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Central Bank Governors Gone Wild: Don Brash Was Never Like This, Part II

Previously, we highlighted the unprecedented tightening in monetary conditions presided over by RBNZ Governor Bollard.  The RBNZ’s March Monetary Policy Statement has now ruled out any easing in official cash rate during 2006. 

This can be partly justified by an inflation target breach, but the RBNZ’s discussion of the inflation outlook has recently been dominated by its views on the housing sector and the supposedly ‘unsustainable’ domestic saving-investment and current account imbalance.  In the March MPS, Governor Bollard says ‘the other key inflation risk over the next two years remains the housing market.  We need to see this market continue to slow, so that consumption moderates and helps to reduce inflation pressures.’

Governor Bollard is implying that causality runs from housing to consumption to overall economic growth to inflation.  But if this causal reasoning is wrong, or even if there is bilateral causality between housing and activity more broadly, then the New Zealand economy is in serious trouble.  The risk is that by the time the housing market cracks, New Zealand will already be in recession, particularly given the slow transmission from changes in the official cash rate to effective mortgage interest rates in NZ.  Indeed, the yield curve inversion driven by RBNZ tightening is even facilitating longer-term fixed rate borrowing, while encouraging capital inflow that makes the current account deficit even worse.

Just like Australia in the early 1990s, the authorities will probably argue that any subsequent recession was necessary to correct these imbalances, substantiating their view about their ‘unsustainability.’  The real lesson from Australia’s experience in the late 1980s and early 1990s is that the monetary authority has no business targeting private saving-investment and current account imbalances or the housing market.

posted on 09 March 2006 by skirchner in Economics

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Australia’s dreadful current account deficit’s WILL have deleterious implications for this country’s exchange rate and economy. This implication comes from no lesser authority than Paul Volcker, Former Chairman of the US Federal Reserve, April 10, 2005.  Australia’s net foreign liability position per capita is much worse than the US, and our rate of debt accumulation is higher. Most importantly, we are NOT a reserve currency like the USD. This is what Volker said.

“Under the placid surface [of the economy], there are disturbing trends: huge imbalances, disequilibria, risks… call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot…The difficulty is that this seemingly comfortable pattern can’t go on indefinitely. I don’t know of any country that has managed to consume and invest 6 percent more than it produces for so long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars…I don’t know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.” - Paul Volcker, Former Chairman of the US Federal Reserve, April 10, 2005.

Given a decade of economic debt-consumption-agraryan led structural regression (ie real estate agents earning more that scientists and engineers; no 21st century industry development in Australia like other small countries, eg, Samsung, Acer or Nokia here, ‘we’ll just dig up our FX out of the ground until it runs out and speculate the proceeds on quasi consumption items like housing…’ mentality…etc). And Australia is neither a military nor political superpower. Importantly, it is not a reserve currency. Just in case you don’t believe the Former Chairman, witness what Former US Treasury Secretary, Robert Rubin said (with 2 others) in a paper presented to the American Economic Association, January 2004.

“The traditional immunity of advanced countries like America to Third-World-style financial crises is not a birthright. Financial markets give us the benefit of the doubt only because they believe in our political maturity…in the willingness of our leaders to do what is necessary to rein in deficits, paying a political cost if necessary. And in the past that has been justified. Even Ronald Reagan raised taxes when the budget deficit soared. If this kind of fecklessness goes on, investors will eventually conclude that America has turned into a third world country, and start to treat it like one. And the results for the U.S. economy won’t be pretty.” - Robert Rubin, Former US Treasury Secretary, in a paper written with 2 other authors presented to the American Economic Association, January 2004.

How direct and honest. I wonder if our policy amateurs pulling the levers would ever be as candid.

Still not convinced? Take a lead from the most successful investor in the world Warren Buffet, where he shifted billions out of the US because of the impending adjustment of the US to the CAD disequilibria that Volcker referred.

[PS I tend to believe ‘insiders’ like Volker, Rubin and Buffett, who have held positions of unprecendented power within the financial markets, who understand the disruption of market priciples by fiat biased central banks (eg witness the creation of Greenspans Plunge Protection Team after the failure of LTCM. Why do taxpayers have suffer the added taxation of hedonic manipualations and ‘core’ inflation. Why is the US Fed monetarizing massive debt through the repo desk, injecting unprecedented liquidity, to sustain the paper wealth illusion of overvalued stock/ asset markets. Why do free markets need such manipulations?

Answer, just read what the maestro George Soros has to say about the unsustainability of financial markets. Since he made over a billion pounds in just one day arbitraging against the Bank of England, I think he knows a thing or two.]


Craig Stevens ACT   0428 351 308

Posted by .(JavaScript must be enabled to view this email address)  on  03/11  at  01:00 PM


It is interesting that people argue both that Australia and NZ are too small and vulnerable to run such large current account deficits; and that the US is too big and important as a provider of a ‘reserve’ currency to do so!

Posted by skirchner  on  03/11  at  01:58 PM



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