Another Rate Cut Today Would Damage the RBA’s Credibility

Interest rates

The RBA meets today to decide whether they should make the price of credit even cheaper. Yesterday I wrote that the RBA should just sit on their hands. What’s another rate cut really going to achieve?

Today, the Financial Review’s editorial agrees:

Financial markets are punting that the Reserve Bank of Australia will reluctantly cut its already record low cash rate from 1.75 per cent to 1.5 per cent today. That would be a mistake. The economy may be running a bit below par. But that is not because of any lack of cheap finance: the cash rate has been 2.5 per cent or less for three years now. And the Reserve Bank was relatively upbeat about the economic outlook in its May monetary policy statement. Moreover, there is little prospect that cutting interest rates even further would stimulate any more economic activity – apart from inflating already overblown housing prices. Even looser monetary policy can be counterproductive, as Governor Glenn Stevens suggested in New York at the end of April. It might even dent business and consumer confidence by suggesting the need for extreme policy stimulus.

That’s spot on. The only reason for cutting rates today would be to try and put pressure on the currency. And that’s a battle the RBA shouldn’t even try to engage in. It’s not going to win. There are much bigger forces at play in the global currency wars.

A rate cut today would damage its credibility in a big way. Let’s see how smart (or clueless) our central bankers really are.

One man who understands the futility of relentlessly cutting interest rates is Satyajit Das. He’s one of the keynote speakers at our investment conference in Port Douglas in October.

Writing in the Financial Times today, Das lays bare the trap the central bankers have gotten themselves (and us) into. That is, low interest rates create enormous debt levels, which then require ongoing low interest rates to sustain these high debt levels in a bid to avoid default.

The global economy may now be trapped in a QE-forever cycle. A weak economy forces policymakers to implement expansionary fiscal measures and QE.

If the economy responds, then increased economic activity and the side-effects of QE encourage a withdrawal of the stimulus. Higher interest rates slow the economy and trigger financial crises, setting off a new round of the cycle.

If the economy does not respond or external shocks occur, then there is pressure for additional stimuli, as policymakers seek to maintain control. All the while, debt levels continue to increase, making the position ever more intractable as the Japanese experience illustrates.

This is exactly what has been happening over the past few years. The truth of the matter is that we are caught in a trap. Central bankers know it. They just can’t admit it. So, instead, they maintain the charade…they keep telling us things are getting better and that interest rates are in the process of returning to normal.

Do not believe it, dear reader. We are no closer to interest rate normalisation now than we were in 2010, when Ben Bernanke first raised the issue. You cannot ‘normalise’ interest rates when the global debt-to-GDP ratio is 300%.

As Das points out in his article, at such debt levels, a 2% interest rate means the economy must grow at a nominal rate of 6% to pay the interest bill.

We are now in a situation where a great deal of the productive capacity of the global economy is going towards servicing debt…debt created, I should add, to supposedly improve the productive capacity of the economy!

When you stop listening to the daily blabber of the business media, and you sit back and see things for what they really are, you can see what a farcical situation we are in.

Yet no one in any position of authority wants to tell it like it is. And as I keep saying, there will be no genuine recovery until we get a genuine crisis.


Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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