Has the Reserve's monetary tightening killed the boom?
Gerard Jackson
Not only is the economy getting worse so is the economic commentary. Terry McCrann is a prominent member of our economic commentary and — like the rest of them — he just cannot get his economics straight. Our falling share market is the result of excessive interest rates. It never occurs to him — anymore than it does to the rest of our solipsistic commentariat — that "interest rates are too high" because the Reserve Bank of Australia's reckless monetary policy had kept them too low. (By too low I mean below the market rate).
The truth be told, McCrann hasn't a clue on the nature of interest and vital role it plays in shaping the country's capital structure. In this respect he is at one with his colleagues. (On the RBA's tightrope, Herald-Sun 20 August 2008). If he knew what he was actually talking about he would understand how the RBA's 'cheap money' policy fuelled the share market boom as well as the housing market. Fritz Machlup explained that a share market boom requires a continuous flow of bank credit. This can only happen if the central bank loosens the monetary spigot. Therefore a
... continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply. (Fritz Machlup The Stock Market, Credit and Capital Formation, William Hodge and Company Limited, 1940, p. 290).
This suggests that once credit is tightened the share market will drop. Guess what? The money supply has contracted since the end of last December*. And I mean by contracted that it has fallen in absolute terms. In plain English the RBA has — for now — implemented a deflationary policy. Yet McCrann, along with the rest of the commentariat, have completely missed this vital fact. Why? Because for this lot money doesn't really matter. No wonder the economic commentariat keep getting it wrong.
For the likes of McCrann the links between monetary policy, investment booms and current account deficits are pure fiction. He even tells us "not only might inflation not fall but actually cement itself in high wage settlements". Wage rates can never be inflationary. Unfortunately this is a view that our so-called economic punditry refuse to debate. (Come to think of it, I cannot recall them ever debating any economic topic).
McCrann appears to be of the opinion that the resource boom will allow us to avert a recession, so long as the RBA exercises proper control over interest rates, proving that this lot never seem to learn. On the eve of the 1991-92 "recession we had to have" Michael Stutchbury of the Australian Financial Review assured his readers that the demand for our resource would be sufficient to prevent a recession. I warned at the time that irrespective of the demand for resources recession was now unavoidable. Stutchbury, like McCrann, is still writing on the economy.
The RBA Statement on Monetary Policy for August painted a relative optimistic picture of the country's economic prospects because indicators point "to a growth in firms’ investment plans in 2008/09" while admitting that "much of the growth was expected to be resource-related". It is important to note this because the RBA also observed that:
In contrast, investment in other industries has fallen modestly as a share of nominal GDP over the period.
What does it say about the RBA's competence in economics that it cannot see that it has described serious economic imbalances. In the circumstances there is nothing incompatible with a rising demand for commodities and a severe drop in domestic production. Let us now turn to a less rosy though more realistic look at economic conditions. The Australian Industry Group's Performance Manufacturing Index for July is headed: Manufacturing activity falls for second consecutive month. As we can see, there has been a significant drop in key indicators, signaling a recession. So much for the Reserve's model.
BrookesNews.Com
Monday 1 September 2008
|
| Australian PMI | |
| Production | ||
| Employment | ||
| New Orders | ||
| Input Prices | 70.2 | |
The index is shows a contraction for June and July. I do not find it coincidental that this contraction swiftly followed the RBA's contractionary monetary policy. (in December 1928 the Federal Reserve froze the money supply: manufacturing started to contract some six months later and the stock market dived in October).
*The monetary figures for June suggest that the Reserve might be trying to reflate. It would require an interest rate cut far in access of 0.25 per cent to completely offset the monetary contraction the bank set in motion.
Gerard Jackon is Brookesnews' economics editor