Reserve Bank will likely defer needed cut

With a worsening global economy and rising unemployment here, the Reserve Bank should cut interest rates by a further 50 basis points today.

However, "well-connected" commentators say the Reserve will sit pat for another month, so Henry's wish may not be achieved.

The global news includes some cheer.

In many places the message is that the rate of decline seems to be slowing.

More importantly, the leaders of the G20 nations have met in London and reached some sort of accord.

The G20 leaders released a "six-point plan". This includes tighter controls on an extended number of financial institutions, including hedge funds, a common global approach to dealing with toxic assets, a $US1.1 trillion ($1.53 million) package (doled out via a strengthened IMF) to supplement the $US5 trillion stimulus to the global economy by individual countries; $US200 billion of trade finance over the next two years to help reverse the steepest decline in world trade since 1945; more power to developing nations within international agencies including the IMF and OECD; and a pledge that the fiscal stimulus, including the sale of gold by the IMF due to raise $US6 billion, will help the poorest nations and create green jobs.

The idea of a global super-regulator of all significant financial institutions, including hedge funds, fills Henry with apprehension. So too does the apparent evolution of the IMF as a global central bank and the OECD as some sort of global Treasury.

The details of how to deal with "toxic assets" were not spelled out, so one presumes there will be some version of the American plan, which itself is not certain to work well, if at all.

All the standard objections to fiscal stimulus of demand apply - negative effects on confidence, minimisation of stimulus to the extent that handouts are saved rather than spent, "crowding out" of private spending as recovery builds and indeed the strong inflationary risks due to the inability of these crypto-global agencies' to withdraw stimulus as recovery builds.

Still, the immediate effect was positive for confidence, as shown by the rise of global equities as the G20 met.

Locally, there have been several bits of news that, together, make a case for further easing.

Most importantly, the real rate of unemployment is moving sharply upward.

In retrospect, this measure, developed by Henry Thornton and Roy Morgan, gives a far more accurate reading of the true state of the labour market than the official (ABS) figures.

Its message is reinforced by the sharp drop in advertisements for skilled job vacancies, which fell by 10.8 per cent in March from February, and was 58 per cent lower than a year ago.

Apparently better news comes from a large trade surplus, which will be temporary, and strong housing starts, which is creating Australia's very own sub-prime crisis by encouraging first-home buyers to extend themselves undesirably.

Those insiders who receive, or think they receive, hints about the Reserve's intentions, are suggesting that the decision today is likely to be to sit pat. If so, this would be a foolish mistake.

The Australian economy is already in recession and the time of labour hoarding (to keep good people on the books) is generally over.

The most interesting commentaries about the state of Australia's economy in the recent past come from two former insiders, now outsiders but still well connected. Hugh Morgan and John Stone both have powerful minds and tons of experience, and have spent a fair bit of time sitting around the Reserve Bank's board table.

Morgan, to his credit, issued a mea culpa at a recent meeting of the HR Nicholls Society.

"A very important thing about the GFC, now morphed into the GEC or global economic crisis, in my view, is that none of our key institutions with responsibilities for monitoring the state of the economy, and advising governments and the community at large on what was going wrong, and what had to be done to avert the situation we now find ourselves in, made the right call when it was all beginning to come together.

"I include myself in that category, at least in a modest way. For many years I served on the board of the RBA, and made myself a bit of a pest by asking questions which gave me a reputation for gloom and doom.

"But I never had the courage or the gall to really pursue the issues which were bothering me.

"When we look at the three pillars of the economic establishment in Australia, the RBA, the Commonwealth Treasury, and the Productivity Commission, we find that none of them made a warning call when it was most required, despite the fact that the evidence of gathering disaster was piling up month by month."

Morgan apparently did not notice or discounted the regular warnings shouted in this column.

These warnings focused on the very things that were most obvious, including the unsustainable growth of credit, the monetary aggregates, consumer demand and housing prices.

Quoting Morgan again: "It was beyond argument that the rate of change in the growth of credit in all markets, particularly the household sector; the rate of growth in the money supply, however defined; the rate of growth in consumption and the staggering increase in housing prices; were proceeding at an unsustainable rate. It is just not possible to have credit growth and money supply increases in the realm of 14 per cent compound, without a disaster occurring."

To me, the woeful performance of the "official family" shows the dangers in group think and the closed, indeed incestuous, cultures that have developed in these institutions.

One assumes and hopes that one benefit of the global financial crisis may be to break open this cosy club, but then again they may merely pull the wagons into a tighter circle and more often tell each other what splendid chaps they are.

John Stone at the same meeting of the HR Nicholls Society forecast dire times ahead for Australia. Space does not allow this prediction to be reproduced here, but the full talk is reproduced on the Henry Thornton website.

His main focus was on the labour market and he produced wonderful quotes from the 1930s Depression to illustrate the need then for labour costs to be cut if recovery was to occur.

"Employment must be made profitable. This cannot be done by government relief works or subsidies to private industry, but only by removing obstacles to reduced costs, and by the restoration of confidence," he said.

This was written by four state Treasury heads for the Premiers' conference in 1931.

One cannot imagine the people in these positions today even thinking such thoughts. More's the pity.

Fiscal stimulus of demand may do little more than create massive debts to be paid off by future taxpayers.

The new "fair work" legislation has increased, not decreased, labour costs, thereby making employment less profitable.

Australian monetary policy is reaching the limits of what it can do to help the situation. The Reserve Bank should, however, cut cash rates by another 50 basis points today and then wait to see how the economy is responding to all the news, including the federal budget in May.