The Reserve Bank tightened monetary policy far too slowly in the boom. By allowing the economy to build excessive momentum, including inflationary pressure, this led it to tighten too far.
When the seriousness of the global financial crisis became clear, the Reserve eased dramatically quickly – with 400 basis points of rate cuts in six months.
Is the speed of the easing due only to the speed and extent of incoming bad news or does it represent the lessons of the boom?
Only time will tell, but clearly rapid easing was required and has been provided.
Most of Australia’s ‘well connected’ journalists say a pause in the easing is the likely outcome of today’s meeting of the board of the Reserve, while apparently there are others who say another 100 basis point cut is on the cards. Henry buys the ‘pause’ story, based as it is on logic and common sense.
There has been a lot of both monetary and fiscal ease for the economy to absorb.
Not surprisingly to experienced observers, Australia’s recent economic statistics are surprising on the upside. The economy was growing strongly when the global crisis hit and momentum works for economies as well as sporting teams. The Australian dollar has fallen a good deal, encouraging exports and local production while discouraging imports. Inflation has risen again.
A halving of mortgage rates, reinforced by various fiscal handouts including substantial amounts for first home buyers, has removed the worst of the gloom from the housing industry.
Substantial cash handouts boosted consumption in December and the Rudd government will be splashing more cash around about now and, presumably, in the May budget.
Banks have, however, been less generous in their lending to business, and despite the general perception that Australia’s banks are in relatively good shape, their managements are playing safe. Bankers are using every excuse to re-price loan rates upwards, and even sound businesses are finding loans hard to get.
Business confidence is low, but in the December quarter business investment rose, perhaps illustrating momentum at work.
Employment statistics have held up, and it seems many businesses are encouraging people to take leave or work shorter hours to keep trusted and experienced workers on their books.
The budget is now clearly in deficit and the government has asked for approval to borrow up to $ 200 billion.
Current stimulus is effectively a burden on future generations, a point the opposition has made strongly and often.
As we have also said repeatedly, some stimulus is clearly worthwhile, but we have made two points apart from the burden on future generations.
The first is that some restraint in limiting direct assistance to people in serious trouble would limit the burden on both current and future generations of taxpayers. Leaving room for additional stimulus would be a wise precaution, especially given the continued speed of economic deterioration abroad. From a moral perspective, helping those who do not need help is at best distasteful.
Our second point is that fiscal stimulus so far has focused on boosting demand. A safer course would be to provide additional spending or tax cuts to stimulate the supply side, making Australia more productive and competitive.
Some pause in the headlong rush to stimulate demand might provide time and space to debate these important matters.
Another matter to debate is why the world finds itself in such a mess. ‘Extreme capitalism’ and ‘excessive greed’ is the diagnosis of the Social Democrats, including Kevin Rudd, Gordon Brown and Barak Obama.
That capitalists are greedy and willing to do virtually anything to further their aims (which is to get rich) should come as no surprise. Indeed, Karl Marx, the philosopher-king of the left, said in Das Capital: "With adequate profit, capital is very bold. A certain 10 percent will ensure its employment anywhere; 20 percent certainly will produce eagerness; 50 percent....positive audacity; 100 percent will make it ready to trample on all laws; 300 percent and there is not a crime at which it will scruple, nor a risk it will not run, even to the chance of its owner being hanged.".
Adam Smith, the definer of modern capitalism, thought extreme capitalism would be limited by men’s desire for the regard of their fellows. Sadly, however, modern capitalist leaders seem not much interested in the regard of their fellows. Leaders inhabit a narrow peer group and in Henry’s experience admire their peers’ ability to create the highest ratio of wealth to effort.
It was Milton Friedman who defined the role of the modern corporation as one of maximizing profits subject only to the law, meaning in most interpretations the very letter of the codified law. Nothing much about earning the regard of ones fellow corporate leaders, except by maximizing profits at whatever cost.
If Karl Marx and Milton Friedman agree on the role of corporate leaders, and Adam Smith is an outdated idealist, who or what is to control the ‘extreme capitalism’ or excessive greed that has led to the world economy’s current unhappy situation.
By definition, it is the law that was defective, and in the case of the world financial system it is the weakness of financial regulation. This point has been acknowledged by no lesser man that Alan Greenspan, who has declared he was wrong when he assumed financiers would regulate themselves.
Greenspan’s mea culpa would be more convincing if he also acknowledged that he drove US interest rates far too low following the tech-wreck.
The world economy has seen 30 years of strong growth. This growth has been driven by technical progress and the industrialization of previously undeveloped nations of Asia, Eastern Europe and Latin America.
Growth has also been fuelled by increasingly deregulated financial markets, an orgy of lending and borrowing and erosion of traditional standards of acceptable behavior, whether in the utterly disproportionate salary payments for senior executives or in the lack of restraint on unacceptable behavior either from the operation of conscience or the work of regulations and regulators.
In seeking to apportion blame, general societal mores must take first place. But given the extremely damaged state of the global financial system, financial regulators must be held responsible in a more immediate way.
Political response to obscene payouts for failed financiers will produce some welcome rollback of excessive greed. Nationalisation or part-nationalisation of failed banks will, if governments have representatives on boards that do their job, produce further force for reform.
But unless this is followed up by serious reform of financial regulations and regulatory agencies, the problems of a failed global financial system will be merely papered over and will return, far more damagingly, within a generation.
In Australia, the Reserve Bank’s role is two-fold. Not to ease monetary policy to the point that excessive lending and borrowing resumes anytime soon. And to insist within the ‘official family’ on a serious, deep and thorough redesign of the rules for regulating modern finance.
Published today in The Australian.