Two weeks ago the G20 Meeting ended with a whimper, and Australia’s Reserve Bank Governor gave a retirement interview to the Australian Financial Review (AFR). What is the connection? In our view, both events displayed what is wrong with the conduct of economic policy across the world.
Very few people in positions of real power are prepared to say what needs to be said because they fear it could offend someone or be misconstrued by markets. Political correctness is ingrained in politics and it appears to have corrupted the commentary of central bankers as well.
The interview with Governor Stevens in the AFR is a case in point. During the interview he made a unique remark (for him) on currency manipulation. He noted that the world’s top central banks are “undoubtedly keeping an eye on exchange rates” when they set monetary policy. As the Governor confessed “It’s not the done thing in polite company to say that, and everybody has to motivate what they’re doing by their domestic objective, but I don’t think it could be denied that people have an eye on exchange rates when they’re making these decisions”.
For years, our Governor failed to criticise or even comment on the policy settings of his international peers (ECB and the Japanese Central Bank) for manipulating their currencies via monetary policy settings. He may have done so in private but it clearly had no effect. Today the management of Australia’s monetary policy is held hostage by foreign central bank policies and the RBA’s response has been meek. Further, the RBA has been slow to address much needed financial regulation as it affects Australian residential property markets. We will return to this theme a little later.
Another show of political correctness was the G20 Meeting’s final communique  in China. There was no mention of the fact that the G20 host, the second largest economy in the world, continues to blatantly manipulate its currency for its own benefit. However the communique did identify the excessive production and dumping of steel as a serious issue, although this was buried deep in the statement. Note 31 declared:
“31. We recognize that the structural problems, including excess capacity in some industries, exacerbated by a weak global economic recovery and depressed market demand, have caused a negative impact on trade and workers. We recognize that excess capacity in steel and other industries is a global issue which requires collective responses. We also recognize that subsidies and other types of support from government or government-sponsored institutions can cause market distortions and contribute to global excess capacity and therefore require attention. We commit to enhance communication and cooperation, and take effective steps to address the challenges so as to enhance market function and encourage adjustment. To this end, we call for increased information sharing and cooperation through the formation of a Global Forum on steel excess capacity, to be facilitated by the OECD with the active participation of G20 members and interested OECD members. We look forward to a progress report on the efforts of the Global Forum to the relevant G20 ministers in 2017.”
No one should doubt that China will continue to produce steel to excess and dump it on world markets. It is China’s strategic objective to dominate global steel production and drive out competition. The G20 should have directly confronted the issue and named China as the primary culprit. As the US placed import duties on Chinese steel (is that anti-competitive, or responding to anti-competitive behaviour?) the majority of the western world has buckled and curtailed their own steel production. Here in Australia, we have virtually given up on steel production but we have benefited from the sustained demand by China for our iron ore and coking coal. The massive demand for our two largest exports did momentarily take us into a trade surplus in 2013, but last week’s June quarter GDP announcement reminded us how poor Australia’s overall trade position is.
While the annualised trade deficit run rate has improved from $35 billion to $25 billion over the last year, it resulted from weaker capital imports consistent with a sharp decline in private business capital investment. Much was made of the June economic growth figure (annualised +3.3%), but it was buoyed by a rise in expenditure by both Commonwealth and State Governments. Without Government investment, Australia’s total capital investment would be consistent with recession-type levels. Australian businesses are simply not investing and lower interest rates aren’t going to help.
The mining boom and bust
Figure 1. The mining boom and bust
Source. ABS
The retiring Governor of the RBA Glenn Stevens presided over a tumultuous ten year period. He was arguably a steady hand in a period that needed just that. But could he and the RBA have done more since the GFC to circumvent the massive build-up in Australia’s household debt?
Household finances
Figure 2. Household Finances (Per cent of after-tax household disposable income)
Source. ABS; RBA
It could be said that he was the right conservative governor for a crisis but the wrong governor for dealing with a world full of central bank manipulation. The RBA has certainly not tested policies or co-ordinated with the Commonwealth Government in dealing with currency manipulation or QE.
He was questioned by the AFR on monetary policy –  “I wonder if you can reflect on whether it’s really possible now to use monetary policy when you’ve got the rest of the world, among your peers, in a very unorthodox place with negative rates, quantitative easing, whatever else might be in the pipeline?”
“… It’s not that you slavishly have to do everything they do, but when the central banks are on a very strong course, you’re going to be affected, and you can try to chart your own course to a certain extent, but there’s a limit to how much you can do that, I think, realistically, in a world where capital is mobile. So that’s what we see. That doesn’t mean we’re completely impotent to do things for our own good, but it’s just you’re not an entirely independent agent either in that world.”
In our view, it has been the minimal intervention by the RBA into lending practices adopted by our banks and the allowance of non-resident investment in residential property that has led Australia into our greatest residential property bubble. Indeed, it will be the legacy of excessive household leverage and excessive residential property prices that will be reflected upon in future years when the GFC and the RBA response in its aftermath is reviewed by historians.
2016 Australian Property Price Index
Figure 3. 2016 Australian Property Price Index
Source. CoreLogic
On a more positive note, the steady hand of the Governor is reflected in his comments on the role of the RBA at the height of the GFC as international wholesale funding lines were being cut to our banks –
“I think the central bank’s job is to make sure the system has adequate liquidity, make sure that the players that are under more stress have a plan, whether that plan involves tapping our standard facilities, which – that’s what they’re there for – but you’ve got to have the appropriate collateral if you want to do that”.
The RBA did well to keep Australian banks liquid during the GFC and ensured that both Bankwest and St George Banks were “absorbed” by other market players before their issues became serious. However, the AFR interview does show that the RBA has consistently denied there is an issue with household debt in spite of it being the highest in the world when measured against household income. The RBA also refrains from taking responsibility for inflated residential property markets which have pushed affordability (based on income ratios) to the lowest levels in decades.