The hand behind the back
Friday, 26 July 2019
By Matt Hibbard
Imagine, just for a moment, that you went to a bank and deposited $1000. And exactly one year later, you go back to that bank and take your money out.
As the cashier counts out the cash, you sense something is missing.
Sure enough, they have taken money out for ‘fees and charges’. What else would you expect?
But something else is also amiss. They have charged you interest for depositing your funds.
Sounds weird enough…not to say disturbing. But that is exactly what happens when interest rates go negative. It costs you real money to put your hard-earned in the bank.
Is this where Australia is heading? And did you think interest rates could only fall to zero?
We will find out in a moment. But first a look at the markets…
Overnight, the Dow Jones Industrial Average closed down 128.99 points, or 0.47%.
The S&P 500 closed down 15.89 points, or 0.53%.
In Europe the Euro Stoxx 50 index finished down 27.75 points, or 0.64%. Meanwhile, the FTSE 100 lost 0.17%, and Germany’s DAX closed down 160.79 points, or 1.28%.
In Asian markets Japan’s Nikkei 225 is down 128.50 points, or 0.59%. China’s CSI 300 is down 0.13%.
In Australia, the S&P/ASX 200 is down 16.10 points, or 0.24%.
West Texas Intermediate crude oil is US$56.17 per barrel. Brent crude is US$63.48 per barrel.
Turning to gold, the yellow metal is trading for US$1,416.35 (AU$2,041.14) per troy ounce. Silver is US$16.45 (AU$23.71) per troy ounce.
And bitcoin’s 2019 rally remains stalled. One bitcoin is worth US$9,720.00. What’s next for bitcoin? Find out here.
The Aussie dollar is worth 69.41 US cents.
If you have studied economics 101, you will be more than familiar with the role of the RBA.
Apart from printing banknotes, the RBA is responsible (or has a ‘duty’, in its own words) for three things:
‘…to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.’
That quote is directly from the RBA. There’s a good chance you will know it verbatim.
It is a description so broad, however, that it is almost unquantifiable…let alone achievable. You may as well put them in charge of motherhood, good times and world peace as well.
While these duties are incredibly broad, the tool it uses to achieve such things is incredibly narrow. All it has at its disposal is the cash rate.
Mind you, that is no small thing in itself. Apart from the odd loan-shark, the RBA’s target cash rate is the basis from which all other rates are set. From your mortgage rate through to the amount of interest you earn (or don’t earn) at the bank.
While setting the cash rate is easy enough to comprehend, the second part of that equation is easily missed.
The reason the RBA adjusts the cash rate is to achieve one primary goal. That is — and again, this is straight from the RBA — ‘…to meet an agreed medium-term inflation target’. As you know, that medium term target rate is 2–3%.
In a low interest, low inflation environment, that target has become increasingly impossible to achieve. And that is with an unprecedented amount of cash in the system — the very thing that should help drive inflation.
So impossible has this target become, that the RBA is now even quizzing whether it should be adjusted. And to be fair, they may be right.
Back when that target was set almost three decades ago (in the 1990s), that 2–3% target rate would have almost been nirvana. Particularly after the rampant and double-digit inflation of the decade before.
Now even hitting the lower band of 2% seems like an impossible task. But what to do if inflation is dead? The primary role of the RBA becomes obsolete.
Unlike the widely held view, the role of the RBA is not to adjust rates to boost, or contain, the economy. The very reason it adjusts rates is to achieve a target inflation rate.
If inflation is dead — for the time being at least — what is the RBA to do? Its only tool in the toolbox is irrelevant. It might as well be playing tennis with a cricket bat.
And that is where the other side of economics must come back to the fore.
The other ‘F’ word
While monetary policy is one tool — the tool of the RBA — the other great tool belongs to the government…fiscal policy.
Fiscal policy revolves around two central themes: taxation and spending. Those two words together sound like a slogan straight out of an election campaign.
Nevertheless, their importance cannot be underestimated.
Monetary theory tells us that higher interest rates should lead to lower spending (and consumption), thereby reigning in inflation.
It is also tells us that the opposite should be true. That is, lower rates should increase spending and lead to higher inflation.
Yet as we have discovered, that last part is no longer true. While spending has increased, inflation is systemically anemic. Adjusting the cash rate lower is no longer effective.
And that is where the government comes back into play. Adjusting tax policy and where the money is spent in the economy, can have a much more targeted effect, than the bluntest instrument of all — interest rates.
Already the government has got its tax cuts through the parliament. Forget the ‘State’. No one will ever know better than you, where to spend your own money.
After a bit of showboating, the opposition finally came on board. Though so late, it didn’t matter, as the government already had the numbers.
And forget the ‘cat’. This week the government threw a lion among the pigeons, deciding to tackle that great intransigent behemoth — the federal public service.
Such bureaucracy consumes a massive chunk of the federal budget — money that could be spent in other parts of the economy. Like infrastructure, for example, or research via such organisations as the CSIRO. Investments that could pay a much higher dividend down the track.
And by not providing tax breaks and other forms of incentives to things like renewable energy, for example, the government can better choose where to spend your money.
Don’t even get started on the lerks and perks of the public service, either. RDOs, ‘training’ days and the biggest perk of all — superannuation.
Quite how a public servant receives substantially better superannuation benefits than all we minions who pay their salaries via our taxes, is beyond me. However, we’ll leave that argument for another day.
The newly elected government now has the chance to do what no government could, or chose not to do, in more than a decade. And even further back than that, you could argue.
Though, one thing will always hold true: where you spend the money is critically important. Pink batts? Cash for clunkers? Hopefully, this government can choose its spending much more wisely than that.
More importantly than any of this, though, is something that matters much more to the economy. Especially to those relying on their savings to supplement their income.
If the government gets its spending and taxation right — that is, its fiscal policy — it takes the pressure off the RBA. Meaning they won’t have to keep cutting rates into oblivion.
It also means that savers have some chance — no matter how small — of actually receiving some interest (and income) from their funds in the future. That is something else that will help reduce government spending in the future.
By taking this other hand out from behind its back, the government can also save us from the great ignominy (and destruction) of negative interest rates. What else lies in the future if it doesn’t?
For if money ceases to have value — or more to the point, it actually costs you money to keep it — what’s the point of keeping it? You might as well go and p*** it all up against a wall.
All the best,