My Questions to the Reserve Bank of Australia

In case you’re wondering, official interest rates in Australia will be on hold for some time. And the next move is likely to be down, not up. The release of the Reserve Bank of Australia’s minutes yesterday from its June meeting confirm this ‘rates on hold’ view.

The RBA said:

‘Low interest rates were working to support demand, although it was difficult to judge the extent to which this would offset the expected substantial decline in mining investment and the effect of planned fiscal consolidation.

‘Notwithstanding a pick-up in growth around the turn 2014, GDP growth was expected to be below trend over the next year or so, rising gradually thereafter.’

Below trend growth, in the absence of inflation, means interest rates are going nowhere. If growth slows even further, theReserve Bank of Australia will be thinking about cutting rates again. Slowly but surely, we’re joining the ‘basket-case’ economies from the northern hemisphere. Weighed down by debt, Australia too will ‘enjoy’ a prolonged period of low interest rates.

This won’t be news to you if you’ve been listening to cycle and trends guru Phillip Anderson, the latest addition to the Port Phillip stable of editors. Phil reckons you should get used to low interest rates for the next, wait for it…70 years! Phil’s new service will be out in a couple of weeks, so stay tuned if you’re interested in his take on the interest rate and property cycle, amongst other things.

Low interest rates for a long time…that’s good news right?

If you’re up to your eyeballs in debt, yes it is. If you’re a saver, not so much. Who then, is the RBA looking out for when its sets interest rate policy?

Let’s find out…

Earlier this month, the head of the RBA’s Financial Stability Department, Luci Ellis, delivered a speech to students at the University of Adelaide, in which she said that one of the legislated mandates of the RBA was ‘to improve the welfare of society’ and that the ‘problem we are trying to solve is to reduce the risk and cost of financial instability. We should therefore seek to reduce the build-up of risk, which might or might not manifest as a boom in asset prices and credit.’

Given that the Reserve Bank of Australia had just caused an emerging asset boom (both stocks and house prices) that did anything but improve the welfare of society, I couldn’t help but send the RBA some questions seeking clarification on what they are actually trying to achieve.

Here’s what I asked them, with my questions in bold:

Do you not think that holding real interest rates at negative or zero percent (which is where they are now, depending on the measure of inflation) is contributing to the build-up of longer term financial risk? Do you think that this ‘financial repression’, which redistributes wealth from savers to banks and debtors, is improving the welfare of society?  

I understand that the Reserve Bank of Australia has a number of mandates, financial stability being just one.

Full employment, currency stability and economic prosperity are the others.

My next question is how does the RBA prioritise these mandates? To what extent do you focus on full employment over financial stability? The secular fall in real interest rates over the past decade or two (and it’s now zero, which discourages saving and encourages speculation) suggests the Bank’s focus has been on full employment…and because financial stability is much harder to measure, the full employment mandate is much easier politically to justify.

But now we’re at a point where the bank has done everything within its limited power to foster full employment…AND you’ve been helped by the China boom, which is now ending.

This has created a distorted economy that is overly reliant on constant monetary fuel.

At what point does the RBA say, look, we can’t keep cutting (real) rates into negative territory because of the longer term risks it poses to financial stability?

Would you ever be brave enough to recognise the limitations of monetary policy and start putting more pressure on politicians to enact genuine structural reform?

I understand that the RBA is hamstrung in this regard by large foreign central banks that don’t seem to factor long term financial stability into their policy actions. At the start of her speech, Luci says that policymakers have learnt a lot in the past six years. I know she was talking to students, but c’mon, seriously? They’ve learnt nothing.

The real issue here, as everyone who understands this stuff knows, is that the world has too much unproductive debt that is never written down and thus weighs on growth, which requires lower and lower rates to sustain it. The lower rates in effect sustain what would otherwise be uneconomic production, and also incentivise new production, which also exerts a deflationary force through additional supply.

Do you really think you can get out of the hole created by low interest rates, by lowering interest rates?

To conclude, I understand your limitations (in a global context) and the enormity of your task in trying to fulfil multiple, and at times competing, mandates.

But if you could answer my questions as honestly and intelligently as possible, it would be greatly appreciated.  

I did get a response about a week later, which pointed me to a number of Glenn Stevens’ recent speeches on the issues I raised. I’ll give you the details tomorrow.

But the point I was trying to highlight in my emailed questions was the insanity of everyone thinking that lower interest rates are the answer…especially in a small, open economy like Australia’s.

Because of our good fortune in recent decades, we’ve had a lazy reliance on monetary policy to pull us out of short term demand slumps. Because of this reliance, Australia’s policymakers have completely ignored genuine, long-term, productivity enhancing reform.

An article in The Age today cites an Ernst and Young report that says ‘politics and self-interest have to be removed from the tax system if it is to be rescued from its disarray’.

In other words, our politicians are too useless to enact reforms because they’re scared of upsetting the electorate.

You could blame the electorate for getting what they deserve. But I blame the politicians and the political process. True leaders lead through their vision and passion, and bring around the reluctant masses. That’s what leadership is all about. Australia’s politicians (and politicians everywhere) breed cynicism and apathy amongst the voters, not pride and motivation.

The people know politicians (not all, but many) are borderline corrupt, and are just out to line their own pockets…so why should they make any sacrifices?

The politicians, whose only aim is to cling to power, think that doing nothing is better than doing something beneficial but unpopular. And so we rely on the RBA to fix our problems, with broad and conflicting mandates, time and time again. But eventually, they become as much of a problem as they are a solution.

It’s the same all around the world now. We’re in a monetary Catch-22. Just watch what happens as the US tries to normalise its interest rates settings (the next instalment of which will occur overnight).

Phil Anderson is probably right…expect many years of low interest rates and anaemic growth.

Read the rest of this article at The Daily Reckoning