RBA has a bubble battle on its hands

When analysts write of global "imbalances" they are usually writing about an incomplete adjustment in which one country or group of countries has an external deficit (or a falling exchange rate), and another country has an external surplus (or a rising exchange rate) with incomplete price adjustment. The great modern example has the US and other developed economies in deficit and China and similar nations in surplus.

My point is that, if prices of a great many goods and services are held down by structural change or by the effects of recession or depression, asset inflation will take the place of product inflation in response to expansion of money. This is part of the story of the global economy in the 2000s. Since China did not allow its exchange rate to float upwards, eventually it began to suffer goods inflation and global asset inflation lost some of its strength, and became for a time severe asset deflation.

Asset deflation was greatly reinforced by the financial sector gridlock when the US government declined to bail out Lehman Brothers, creating a "torrent of mistrust" among bankers globally. Then the US Fed stepped in and restored monetary expansion and this has fuelled real recovery in the US (where severe recession holds down US goods and services inflation), asset inflation generally and goods and services inflation in China and other booming nations.

A standard response to low goods and services inflation and high unemployment would suggest the need for easy money. But cash rates near zero plus "quantitative easing" amounts to excessively easy money, and there is a similar dangerous tendency in the euro zone.

China and other inflationary nations are complaining about the current situation, to the point where China no longer believes that the US dollar should be the effective global currency.But the RBA's Stevens has his own problems. At today's meeting of the board, he is faced with commodity price inflation, (aka powerful terms of trade increases), share price inflation and (I predict) renewed house price inflation. All of these things will drive the Australian economy faster than the rate at which goods and services inflation is in the RBA's target range. As well as international (developing nation) goods and services inflation, imported and home-grown asset inflation will frustrate the RBA's attempts to fulfil its mandate.