I expect–and hope–that the tenor of discussion at this month’s RBA Board meeting will be very different to last month’s. In August, I imagine, the community members of the Board listened sagely as the RBA’s economists explained why the risk of future inflation had risen, why this justified a “pre-emptive strike” of raising interest rates, and then reluctantly agreed to the rise.
I hope that this month’s discussion is more along the lines of “if you guys are the money experts, how come you didn’t see it coming?”–it, of course, being the unfolding collapse of the US housing market, and the resulting extreme turmoil on financial markets.
That turmoil had begun before last month’s meeting. No doubt, Board fears about its potential impact on Australia were assuaged:
- by reference to FRB Chairman Bernanke’s assurances that losses in the US subprime mortgage market would be in the relatively trivial range of “in the order of between $50 billion and $100 billion” (Reuters);
- by the assurance that the exposure of Australia’s financial institutions to US subprime loans was limited; and
- by the observation that lending practices in Australia were far superior to those in the USA–with subprime lending accounting for 13 percent of US loans versus 1 percent for the equivalent Australian classification of non-conforming loans.
That is all so last month now.
- Bernanke observed last week that “global financial losses have far exceeded even the most pessimistic projections of credit losses on those loans”.
- Several Australian financial institutions and funds have folded, and quite a few more are facing the need to increase their rates above the 0.25% increase mandated by the rise in the cash rate; and
- If Australian lending practices are so much more prudent than those in the USA, how come household debt has risen more than three times faster in Australia than in the USA? (see Chart 1) And why can Australian households cope with an aggregate level of debt service that, clearly, American households can’t handle? (see Chart 2; but also see my closing note below)
Note: I’m having trouble uploading charts, but they are available in the PDF document that is accessible from the Debtwatch Reports page.
Chart 1: Household Debt vs GDP, USA and Australia
Chart 2: Interest Payments vs Household Income, USA and Australia
One explanation that I don’t expect the RBA’s economists will give the Board is possibly the most important: its economic models consider neither credit conditions, nor debt, nor even money itself. As a result, its technical advisors don’t even pay attention to the key variables that brought us the subprime crisis in the first place.
In this, they are no different to the vast majority of economists, who share, as Federal Reserve Governor Bernanke and Board member Mishkin once put it:
“the widespread acceptance of the view that there is no long-run tradeoff between output (or unemployment) and inflation, so that monetary policy affects only prices in the long run” (Bernanke and Mishkin, 1997, “Inflation Targeting: A New Framework for Monetary Policy?”, Journal of Economic Perspectives 11, pp. 97–116)
As a consequence, most economists omit money, credit, debt and the like from their economic models–because they don’t believe that they have any impact on the economy (apart from causing inflation).
As the subprime financial crisis spreads, I expect that Bernanke and Mishkin will look back on this statement as so much naive wishful thinking. Hopefully, the RBA’s economists will do likewise. In the meantime, they–and the RBA Board, having agreed to a rate rise at the last meeting–must now be wondering how long it will be before this “unanticipated monetary shock” forces them to consider lowering rates to avoid an even more serious economic downturn.
… And Deeper in Debt: Australia’s obsession with borrowed money
The Centre for Policy Development (www.cpd.org.au) will be launching mini-book by me with the above title on September 18, at the Sydney Mechanics School of Arts (280 Pitt Street) at 12pm. Please email the Centre (firstname.lastname@example.org) if you would like to attend, and/or reserve a copy of the report. Go to www.cpd.opg.au/events/…and-deeper-debt for more details.
This is an abbreviated Debtwatch, since I’m putting most of my energy into … And Deeper in Debt. My standard charts are appended below, but the majority of my analysis for this month will be reserved for that book.
While I play down the differences between Australia and the USA above, there are some aspects of the US market that do make it substantially worse than here–notably the practice of extending “teaser” loans to borrowers with initially low interest rates, where the gap between the initial and standard interest payments is added on to the principal. The “honeymoon” period on many of those loans expire in the next few months, and households who took them out will face the double whammy of increased debt and higher repayments.But Australian households are still under substantial debt-stress, and the recent blowout in personal debt may indicate that it is really starting to bite hard. Last month’s growth rate in personal debt was astronomical (see Chart 3), and it may be a sign that households are resorting to easily available credit-card debt to meet living expenses and still be able to pay the mortgage.
Chart 3: Monthly growth rates in types of debt