RBA Hoping it Has Done Enough for Economy

Well what do you know…the carry trade is back! Yesterday’s decision by the RBA to leave the cash-rate at three percent tells you that Glenn Stevens is buying into Ben Bernanke’s optimism. Riding the China recovery train, the RBA is hoping the worst is behind us and that it’d done enough to get the economy going later this year.

For now, at least for this week, it sure does look like the appetite for risk is back. The U.S. dollar and Japanese Yen are weak, while commodity currencies like the Australian, New Zealand, and Canadian dollars are up. Bond prices are down, stocks are trending up, and even oil is creeping back over $50, looking to make a breakout. All of this confirms that we may have a “second wave rebound” from the March lows.

We have grave doubts about the durability of this rebound, given the state of the economy (unemployment, debt, and rising deficits). However we’re not going to bother with any of that today. If you traded the rebound for profits, good on ya! We are using this moment of relative tranquillity to ponder what’s just around the corner.

One object bearing down on the Aussie economy is a ‘temporary’ deficit that may last until 2016. Liberals, Labor, Republicans, Democrats…they all know how to spend money they don’t have. All political parties appear to support big government these days. It’s so trendy.

But you wonder if the Australian is starting to worry that the current government is writing checks the future will have to cash. Today’s Australian Financial Review reports that next year’s Federal budget deficit will be at least $70 billion. It says that Treasurer Wayne Swan has told his state counterparts that, “tax collections would fall by $200 billion over four years, worse than a $115 billion write-down in February.”

“There is no doubt that the deficit will last longer, the temporary deficit will be longer, as a consequence of the revenue downgrades imposed on this country by the rest of the world,” the Treasurer said. The AFR says the government plans to return the budget to surplus…by 2016.

Here’s a stupid question: is something really temporary if it lasts for seven years?

However long it lasts and however big it gets, the deficit (and growing debt) mean Australia will be borrowing more to support its current lifestyle. This is an alarming trend. Temporary government spending and revenue programs almost always become permanent. And that’s what would worry us about this deficit: it’s the beginning of Australia’s long road to debtor status.

But hey! Judging from the hate mail in the mail bag, people are tired of hearing about the long-term consequences of making promises you can’t keep. It is not fun to think about the transfer of national income that occurs when you rack up debts to bond holders. And it’s not fun to think about what happens when the government is unable to fulfil the promises it’s made. So let’s not think about that, shall we not?

Instead, let’s go straight to the mail bag. Lots of good stuff. And finally, some contempt!

–Hi team,

Your comment “Copper rises on Chinese buy prospects” is interesting except that Chinese are buying copper ASSETS and will no doubt dictate the future price they pay from their owned Australian producers (refer Oz minerals buyout and others).


–Actually, we were quoting a headline from an article in The Australian, but your point is well taken. China is doing both. It’s stockpiling raw commodities. And it’s buying shares in publicly listed commodity producers. However, there’s a big difference between a customer of an Aussie resource producer buying the producer, and another producer buying the producer. If the customer is buying the producer (iron ore), then it’s conceivable the Aussie firm will be run not to maximise shareholder value but to give the consumer (who owns a sizeable chunk of equity) bargain basement prices. When a producer buys a producer, the interests of the two parties (getting the highest price of the commodity produced) seem more aligned.

–Dear DR,

I’m still curious as to how can we have hyperinflation and a property market crash at the same time. While I understand the logic, I still can’t wrap my head around how the also heralded hyperinflation will come into this. Please end my suffering by addressing this in your next issue as this enigma just keeps me wondering.

Kind regards,


–Ah. Two good questions. A real hyperinflation destroys wealth and puts a premium on real goods that are tradable (liquid). A house is not tradeable. So while the value of mortgage might quickly be inflated away in the early stages of a hyperinflationary scenario, we would not recommend it as a way to get rich. With prices so surreal, the value of large assets in hyperinflation becomes volatile. We’d suggest this makes for an illiquid market, and doesn’t help you at all with respect to day-to-day economic activity (where you can barter liquid tangible goods for other goods or services). Try bargaining your rumpus room.

On the other hand, at least you have a roof over your head. It’s a subject we need to more research into. But to be as clear as possible, we don’t believe buying a house is a real hedge against hyperinflation. Not much is.

The other question you had is how it all begins, this hyperinflation. We would argue that the expansion of the global monetary base has been so large that it’s going to be nearly impossible to reverse. So far, the huge expansion by the Fed and other central banks has not made its way into the real economy. Its being held as “excess reserves” at those central banks rather than loaned out into the economy where the multiplier effect would quickly lead to inflation.

The Fed thinks it can soak up these excess reserves before the banks loan them out. After all, the banks would only do so once they thought the economy was safe enough to lend into again, as my colleague Gary North points out. The Fed can try and prevent this increase in the money supply by raising reserve requirements (effectively forcing the banks to keep the cash parked). But if it does so, it risks derailing the so-called recovery. The whole point of the Fed’s balance sheet expansion was to create a recovery anyway.

The Fed is hoping that it can reduce bank reserves before they hit the economy. It thinks that the demand for its short-term lending programs will go away as the economy recovers. It also says it can conduct “reverse repurchase agreements.” This essentially means the Fed will be SHRINKING the money supply as the economy recovers.

Our guess? The Fed is going to have a devil of a time preventing excess bank reserves from departing the monetary base into the money supply and the real economy. New bank lending and higher interest rates will fuel even higher prices. And down the rabbit hole we go.


There has been a lot said about the problems easy credit has caused. But what is the solution to easy credit? How do you suggest credit is made harder to get? Is there any other ways than just lifting interest rates?

Glenn D

–Taking the power to dictate the price of money away from a cartel of bankers would be a good start. There is a market price for money, or a natural rate of interest required by lenders to make surplus capital available to borrowers. This natural interest rate is what Central Banking is designed to distort.

The government prefers a monopoly on money because two institutions stand to benefit the most from “just a little inflation;” the government and the banking sector. A free market for money would mean that the supply of credit would probably not exceed available savings. At the very least, the collateral required to secure a loan would be more substantial that it has been for the last twenty years.

Is there a cure, then, for credit excesses? The Austrian economists say no. The only cure is prevention. One the disease has been unleashed, you can only deal with the misallocated capital and try to liquidate the losses and begin again. Ludwig Von Mises argued that the government control of the interest rate is what sets off the boom/bust cycle to begin with. With a market rate of interest, these booms and busts would be moderated. But that would destroy the illusion that central banks can carefully manage an economy (price stability and full employment) by manipulating interest rates.

This was the subject line of an e-mail this week: “Stupid remarks from DR”

For example: “This represents a $50 billion deficit. Compare that to last year’s $22 billion surplus. Not a good look for K-Rudd’s CV.”

What a truly mindless buffoon you appear to be.

Doubtless you also supported your erstwhile heroes who sat on an unprecedented minerals boom, passing the surplus out to their mates instead of investing the surplus in Australia’s future.

Do you really believe that Rudd caused our current problems? Really? Maybe his solutions will prove inadequate or wrong but unlike you and your cronies he is doing something. And what suggestions have you got to get us out of the problems caused by your like thinking mates??

None, except the greed based “look after yourself and to hell with everyone else”.

As I am sure even you have realised by now I am less than impressed by your vacuous political drivel.

Leave comments to those who are at least prepared to try and do something about the situation and stop the cowardly firing at their backs.

Contemptuously yours,

Alex Millar

–We don’t support politicians in anything, ever. If more of us looked after ourselves and our neighbour and families instead of looking to government to “do something” the world would be a lot better off. Does this mean you’d like to unsubscribe?

–Dear Sir,

Your newsletter is really up with the best. My question is since most governments are going broke and most banks are broke where is all the money coming from? The Australian banks have $7-$14 trillion of toxic debt, the world supposed to have over $1000 trillion, ten times more than all the GDP of all the world. If this is the case, where is the money coming from? Who or what is holding up the economies of the world? If the money is just being printed which I believe it is there is no way out but a TOTAL collapse.

If you can answer me it would be really appreciated.


Rafael C.

–We’re not sure about your toxic debt figures. But you ask a good question. Asset values-as we’ve found out in the last year-are largely bogus. They are deflating. As for what’s holding up the economies of the world? Well, there are real industries and demand for real goods. But if you mean all this deficit spending and bail out money, that either is borrowed (mostly from Japan, China, institutions, and private investors) or its printed out of thin air by central banks.


Thanks for your constantly interesting pieces. My question is – why should we really believe gold has any value? For most of the last 5,000 years, animals were the key mode of long distance transport – they no longer are. Why will gold not go the way of the horse and cart?

I understand the reasons behind why you think the gold price will rise. However I think there is a flaw in your logic. You say that “But just remember, this whole experiment with fiat money is not even one hundred years old. Just because it’s all we’re used to doesn’t negate that for 5,000 years of human history, people have been using gold as money”. This always seems to be the argument for gold. The fact that it has always been used as a currency, therefore it is what will keep its value.

For gold to store value, don’t people need to agree that gold is valuable? I have never understood why people put a value on gold. I agree it looks nice and is useful in jewellery and fillings, and I think it’s also a reasonable conductor of electricity – but that’s it.

If tomorrow, someone succeeds at alchemy, or the world just decides that gold isn’t it anymore, it will be absolutely worthless – and it will go down the path of the Zimbabwean $. Wouldn’t we be much better off storing some real, useful commodities (copper, tin, tarmac, soy, hogs, OJ – of course limited to the practical problem of actually storing these things). It seems to me that to believe gold will increase in price, requires other people to believe it will increase in price and has a real value/use – whereas actually it doesn’t.



–Gold has four physical properties that have made it extremely useful as a medium of exchange over time. It is durable. It’s divisible. It’s convenient. And it’s consistent. That doesn’t mean other things haven’t or can’t be used as a medium of exchange. It just means these physical attributes of gold make it especially useful. That’s not a matter of mystical belief. It’s a practical benefit.

The fact that you can’t “succeed” at alchemy is also what makes gold desirable as a medium of exchange: it’s supply is relatively stable because it cannot be counterfeited by governments. The usefulness of any medium of exchange would decline if a person or a small group of people could easily increase the supply. It would make the unit less stable. Gold supply varies with mine production and above ground sales from central banks. But you can’t just drop it from helicopters like brand new paper money. Well, you could, but it might hurt.

Does that mean it has intrinsic value? Well, if by intrinsic you mean that its unique physical properties make it useful as a medium of exchange, then yes. But value is only ever determined in an exchange. Gold is useful only as long as people believe it to be a useful medium of exchange. We think more people will realise that in the coming years.


Are you an optimist, a pessimist or an economist?


–We’re Catholic.

And one last note on property.

If we are already “smack in the middle of the biggest economic collapse in 80 years”, this economic collapse is not that bad after all! In the worst case scenario; today’s people living in the industrialized countries are unlikely to go begging for foods, unlikely to go through winter without enough clothing.

This financial collapse is largely on paper (or computer screen); the transfer of assert ownership from someone to someone else.

The world’s factories are still standing, infrastructure are still there to facilitate economic activities. Demand is still there, the population in China is a few times that of the United States; with ever improving production technologies, they will not allow their living standard to be substandard for long.

Wherewithal is still there, if someone owe [sic] someone else three trillion dollars, that someone else must be rich, has plenty of money to spend and invest!

Even confidence is still there; for sure the share market will go down after ups, but the surge in the last two weeks indicated refreshingly, more investor [sic] than not don’t share the dim view of the Markets and Money.

For those unfortunate home owners being foreclosed, many may not be eligible for a home loan in the first place.

I think you are wrong.

David Tam

–We’ll drink what you’re drinking. But fair enough. If we’ve learned one thing in the last year, it’s that we can be just as wrong as the next guy. That’s why we reckon it up every day. Keep thinking!

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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5 Comments on "RBA Hoping it Has Done Enough for Economy"

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Bill Foord
Good article Dan, Australia needs more commentary like yours stating the stark reality. There are too many commentators who don’t have a clue about classical economics, which describes how an economy really works. The problem for Alex Millar is that he doesn’t understand that when the government goes into the market with its large spending schemes is that it re-allocates resources in a way contrary to what the private sector would have done, particularly when the money is created out of thin air. Before any of us consumes any thing we each have to produce something first. When the government… Read more »
I agree Bill, good comments. Dan Denning: “We are using this moment of relative tranquillity to ponder what’s just around the corner.” Thank you. That’s probably business as usual for you, but that is why I come here. I think we have started getting caught up in the ‘now’ and have had less ‘future’ ponderings lately. And I agree, our national debt here will shackle us good and properly. Unless there is a world war. Or default (which is probably worse). Reader mail replies: Alex Millar: The DR never appeared to be pro liberal, nor anti labor. Just anti stupid… Read more »
Governments always feel like they must do ‘something’. Doing ‘nothing’ is impossible for them, but what ours has been doing has been quite damaging indeed. They are either stupid, or terribly corrupt, or both. Still, there are things that have been done well in the past by governments, such as supporting practically free public transport, universal health care, free tertiary education. They are all expensive, and the departments are criticized for being inefficient, but in fact they have tended to be run quite cheaply when R&D, training and quality control are taken into account. That kind of nation building could… Read more »
Greg Atkinson
Hey no use blaming the government or calling them stupid because we “the people” voted them in and in Australia Kev07 is flying high in the polls. Instead of the government doing what it does best (whatever that is) we now have the government getting into running a telecommunications company and throwing money around to keep us plebs happy. I just love the logic behind the Government spending like crazy to look like they are doing something and now telling us to get ready for a tough budget because they need to get debt under control. One wonders why they… Read more »

Dan, I really appreciate the great article and your good humored response to the commentary. And thanks to Bill Foord for one of the most lucid explanations I have ever read on economics 101.

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