The rate increase this week in Australia may have been presented as evidence that the Australian economy is picking up but for me it was anything but.
I am not normally a fan of using rates to control economic activity but on this occasion it was only partly about the economics narrowly defined and a good deal more about providing a warning to the loose fiscal cannons in charge of managing our economy. The rate increase could not have come soon enough to suit me.
Do I know why the RBA raised rates? No. Am I privy to the discussions of the RBA Board? No again. But I do know this. I do know why I would have raised rates, and would keep on raising them until the Government gets the message. That I do know.
The data below are from the most recent set of National Accounts. The data, which I discussed in my previous posting, show the level of National Net Saving and the Saving Ratio. Both are at extraordinarily low levels.
The figures make it unmistakeable that there has been a collapse in the level of national savings available to all users across the economy. These are investable funds that are potentially available for those who would wish to increase our capital base by borrowing the incomes earned by others for use in projects of their own. The funds available have not only cascaded downwards, falling by half over the past year, but the rate of decline has even been accelerating.
This is an outcome that would worry any central banker worth his salt. Depleting our savings in such a savage way will have left us even less able to regenerate growth than we were twelve months before when the stimulus spending began.
Parenthetically, it might be noted that the only justification for a Keynesian stimulus – at least if there were any consistency between the Keynesian models that are taught and the policies everyone is attempting to pursue – is that there are unused saving that need to be soaked up in higher levels of public spending.
Saving in a Keynesian model creates damage because it reduces the level of spending. Since in a Keynesian model we can’t count on investment rising to fill the expenditure void created by our savings, it is the government which must come to the rescue to spend our way to prosperity. It is increased public expenditure and higher deficits that move the economy out of recession.
Well, how much nonsense is that! The government, rather than deploying savings no one else is willing to spend, is spending our savings before anyone else has a chance to get at these savings themselves.
There is then the savings ratio, which the ABS defines as “the ratio of national net saving to national net disposable income.” The data show that in the latest quarter, the ratio has not just fallen, it has become negative. Individuals in aggregate are taking money from their savings and using it to pay the bills. Expenditures are rising faster than disposable incomes.
That interest rates must rise in such circumstances is beyond question. They will rise with or without the RBA, and in fact, aside from mortgage rates, already have. Partly the interest rate number has gone up, and partly there has been a restriction on the availability of credit. But up interest rates have gone and for good reason. The RBA is mostly just catching up with the market.
There are then the data from the RBA showing the growth rate in Business Credit between March and August this year. No economy entering a serious growth phase has numbers anything like that.
In the last month for which there are data, in August 2009, there was again a fall in business credit and over the year the level of business credit has fallen by 2.2%.
This is almost the classic case of crowding out. Others are getting to these funds sooner and more cheaply than business. Government spending has replaced business spending. The government stimulus is thus not only wasteful almost down to the last dollar spent, but is preventing the private sector from having access to the funds it needs to invest and employ.
The political side to the rise in interest rates therefore strikes me as a warning shot across the bow of the government. It is a statement from someone worried about the way in which we are ploughing our productive potential into the ground with the certainty that in a year or two we will have an immense debt and nothing to show for it.
Raising rates may begin the process of sobering up those who have been wasting our resources hand over fist and remind them that there is a price to pay and the debt is starting to be called in now.
And let me add one last point. It is said that the rise in interest rates is working in the opposite direction from the increases in public spending. Higher rates will slow the economy while higher public spending will increase it. There is therefore an inconsistency and contradiction in public policy.
This would be true only if there actually were some kind of stimulating effect of higher public spending. Since such spending is a negative, since it only acts to weaken an economy and slow it down, there is nothing whatsoever contradictory about using higher rates of interest as public spending goes up.
I am, in fact, inferring the highest motives to the Governor of the RBA who may himself actually see only negative implications in the stimulus and is trying to get the government firstly to stop spending, and then, if possible, to roll back what planned levels of spending has not yet taken place.
But as for this rise in rates being a contradiction, there is none at all. Savings are being plundered by the government, and if we are going to find our way to a genuine recovery, the government’s hands must first be pried off the savings of the nation. A really sharp rap on the knuckles may be the only way.
Dr. Steven Kates
for The Daily Reckoning Australia