The financial media brings us to tears of laughter surprisingly often. This morning the former treasury economist and current Labor MP Dr Jim Chalmers pulled it off in spectacular style.
Interviewer Malcolm Farr starts off boringly enough on the news.com.au website: ‘[It’s been] 30 years since the decision to float the dollar. Why did it have to happen then?’
Dr Chalmers replies with an absolute rip roaring barn storming Freudian slip of toe curling proportions:
‘It was a massive decision…It had to happen because, by the early 1980s we were persevering with this absurdity that a few blokes sitting around a table in Canberra could determine the exchange rate for a little nation in a big global market.‘
At that point, we lost it.
Now you may not yet see the irony of pointing out the ‘absurdity of a few blokes sitting around a table‘ determining financial market prices. So can you think of anywhere we are still ‘persevering with this absurdity‘ today?
We’ll give you a hint: There are a few blokes who sit around a table in Martin Place determining the interest rate for a little nation in a big global market.
That’s right, Dr Chalmers is inadvertently campaigning to end the Reserve Bank of Australia. We might actually vote for this guy.
Of course, nobody should be dumb enough to think a politician will be consistent in his advocacy against absurdities. But at least he gets it: Central planning of prices is a bad idea. Especially central planning of exchange rates and interest rates. In fact, the second is far worse. After all, the exchange rate only affects a few of us directly. The interest rate affects just about all of us. So having ‘a few blokes sitting around a table’ determining the interest rate is even more absurd and dangerous.
If you think about it, the level of control the Reserve Bank of Australia has over you is incredible. Your decision to spend cash is about weighing up options. Do you value whatever it is you want to buy more or less than the interest you get on cash in your account? If you value it more, you buy. If you value the interest more, you don’t buy.
Because the RBA controls that interest rate, it controls what you give up each time you spend money. (The economist in Dr Chalmers would call that the ‘opportunity cost’.) The thing is, if the RBA controls half of every transaction by setting the price of the opportunity cost, it really controls all transactions. So much for a free market economy.
It’s when central banks get it wrong that things get interesting. Actually, by virtue of the fact that the ‘few blokes sitting around a table’ can’t possibly guess what interest rate the free market would set, central bankers always get it wrong. Even if only for the fact that the free market rate would constantly be changing. That’s why having a central bank is an ‘absurdity’, as Dr Chalmers might say.
Anyway, what happens when central bankers get it wrong? The same as with all price controls. You get shortages and surpluses – in this case of money and debt, which the interest rate is the price of. Take a look at debt levels in Australia (red and left hand side), and you’ll spot the growing surplus.
Now some economists would say the debt levels are high because of high house prices. Mortgages make up a whopping proportion of private debt, and they’re where the growth in debt has mainly come from.
But when you’ve got the RBA controlling the price of debt, you can’t put a change in the amount of debt down to other factors. If the government set the price of oranges, you would get a surge or plunge in the amount of oranges, depending on where they set the price. It’s the same for debt.
So Australia’s house prices are floating on a rising tide of debt subsidised by the RBA. We know where that ends from the American, British, Irish and other recent experiences. So let’s skip ahead a few steps. You see, those countries are dealing with the fallout of blowing a debt bubble. Their blokes sitting around their tables got it spectacularly wrong. And now they’re trying to engineer a recovery. Believe it or not, they’re dumb enough to use the same methods that gave them the debt bubble in the first place. They’re asking ‘a few blokes sitting around a table’ in Washington, London and Frankfurt to fund a new debt based boom.
The obstacle at the moment is that the banks are having none of it. Usually bankers like to lend out cheap money. But right now, they’re holding onto the cash that central bankers are throwing at them. They’re parking it right back with central banks in an account called ‘excess reserves’, which they are required to maintain a small amount of in more normal times.
Princeton professor and former Fed Vice-Chair Alan Blinder explained in the Wall Street Journal that American banks are parking their cash with the Federal Reserve because the Fed actually pays them interest to do so. So he wants to get rid of that interest payment, or even start charging banks to keep their cash at the Fed. That will force them to start lending.
But blogger Mish Shedlock reckons the banks aren’t lending because the economy has had enough of debt binges that end in a crisis. Even the banks learned their lesson recently enough not to play that game again.
But their reluctance will evaporate slowly. Eventually, banks around the world will be gamed into lending. And then the central bankers will have a real problem on their hands. They’ve pumped in trillions of dollars in various currencies with disappointing effects on the real economy because banks didn’t lend it out. If banks start lending, all that stimulus will hit the economy suddenly. It will be like a dam burst.
The central banks will try and reign in the sudden surge in credit growth. But they might’ve given the economy enough rope to hang itself with. Inflation could surge out of control and interest rates would spike. That will put the government budgets of the world into chaos as their interest bills spike, further driving inflation.
Of course, all this presumes the banks will get lending at last. In other words, it’s just one scenario. And it’s an odd one for Australian investors, because we’re following the world quite a few steps behind. We haven’t had the initial debt bubble burst yet. So what would happen here if overseas economies experience an inflation based boom? Would our debt bubble still pop?
For now, there are just too many possible outcomes to make predictions on. The best you can do is watch and wait for more clues. And central banks are a key place to keep your eye on.
Yes, understanding central banking isn’t everyone’s cup of tea. But it’s the biggest game in town at the moment. At least in the long run. You can bend your brain around more of the issues here.
But there are also short term concerns for you to panic about in the meantime. Like this one from Zerohedge:
‘The ratio of bulls to bears has never (that is ever) been higher according to (the perhaps ironically named) Investor’s Intelligence. There are now more than 4x more bulls than bears and even more concerning, the only time "bears" have been lower than the current 14.3% was in the spring of 1987…‘
And here’s what happened in 1987:
Whether it’s a stock market crash or a debt implosion, Vern Gowdie has his readers prepared. He’s making a recommendation so unpopular we’ve only ever heard it once before. That was back in 2006 in America, when the country was facing the same housing and private debt bubble we are now.
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