Making heads or tails of Australia’s economic strategy
The RBA has painted itself into a corner on monetary policy, while the Federal Government is talking about massive black holes while simultaneously saying the budget won’t be too tough, writes David Llewellyn-Smith.
Institutional stability is one of those vague terms that is cited as a crucial support when one assesses the relative merits and risk of any given market.
In Australia’s case, it is often cited as a strength of our economic, regulatory and banking systems, and is a bit like an unloved old partner, taken for granted until it’s not there.
Despite occupying impressively solid marble halls, our institutions are really only as strong as the people that occupy them, and, to be frank, they’ve seen better days. I’m not one to leap to conclusions about the impacts of uncertainty on animal spirits but, right now, the instability sweeping our macro management is impressive enough for it to be a concern.
There are three pillars of institutional macro management in any economy. They are monetary policy, fiscal policy and prudential policy. The combination of these three levers calibrates the macroeconomic settings for the economy, determining the direction and speed of capital flow which, let’s face it, is really all that matters. Right now, all three are at best in a controlled transition and, more truthfully, are struggling to cope under rapidly changing economic circumstances.
Consider each institution for a moment. In monetary policy, the Reserve Bank of Australia (RBA) has painted itself into a corner from which it refuses to move. Its cash rate is low enough to be re-inflating the housing bubble but not low enough to bring down an over-inflated dollar. The answer to its dilemma is very obvious in the use of temporary macroprudential tools such as those working beautifully in New Zealand, but it won’t use them.
As such, its communications are becoming more and more confusing as its jawbone aims to keep conflicting economic actors exuberant or fearful at the same time. In a few short months, the RBA has both demanded a lower dollar and accepted a higher dollar, promoted a housing boom while castigating speculators, canvassed the need for policy innovation while writing it off, as well as embracing recovery while warning of lingering weakness.
In prudential policy, it is at least as confusing and probably even more so. The RBA keeps insisting that it need not do anything new because the Australian Prudential Regulation Authority (APRA) has promoted itself as embracing “Basel III plus” conservatism in which it’s asking the banks to hold more capital for a rainy day. But it’s done no such thing, and instead has allowed the banks to game the system.
It’s at odds with its own soft regulators, the Bank of International Settlements (BIS) and the International Monetary Fund (IMF), over the capital reserving issue, both of which rightly see APRA being far too lenient on the too-big-to-fail (TBTF) banks.
At the same time, a former CEO of the same TBTF banks (David Murray) has been appointed to run a generational inquiry into the banking system, and he has already publicly declared his biases, which include the carriage of too much capital by the major banks. This has emboldened the banks themselves, which are now mounting a major rent-seeking offensive upon the inquiry, demanding much lower capital reserving, at the same time as higher reserving is desperately needed to prevent the housing bubble from inflating to new historic proportions.
This doesn’t say much for the motives of the new government.
Fiscal policy is the final lever and on that front there is more confusion. After years of hopeless budget misses, the new Government has insisted on bearish forecasts. But they’re still not gloomy enough, in part because the Government’s own agenda of returning to surplus as soon as possible will hit growth much harder than it expects.
In the past two days we’ve had Treasurer Joe Hockey warn of a $60 billion black hole in the budget and Prime Minister Tony Abbott reassure us that the budget will not be too tough. This continues a pattern of good cop/bad cop rhetoric that has gone on for six months. Like the RBA, it’s not really coming off as a clever communications strategy so much as it is wholesale confusion.
And, of course, underneath all of that, there actually is a budget crisis. The budget must be returned to surplus in good time to protect the AAA rating, not because that’s of any great value to itself, but because the rating is the linchpin in major banks’ liability management via the implicit wholesale guarantee, which is one major reason why the banks can carry so little capital.
As you can see, current macroeconomic management is a deeply interwoven mess of ideology, politics, interests and bureaucratic arse-covering in which semi-independent economic managers are under intense pressure from each other, as well as the regulated, and it’s not at all clear who is winning and what the outcomes will be.
Some of this is just bad timing and will work itself out. But most of it is emanating from a post-mining boom economic adjustment that has no over-arching macroeconomic or regulatory plan. For that, one must surely blame the Treasurer.
I’m not one to worry too much about the ebbs and flows of policy having a negative impact on wider confidence, be it that of consumers or investors. I see economic and investment fundamentals as the driving force of confidence. No doubt most observers see only the odd detail and not the big picture but, even so, one can only wonder how in control the wider community feels about their finances right now given the increasingly frequent symptoms of systemic instability.
This piece was originally published at MacroBusiness.
David Llewellyn-Smith writes as House and Holes at MacroBusiness, where he is editor-in-chief and publisher.