What did Glenn Stevens tell Cabinet?

From Peter Hartcher on Saturday:

In briefings to the Abbott cabinet this week, the governor of the Reserve Bank, Glenn Stevens and the secretary of the Treasury, John Fraser, agreed on the missing ingredient for a thriving economy – business confidence.

They emphasised that the elements of a faster-growing economy were in place, with the standout exception of confidence. The Australian dollar has fallen dramatically, restoring much lost competitiveness. Interest rates are low. Wages are not growing but remain stable. Inflation is well in check. The services and agriculture sectors are poised for growth. But business confidence is low. It fell after the federal budget last May and has remained feeble since. And that means that firms are reluctant to take risks, to invest, to expand, to hire. Both Stevens and Fraser emphasised this point, according to multiple cabinet ministers who were present.

And from Jacob Graeber at the AFR:

Every time business leaders peer over the barricades to see what’s happening in Canberra –or Queensland and the Northern Territory for that matter –they yet more see reasons to bunker down and wait out the chaos.

Hopes for more meaningful reform –another rallying cry of the Coalition in the lead up to the September 2013 poll –are being dashed at every turn. Most of the serious changes are still wrapped up in white papers, inquiries and delays.

All of which helps explain why the Reserve Bank, given the greenlight by low inflation figures, decided to move after 18 months of inaction.

While part of the decision to lower rates can be justified by the need to keep the dollar down, as well as neutralise the impact of a surge of monetary easing by no less than 12 central banks around the world since the New Year, Stevens was ultimately swayed by a growing need to do something about confidence.

A few points then. First, it appears Capt’ Glenn has played a not insubstantial role in destroying the Abbott/Hockey leadership team. Not directly and probably not deliberately but all the more powerfully for that. Ironically, so has John Fraser, the Abbott/Hockey captain’s pick for the job.

Second, the two top economic jobs in the country are occupied by gentleman that are trapped in Australia’s old growth model thinking, have no idea of the magnitude of the commodities bust, don’t understand the structural shift that’s happened in households and are unable therefore to find lasting fixes for any of it. Given Stone is new and Stevens seasoned, both very likely represent the dominant views of their respective institutions.

I could show you the charts all over again but it’s really not necessary. Let’s just spell it out. This simplistic and maddening “confidence” narrative finds its root in thirty years of pro-cyclical economic policy. It comes from a school of thought that is labelled the “Pitchford thesis” after an elderly gentleman who never meant his thoughts to define an era of profligate policy making.

During the Paul Keating “Banana Republic” fiasco in 1989, John Pitchford wrote that:

Australia’s current account deficit consists very largely of additions to the private sector’s foreign debt. John Pitchford argues that no good case has been made for government intervention to inhibit private debt-creation, and concludes that the government’s present macroeconomic approach to reducing the deficit is not cost-effective.

This simple argument became the talisman for three generations of institutional economists. So long as debt is in the private sector, resulting from decisions made by consenting adults, it does not matter. End of story.

Well, 25 years later, with a banking hegemony controlling much of the political economy via an incredible mortgage addiction, wider business utterly dependent upon this one source of demand, a budget held hostage to offshore bank borrowing guarantees, fiscal policy distorted around giveaways to sustain a vast asset quango, interest rates marching inexorably to an Australian ZIRP, households paralysed by the fear of asset-price retrenchment, generations of Australians locked out of housing, as well as competitiveness and productivity persistently, nay, hilariously low, I’m sorry to have to tell you gents, it does matter.

It is not “confidence” that is missing, it is a viable economic structure. Households can sense it (if not see it) in shaky savings overly reliant upon asset prices, and won’t support the model any longer by spending like yesteryear’s drunken sailors. This conservatism is so entrenched that not even the greatest mining boom in history, nor a subsequent house price boom, nor huge immigration, have remotely dislodged it. As a result business faces overcapacity and has no reason to invest.

This is our own version of the same story of demand deficit playing out throughout developed (and increasingly emerging) economies. It’s about time that the economists that engineered this impasse wake up and see it too. Private debt does matter and until the Australian economy passes through a deleveraging and restructuring phase, blabbering about confidence is badly mistaking symptom for cause.

The real cure is to improve Australian competitiveness so that import competers and exporters see boosted demand, and that will drive investment. If Capt’ Glenn is selling the idea to pollies that that has already been achieved then God help us all. Australia’s real effective exchange rate remains paralysingly high, higher than at any time in modern history other than a few short years in the seventies.

It’s one thing to be keeping up appearances for the public but one really wonders why Glenn Stevens is peddling fanciful “confidence” cures to the pollies, the only ones that can actually deliver the structural reform needed to restore competitiveness? It would take implausible cunning for him to have deliberately destabilised Abbott so that real reform might take place. It can only be that he is unable or unwilling to understand.

Perhaps it is difficult for him because his RBA is also in large part responsible for the destruction of confidence. After the GFC, Captain Glenn appeared to have made a conversion: household debt did briefly matter and deleveraging was de rigeur. But in retrospect that appears to have only been a part of the bizarre embrace of the “sell ‘em dirt” national strategy of greater economic dependence upon mining exports. Recall that it was the RBA that most openly championed this story and deliberately jacked interest rates and the dollar to extremes to “make room” for the first endless commodities boom in human history. That is not working out quite as planned as the commodities bubble bursts, the dollar won’t fall, and volatility is now far more embedded in Australia’s tradable sector than it was before.

Moreover, after this mistake, the Stevens RBA compounded the nation’s troubles by reversing spectacularly and championing a renewed round of household leveraging via painfully slow innovation in its own policy tools which ensured that lower interest rates would largely be tipped into house prices not a lower currency.

These radical reversals of thinking and fortunes have seen wild swings in growth and recession from west coast to east as the RBA chases its tail from one boom to the next. How exactly is business or household confidence to flourish amid such extraordinary volatility in monetary policy management?

Don’t get me wrong, the RBA is limited in its options and one doesn’t mean to underplay the challenges, even if it could have done much better. But what it has consistently failed to do is provide a sensible alternative economic narrative to government. It could have been quite consistent since the GFC that Australia had a dose of double-Dutch disease (first from housing and then from mining) and needed to repair and protect its competitiveness.

Instead, it seems we’ll just keep kicking the can, very earnestly, right to the edge of the looming cliff where both monetary and fiscal policy are exhausted. It is only a few years away now at best and when we reach that precipice, global markets will push us off, demanding the required restructuring that we could have managed far less painfully ourselves.

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