How Much Lowe(r) Can He Take Interest Rates?

Girl counting Australian money

The first bogey month for the share market — September — has passed without too much fuss. The market’s done nothing spectacular either up or down.

Will October — the infamous month of the 1929 crash and Black Monday in 1987 — be a little more volatile?


Markets are a long way out on the valuation limb. When you’re perched that high in a tree on a bending branch, any slip in the economic data, or nervousness over the solvencies of banks can give you sweaty palms — and an elevated heart rate. We’ll see if October is the month when the shout of ‘Timberrr!’ is heard all around the world.

What we do know for certain is that, on the first Tuesday in October, our new Reserve Bank Governor, Dr Philip Lowe, will decide whether to turn the interest rate thumb screws (again) on Australian savers and retirees.

If you take Dr Lowe at face value, then rates are likely to be kept on hold, not just in October, but in November as well…and every other month of his tenure, too.

In his first public appearance since taking up the governor’s position last week, Dr Lowe told the House of Representatives economics committee that although the Reserve Bank could lower interest rates if needed, it did not want to follow other major central banks in cutting them all the way to zero. “There are better ways to stimulate the economy than to set the interest rate at zero or below zero,” he said.

Dr Lowe said continuous cuts to the level of interest rates were becoming less effective in stimulating growth. “You can keep doing more of something in the hope that it finally works, and my judgment is that that has not been particularly useful,” he said.

The Australian, 23 September 2016

That last sentence is Dr Lowe channelling Einstein’s definition of insanity — doing the same thing and expecting different results.

These central bankers are quick learners…it’s only taken eight years of low interest rates in the Northern Hemisphere to work out that — ‘duh…they don’t work’.

But, in spite of this apparent and belated Road to Damascus moment, my money (which is in cash, literally) is on Dr Lowe going lower…much lower.

Dr Lowe(r) is not going to fulfil this prediction on Tuesday. Rates will be kept on hold…for now.

Why will Dr Lowe(r) eventually take rates to a level that starts with a handle of ‘0.’?

Because central bankers do not have a wide range of tools in their toolbox.

If all you own is an (interest rate) hammer, then everything you see is a nail.

The ‘global economy is slowing’ nail pops up. Bang. Hit it with the hammer. Tap it down 0.25%.

‘Retail spending is weak’ nail inches above the floorboards. Whack. Down you go another 0.25%.

‘Housing market is in a slump’ nail rears its head. I think we’ll need a hole punch for this one boys…after all, drastic action is required to batten down the one pillar supporting the Australian economy. Drive it in harder with another 0.5% reduction.

‘Europe’s banking crisis creates turmoil in global markets completely’ nail flies out the window. Hey boys, tell Chris Hemsworth we need Thor’s Hammer for this one. There goes the remaining 0.5%.

A tap here, a full blooded swing there, and pretty soon we are at zero.

I understand that Dr Lowe(r) doesn’t want to use the hammer. He knows those nails go straight into the coffins of savers. But he has no choice.

The political and social pressure will be too great. Do something. Do anything. That’s why we pay you the big bucks. You have to fix the problems we created. Don’t just stand there and tell us you’re out of options…we know you have a hammer in that toolbox of yours.

And so he will take rates lower, much lower. Not next week, but in the coming months and years.


Deflation is crushing in and it is not relenting. It is a superbug that’s proven to be immune to the inflation-boosting cures of QE and zero-bound interest rates.

This week, Newsweek (27 September 2016) published an article on the World Trade Organization’s (WTO) warning of a slowdown in global trade:

The World Trade Organization (WTO) has reported a “dramatic” global trade slowdown, warning that “anti-globalization sentiment” had the potential to damage the world economy.

World trade will grow more slowly than expected in 2016, expanding by just 1.7 percent, well below the April forecast of 2.8 percent, according to the latest WTO estimates.

The WTO has also revised down its forecast for 2017, with trade now expected to grow between 1.8 percent and 3.1 percent, down from 3.6 percent previously.

With expected global GDP growth of 2.2 percent in 2016, this year would mark the slowest pace of trade and output growth since the financial crisis of 2009, the WTO stated.

WTO Director-General Roberto Azevedo said: “The dramatic slowing of trade growth is serious and should serve as a wake-up call. It is particularly concerning in the context of growing anti-globalization sentiment.”

Couple of things before we get to the meat in this sandwich…

Firstly, the WTO, IMF, ECB, BoJ and any other ‘acronymed’ organisation are continually revising their growth rates lower. Newsflash boys: Ever heard of ‘under-promise and over-deliver’?

Secondly, the WTO partly blames the slowdown on populist politics.

Which looks to me like the establishment is saying: ‘How dare anyone upset the political status quo?’

Another newsflash: The rise in popul-ist politics is because the popul-ation is peed off. Rather than blame the cause, look at the symptom…which is deflation. Stagnant to falling wages. High unemployment and underemployment in the real world (as opposed to the phony numbers generated by some statistician’s employment modelling program). Retirees being forced to act with spending restraint due to zero returns on their savings. Too much cheap money has gone into building productive capacity for a world with falling demand.

Populist politics is a result of the growing disconnect being felt between the haves and the have-nots.

Anyway, the real number to take away from the WTO announcement is (emphasis mine): ‘Global GDP growth of 2.2 percent in 2016.

Personally, I think GDP should stand for Gross Distortion of Production. Including vast sums of credit in the calculation of economic output is a great con. The more borrowed money you put into the economy, the greater the quantity of GDP…but the quality is poor.

Let’s put that argument to one side and work with the official con-struct of global GDP.

Ever given much thought to where that 2.2% global growth comes from?

China — in round numbers — delivers consistent 7% GDP growth (if I recall rightly, Bernie Madoff operated on the same reliability principle). China’s economy represents 16% of the global economy. Simple maths of 7% x 16% = 1.1%.

Half the world’s GDP growth is coming from the ever reliable Chinese economy.

The remaining 84% of the world produces the other 1.1% of global GDP growth.

Do you think that, if China slowed down, the other 84% would take over the heavy lifting OR get caught in the downdraft?

Europe’s got nothing. The US keeps spluttering. Japan is in reverse gear. Take those heavy hitters out of the equation and there are only the economic rats and mice left to make up the remaining 84%.

Michael Pettis — a professor of finance at Guanghua School of Management at Peking University in Beijing — has a pretty good track record when it comes to forecasting on China and its impact on commodities and the global economy in general.

Go here to read his excellent blog.

In his latest post, ‘Does it matter if China cleans up its banks?’ he expects the debt burden in China will constrain economic growth:

I expect it to force economic activity to drop to less than half current levels well before the end of this decade.

If China’s growth slows by half — well before 2020 — then its contribution to global GDP will be around 0.5%. If, like me, you think the other 84% are going to be caught in China’s downdraft, then global GDP (even with the distortion of credit to boost the numbers) is going to struggle to move the needle above zero.

And as that reality starts to dawn, Dr Lowe(r) will reach into the RBA toolbox and grab the only tool in there that can start hitting those nails.


Vern Gowdie,
For The Daily Reckoning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.

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