Logic fails money market
Illustration: Pat Campbell.
Wayne Swan and Penny Wong probably do not need more institutional enemies at the moment. But they might contemplate why everyone (including, usually, themselves) assumes that an independent Reserve Bank is a really good idea, both in theory and in practice.
One is continually being reminded that the RBA, and monetary policy, is a very poor lever with which to influence the economy, or even good government accounts.
The Reserve Bank's first remit - to fight inflation - is, generally, a very good idea, and the idea of having detached specialists, rather than politicians focused on short-term goals, to manage interest rates, exchange rates and other chores associated with central banking seems logical. But it is far from clear that politicians are less disinterested managers than captains of industry, academic economists or miners and retailers. Even more dubious is the idea that the bank has much influence either on the price of the dollar, or even the direction in which that price is travelling. If it did, it would be interesting to know whether it, presently, would prefer the price to be going up or down.
Although prices are, strictly, set by free markets, they are markets in which vital conditions - particularly with interest rates - are manipulated by the bank. Higher rates tend to bring in foreign money, and raise demand for the Australian dollar; lower rates tend to force the dollar down.
Alas, the relevant markets are not two dimensional, nor are conditions controlled only by (or even very much by) the Reserve Bank. The demand for Australian dollars is not only a function of Australian interest rates, but of the rates of other countries, the demand for Australian goods and services, the price others are prepared to pay for the dollar relative to their own conditions, and a host of other factors, many arcane, such as general business confidence here and in other places, rainfall, political and social conditions and even local public opinion polls.
It's a brave money market operator who can predict movements of the dollar in the short, the medium or the long term, even against an essential stability, or predictability, in Australian economic conditions. Nor, alas, is there anything much to suggest that the RBA, (or Treasury) is much better in predicting, or even in influencing desired outcomes. The price of the dollar is not only a judgment on us, but on everyone else as well.
The RBA's task is made all the more difficult because conditions are not the same around Australia. Once the RBA would manipulate the compulsory cash reserves held by trading banks to direct money in and out of housing, industry, agriculture, or even into different regions. It might do this at direct government prodding, or, sometimes, from its own judgments of what would help the economy, or help sop up real or potential inflation.
Now it is thought that markets will be more efficient and effective in distributing scarce resources such as money. Thus when there is a mining boom in Western Australia, with mounting employment shortages, but recessed conditions in Australia's south-eastern corners, the bank must generally make a single judgment about what is best, rather than create policies which have differential effects around the states, or the economy. If, despite this, government, state or federal, want to interfere with market distributions, they can always do so by fiscal means, leaving the bank to feel pure about its adherence to theory and freedom from crude politics.
As the RBA looks abroad, it sees a host of conflicting signs - about the state of the Chinese economy, about the problems of Europe, a shaky American economy, signs of sagging demand for some commodities, drought in the US, political instability in the Middle East and so on. It is not obvious what impact any event, or the set of them, will have on the value of the dollar. Here in Australia, most of the signs suggest a generally healthy economy overall, with full employment (if with very little labour mobility) but with very worrying local conditions, particularly in Victoria, Tasmania and South Australia. They have paid heavily for the high Australian dollar - with manufacturing, retail, and tourism particularly hard hit. Now, they might say, they are set to pay all over again, as the boom prosperity of mining contracts, and miners end up paying far less in super-profits taxes.
The big symbol of the problems at the moment is an Australian dollar valued at about $US1.05. It stays at or about this price even as there have been significant falls in the unit prices for key commodities, and, as a result in the trade-weighted index. The high dollar may be keeping the costs of imports - say the new Apple iPhone - cheaper than in some places, but is a significant reason for flat or recessed conditions in the most populous areas of Australia. It is certainly far more significant than the supposed impact of the carbon tax.
All things being equal - which is to say with the RBA's cash rate being pegged at 3.5 per cent - one might expect the dollar to be falling. It is not, despite the pressures on it. No doubt we look a safer home, at the moment, for money than Greece, or New York, or Beijing. Lowering rates might reduce the attractiveness of our dollar, but, even as other nations are seeking to stimulate their economies by effectively printing more banknotes or lowering their rates to zero, or less, it must be admitted that our present rates are low anyway.
One could, however, see politicians arguing for the logic of a dollar sitting at 80c. (Bob Katter, no doubt, would say 55c.) It would be a boon for miners - for many, in effect, restoring their incomes - and for farmers, in any event expecting a very good year because of low US production. It could restore government revenue, state and federal, and perhaps, by itself stimulate fresh rounds of investment, and, assuming there are workers to be found, in manufacturing industry.
It could also, of course, cause a big burst of inflation, though this is by no means inevitable. The RBA, for example, was able to restrain inflation through several decades of roller-coasting with the dollar, even as it seemed that there was no particularly rational reason for market fluctuations.
But that's the problem. Our dollar is worth what the world is prepared to pay for it. Adam Smith, no doubt, would explain that the price is the sum of several million individual explanations - some objective, some subjective, some logical, some sentimental, and some plain irrational - for buying or selling at particular prices. Right now our dollar is high because - as the government so often boasts - we are performing well compared with our competitors.
But there is no formula, and no particular equilibrium, that determines that today's value should be $US1.05, or $US.80 or $1.50, even if the local impact of such rates might be dramatically different. It's not even clear that we can talk our dollar down, or talk it up. And that may be not simply a matter of markets, but a function of the increasing irrelevance of governments, and, probably central banks, independent or otherwise, in setting prices for goods and services. Perhaps politicians should take more responsibility. How, after all, can it be said that the RBA is held to account?
Jack Waterford is Editor-at-Large.