By Alan Kohler 6 August 2016 The Australian
“The decision to float means that the speculators will now be speculating against themselves, rather than the Australian government via the Reserve Bank.”
— Paul Keating, Treasurer, December 1983.
The man who sat beside Keating at that press conference was the governor of the Reserve Bank, Bob Johnston, not the government’s economic poobah, the head of Treasury John Stone, who bitterly opposed the float.
It was, in short, a decision crafted by the central bank, pushed by its head of research, Peter Jonson, to protect the RBA balance sheet and policies from global foreign exchange predators.
Thirty-three years later the RBA is again — or still — at the mercy of the foreign exchange markets.
But there is a big difference: Johnston’s successor, Glenn Stevens, had to cut interest rates this week not because of currency speculators, but because floating exchange rates have connected each country’s monetary policy inextricably to every other.
It’s almost as if every country is part of a currency union like the eurozone, with one central bank. We all have separate central banks that behave the same.
If Australia, or any country, has the impertinence or misjudgment to get out of line, then its currency rises and its domestic industries are destroyed.
That’s what happened to Australia in 2010-11. Three years of parity with the US dollar that was caused by the Reserve Bank getting out of line — it raised interest rates from 3 to 4.75 per cent at the same time as the US Fed held at zero, and commodity prices rose — destroyed the Australian car industry.
The RBA takes no responsibility for that, but is making sure it doesn’t happen again, specifically to Australia’s all-important education and tourism industries (in the absence of mining and manufacturing).
But central banks everywhere are flogging a moribund, if not dead, horse. The economic mystery of the age is not so much why interest rates and inflation are so low, although that is quite mysterious, but why business people aren’t taking advantage of low interest rates and borrowing.
Capital, both debt and equity, is not only plentiful, it’s cheap — perhaps cheaper than it’s ever been. So why is capital expenditure not rising?
Back when the suppliers of equity and debt — that is, savers — demanded returns of more than 10 per cent a year, entrepreneurs lined up to get some and business investment rose year after year.
Investment hurdle rates were 15 per cent, and boards were happy with the margin those sort of returns would provide over the cost of capital.
Now savers have been battered into submission, subjugated to the great cause of higher inflation, and have been forced by central banks to lower the price of capital to half what it was.
Yet business — and governments for that matter — have largely kept hurdle rates of return for investment where they were, and are not buying. As the Reserve Bank once again cut the price of credit on Tuesday to the lowest level since it was created in 1960, it referred to the “very large decline in business investment”.
Non-mining investment is not only failing to pick up the slack on the decline in mining investment, it’s falling too!
And so is investment by the government.
The charts above tell the story.
Despite a 10-year bond yield of less than 2 per cent, the government is not borrowing and building.
The only reason the economy is growing at all is because booming house prices have helped maintain consumption, in turn because of the “wealth effect”. But that’s now coming to an end as the housing cycle dies a natural death.
It’s not just Australia: in the US, last week’s GDP report for the June quarter showed that business investment is in recession, while consumption grew 4.2 per cent, and was entirely responsible for the growth in GDP, as anaemic as that was.
There are four reasons, in my view, each of which tends to create a feedback loop:
- Company profits are weak, and naturally businesses invest less when profits are not rising.
- The fact that interest rates are at record lows might be enticing, but it’s also scary: if the RBA is cutting the cash rate to 1.5 per cent, things must be terrible.
- The pressure on boards to pay out the cash to shareholders as dividends or buybacks is becoming more and more intense, so as a result hurdle rates for new capital expenditure are ridiculously high when compared with the cost of capital — in other words to compete for capital against dividends, a new investment has to be compelling.
- Politics is, to say the least, unusually unsettling: first the Australian upheavals, then Brexit and now Trump. It’s a brave board indeed that commits to a 20-year capital works plan.
At some point central banks are going to have to return interest rates to normal without having declared victory in their fight against low inflation and falling investment. It will be one of the greatest failures of public policy in history.
Only when they release capitalism from the distortions of negative real interest rates and printing money to buy government bonds, and thus driving up their prices, will business get back to normal.
Original article here