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Federal Politics

How funny money takes our mickey

Federal Politics Political Opinion
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Opinion

Peter Hartcher

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The scissorhands budget

How Wayne Swan's federal budget announcement will play out according to cartoonist Bruce Petty.

PT1M0S http://www.canberratimes.com.au/action/externalEmbeddedPlayer?id=d-1eg88 620 349

Visit the nationaltimes.com.au from 7.30pm for Budget 2011 analysis

We humans are a slow-learning species. In the 1980s we blew up what was then the world's second-biggest economy, Japan, with loose money. In the 2000s, we blew up the biggest economy, the US, with loose money.

Not content with that, in 2008 we went on to blow up the economy of most of the world. How? With loose money. Any intelligent species would learn from this experience. But look around.

x

Illustration: Rocco Fazzari.

The economies that account for 96 per cent of the world economy are today running loose money policies. Most are happily handing out free money. Some are supplying money at rates so low that it's actually cheaper than free.

It's done for good cause. When money is cheap, people are more inclined to invest or spend. So it aids economic recovery. The former chief of the US Federal Reserve, Alan Greenspan, was named as Time magazine's person of the year in 1999 for his ready resort to loose money.

But if there is too much for too long, it ends badly. Exactly a decade later, Time named Greenspan as No. 3 on its list of "25 People to Blame for the Financial Crisis". And I think they let him off lightly.

chart

The evidence of the past three decades should be enough, but you can go back further. In fact, every major financial crisis in the four centuries of capitalism has had its origins in loose money.

How does it work? It's simple commonsense. The basis for value is scarcity. If scarcity is destroyed, so is value. And when money loses its value, it is abused.

Human societies have always abused commodities when they're provided too cheaply or free - free fresh water, for example - and money is no different. The loose money creates a "bubble" in asset prices, which ultimately collapses, dragging the economy into a recession, or worse.

The lyrics change from one episode to the next, but the song remains the same.

This time, it's happening in so many countries that it's much easier to list the countries where it's not happening. Brazil and Australia are the only economies of any reasonable size where money is not loose.

The standout champion of loose money in the world today is the US. For 2½ years now, the US Federal Reserve has been supplying money to America's banks at an official interest rate of 0-0.25 per cent a year.

Inflation in America is running at 2 to 3 per cent. So, in real terms, the American central bank is lending at an interest rate of minus 2-3 per cent. It is, in effect, subsidising the banks to borrow money.

The US is debasing its currency so effectively that the US dollar has fallen by 14 per cent in the past year, as measured by the Fed's major currencies index. But China doesn't want to lose export competitiveness to the US, so it has maintained its peg to the dollar. This means that China's renminbi is also depreciating in real terms against its other trading partners. So the US and Chinese currencies are debasing in tandem.

In the meantime, the central banks of the EU and Japan are handing out money cheaper than free. In sum, almost the entire world has gone monetarily mad. And the cheap money is forming a bubble in the price of commodities.

Central bankers in many countries are quietly worried about this. Each thinks that his bank alone cannot make any difference. So they leave their interest rates low. Yet their collective inaction guarantees that they are all facing a problem of growing inflation and a dangerous bubble in commodity prices. This is the same problem, the "prisoner's dilemma", that we see in the case of carbon emissions.

What can Australia do? The Reserve Bank is one of the very few central banks which is not running loose money, so it's not part of the problem. But the Australian government has a key part to play.

It's prudent for Australia to assume that the floodtide of global liquidity will eventually generate a crisis. Time magazine has already named Greenspan's successor, Ben Bernanke, as its person of the year, in 2009. We cannot pick the date of the next crisis, and it is probably years away, but we can identify the trend. And prepare.

When the global financial crisis rocked the world, the key to Australia's relative immunity was that we went into the crisis with zero federal government debt. This was Peter Costello's gift to the nation.

It allowed the Rudd-Gillard-Swan government to launch two stimulus packages without any danger to Australia's rolled-gold credit rating. It's now time for the Gillard-Swan government to roll back the debt and restore Australia's fiscal health.

Swan has been busy pointing out that his plan to return the budget to surplus by 2012-13 would be the fastest consolidation in federal finances in modern history. But as the accompanying chart shows, this is just as well. Because the run-up in Australia's debt was among the fastest in the world.

Australian government debt has risen by 250 per cent since 2007, in the comparison prepared by Ken Rogoff and Carmen Reinhart of the London-based Centre for Economic Policy Research. This is the biggest percentage increase of any ''non-crisis country'' and third only to two of the front-line "crisis countries", Iceland and Ireland. They have had to resort to emergency loans from the International Monetary Fund to stay solvent.

Among the nations classed as crisis countries - Iceland, Ireland, Spain, Britain, the US, Greece and Portugal - the average debt run-up was 136 per cent.

Australia was superfast in resorting to debt. It worked and we avoided a painful recession. But the government must now conduct a superfast rundown in debt. This is a prerequisite to brace Australia for the crisis to come.

Peter Hartcher is the Herald's international editor.

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107 comments

  • I agree in part - yes the govt had to stimulate the economy and yes it now has to reign it in but it should also look at other factors that lead to bubbles. Rewarding speculation over saving and investment in productive assets in the tax system is one area that is easily fixed with the stroke of a pen.

    Commenter
    Franky
    Location
    Sydney
    Date and time
    May 10, 2011, 7:34AM
  • Peter - sorry, I cannot see the chart online. But debt increased 250% from 2007? I thought government debt was 0 then? So 250% of 0 is.......0? Or was there some tiny amount of debt that increased 250%? 250% of $1 vs 136% of $100 ....hmmm, which would I prefer? Could we have some context in relation to GDP/person please? Thanks

    On the broader question - yes, the world is awash with money....unfortunately no-one is pulling out the super-soper. Better buy gold old son....

    Commenter
    Cabby
    Location
    Sydney
    Date and time
    May 10, 2011, 7:36AM
  • Its interesting to see the penny is now dropping with this issue, I seem to remember Barbaby Joyce being riddiculed acouple of years ago by many in the press for raising the exact same issue.
    I guess old Barnaby is smarter than is given credit for. I think you and your friends in the press gallery should appologise and going forward judge what is said not who is saying it, then perhaps we can have a balanced media. Fat chance I know..

    Commenter
    soap on arope
    Date and time
    May 10, 2011, 7:42AM
  • But a superfast recovery requires some bold, aggressive and unpopular budget decisions. Does anyone seriously believe that Swan and Gillard are capable of doing as much?

    The answer, unfortunately, is no.

    As another article in today's paper highlights, Gillard needs to "capture the political agenda" from Abbott - and making "tough" or unpopular decisions will not achieve this; rather they would hand the political agenda to Abbott on a plate.

    Instead we will see populace policies dressed up as being "tough", days of spin by the government to make out the populace policies truly are "tough", and perhaps even dragging out one or two tame union officials to claim the measures are "tough".

    Meanwhile the government will continue increasing spending, bumbling from crisis to crisis until the mid-term forecast revisoin is released when the house of cards will collapse.

    Commenter
    rob1966
    Location
    Sydney
    Date and time
    May 10, 2011, 8:04AM
  • We all know what needs to be done, but we also know that Labor governments only borrow money. They always leave it to the conservatives to pay it back. Swan's tough budget will be like being beaten up with a feather.

    Commenter
    DLS
    Date and time
    May 10, 2011, 8:07AM
  • As an economics writer, Peter Hartcher makes a great international editor. Perhaps leave the grown-up economics analysis to Gittins and Irvine and stick to writing Israeli apologias.

    The GFC was primarily caused by lax or non-existent regulation of financial institutions, not cheap money, and you should try reading some Paul Krugman (an actual Nobel prize winning economist) on the debunking of the link between interest rates and commodity prices. Commodity prices are being driven by real supply and demand forces, not anything to do with interest rate policies.

    Keeping interest rates low whilst there is significant growth and unemployment problems is the right policy if you actually care about the economy and the people who make it up. Raising interest rates will do nothing to solve the debt problem and would make it worse as it would kill any recovery.

    Commenter
    Simon
    Date and time
    May 10, 2011, 8:27AM
  • Excellent article Peter. I think the signs are there that the Developed World COULD enter a period of stagflation coupled with Hyperinflation. The remarks about the systematic depreciation of the US Dollar are warranted here, but we must also elude to the fact that this is predominately caused by quantitative easing. This is extremely inflationary in the long run and either the Developed World reduces this by constraining money supply and raising nominal interest rates or PRICES will Skyrocket. If you are to look at markets the increasing prices of precious metals like Gold and Silver are clear indicators in a lack of confidence in the FIAT money system. I'm not sure if Keynes was right in his assertions anymore.

    Commenter
    Jonas
    Location
    Sydney
    Date and time
    May 10, 2011, 8:34AM
  • So much missing from this article, Peter, and an indication as to why SMH journalism is in the dumps. What you propose is exactly what the government knows and is doing - bringing down debt. While the rise was huge at 250%, it was on top of a fairly low base relatively, and with the sure knowledge that Australia was better equipped than any other country to repay. Which the government is now doing, rapidly, necessarily and responsibly. Give credit where it is due. Criticize when it is due. Don't mix the two things up.

    Commenter
    Mike B
    Location
    Sydney
    Date and time
    May 10, 2011, 8:39AM
  • Agreed Peter but we wont be saving since we have people arguing for more spending and saying "What is the use of a surplus?". These people don't understand what a structural deficit is or what it leads to. I think that over the long economic cycle (that includes depressions) we should have at least neutral savings. This means that in non depression times we should be running a structural surplus. This should be the reason behind getting more people from welfare to work. Which improves the participation rate and eases the burden on the tax system making the load lighter for all of us. The social contract was and should be those that can work should work welfare is not a gift but a helping hand to get on track again if capable.

    Commenter
    bill
    Location
    sydney
    Date and time
    May 10, 2011, 8:41AM
  • Another $2billion in mental health policy announced today...
    So where are the cuts going to be? If I was the Swan, I'd keep some of the good news for tonight because it's going to be bad news for the public whether they announce big cuts to offset all this spending, or bad news for themselves if they don't announce any significant cuts.
    Screwed either way.

    Commenter
    amash
    Location
    St Peters
    Date and time
    May 10, 2011, 8:44AM

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