Bill Evans begs for no more rate cuts

From Westpac’s Bill Evans:

The Reserve Bank Board meets next week on December 6. The Board is certain to keep rates on hold despite the prospect of a weak print for GDP growth in Australia in the September quarter. Westpac’s current estimate is 0.2% – the lowest since March quarter 2011.

It appears that the new Governor Lowe has decided that any benefits to the economy from a further short term boost to housing and spending from even lower interest rates would not justify the potential risks around household debt that even lower interest rates might bring.

From that perspective it is interesting to consider the debt burdens currently experienced by the world’s major economies.

The Figure uses data from the Bank of International Settlements (BIS) to provide a “like for like” break down between corporate; household; and gross government (including states) debt.

From Australia’s perspective, the key issue is that Australia has “around average” corporate debt but record low government debt (34.5% of GDP) and record high household debt (125% of GDP).

This not a new situation. Australia’s household debt boomed in the ten years leading up to the GFC while Australia’s government debt position deteriorated sharply in its aftermath. That reflected the weight of the short term stimulus packages offered by the Rudd/Gillard governments; the collapse in commodity prices and the embedding of a series of generous social packages during the “plentiful” years when commodity prices were booming.

Australia’s government debt position was so strong during that pre GFC period that it could afford a sharp deterioration post GFC and still have a very strong position relative to other developed economies. The pace of this deterioration has slowed markedly with “calmer” times for commodities; no more poorly targeted short term stimulus packages and some spending restraint from the Coalition Commonwealth government and some state governments.

Household debt ratios have not fallen since the GFC despite a much more cautious household sector. Sharply lower interest rates have sufficiently stimulated new lending that household credit growth continues to exceed growth in incomes.

These issues should be sending a very clear message to the authorities around the optimal policy mix. The policy mix over the last five years has been to slash interest rates thereby putting upward pressure on household debt despite its already excessive starting point. It appears that the Reserve Bank is no longer attracted to that policy mix. On the other hand, the fiscal authorities, with a very strong balance sheet show no inclination to use that balance sheet to provide whatever future boost to demand might be required.

This week both the OECD and the IMF, following intense study tours of Australia, recommended a boost to infrastructure investment, to be funded by borrowings, by the Commonwealth authorities.

Reserve Bank officials have already been on record supporting such an approach. It appears clear that given Australia’s extreme debt mix the Reserve Bank sees fiscal policy as a more appropriate tool to boost demand and raise productivity than further leaning on household balance sheets.

Unfortunately there has been no encouraging response from the government. In response to the IMF/OECD suggestions the Finance Minister indicated that it was not appropriate to borrow for “investment” until the government was not required to borrow more to finance current activities. A likely interpretation of that position is that borrowing for infrastructure cannot be supported until the Budget is in surplus. On current estimates that will not be until 2020/21.

This approach may be a calculated strategy to retain Australia’s current AAA sovereign rating. My view is that the most significant headwind for Australia retaining its AAA rating is its excessive foreign debt (public and private) which runs at around 60% of GDP (compared to the AAA “average” of around 15%). That high foreign debt, in turn, reflects the excessive household debt, as banks funded Australia’s housing booms with offshore funds.

It is certain that Australia will not be able to significantly lower that foreign debt anytime soon.

If the Commonwealth Government is relieved of its battle to retain the AAA it may be more open to adopting a sensible long term infrastructure program. Such a program would boost productivity and while the direct short term impact on demand might be limited, it is likely to boost the confidence and growth expectations of the business community. In turn lifting investment and employment plans.

In the meantime, the government should not look to the RBA for a “short term” fix by further boosting household debt with even lower rates.

Hmm, interesting notion, losing the AAA rating would increase fiscal spending. I think the opposite more likely. More rate cuts are coming.

What you are better off campaigning for, Bill, is much tighter macroprudential policy to accompany the cuts.

Houses and Holes
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  1. They still don’t get it!

    And it appears you don’t get it either H&H.

    Bill Evans is right to call for no more interest rate cuts.

    As I have been writing here for around 15 months now; Lower interest rates are equivalent to pushing on a piece of string, useless (and even destructive.)

    As I have also been writing here for about 15 months now; massive government spending (deficit) on R and D and implementation of R & D outcomes is the answer to Australia’s (and the western worlds) current economic illness..

    Now there is a suggestion that there should be significant infrastructure expenditure! (Think Trump here also). But that is only a SMALL PART of what is needed. The VERY IMPORTANT step is one step further and that is the R & D spending and implementation of the results that I mentioned above and below.

    Try this 30 minute video to understand what I mean:

    The solution is simple. To get a grasp of how simple the solution is read what I have written below and watch the TED TALK video on the link below (My writing and the TED TALK may save your economic life!):



    (I refer to Australia below but the same solution is essentially universal for all advanced economies).

    We need massive government spending on R&D in potentially deflationary industries including clean alternative energy supplies, nano technology research and development, and medical research (including the effect of lifestyle and diet on diseases such as cardiovascular, diabetes and cancer). The subsequent deflationary effect that will occur in all of these industries and parts of the economy affected will bring, for example, lower power prices and medical costs. This deflationary effect will, over time, pay for the government expansion and will provide employment in a transformed high tech Australia.

    This a a form of QE for the people instead of for the finance and banking industry at a time when new private debt cannot be used as a stimulant because private debt is too high.

    Coupling such an approach with a reduced level of immigration (except for experts who are essential to fill job roles in the areas of expansion) and the end of negative gearing and the end of superannuation advantages for the rich will provide government with additional tax cash to beneficially use to further the expansion. Further, the cost of business and other premises for use in the expansion will fall, as will the cost of homes in which to live, and the expansion will be further fired-up with many more opportunities for entrepreneurism.

    Notably, accurately targeted deflationary stimulation creates a virtuous circle where government must spend more to off-set deflation. Thus, a virtuous circle is created until no more deflationary inducing spending is possible. At this point the population has the advantages of a newly established higher standard of living and the government stimulation can be withdrawn.

    H & H and other neo classical economists (more than about 90% of the world’s economists) just don’t get it!

    As I have mentioned in recent months I expect that governments and central bankers will understand better by abut mid 2017 and we will (hopefully) see massive government spending then. But the next step MUST be taken to R&D and its implementation and not just infrastructure spending or the currently “advanced” economies will fall further back towards the developing countries standards of living.

    • Jumping jack flash

      “As I have also been writing here for about 15 months now; massive government spending (deficit) on R and D and implementation of R & D outcomes is the answer to Australia’s (and the western worlds) current economic illness..”

      Indeed. Government to take back control of essential services and build and own income generating assets to earn national income from the rest of the world. They could even tender the management of them to private companies, if they like.

      I think H&H was referring to what will happen, not should happen.

      Everyone knows that the only thing they can really do is squeeze the interest rate debt machine accelerator downwards to try and get more debt bubble growth, and hence more economic growth.
      Of course the other thing they can do is open the foreign investment gate a little wider, and tie on their blindfolds a little tighter. No surprises they have been discussing this lately, too.

      Building mega factories with subsidised worker communities to cheaply produce useful things to sell to the rest of the world to earn national income? Nobody wants to do that. Too hard, you see. You actually need to think and plan, something politicians have forgotten how to do decades ago.

      The options are literally limitless, if they could actually think of some decent strategy.

      Think? Stuff that! Far easier to borrow a mountain of debt and attach it to a house. How easy is that?

    • The fly in your ointment is that R&D without productive industry goes nowhere. H&H advocacy is for saving what little remains and then play from there. Australia has some natural strengths left but most is gone. Maybe some biomed…

      • CSIRO if funded does research for industrial application..its been very good at it.
        For example its Novaq prawn food, wild fish are replaced by prawn tank grown ocean microorganisms in the off season dried and the food produces super healthy prawns 40% bigger or same size 40% faster. This means avoidance of issues to do with fish deletion, metal pollution and Fukishima products in the water. i.e. CSIRO addressing issue of protein supply. CSIRO invents things…. its has made many interesting commercial applications.
        We have already a way.. just needs massive re-funding, proper policy again and re-stocking with great scientists.

      • Glo, what are you on about buddy. Aside from the fact that Australia is a major aquaculture producing nation (i.e. there is an industry behind the research), and therefore your example supports my point, the issue is that you can´t spray cash around and hope the R&D sticks. Saying CSIRO is good at research does not obviate the fact that it doesn´t do it in a vacuum.

        Edit: “Fukushima” products is the funniest label for radioactive byproducts, ever.

  2. ”My view is that the most significant headwind for Australia retaining its AAA rating is its excessive foreign debt (public and private) which runs at around 60% of GDP (compared to the AAA “average” of around 15%).”

    Oh ! just 4 times what is a reasonable exposure to foreign debt, 4 TIMES !

    I know this will irk you H+H but that ratio and not being able to cut when we (perhaps) should be is a direct result of lack of effective MP which needed to be brutal and in concert with APRA FIRB ATO et al.

  3. Another perspective, the RBA can do what it wants, move rates up or down, but the age of central bank control is over. The UST 10 yr yield went up by 3% to 2.45% overnight! Has the global sequence of sovereign currency crises begun?

    • If the Fed wanted, they’d lower that rate. They generally like to see the overnight rate operate within a band and act accordingly
      Given the 10 year rate, and not the overnight rate, was impacted, I don’t see it as a big deal – Storm in a teacup.

  4. Bill seems to have heard a penny falling in a forest.

    A whole range of ideas in that post that Bill usually dodges.

    Cutting rates driving household debt to record highs post GFC. A concern that cutting rates further will just make that situation worse.

    Be still my beating heart.

    “…What you are better off campaigning for, Bill, is much tighter macroprudential policy to accompany the cuts…”

    The problem with that recommendation is that it needs to be clearer and let Bill know that the MP Bill should be campaigning for is for APRA to direct the local ADIs to wind down their use of offshore wholesale lending to support mortgage lending where the security is existing rather than new property.

    That explicit advice would result in

    1. Higher mortgage rates for the existing property asset price speculators

    2. Lower mortgage rates for new construction.

    3. A lower exchange rate.

    Though it preferable that any offshore lenders who want a taste of Aussie property do so directly via RMBS and not via the ADIs.

    Just cutting teh rates without the above recommendation to APRA will result in a higher $AUD as the banks increase their reliance on NIRP/ZIRP capital to allow them to pass on the RBA target rate cuts.

    It is no coincidence that when the RBA started cutting rates in 2013 that the external liabilities of the ADIs took off again with APRA watching quietly.

    Keep in mind that if the RBA target rate was the only determinant of mortgages rates there wouldn’t need to be any offshore wholesale borrowing at all.

    If Bill succeeds in convincing APRA that would be about $600B less offshore debt whose rolling over keeps the $AUD significantly higher than it should be.

  5. Not that I necessarily disagree with Bill, but he’s basically advocating the RBA throw out its mandate or admit its only tool is limp to do anything.

    The Aussie economy is weak, inflation benign and with employment figures flattering (due to increased casualisation of the workforce), construction horrible and mortgage arrears creeping up – even before the latest shock to bond yields (which has effectively given a tightening to households).

    Unless the RBA is now Austrian, there’s a good case for more easing.

    • “…admit its only tool is limp to do anything…”

      Yes – I think that realisation is finally dawning for Bill (along with lots of other people – possibly including the RBA but their track record for admitting error is not great).

      Year after year we have had people calling for the RBA to cut rates without any real discussion of why the last cuts (and all those ones before those) did not work or why they stopped ‘working’.

      It is a pretty obvious question to be asking – why does the demand for credit continue to decline after the price for credit has been lowered? If additional demand for credit can only be stimulated by further price reductions what is that telling us?

      Had those questions been asked about 5 (or preferably 20) years ago we may have worked out the flaws in the current RBA/APRA centred monetary model and been well on the way to a better approach to regulation of the public monetary system.

      There are plenty of alternatives but there is zero discussion of them in Australia.

      Instead we are in the position of having watched other countries pursue failed policies to ZIRP and NIRP and without any real reflection continue to march on in their tracks.

      It is good to see some doubts creep into Bill’s thinking but it has taken a looooooooog time to get there.

  6. How can you cut rates in the face of
    1. Interest rates overseas rising
    2. Loss of AAA credit rating and a general loss of credibility in our economy resulting in higher margins on IR’s for our overseas borrowing

    Every time you print an A$, the process of lowering rates, in this economy while running a budget deficit, you get another $ of CAD and foreign debt? Debt that has to be borrowed at rising IR’s. How is lowering IR’s into that environment going to hep at all? More likely it will just even further undermine our economic credibility raising IR’s even more.
    Lowering interest rates, in already negative RAT IR environment never has been, is not and never will be any sort of solution.

  7. Bill talking about Foreiogn Debt is a GIANT shift in his prognostications!!! Strewth! If this keeps up another decade he’ll be talking about the CAD that caused the foreign debt. Mayber a decade after that he’ll start worrying about how we have already sold off or closed down any asset that might be of any effect in reducing the CAD and Foreign Debt.

  8. “sensible long term infrastructure program” equal to or less than one term of office (or 2 prime ministers)

  9. Too late to try fixing things… pretty hard to stop the enormous balance sheet depression to come.
    And we are already used to living on the smell of an oily rag.
    Let the Bear throw out the trash.