Today is a day where we talk all things central banks.
Well, at least about all things from our central bank.
We can save the diving into what the others are doing for another day.
You see, earlier this week the November minutes from the Reserve Bank of Australia (RBA) were released, and analysts have been poring over them to get some insight as to what might happen next…
Frankly, I’m less interested in what may come next.
Rather, what their most recent actions mean for you…
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The double whammy of never-evers
November was the month the RBA devolved into ‘never-ever’ territory…again.
When I say never-ever, I mean that a couple of years ago there was much rhetoric around how rates would go up before they’d go down.
That quantitative easing (QE) in Australia was highly unlikely. Something for other central bankers to dabble with. But not us.
All the things the RBA said they’d never do…they went and did.
Now, now, there’s no need to come to their defence (we try to avoid that for central bankers). Yes, this has been an unprecedented year. But they started playing limbo with rates last year.
And an eon ago, back in March this year, QE went from never-ever to on the table.
Lo and behold, that is what November gave us.
The RBA kicked the cash rate down from 0.15% to 0.10% (the first time ever rates haven’t moved in a 0.25% lot), and then they introduced the $100 billion bond-buying program (that’s the QE part).
It was this double whammy of the never-ever-will-we that brought all the analysts to the yard.
While the QE was widely expected in October, bean counters and finance types wanted to know — what comes next?
What could possibly be in store for us now that the central bank has gone and done the unthinkable things?
If reading RBA minutes is your jam, November’s release is a long one.
There are plenty of takeaways to chew on. There’s a handful of comments about the economic recovery in China. Just two days ago RBA governor Philip Lowe said we need to play nice with the Middle Kingdom in order to support our own economic recovery. In other words, we need someone to buy our rocks…
There are a few comments on the very high savings rate and lack of spending. The RBA appeared to be baffled about why people would hoard money in uncertainty. Simply blaming the reduction in consumption on a lack of ‘opportunities’ to spend.
I’ll bet there are a dozen PhDs in that room and they still can’t grasp the basics of how unpredictable outcomes cause people to hold onto cash.
A study from 1996 concluded — based on data going all the way back to 1968 — the more uncertain the future, the less likely people will spend money.
The fall in consumption, the high savings rate, and the enormous draw down in businesses’ lines of credit, is something we’ll tackle next week.
Because right now, we need to talk about the unintended consequences of what that new low interest rate means for us.
The path to poverty if you don’t have debt
Here is something that goes against almost everything the headlines tell us: Low rates are bad for us, but good for you.
Overall, ridiculously low rates devalue the worth of the fiat dollars the government issues. Low rates are stimulatory in the fact that you are encouraged to spend more before they become worthless.
Of course, for inflation to take hold, the velocity of money needs to increase (that’s the speed at which money is being used). The velocity of money relies on people spending. Something central bankers struggle to force.
But there’s a preserve effect of next to nothing interest rates that needs to be discussed.
And that is, they discourage lending.
Simply put, an interest rate is what a bank receives as the return on investment for lending out cash. And that interest — in normal times — moves up and down to reflect the underlying risk of the loan.
The problem is — while banks do set their own margin on top of the cash rate — the next to nothing low rate for loans, is a disincentive for taking on riskier loans.
In the RBA’s minutes, they trumpeted ‘Australian banks’ funding costs at historically low levels and had supported the availability of credit to households and businesses.’
But that only works if the banks want to lend.
Low rates are good for people who already have a loan, but a disaster for people who don’t.
People who have a loan that moves with the cash rate eat into the ‘principle’ more quickly because they are paying off less interest.
Plus, if you’ve already got a mortgage, your credit worthiness is proven.
And the insipid nature of debt is once you’ve proven to be good at paying it back, they’ll continue to lend more to you. Think about it. How often have you received an offer to increase your credit card limit? Or a higher mortgage redraw amount…
People who don’t have a loan, however, will find that any savings they have stashed away isn’t ‘growing’ because of the lack of interest being earnt at the bank.
But more to the point, without higher interest rates the banks are far less willing to increase leading to risky parties. Basically, the interest you pay is their reward for taking on riskier levels of debt.
If that reward is gone, why would they lend to people or companies who are unlikely to pay it all back?
This is how low rates actually ‘lock-up’ capital. The risk-reward trade-off banks use to incentivise them to create loans is gone.
The thing is, our economy relies on the expansion of credit to grow. The lower rates are likely to have the opposite impact on the expansion of credit.
What does the RBA do? Force banks to lend to anyone over 18 with a heartbeat? Or this is where the Australian government steps in, and starts some sort of guarantee to loans?
I guess we’re about to find out…
Until next time,
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Shae Russell,
Editor, The Daily Reckoning Australia
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