Rate Cut of 100 Basis Points Couldn’t Cheer Up the All Ords

Well well well. Not even a bonus rate cut of 100 basis points could cheer the All Ords up yesterday. There was red in nearly every sector of the market. Stocks rallied on Wall Street overnight. The futures are up 70 points ahead of the market opening. Looks like more green here in Australia.

The RBA wouldn't have been that fussed about the action in the stock market yesterday. It's got its eye on the Australian economy. The new cash rate of 4.25% is the lowest in seven years. And it could go lower. In its statement on monetary policy, the Bank said inflation wouldn't be much of a worry in 2009.

"Financial market sentiment remains fragile," Governor Glenn Stevens wrote, "as evidence accumulates of weak economic conditions in the major countries and a significant slowing in many emerging countries. Commodity prices have fallen further. This, combined with the likelihood of below-trend growth in the global economy, suggests that global inflation will moderate significantly in 2009."

If the RBA over-cooked things to the tight side in raising rates through 2007, you get the feeling they are making the same mistake on the loose side, and that it will lead to an unwelcome and massive rise in inflation in 2009, probably after the middle of the year. Central banks, like markets, tend to overshoot first and ask questions later. But please don't confuse Mr. Stevens with the head of catering on the Death Star.

Australian monetary policy is now in an "expansionary setting" according to the RBA's statement. Picture if you will, rolling hills at sunset, with fields of lush, deep, dark green grass. Row after row of trees line the horizon, heavily laden with green and gold notes. This, we suppose, is what an "expansionary setting" for monetary policy might look like.

But it's not as if the money is just there for the taking, is it? Homeowners with fixed rate loans must choose to refinance. And they have to get a loan from the bank. And we're not so sure the banks are going to sign off on big loans in 2009. You've already seen the hard ball the banks are playing with the miners.

Now there's this in today's Age, "ANZ has raised doubts about passing on further cash-rate cuts in full after warning that wholesale funding costs are likely to remain inflated in the medium term." ANZ and Westpac went ahead and passed on most of the RBA rate cut, but not all of it. And it raises an interesting problem.

For ANZ, there are two prices for money. There is the price it pays to borrow money in the "wholesale" market. This is the global capital market. And despite the laxative efforts of the Fed, global capital is not exactly free-flowing at the moment. That means ANZ continues to pay more to borrow globally than it is used to.

The second price of money is what you pay for it. ANZ has lowered that price. But you can see that if it's wholesale price of funds remains "elevated" that it faces a simple choice. It can pass on the full rate cut to consumers, continue to pay the wholesale price of funds, and take the hit on its profit margins as the spread widens. Or it can stiff the consumer and keep margins high. What do you think it will do?

Here we come back to a point made a few weeks ago, that successful businesses must, in the long-run, be run for the benefit of customers and not, say, the employees. The investment banking model admittedly challenged this thesis.

Investment banks existed primarily for the benefit of investment bankers, who hopefully, on the side, did a decent job of getting capital from the people that had it (the capitalists) to the people that could put it to its most productive use (entrepreneurs).

Somewhere along the way, the capital itself got hijacked by the investment bankers and money shufflers. They had a big party. And in the process, a whole generation of savings has gone down the economic toilet. Capital is now becoming scarcer and more expensive.

Also, we say "savings," but really the money lost is destroyed. You can't make up for that by creating new money. All this new spending is borrowed from future generations, who must now pay back the trillions of U.S. bonds sold to foreigners in order to finance Wall Street's capital destruction. It's a tax on the future and the unborn, and in moral terms, it's deeply disturbing.

But back to business. It turns out, then, that the interests of investment banks (and to some extent, retail banks) were not at all aligned with customers (or shareholders). Now, the banks are paying the price. And in a world where no one bank had a monopoly on printing money, these banks would be put out of business by sounder guardians of the currency. Competition for sound money would expose the counterfeiters.

But wait. Isn't the Fed a private bank? Why yes. Yes it is. And you can be sure the Fed is looking out for the interests of its member banks. In fact, according to Bloomberg, the Fed has just extended three of its lending programs designed to "ease credit conditions."

"The Federal Reserve extended the term of three emergency-loan programs to April 30 from January 30, aligning their expiration dates with other central bank efforts to mitigate the credit crisis. The Primary Dealer Credit Facility and Term Securities Lending Facility, created in March, and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, begun in September, were lengthened in light of continuing strains in financial markets."

This is what we meant by the development of a modern kind of feudalism. Indicted on the stage of history for gross mismanagement of paper money, the central banks know that ordinary people are losing confidence in their product (paper money). Once the illusion of paper money is shattered, confidence goes too. It never recovers.

That's why the banksters are trying so hard to keep people from asking serious questions about the nature of our monetary system. They want you to go about your business, stay forever in debt, and send them interest payments for the rest of your life like a cubicle farm serf. That's no way to spend a life! More on life tomorrow.

Dan Denning
for The Daily Reckoning Australia

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