Sometimes everything comes together in unintended ways. That has happened to me this week. I…
Today’s blog comes to you from beautiful Boomerang Beach, on the mid-North Coast of NSW and within the Booti Booti National Park. I am experimenting with the concept of a mobile office – well a cabin by the beach. Armed with my USB turbo mobile broadband and my portable computer, some files and books (not to mention a guitar and a couple of surfboards) I decided I can work nearly anywhere these days. Connectivity is no longer a problem. So I decided to head north for a couple of days to see how the concept works. Maybe it will begin a gypsy research life although I know one person who won’t allow that to happen! Anyway, it is a lovely setting and I can walk about 200 metres to the surf through the sand dunes. The perfect antidote to the sort of hysteria I covered in yesterday’s blog. Today I am considering corporate welfare among other topics and you definitely need a peaceful and soothing location to delve into that topic in any depth.
The local banks have been screaming lately about the proposed BIS liquidity reforms (see the blog – Bond markets require larger budget deficits – for more discussion on the reforms). They have claimed that the new proposals will raise costs (because they will have to hold some of their assets as government bonds) but, of-course, didn’t hesitate to use other government interventions.
While the Australian banks claim they were a step above the rest during the crisis – a lot of self-congratulation went on – the reality is that the Government’s wholesale funding guarantee rescued them from possible funding shortages and insolvency. In the days before the guarantee was announced there was a real fear that the Australian banks would not be able to refund maturing positions, given the severity of the credit squeeze elsewhere. The announcement of the government guarantee changed all of that immediately.
Anyway, the guarantee is about to be withdrawn but the other subsidy to the banks was just increased today.
The RBA today pushed interest rates up a further 1/4 per cent to 4 percent. Here is the statement from the RBA Governor. The RBA seems to be ignoring the fairly gloomy economic data that is coming out of Europe and the US at present and is instead pinning its hopes on Asian growth and focusing on positive trends here.
They claimed today that:
In Australia, economic conditions in 2009 were stronger than expected, after a mild downturn a year ago. The rate of unemployment appears to have peaked at a much lower level than earlier expected. Labour market data and a range of business surveys suggest growth in the economy may have already been at or close to trend for a few months.
The Australian National Accounts data comes out tomorrow so we will see whether that statement is correct. I doubt that we are near trend GDP growth at present. It would have to have been a spectacular reversal of private spending for that to be the case.
The RBA also acknowledge that “(i)nflation is expected to be consistent with the target in 2010” which should shut a few of the hyperinflationists up although that lot never bother to check any data other than the size of the budget deficit and they have a very childlike reaction to movements of the same. Sorry kids, that wasn’t fair … you are much more perceptive than that lot!
The RBA also said that it thinks “it is appropriate for interest rates to be closer to average” and “Today’s decision is a further step in that process”. Previously, they have been using the term neutral. It is a little unclear what any of these terms mean. The neutral rate is allegedly between 5 and 6 per cent and the average target rate since August 1990 (when the data goes back to) is 5.95 per cent. So we are some way from that sort of level and I would doubt that we will get back to there anytime soon.
I am always in two minds when it comes to thinking about these decisions. On the one hand, monetary policy is a very ineffective means of managing aggregate demand. It is subject to complex distributional impacts (for example, creditors and those on fixed incomes gain while debtors lose) which no-one is really sure about. It cannot be regionally targetted. It cannot be enriched with offsets to suit equity goals.
So, fiscal policy (when properly designed and implemented) is a much better vehicle for counter-stabilisation. However, the impact of monetary policy also has to be considered in relation to the levels of debt that households are currently holding. Australian households have record levels of debt and in the financial crisis lost a large slab of their nominal wealth. The RBA has always claimed that the debt was manageable because asset values were rising at a faster rate.
I always found the argument to be dubious given that a rising proportion of the “assets” being purchased with the increased debt were subject to significant private volatility (for example, margin loans to buy shares). But even more troublesome was the direct link between the debt-binge and the real estate booms which have pushed “investment” funds into unproductive areas at the expense of other areas of economic activity which would have generated more employment.
Part of the genesis of the financial – then real – crisis has been the skewing of economic activity towards “financialisation” and away from productive enterprise. So I found the RBA’s line unsatisfactory in that respect. Moreover, now that the household sector has responded to that sort of encouragement, the RBA thinks it is reasonable to punish the most marginal of this group with higher interest rates. Some people will default on their housing mortgages as a result of today’s decision.
Anyway, back to the subsidy theme. Today’s decision also hands over probably millions of dollars to speculators who exploit the so-called carry trade.
The following graph shows the policy rate spreads for Australia against Japan, the EMU, the US and the UK since 1990. Data is available at the RBA statistics. You can see that in recent years, the spread on all major currencies has increased and is now around 3.9 percent in relation to the US rates and Japan, 3 per cent above the ECB policy rate and 3.5 per cent above the UK rate.
Given these spreads (and the deposits guarantee) the carry trade in the $A has been booming. Anyone with half a wit knows it can borrow at low rates in the US, for example, deposit the funds into our banking system and make a handy deposit.
The gains have been amplified by the appreciation of the AUD which has been mostly driven by the carry trade. So the RBA has not only been seeking to damage aggregate spending in Australia – which presumably is associated with a rising material standards for us – but it has also been giving foreign investment bankers the carry trade subsidy.
Furthermore, the local banks then screw the householders even further into debt.
And if that isn’t enough … the exchange rate appreciation driven by the cross-border fund flows are squeezing the competitiveness of our traded-goods sector particularly manufacturing, which is now in absolute decline (although there was some good news yesterday on that front).
Once again we see the unintended consequences of relying on monetary policy to fight inflation. It can only do that, ultimately, if it scorches the production-side of the economy yet along the way there are other consequences – none of them good.
While on the topic of banks and their activities I note that Paul Krugman is now pessimistic about securing any banking reform at all. In his latest Op-Ed (February 28, 2010 ) – Financial Reform Endgame he says:
So here’s the situation. We’ve been through the second-worst financial crisis in the history of the world, and we’ve barely begun to recover: 29 million Americans either can’t find jobs or can’t find full-time work. Yet all momentum for serious banking reform has been lost. The question now seems to be whether we’ll get a watered-down bill or no bill at all. And I hate to say this, but the second option is starting to look preferable.
He blames the US legislative process which the crisis has exposed to be rather odd to say the least – that is, how can anything sensible actually ever get through the Republicans, the conservative Democrats, and the Administration which is full of deficit terrorists? And this is a nation that has serious weapons!
But this brings the argument in the recently published 2009 Annual Report of the Australian Financial Markets Association into somewhat different light.
The Report noted that the 2008-09 financial year was a “tumultuous one for over-the-counter (OTC) markets, as it was for other financial markets” and required “unprecedented actions were taken by governments, regulators and central banks in an effort to prevent a collapse of financial systems”.
They then said that the:
Basel prudential framework emphasised capital adequacy, capital regulation was imposed in a way that allowed significant build up of leverage and exacerbated the cyclical nature of financial markets. As well, many extremely large, and therefore systemically critical, financial institutions were outside the scope of prudential regulation.
In other words, it failed to do what it had claimed it was designed to do. That is why the liquidity proposals we examined in this blog – Bond markets require larger budget deficits – a now being entertained which is a complete about turn on the capital adequacy paradigm that was touted as being the best way to prevent financial collapse. The BIS and prudential regulators around the world are now talking about regulating the asset side of the balance sheet again to ensure there are enough high quality liquid assets available to cover potential bank runs. This is the old way of regulation.
However, the other problem with the regulative structure has been the way in which a significant amount of “banking” has been able to evade its reach. That is what the OTC markets are all about. OTC markets do not appear on the balance sheets of the banks and there are scant reporting available on these activities which is where the derivatives and swaps and all the rest of it are bought and sold.
The warning signs that the financial crisis was emerging evaded regulators because they had no way of understanding the OTC trade, which dominates the so-called exchange-traded markets (where regulators can see into).
So by failing to deal with this high risk area our legislators are leaving our economies exposed to another collapse.
The Australian Financial Markets Association Report recognises the need for reforms:
As a result, the international regulatory environment for OTC markets is evolving very rapidly, driven by powerful political forces in the US and Europe. Initiatives there have strong influences on regulatory policy in Australia. Legislation put to the US Congress in the middle of 2009 would require all ‘standardised’ OTC derivatives to be cleared through regulated central counterparties (CCPs). CCPs will impose robust initial and variance margin requirements, along with other risk controls, with the effect that customised OTC derivatives will be discouraged. The legislation will also mandate the development of a system for the timely reporting of trades and prompt dissemination of specified trade information. The US reform proposals are internationally significant because they are shaping the practices and infrastructure of global trading in the OTC market.
But that statement is now unlikely to reflect what emerges from the spineless legislatures in the US and elsewhere.
From a modern monetary theory (MMT) perspective there is no need for any OTC markets and they should be outlawed. Banks are public-private partnerships and should only operate to advance public interest. Please read my blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks – for more discussion on how financial markets should be regulated and banks structured.
Somewhat of a digression – cricket
It was announced today that the former prime minister John How had been “nominated as Australasia’s candidate to serve as International Cricket Council (ICC) president from 2012”.
Howard was one the worst prime ministers in our history. Even his own party called him the “lying rodent”. He was divisive across gender, ethnic and socio-economic lines. He promoted racism (very subtely) which is still reverberating now in the form of violence towards Indians and other ethnic groups in this country. He treated the unemployed and other income support recipients with callous disregard.
He ran budget surpluses while our public infrastructure degraded and even at the top of the last growth cycle (which coincided largely with his demise) the total labour underutilisation rate was 9.5 per cent. He significantly cut spending on public education and universities, and, instead, transferred billions of public spending to private elite education and fringe (mad) religious schools.
He lied to the Australian population about WMD and took us into wars that the vast majority did not want to be any part of. He was the self-styled “deputy for George W. Bush”.
He also is only the second prime minister to not only lose government but also his own lower house seat – that is how much he was loathed at the end.
And now, he is about to take over as the boss of our national game.
Here is a video of his cricketing CV. For US and other non-cricketing readers, the bowler (that is Howard in the video) is meant to bowl the ball somewhat further down the pitch (the thing they bowl on) than at his ankles! This video was shot in Pakistan a few years ago while he was visiting the troops he sent on false pretences.
Anyway, cricket is in a mess at present with the capitalists taking it over and turning the game into a circus. What was once a complex web of intrigue traditionally fought out over five 6-hour days with sometimes a result evading th egrasp of both teams is now a bash-fest with US-style blaring music, ridiculous gee-up announcers and diminishing technique.
I guess Howard is well-qualified to wreck it even further.
Total digression: a mystery now solved …
I now know why I ran out of time the other day – it was shorter!
The outlook …
So now I am going back down the beach for a (very) late afternoon surf to follow up from lunchtime. Here is the local beach.
Tomorrow the Australian National Accounts comes out and I will probably comment depending on what the surf is like (-: This mobile office thing could catch on.
That is enough for today.