interest rates
8 Oct 2008
A Shot in the Arm?
The RBA has lowered rates but Alan Thornhill argues that the background factors are just as vital to the long-term health of the Australian economy
It should have been good news. The Reserve Bank surprised everyone when it cut interest rates by one percentage point yesterday.The cut was twice as big as expected and Australia's big four banks got into the spirit of things, announcing that they would in turn cut their variable home loan interest rates by 0.8 percentage points. Repayments for a family with a typical home loan of $248,000 will fall by about $128 a month.
Rate cuts aren't the only positive economic news of the week. They follow a sharp drop in world oil prices. Overnight on Monday, Australian time, oil futures tumbled by 6 per cent to $US88.56 a barrel.
In view of all these promising symptoms, why was the cheering muted?
Perhaps it was because of the looming backdrop against which developments in the Australian economy play out. As Reserve Bank governor Glenn Stevens put it, his Board acted because: "conditions in international financial markets took a turn for the worse".
On the same day, in a speech to the Infrastructure 21 Summit in Brisbane, Prime Minister Kevin Rudd admitted for the first time that global credit crisis will hit Australia hard. "These developments will affect growth," he said. "They will affect employment. They will affect government revenues." Until then, Rudd had been relying heavily on what economists call "incantation". That is, repeatedly talking up Australia's strengths, in the hope that the situation would improve. It didn't.
The Prime Minister is still saying — correctly — that Australia's banks are "well capitalised and profitable". But now he is also referring to the 25 banks overseas that have either failed recently, or required bailouts. He spoke frankly about the $US700 billion rescue package that the US Government has drawn up to salvage America's deeply troubled financial system.
The bailout is a very big gamble — especially as the International Monetary Fund now estimates that there is $1.4 trillion worth of bad debt in the US. Two dollars of dodgy debt for every dollar in the rescue package. The New York Times said the three-day-old rescue package already "looks like a pebble tossed into a churning sea".
The Reserve Bank's rate cut is also a gamble. The bank judged "that there had been a material change to the balance of risks surrounding [Australia's] outlook". Sadly, the balance of risks has not tilted in Australia's favour. So will the bet pay off?
The early signs are good. The Australian stock market, for example, closed 1.7 per cent higher last night after falling 3.3 per cent earlier in the day. But nobody yet knows what will happen, either in Australia or overseas, in the weeks and months ahead. The respected US economist Paul Krugman admits that the global economic downturn might "accelerate". If that happens, Australia will not escape.
Kevin Rudd's emergency plans are based on the premise that risk and opportunity are closely related. He is certainly not predicting that Australia will face a sharp downturn but he has explained what his Government will do if the worst happens.
Firstly, a comprehensive program of micro-economic reform to boost long term productivity growth and secondly, a $76 billion nation building plan for the future. Rudd envisages a good, old-fashioned Keynsian boost to the economy: better education systems, taxation reform, coupled with badly needed port, road and rail projects. This strategy will work well if the economy falls into a deep hole.
Rudd's goals are realistic. Quoting a study undertaken by the Committee for the Economic Development of Australia, he claimed such an increase in public spending could boost Australia's output by a very useful 1.8 per cent a year, and lower prices by 3.2 per cent.
But there are risks, too. Inflation could break loose again if the Rudd Government mistimed its efforts, spending heavily on infrastructure while private spending is still high. It's a mistake which is easy to make and such mistimed initiatives have, in the past, sent prices spiralling upwards. Keynes is still revered by many but experience has taught economists, administrators and governments to apply his theories more carefully to real life situations than they have in the past.
There is bad news on the way for motorists as well. The recent fall in world oil prices is not likely to force petrol prices down at Australia's service stations. Why? Because the Australian dollar has been falling sharply over recent weeks.
So where is the hope? The best of it lies with a gathering of the world's treasurers and monetary authorities in Washington later this week at a series of World Bank and IMF meetings. They don't yet have the machinery they need to tackle the job of restoring balance to world financial markets. But the risks are now so high that they might well call in the bulldozers.
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In light of all the worry, why is Rudd bringing in so many more people? How is that going to help reduce our carbon footprint as a nation? How is that going to ease the housing affordability crisis, how is that going to work in with the drought?
We are bringing those people in banville because our shitty education system is too piss poor to provide the skilled labour this nation needs to function properly.
Why don’t we all ask the sort of questions you have been raising in these blogs banville?
Interesting article from a fiscal point of view, however there was very little mention of how these economic strategies effect the most important basic in our economy, people and employment. On a positive note, Rudd’s strategy does appear to be directed to take up the slack in that area by increased public spending.
Only lowering or raising variable home loan interest rates according to the direction of the international borrowing rate, is counter-productive if applied automatically without due consideration to the domestic market place. It seems unfair to use the interest rates of mortgagees as the main mechanism to keep a lid on inflation.
Income taxation rate adjustments could also be used to manipulate the consumer demands of non-mortgagees, by lowering and raising the rates of disposable income available to high and middle ($60,000+) income earners according to the current state of the economy.
I don’t know much about macro or micro economics, but I was very interested to hear Paul Keating the other night talking about this financial meltdown we had to have.
Keating (Mr. Bracket creep himself) explained the difference betwen liquidity and solvency. He actually explained it very well.
In any business there is a divide between the intrinsic value of the business (solvency) and how good that business is at turning a dollar.
(liquidity)
Theoretically if a business has adequate reserves to pay its bills then it is solvent. If it has a good cash turnover, it has good liquidity.
Now, applying these principles to our country:
The Japs start selling off our dollar while it still has a good exchange rate. The value falls and drops fast. Below 70c as I write, remember a few months ago it was nearly equal to $US.
Why if we are in such a strong position do we have OS (offshore) entities have so much stocks of our currency, I can’t take out more than about $5000.?
Is it, that our money has little or no intrinsic value of its own, or
has everyone lost touch with what it is supposed to represent, and only represents what the rest of the world want to pay for it? Once a gold bar was worth say $100000, the value of a modest home in the suburbs.
Sure a low dollar rate is good for our exports, in a competitive sense, i.e if any one is still exporting now that the commdity prices have also fallen through the floor.
It may also be good for tourism, if the world still has any interest in us after the "Where the bloody hell are you ? ad campaign ? a year or so ago.
But looking at our balance of payments , we import far more than we export, like oil, so if the US is stuffed, then the gov’t can throw as much money into the system,it will only be good money after bad.
Having allowed the sharks, barracudas and pirrhanyas have their way in the aquarium for so long, the golfishes and guppies have all been swallowed up, and what’s in the pond now is not going to be content with only gold fish food.
Carbon credits ?, sure Keynes has an expression that deals with that too, even though the notion did’nt exist in his day: "A fool and his money are soon parted…remember there’s one born every minute"
Bon appetite,
Oli