Friday, October 15, 2010

The Joy of Misery

So last night all political-economics nerds and those with no life (but I repeat myself) were watching the currency markets in the hope the Aussie dollar might hit parity with the US Dollar. It topped out at 99.936 cents, which some wit on Twitter quickly pointed out could be rounded to 99.94 meaning currency traders are obviously cricket fans.

Last week was also a fun one for political-economic nerds with the RBA making a decision on interest rates and the ABS releasing the latest unemployment figures.

So much fun to be had; so much joyful news to be turned into misery.

Firstly the Reserve Bank decided to trick the market and Terry McCrann (and myself I must add) by not raising the cash rate. A few commentators (notably Rismark’s Christopher Joye) suggested part of the RBA’s decision may have been to purposefully wrong foot McCrann. That may be true, though for mine I think McCrann just made the wrong call because he is blinded by his bias against the stimulus and all things ALP. Consider the article he wrote on the day of the RBA’s non-decision:

YOU can blame Julia Gillard and Wayne Swan - and Ken Henry - for being at least partly and arguably significantly responsible for Tuesday's interest rate rise.

They are continuing to run a hugely expansive fiscal policy, splashing taxpayer money around - stupidly, I might add, but that's another story - in the middle of the biggest commodity boom in this country's history.

Reserve Bank governor Glenn Stevens won't put it in quite these words today, but he's forced to move in part to offset all that spending with a rate rise

This was a decidedly odd statement to make, given nowhere in any of the previous statement since the Global Financial Crisis and the injection of the stimulus has the RBA made any negative murmurings about the the fiscal policy. Last Tuesday again the Governor's statement was sadly lacking in any joy for Joe Hockey, McCrann and others who would have us believe the Government has ballsed up the economy.

The Governor’s statement on the fiscal side of life said:

Information on the Australian economy shows growth around trend over the past year. Public spending was prominent in driving aggregate demand for several quarters but this impact is now lessening, while the prospects for private demand, and in particular business investment, have been improving. This is to be expected given the large rise in Australia’s terms of trade, which is now boosting national income very substantially.

So it was prominent, but now is lessening. Hardly the RBA laying blame for any future rate rise at the feet of Gillard and Swan (let alone Ken Henry!). The RBA’s outlook on inflation was equally moderate:

Inflation has moderated from the excessive pace of 2008. The effects of the rise in tobacco taxes aside, CPI inflation has been running at around 2¾ per cent over the past year. That looks likely to continue in the near term.

But of course the statement did give out a pretty good indication of what lies ahead:

If economic conditions evolve as the Board currently expects, it is likely that higher interest rates will be required, at some point, to ensure that inflation remains consistent with the medium-term target.

Meaning that rates are pretty likely to go up in November and possibly December.

They almost have to go up now if only because it is not good for the RBA to play funny buggers too often. Back in September the Governor's  statement said:

… members considered that if the central scenario came to pass it was likely that higher interest rates would be required, at some point, to ensure that inflation remained consistent with the medium-term target.

Now, it’s ok to put out a such a statement and not back it up with a rate rise, but to do it twice would start having the market distrust the words of the Governor – and it is not good for the market to be thinking when the head of the Reserve Bank says one thing to expect the opposite. 

But such things are amazingly fickle. Here was a report back in the far past of August:

BORROWERS will not be slugged with any more interest rate rises this year after the release of softer jobs figures, economists say.

The joy of economics is its fluidity. You can never predict anything with certainty because all predictions are based on assumptions based on economic theory, and economic theory quite often has buried beneath its own assumptions the phrase “certeris paribus” (“all other things being equal”). And unfortunately in real life all other things are never equal.

However there are some things in life you can count on – and idiocy from the opposition on economic matters unfortunately seems to be one.

Andrew Robb has been standing in for Joe Hockey in the past couple of weeks, and some would think that would mean an appreciable increase in economic acumen, but I have to say  think Robb is massively overrated by many in the media. Last week he came out with this pearler:

“The government should urgently consider a mini-budget to rein in the reckless spending which is attributing to higher interest rates and therefore a higher dollar. The message to the government is that with the dollar at its 27-year high, everything should be done to minimise the rise in the dollar so that the competitive position of Australian industry can be maintained.”

That Robb would think the Government needs to cut back on spending to stop interest rate rising suggests he reads McCrann religiously, but forgets to read Glenn Steven’s statements. A mini-budget? Seriously?

And to top it all off Robb did it again today:

A PRE-CHRISTMAS mini-budget is necessary to reverse the reform malaise that has gripped the Gillard government.

The new government is already asleep at the wheel. It is simply sitting back letting higher and higher interest rates, and a record high exchange rate, do all the heavy lifting in taking the inflationary steam out of the Australian economy. And industry and mortgage holders are paying for it.

Let’s look at this dollar issue. Yep it is at a 27 year high. What exactly does Robb think the Government can do about it? The Aussie dollar is but a cork on the sea of international currency exchange. Our economy is not of a size that could in any change in policy could have any meaningful impact on the exchange rate. Let’s have a look at the dollar since Rudd beat Howard:


Check out September 2008 to March 2009. Was the Australian Government doing anything wrong then? Nope – in fact then as now the Australian economy was looking better than anywhere else. It was just that commodity prices took a hit because of the recession in the US and Europe, in times of panic investors tend to flock to the US Dollar because they know the Greenback is not going to go broke, and the RBA put the cash rate at emergency levels.

Could the Government at that stage do anything to increase the value? Well yes, and it has. Since that time the US economy has continued to perform poorly; the Australian economy has continued to perform well. Commodity prices have boomed, and the stimulus worked. As a result Australia’s interest rates are increasing, the US’s are stuck at emergency levels of 0-%0.25%.

The only way to do anything about the currency in the short term would be to have our interest rates decline.

Here’s Robb today:

The director of Access Economics Chris Richardson said this week: "The rough rule of thumb in economic models is that you have to cut by about $13 billion a year to achieve maybe a 1 per cent reduction in interest rates, which might, in turn, make maybe a cent or two difference to the level of the Australian dollar."

This confirms that Australia's interest rates, and exchange rate, would be lower, saving households thousands of dollars a year if the government's reckless spending and waste had been reined in during the past 12 months.

Well yes, ceteris paribus. Problem is things aren’t equal at the moment – the US, Japan and others are doing what they can to keep their own currency down. The other problem is Robb may be right that the Government should do what it can to ensure interest rates don’t go any higher than they need to, but get them go lower? Does Robb really think the RBA would cut interest rates because the Government cuts spending? The RBA sees interest rates at the moment at a neutral setting. The only reason they would drop them is if the RBA thought the economy needed stimulating.

Do we really want to be in that situation? Does Robb suggest the Government hold a mini-budget where it announces that it is slashing Government expenditure so greatly that the public sector withdraws from the economy to such an extent that the Reserve Bank thinks it needs stimulating through lower interest rates? Really – is that what Robb? Because at this point unless the US economy starts to pick up, that is the only way the dollar is going to go down.

In the short term, the boom in the mining sector and the basket case economy of the US, and the currency “wars” means the Aussie dollar is going to be high and all the blather from Robb is not going to change a thing.

In the long term, the best thing the Government could do to reduce a high dollar is to do something about the mining boom – for example bring in a resources rent tax on mining such that the heat in the boom is lessened. Though suggest such a thing to Robb or Abbott or Hockey and they’ll say you’re killing the golden goose, meanwhile they’re ignoring the goose is being burnt to a crisp.

On the inflation front it might be nice to think that people are reacting with some rational expectations and because the Governor says rates will likely go up, that people are saving and spending as if rate have gone up – meaning that they don’t need to because demand has declined. Christopher Joye, however put paid to that theoryrbs1:

The graph shows that consumer spending is spiking – and when that happens inflation generally increases and thus interest rate rises are sure to follow. (Incidentally if you are interested in finance and economics Joye’s blog is a must read.)

One positive of the increased dollar value is that the price of imports has declined meaning inflationary pressures ease on that score (by the way I’m betting this Christmas we’re going to see some amazing specials on flat screen TVs). But that in turn fuels demand for such products, and off we go again.

So we’ve got consumer spending increasing, import prices coming down, interest rates going up, unemployment going down and the exchange rate going up... And people wonder why I love economics? Herding cats has nothing on keeping control of the macro economic picture, and contributions like Robb’s do nothing except suggest he’s not up to the task of being in charge of it.

Now despite my slap down on McCrann and Robb and the lack of anything remotely suggesting the stimulus is currently fuelling inflation, that doesn't mean I think the Government can sit back with their feet up. If the private economy is powering on, then it behoves the Government to get out of the way – in effect get back to a surplus ASAP – and if that means looking for ways to get there earlier than the dopey “three years ahead of schedule” then so be it. But you shouldn't be setting you fiscal policy around what it will do to the exchange rate – that is unless you think you can also control events outside our borders and control.

[By the way, bragging that the budget will be in surplus 3 years ahead of schedule gives me the sh*ts. It’s not like they’re getting through High School in 3 years sooner than everyone else. All that happened was a prediction was made, and now another prediction has been made that suggests the same thing will happen 3 years’ quicker than they first thought. Such talk is just more of the useless spin that got the ALP into trouble in the first place – please Wayne stop it!] unem 0810

So now we wait for the next inflation figures to give us an indicator of where things are at; to give us an idea of what the RBA will do on Cup Day. The employment scenario however is damn good:

The announcement by the ABS last week that unemployment was steady at 5.1%, and that full time employment grew by 55,800 jobs was a truly startling figure.

It of course meant that the media took about 0.0001 seconds to begin with stories of an interest rate rise next month (first law of economic reporting – everything must be reported through the prism of what impact it will have on interest rates).

The figures are  excellent and should be greeted with joy, and bugger the impact on interest rates. 

I will say this again and again and again: were anyone to be forced to choose between having a job or having to pay more for his/her mortgage, he/she would take the job every single time – unless you think paying a mortgage on the dole is fun.

Interest rates are important – hell I don’t want them to go up, I’d love to be able to have more money to spend each month – but jobs are the key to an economy – would you really prefer to be like America and have the cash rate at 0-0.25% but have unemployment at 9.6%?

imageI’m not saying having unemployment at 0.25% and interest rates at 9.6% would be all that wonderful either (it would be an almost impossible combination for a start), but there is a balance to be had, and I like Australia's balance at the moment. Just as a reminder here’s the comparison of the US and Australian unemployment rates:

In point of fact when the Reserve Bank kept the cash rate at 4.5%, and the unemployment figures came out it continued a rather unusual run of low unemployment and low interest rates.

The usual combination of statistics to arrive at the “Misery Index” is unemployment and inflation, but I actually prefer the combination of unemployment and interest rates.

Inflation certainly is crucial – it does impact on our daily lives – but in many ways the impact of interest rates is more immediate.

Since November 2008 this Misery Index (call it Grog’s Misery) has been in uncharted territory:image

For the first time ever the index has been under 10 – ie the unemployment rate+cash rate = less than 10.

You can see for much of the Howard years post 2001 it was bumping between 10 and 12, but with the GFC and the huge drop in interest rates for the first time it went below 10.

But will such a state of affairs continue? Has the GFC changed things in a structural sense?

It would be nice to think we have entered an era of low interest rates and low unemployment, but I think it would be foolhardy to think thus.

The cash rate is likely to go up 0.5% by the end of the year, and if it does we’ll be back over 10 on the Grog Misery scale, unless unemployment drops by a similar amount, and I think that is a bit much to ask. 

What the Government will need to consider is what can it do to keep inflation down (and thus pressure on interest rate) but such that the the employment growth continues. Is the economy at a point that the private sector is able to once again take up the slack when the Government gets out of the way? Will the high dollar have an impact on exports such that growth abates? Will the high dollar be enough to have the RBA pause and consider whether or not to go higher with interest rates? Will banks go higher all by themselves, thus meaning the RBA doesn’t need to raise the cash rate?

So many questions (which is why economics is the field where retrospective brilliance is most observed).

The balance we seek is the key, and the joy of economics is that the balance is never set; never constant.

And whenever there is joy for some there is misery for others.


Steve said...

It's articles like this that make me glad you have not given up on blogging. Keep the bastards honest and don't let the turkeys get you down!

Sonia said...

Great article and cleared up a few things for me. This obsession the media has with interest rates is completely ridiculous. I was relieved when the last rise did not occur (and delighted that so many economists and the media got it wrong ). The 24 hour news cycle is not helpful in all things economic. The day after the last decision the media were already tipping a rise next month. The 24 hour news cycle also makes it impossible to believe anything you read in the SMH or other publications. One day they are telling us house prices will rise by 20 percent and the next day they are telling us housing prices are likely to fall. I think I'll rely on your for all things economic in the future

Anonymous said...

I agree entirely about jobs v interest rates.
My take is that the media is essentially by and for the middle-class, so of course they will be more affected by the latter.
It's worrying that important stuff like this isn't on the news radar.

Andos said...

I must disagree with you about the surplus, Grog.

The private sector will never be able to achieve full employment. The Government is never justified in running a budget surplus unless our economy is running into production constraints.

With six hundred thousand unemployed Australians (not to mention underemployed), those constraints are a long way away.

We need to be talking about the right to work in this country, and why the workers party has abandoned it.

Hillbilly Skeleton said...

What I'd like to hear is your analysis of what we need to do to create a Productivity Agenda that, so 'they' say, will provide another avenue to take heat out of the economy due to the distortionary effects of the Resources sector.

MissHeliotrope said...

Thank you for going through things in comprehensive & comprehendable fashion. As usual, a combination missing in the msm.

The dollar thing should be doing wonders in the US economy for any company prepared to ship to Oz -

Anonymous said...

I have never understood the obsession with budget surpluses. If your income (taxes) exceeds your expenditure (provision of services) then either taxes are too high (THEFT) or your provision of services is inadequate (THEFT again).

Perhaps it's about time to regard surpluses as a sign of policy failure.

the bogan whisperer said...

great post - alot of effort by you and enlightenment for the reader.

no idiot at the australian could write solmething as incisive and thought out as this (even though it is their full time job).

james massola should keep on writing about paris hilton: it is all he is capable of.


Anonymous said...

I find myself amazed that there's so much focus on the Aussie dollar against the US dollar. OK, the US dollar used to be the effective gold standard for the world economy, but each time our dollar has got up there near parity, this has been the result not of economic wizardry on the Aussie side, but rather of economic misery on the US side. To get a better picture, let's look at our dollar against a whole basket of currencies - the Euro, the UK pound, the yuan, the yen, the Vietnamese dong etc - and see whether we're seeing any major changes there. I suspect the answer will be "nope" - which implies for the US dollar to be trading near parity with the dollar of an economy 1/15th their size (i.e. the Aussie dollar) something is seriously wrong with the US economy. Or is the Aussie government somehow supposed to be running the US economy as well (which appears to be the implication of HM Loyal Opposition).

As it stands, I'm hoping the dollar will stay up there for another couple of days, so I can order a few bits and pieces from US sources, and afford the shipping as well as the product.

(PS: nice to see you back. Non illegitimi carborundum).

Anonymous said...

Great post as usual, Grog.

I find this recent Treasury paper useful in thinking about the link between fiscal and monetary policy (the 'crowding out' thesis beloved of Hockey and Robb):

The relationship is negligible at best, so massive, unprecedented fiscal consolidation would be required to affect monetary policy and the exchange rate to any meaningful degree. If that's what the Coalition is advocating then I think it's good news for the Labor Party; there can be few policy programs less popular with the Australian people than the wish to halve the State and shut down hospitals, schools, etc. The problem is that few journalists have the knowledge and/or courage to demand that the Coalition follows through the chain of logic to its conclusion. Instead, they're allowed to get away with easy, cheap calls for a "mini budget" (of course, forgetting the MYEFO exists) without being called upon to make explicit their alternative fiscal strategy.

Anonymous said...

Also I share your frustration with the "first law of economic reporting – everything must be reported through the prism of what impact it will have on interest rates". I called it the "cash rate cringe":

2353 said...

I'm wondering if Hockey & Robb are trying to seed some form of self fulfilling prophecy here. While the "blue tribe" true believers will swallow the line that the "Government is spending too much money" (as demonstrated time and time again), if Gillard & Swan do a mini-budget before next May, Hockey will be able to pounce with the "we told you so" and "it should have been sooner" lines.

There is also an interesting article by Paul Syvert in this mornings Curious Snail (can't find it online) that suggests that the Aussie Dollar is caught up in a battle between the US and China over currency valuations. If that is the case - nothing Swan (or Hockey in the alternate universe) could do would make a scrap of difference.

Anonymous said...

As witty and knowledgeable as usual!

Mad Dan Eccles said...

Is it not true that those wailing about the dollar being US$1.00 were the same ones gnashing their teeth when it was US$0.58?

Greg Jericho said...

Matt - I love Hockey's crowding out line. I hope he never stops using it ;-)