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Reserve has to bank on more than good luck

| 24.01,12. 01:17 AM |


Reserve has to bank on more than good luck

January 24, 2012

As the world of commerce again threatens to unravel with the Greeks dressing up for the latest instalment of their tragedy, most of us have been too busy to notice, firing up the barbie in preparation for this year's

As we are constantly reminded, we have every reason to be smug, so why not indulge in a bit of jingoistic flag waving? Our economy is still growing. Our national debt is low. And our Reserve Bank has plenty of ammunition in the tank should it need to cut interest rates.

Those three things combined make us a rarity in the developed world, and a good reason as to why Australia still has a AAA credit rating.
But if ever there was proof that economics, dismal as it may be, is an evolving science, it is the manner in which the whims and fears of those controlling global capital flows could be jeopardising our ability to manage our future.
For our good luck trinity is being countermanded by a triad of opposing forces that this year will weigh heavily on the Reserve
Bank and its ability to kick life into the economy through looser monetary policy.
Our dollar, once among the most volatile of global currencies, obstinately refuses to give ground. Our banks have made it clear they will act independently of any moves in official interest rate. And our federal government has steadfastly refused to countenance anything other than a tight fiscal stance so that it can deliver a budget surplus.
Those three factors could force the Reserve Bank to cut rates far more aggressively than it ordinarily would have in the past, should the need for economic stimulus arise. That effectively diminishes the amount of ammunition our central bank has in the locker.
Ever since the Aussie dollar was floated in 1983, it has assumed the role as principle shock absorber between the domestic economy and the globe.
Strong global growth meant higher commodity prices, and punters would pile on board pushing the Aussie higher. The first whiff of trouble and there would be a stampede for the parachutes. In the dark days of 2008, it plumbed US60¢.
That gyrating currency enabled rapid adjustment. A weaker dollar would lift the competitiveness of domestic industries, instantly make our exports cheaper and lift export revenues in local dollars.

During any kind of downturn, it gave domestic producers a quick kick along at the expense of consumers who could no longer afford vastly more expensive imports.
The opposite was true during strong growth periods.
In the past 18 months, however, the Aussie dollar has refused to buckle. In the final quarter of last year, commodity prices for both our main export industries - minerals and for rural goods - fell sharply.
Iron ore and coal prices fell about 25 per cent between September and the end of the year while wheat prices dropped by about the same.
The Australian dollar, however, has resolutely stuck to near-record levels. It dropped well below parity in late September and early October when the firestorm raging across the European Union sent global markets into a tizz. Even then, though, it resisted falling any further than US92¢.
But it now has regained its composure, settling just under $US1.05. At the same time, it has surged against the value of the Euro and Sterling despite ever more dire warnings from organisations such as the World Bank and the International Monetary Fund.
To some extent, the currency stability could be explained by Australia being one of the few developed nations to retain a AAA credit rating and because of our exposure to China, giving us a defacto ''safe haven'' status.
Another reason for this new found stability is the amount of capital being imported into the country to expand mining projects; decisions that were given the green light when it appeared the global economy had seen the worst of the crisis.
Whatever the reason, the lack of currency flexibility certainly increases pressure on the Reserve Bank. Rather than tinker with rates with the fine-tuning knob, it may well need to adopt a far heavier hand if it is to force a readjustment in capital flows.
But then we come to the problem of whether or not our banks will pass on any full cut.
Since 2008, the big four banks have taken every opportunity possible to plump up their lending margins, first by refusing to pass on cuts in full, then by piling on super rate rises and now again by threatening to retain all or some of the official cuts.
The Reserve Bank has attempted to dismiss the idea that commercial banks are undermining its authority and its ability to manage the economy with one official recently arguing the central bank, aware of commercial bank behaviour, takes those factors into account.
The only way to compensate, however, would be to make a bigger cut than needed to enable the banks to keep a slice, so that the desired cut can be passed through to the general economy.
The official interest rate now sits at 4.25 per cent. While that is higher than is the case with the vast bulk of other developed nations, given these renewed pressures, it may not be as comfortable a margin as we would like to believe.
To cap all this off, the federal government has committed to running a budget surplus, a gesture that is a tilt towards appeasing political ideologues rather than good economic management.

If the global economy really
does begin to unravel this year,
the fiscal and monetary policy should be working in unison, not counter to one another.


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