Posted on July - 25 - 2011

Calling Central Bankers to Account

So, just what should the price of money be in the Australian economy?

Any ideas? No?

That’s okay – we don’t think Reserve Bank boss, Glenn Stevens does either.

Yesterday’s inflation figures came out much worse than expected. In reaction, everyone turned to Glenn Stevens and monetary policy to do something about it.

‘Price spike spreads rates pain’, says the front-page headline in The Australian.

The Financial Review leads with ‘Inflation rise fuels fears of rate increase’.

We’re grown to believe that monetary policy is the answer to all our economic ills. If inflation is getting a little out of hand, just nudge interest rates higher. If the economy needs a bit of a push, lowering interest rates should do the trick.

But if you really think about it, monetary policy is the cause of all our economic ills. That’s because it’s basically a few blokes sitting in a room each month deciding what the price of money will be.

And it’s a decision they will NEVER get right. Their mistakes won’t be apparent immediately, but over a period of years it should be clear for all to see.

That’s the problem with the state of economic debate in this country though. No one ever questions the ability of the RBA. Actually, that’s not right. People, generally referred to as ‘economists’, do question the RBA’s ability. But they do so to push their own agenda. They think they know better.

No one questions the existence of the RBA. No one asks why Australia should rely on the RBA to set the price of money for a complex, trade exposed economy…and be expected to get it right.

So today, we’re asking the question. Just what is the RBA good for? Discuss.

Back to the inflation question…rising inflation in Australia today is the result of a few different factors, one domestic and one international.

On the domestic front, years of easy money in the early 2000s, combined with a fiscal policy that promoted property ownership and investment over productivity enhancing business investment, led to an historic housing boom.

Channelling much of the country’s investment into a property boom has been none too good for generating long-term productivity gains. Add to that a lack of microeconomic reform and you have a recipe for inflation years down the track. So here we are…the RBA’s past easy money has contributed to today’s inflation problem. And we expect them to fix it?

The international factor in the inflation mix makes the RBA even more impotent. Most of the developed world is pursuing ultra loose monetary policy. And in the developing world, China is pushing for world champ status in easy money.

Because China is Australia’s largest trading partner, we are importing some of China’s inflation via a massive boost to our terms of trade. Our nominal income, or national income in current dollars, is rising much faster than real GDP growth because of this terms of trade boost.

So if Glenn Stevens responds by increasing interest rates, will it have an impact? We doubt it. The resource sector, the prime beneficiary of the terms of trade boost, is not very sensitive to the level of Australian interest rates. International liquidity conditions matter more. And thanks to other blokes around the world setting the price of money way too low, international liquidity is abundant at the moment.

So, we have international inflation washing up on Australia’s shore – which is out of the RBA’s hands – combined with domestic inflation, which is the result of poor policy judgments in the past.

And still no one has stopped to think that the problem might be the arbitrary interest rate setters around the world?

Australia’s problem is that we are a relatively well-managed economy with lots of natural resources. Because the world’s major economies are run by a bunch of egotistical lunatics beholden to the banker class, international capital is fleeing those markets and flowing into Australia, pushing the dollar up to incredible levels.

We’re an economy on the edge of global monetary madness and we’re suffering the consequences. There’s not a lot the RBA can do.

The monetary madness is a boon for the rating agencies though. They’ve never been busier. Moody’s has just downgraded Cyprus’ bonds to two notches above junk. The yield on 10-year bonds has jumped to over 10 per cent, higher than the borrowing rate that led to the bailout of Greece, Ireland and Portugal.

And yields on Spanish and Italian bonds are beginning to creep back up again, as investors grapple with the enormity of the problems facing the eurozone. Last week’s bailout looks like it has bought just enough time for the Eurocrats to take a summer holiday. It could be short one though.

We haven’t even mentioned the problems facing the US…we’ll spare you that fate today. Suffice it to say, the world’s problems, as complex as they are, can be summed up as follows:

We are suffering from too much debt. This is primarily the result of believing that a few individuals around the world know what the price of money should be at any give time. They don’t. It’s time to call the central bankers to account.

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