Like what you've read?

On Line Opinion is the only Australian site where you get all sides of the story. We don't
charge, but we need your support. Here�s how you can help.

  • Advertise

    We have a monthly audience of 70,000 and advertising packages from $200 a month.

  • Volunteer

    We always need commissioning editors and sub-editors.

  • Contribute

    Got something to say? Submit an essay.


 The National Forum   Donate   Your Account   On Line Opinion   Forum   Blogs   Polling   About   
On Line Opinion logo ON LINE OPINION - Australia's e-journal of social and political debate

Subscribe!
Subscribe





On Line Opinion is a not-for-profit publication and relies on the generosity of its sponsors, editors and contributors. If you would like to help, contact us.
___________

Syndicate
RSS/XML


RSS 2.0

Reserve to move on interest rates ... but danger looms

By Henry Thornton - posted Tuesday, 2 February 2010


The reality facing the Reserve Bank is that inflation is too high for comfort as economic recovery gathers strength.

This is why we should see another 25-basis-point hike today.

But there are plenty of reasons for caution. Some facts reinforce the case for rate hikes, while other developments, if realised, would make further rate hikes damaging.

Advertisement

The global economy is now clearly divided into fast and slow lanes. The developed nations are in the slow lane, undergoing tepid recoveries. The latest news from the US shows fast growth of GDP and signs of stabilisation in the jobs market, but unemployment is still officially measured at 10 per cent of the workforce.

With many "discouraged workers" having left the workforce and even larger numbers working fewer hours than they wish, the amount of wasted labour market resources is dramatically higher - at least 20 per cent of the US workforce, in Henry's estimation.

This is a story repeated to varying degrees in the eurozone economies. The US Fed has said it will soon begin to remove "quantitative easing" but leave official cash rates close to zero for some time yet. Alan Greenspan's near-zero cash rates fed asset bubbles in the US and other parts of the world. Very easy US monetary policy will again feed global asset inflation.

It would be hard for Ben Bernanke to begin raising rates while 20 per cent of US workers are unemployed or underemployed, but failure to do this will recreate the asset bubbles of 2003-07. Bubbles create busts, and the next bust will come from a far higher base of wasted labour market resource. Bernanke presumably spent any holiday break pondering this major dilemma.

The US banks are roaring back, and Wall Street's enormous profits and bonuses have fuelled unhappiness, even rage, on Main Street. This is Barack Obama's dilemma, and he has returned from holiday full of resolve to fix the economy and bring the bankers to heel. The global banking crisis is far from over. New rules have been formulated, but The Economist has said: "If the banking system resembles a line of climbers roped together, then regulators are busy making the clothes warmer, the maps more accurate, the rations more filling and the whistles louder. Unfortunately, none of that is any good if someone falls over the edge, as a handful of banks are wont to do in financial crises."

In any case, new rules will not be implemented quickly, requiring as they must far higher capital ratios and major changes to banking practice.

Advertisement

There is potential trouble with banks from Paris to Timbuktu. US and British banks have been bailed out (at great cost) by their governments, but so far in Europe there has been remarkable stability in the banking system. Yet Western Europe has lent vast sums to east European nations and businesses.

There is a shaky row of dominoes waiting to stand or fall and, if the latter happens, one doubts the ability of the eurozone governments to stand them up again.

A major study in 2008 showed that sovereign debt was at a cyclical low during the boom from 2003-07. Yet four times since the year 1800, low points in sovereign debt default were followed by sharp increases. This study effectively dismissed the comforting "this time is different" hypothesis so beloved by those who never learned economic history.

Bankers everywhere are inclined to be a bit short on the lessons of history. China's bankers have been lending like there is no tomorrow. Added to the Chinese government's massive fiscal stimulus, the bankers' largesse has fostered revival with immense rapidity, and the economy is headed for double-digit growth in 2010. The world, and especially Australians and other resource exporters, have cheered. China's leaders are now trying to rein in their bankers, but like bankers everywhere, they also feel the hot wind of economic forces.

There is a direct but badly understood link between US monetary policy and China's banking system. The essential linkage point is created by China's relatively fixed exchange rate.

The liquidity pumped out by the US Fed spreads globally, and China's strong economy attracts a large share of the Fed's easy money. China's banks find themselves able to fund greatly expanded economic activity, including property and share purchases that drive up prices in those asset markets.

Australia went through this damaging cycle of frustration and policy impotence in the late 1960s and early 1970s. More than 40 years on, China is grappling with this problem and will learn there are no easy answers. Instructions to the banks may work better in a strong, centrally governed nation like China than they did in Australia, but one should not bet too much on this outcome.

How China adjusts to its rising status as a global economic powerhouse, and how the rest of the world responds, will be one of the great stories of this century. The fallout will be vital for Australia, and this will be one of RBA chief Glenn Stevens's major concerns in coming months and years.

Australia is caught between its developed-nation status and structure and its "developing nation" heritage as a major producer of gold, food and other raw materials. Like the world economy, Australia is a two-speed economy. Resource-producing areas and companies are already growing rapidly again, with renewed demands for skilled labour. These demands will quickly run up against renewed union power and constraints of the Labor government's Fair Work legislation.

Filled with optimism, in stark contrast to the deep pessimism experienced for much of the past two years, Treasury officials and senior ministers are speaking of the challenges of a much larger population and the need for greater productivity.

Australia coped well during the global downturn. We could afford a large dose of fiscal stimulus - although not the waste and debt that were its inevitable by-products. Our flexible labour market helped limit increases to unemployment though, as in other "developed" nations, one can add large numbers to the official estimates for discouraged workers and the underemployed.

But now the labour market is far less flexible, and recovery is occurring from a still inflationary economy. This fact alone will keep the Reserve Bank leaders' minds on the need to briskly withdraw "emergency" monetary policy.

  1. Pages:
  2. 1
  3. 2
  4. All

First published in The Australian on February 2, 2010 and on Henry Thornton's blog.



Discuss in our Forums

See what other readers are saying about this article!

Click here to read & post comments.

1 post so far.

Share this:
reddit this reddit thisbookmark with del.icio.us Del.icio.usdigg thisseed newsvineSeed NewsvineStumbleUpon StumbleUponsubmit to propellerkwoff it

About the Author

Henry Thornton (1760-1815) was a banker, M.P., Philanthropist, and a leading figure in the influential group of Evangelicals that was known as the Clapham set. His column is provided by the writers at www.henrythornton.com.

Other articles by this Author

All articles by Henry Thornton

Creative Commons LicenseThis work is licensed under a Creative Commons License.

Photo of Henry Thornton
Article Tools
Comment 1 comment
Print Printable version
Subscribe Subscribe
Email Email a friend
Advertisement

About Us Search Discuss Feedback Legals Privacy