      Dollar probably drifts even higher short term (depending on todays manufacturing data)

      The great disconnect needs a stake through the heart to stop it

    • “25bps will assist the debt weaning that we are going to have to do at some point”

      pfh….lower RAT rates have not resulted in lower debt in the past. Zero to negative RAT over a long period is how we got here.
      The current significant lift in both real estate values and volume, while deposits are in decline, is testament to the fact.

      You can get very short term distortions to basic behaviour but current Aus experience suggests that distortion is VERY short term…..as in a matter of only a few months.

      • Flawse,

        I think you have mistaken me for someone else. ๐Ÿ™‚

        Raising rates is the only way to encourage debt weaning – 25 bps is not enough but it is a start.

        I don’t buy the idea that rates should be manipulated down so that savers are forced to ‘help’ debtors pay off their debts.

        Firstly, it is unjust and secondly, it will not work as people are being sent a clear message – borrow and we will provide you with middle class ‘debt welfare’ if you borrow too much.


        • pfh your stance re interest rates is abundantly clear….and correct!

          Sorry I misinterpreted your remark and puzzled over it. The error is mine not taking on board ‘Mad Adam’ is calling for a RISE! I’m too used to the MSM always calling for reductions.
          Hence the ‘Ah Yes’ which may not have been a sufficient notification of my error.

          So my sincerest apologies for thinking you had somehow lost your marbles for a second!!!! I guess I do so I reckon others must as well ๐Ÿ™‚

  3. Why is there such resistance to looking at constraints on hot money? The arguments for seem pretty robust – is it just a case of not wanting unintended outcomes or are there vested interests involved?

    • I suspect it’s because they don’t want to set ANY precedent that OZ could inhibit capital inflows. As a long term CAD nation, when things turn we’ll need the dough.

      Of course, by doing so they ensure we’ll be a long term CAD nation.

    • That hot money is keeping the dollar up. A high dollar supports the strategy of using household debt to drive the economy.

      If the dollar were to fall there would be upward pressure on interest rates.

      This is why the RBA and Mr Swan keep accentuating the positive on a high currency.

        • There is no mystery why the pollies on all sides like to avoid the topic of household debt – they all love stimulating an economy with money that they are not held responsible for borrowing.

          The real mystery is why so many journos in the MSM – let them off the hook so easily and do the usual ‘blame’ the reckless ‘greedy bogan’ borrower routine.

          While the borrowers should ‘man up’ and resist the bait – the hook is clearly being baited and by that I mean the fundamental economic indicator interest rates ‘rigged’ so that debt appears to be a rational choice.

          It’s about time that pollies (and MSM journos) were being asked some hard questions on their position with regard to household debt and how it has been driven up over the last 15-20 years.

      • Yes PHF, I have long thought the RBA ambivalent at best on the question of the strong AUD – seeing the benefits continue to support (short-termish possibly) the economy.

  4. Tks – Probably a bit of both? It is very hard to not be cynical and think that short term expediency doesn’t rule the decision making here.

    • Yes aj…It has for about the last fifty years of my economic consciousness so why change?

  5. A tax on capital inflows would decrease investment (increased cost of borrowing for firms and reduced FDI), so even though there may be a boost to net exports, IMO the net effect of the tax on overall activity is unclear…

    • urbcomm…short term it is clearly negative. We are trying to posit what might be required for a long term sustainable stable economy.

      • I disagree… the focus of the article is clearly on the short-term.

        eg “the currently excessive and damaging currency”

        “If… industry can handle current levels of the exchange rate… then the tax may not be needed”