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Raising interest rates delivers a triple whammy

By James Cumes - posted Wednesday, 9 May 2007

Over the last few weeks, I have been engaged in a world tour, especially taking in the two countries - the United States and Britain - which are most characteristic of the economic and financial phenomena of the last 40 years. I have also re-visited my own country, Australia, which has been in many ways a "satellite" economy swallowing not quite whole, but in very large measure, the self-destructive policies of the two largest Anglo-Saxon countries.

The central feature of the economic and financial situation, as it appears from my travels, is that "inflation" is alive and well and flourishing in the Anglo-Saxon-type economies - economies in which so much policy concern has been focused on "fighting inflation" in the last 40 years.

I have put "inflation" in inverted commas because the term is used so loosely and with such devastating disregard of the real world about us that we must try to be at least marginally precise about our manifest imprecision.


Just as one example, central banks, almost without exception, will tell us that they have got "inflation" under control when their statistics, often false, over-simplified or fraudulent, show that they have "met their target" of 2 or 3 per cent inflation or whatever. This is claimed mostly when the domestic prices of items outside the CPI statistics, together with the external balances, show that the target is a nonsense and anyway cannot, in the estimation of any sane observer, be seen to have been "met".

We need to get a perspective on where we have been headed since about 1969. One approach might be to consider salaries. A salary of $10,000 a year in 1969 in Australia has now ballooned to not too far short of $200,000. However, if the recipient of that salary wants to maintain the same standard of middle-class living, he cannot do it, for his family - small though it might be - on his salary alone. His wife - or her husband - must work and receive a significant salary too.

With careful domestic disciplines, a successful doctor, for example, married to a successful lawyer might enjoy much the same comfortable living as the income of just one or other of the partners might have been able to bestow on the family a couple of generations ago.

But that is far from the end of the matter. Even with nominal salaries 10 or even 20 times what they were 40 years ago and even with both adult members of the household working at full-time jobs, they are still - for the most part - saving nothing and going steadily - or sometimes catastropically - deeper and deeper into debt. The margins of security are very narrow.

That may exaggerate the situation to some extent. Certainly, it lacks the discipline of careful data research that the more punctilious among us would require.

But the broad picture seems to be beyond reasonable dispute. Moreover, the punctilious research that would seem to be required to establish the efficacy or otherwise of the economic and financial policies of the last 40 years has never been done and is not being done at this moment. It is not being done at the academic level and it is not being done either within business or within government.


One must postulate that this extraordinary neglect of so vital a matter - vital not only to the economy and financial system but also to our political and strategic security - must derive from powerful vested interests which do not want it done. Those interests must be powerful enough to ensure that it is not done and that everyone in government, business and academia sings to the same song-sheet.

Right at the fundamental base of our thinking - and our error - is the conviction that raising interest rates "fights inflation". This is the economic and financial equivalent to believing the earth is flat. However, the belief has persisted and grown and become absolute and incontestable dogma long after all the facts and experience over what is now two full generations, have demonstrated beyond any reasonable doubt, that the earth is round, that is, that raising interest rates does not "fight inflation" but invigorates it.

The reasons why this should be so are clear enough. Higher interest rates mean higher costs of production. Higher interest rates mean lower levels of output as some producers cut or cease production. Higher interest rates mean lower productivity by deterring fixed-capital investment which will enhance output per employee. There is thus a triple whammy giving a robust boost to inflation.

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America's Suicidal Statecraft is available most readily through Amazon, at $26.99 a copy.

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About the Author

James Cumes is a former Australian ambassador and author of America's Suicidal Statecraft: The Self-Destruction of a Superpower (2006).

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