It is difficult to mention inflation without referring to interest rates. Yesterday we gave you inflation, today we give you interest rates.
The last few months has seen a reversal of mammoth proportions. Policy makers changed their stance from fearing moderate inflation – only moderate remember, because they discounted the impact of fuel and food prices – to being horrified at the potential for deflation.
The result? Interest rates have been slashed by the Reserve Bank of Australia by 300 basis points (3%) to just 4.25%. That is a record low.
But isn’t that good news? Well, we won’t cover all of the old ground we have been through recently, but needless to say it is good news for the indebted and bad news for the savers.
That much is obvious.
Of course there is nothing inherently wrong with low interest rates. Just as there is nothing wrong with higher interest rates. It is all part of the economic cycle.
As the economy slows interest rates are lowered in order to encourage business to use money. A lower interest rate means that money is cheap, so when something is cheap it increases the demand for it.
With a slowing global economy it surely makes sense that central banks have cut interest rates. Or does it? The US, UK, Eurozone, Australia, China and Japan have all cut lending rates.
The problem is that rates are now at artificially low levels. Left to the free market and interest rates would be higher. At least for the short term.
Because not only are interest rates the cost of money, but they are also an indication on the risk that the market applies to the cost of money. In other words, when risk is high, interest rates should be high as investors want a higher return on the money they are lending.
When risk is low then investors are prepared to except a lower return in the belief that their investment is safer.
On this assumption, how would you describe the current market environment? High risk or low risk?
And this is exactly why the billions and trillions of dollars being wasted by governments here and abroad can and will only make things worse. We agree that it may help to increase consumption and spending, but is that what is required? Only if you are short-sighted.
In short central banks and governments have manipulated the market so that consumers are being encouraged to spend and borrow to buy products that may still be overpriced.
Two stories from News Ltd today illustrate the point.
“Victorian property values plummet $40 billion in six months” the Herald Sun tells us. According to research from BIS Shrapnel, Melbourne’s median house price of $450,000 mid-2008 is now down to $427,500.
That is a drop of 5%.
That is the average of course. Some suburbs have done better than others. A bit like the stock market. The broader S&P/ASX200 lost about half of its value during 2008, yet some shares did worse than that and others did better.
But as an average, is a drop of 5% that much?
What is to stop the housing market from sinking much lower than that? Well, supply and demand should dictate that as prices fall more buyers should be drawn into the market. Even more buyers may be drawn in if a government was to offer a bribe to a narrow range of potential buyers, such as first home buyers.
Which brings us to the story in The Australian. Not content to let the market find a price for the housing market, the government has spent $11.5 million in advertising, part of which has gone towards spruiking the first home-buyers bribe.
Having just come through a period of massive credit fuelled overspending, the government is luring those that can probably least afford it (first home-buyers) into taking out a mortgage during a time of volatile and unstable asset prices.
It may very well be that house prices will not fall nearly as much as the stock market has. But if it does and if the economy does take a further turn for the worse, and if unemployment does rise, then there could be a whole bunch of first home-buyers that learn firsthand what it is like to have negative equity in a house.
The lucky ones will get to keep their house. The unlucky ones will get turfed out and end up owing money on a home that is no longer theirs.
The Poor Need Free Markets Not Government Aid
That’s what the president of the World Bank, Robert Zoellick writes in today’s Australian Financial Review. He is referring to the poor in underdeveloped countries.
Apparently the best way of helping the poor is to give lots of money to government sponsored programmes and allow them to allocate the money to the most pliant and favoured of dictators.
OK, he didn’t write that, but we know that’s what happens when government is given the responsibility for aid programmes.
What he did write is this:
“The new multilateralism must maximize the strengths of interdependent and overlapping actors and institutions, public and private. It should reach beyond the traditional focus on finance and trade, to include other pressing economic and political issues: development, energy, climate change, and stabilizing fragile and post-conflict states. It needs to draw together institutions, with their expertise and resources, to reform them when necessary, and encourage effective co-operation and common action.”
We can break that down into a single phrase: “More government and bureaucratic meddling.”
Of course, underdeveloped countries don’t really need any of that. They don’t need bribes and favours from the West that do little more than keep General This or Supreme Leader That in his palace while the populace starve.
What they need is the West to eradicate the restrictive trade policies and tariffs that it imposes to protect industry in its own back yard. The US and the EU are the biggest criminals – look no further than the Common Agricultural Policy (CAP).
To soften the guilt, these governments then throw a few million or billion around so they can claim they are “doing something.” They are doing something, they are making it worse.
Forget “development, energy, climate change, and stabilizing fragile and post-conflict states,” just get rid of the barriers to free trade. It’s simpler and a lot more effective.
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