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Directors of the bank, mostly Labor appointees, must be watching with astonishment the foolish and outdated class war being waged by the failing Gillard government.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.