The RBA Prepares to Defend Debt Bubble at All Costs

The Reserve Bank of Australia (RBA) has made clear that it has embraced a doctrine of ‘Keynesian bubble economics.’

Recently, the RBA released a significant amount of new information through:

• the RBA Board’s February 2019 Monetary Policy Decision;
• the RBA Governor’s 6 February 2019 address to the National Press Club;
• the RBA’s Official February 2019 Statement on Monetary Policy; and
• the minutes of the February 2019 Monetary Policy Meeting of the Reserve Bank Board

that provides insights as to their thinking regarding the Australian and global economy, the domestic banking system and future direction of domestic official interest rates.

Across these documents and speeches, the RBA continues to project a glowing picture of the Australian economy that is fundamentally strong with a reasonably robust rate of economic growth and low levels of unemployment and inflation (as measured by the Consumer Price Index).

The RBA also noted that the world economy is expected to experience robust economic growth over 2019 and 2020 although they note that there is a growing build-up of ‘downside risks’ that may disrupt the global economy.

These risks, according to the RBA, span a range of political tensions that include:

• trade tensions between China and the United States;
• BREXIT;
• the rise of western world populism (especially in Europe); and
• American nationalism.

What Happened to Australian and Global debt?

Shockingly, however, is the fact that nowhere in the RBA’s commentary was there any mention of the chronic structural economic imbalances that are clearly visible both in Australia and globally resulting from record levels of domestic and global debt.

The RBA made no mention of Australia’s current record levels of household and net foreign debt and their unprecedented nature [1], both in nominal terms as well as in relative terms whether measured relative to household disposable income or national income (i.e. Gross Domestic Product).

Nor did the RBA mention that global debt is at least $US 85 trillion higher than levels in October 2007, meaning that global debt stands in excess of $US 250 trillion, which is the largest level of global debt in world history.

This omission is materially significant because:

• at best, it suggests at least that they have a misguided economic view including the risks that may impact on the Australian economy; or
• at worst, the RBA is seeking to avoid responsibility for its role in the greatest build-up of domestic debt through ultraloose monetary policy and record low official interest rates as well as the inevitable consequences that are likely to result.

More Monetary Stimulus Coming

Nevertheless, the RBA Governor recently opened the door for official interest rates to go lower were the sustainability or serviceability of domestic or global debt to come into question if either:

• the collapsing housing market in Sydney or Melbourne impacts the real economy via lower consumer confidence, employment and income levels; or
• so-called international downside risks impact international financial markets, global economic growth and by consequence the Australian economy.

Thus, with official interest rates already at a record low of 1.5%, the RBA has effectively signalled that it is prepared to protect the domestic debt bubble from imploding through additional rounds of monetary stimulus.

How low is the RBA prepared to lower official interest rates remain unclear, however, Deputy RBA Governor Guy Debelle alarmingly indicated in December 2018 that the RBA stands ready to deploy quantitative easing for the first time in Australian history if required.

Moreover, the introduction, for the first time in Australia, of either zero or negative official interest rates cannot be ruled out, especially given the recent advocacy of negative interest rates by the International Monetary Fund [2].

RBA Defends the Banking System and the Quality of ASIC and APRA

Given the RBA’s commitment to preserving the debt bubble, it comes as no surprise that the RBA came to the recent defence of the main channel in which credit and debt is distributed throughout the Australian economy, the domestic banking system.

With respect to the Royal Commission into Banking Final Report (RC Report), the RBA Governor publicly praised the RC Report stating that it was ‘well balanced’ with appropriate reforms, despite the report receiving widespread criticism across a diverse set of domestic stakeholders.

As I have stated elsewhere  [3], the RC Report failed to address a series of fundamental issues in the banking industry that have played a major role in the build-up of domestic debt.

Moreover, from a macroeconomic perspective, the recommendations proposed in the RC Report does not:

• alter the flow of new credit in the economy, meaning that the debt bubble will continue to grow unabated;
• address the performance problems of the Australian Securities and Investments Commission and the Australian Prudential Regulatory Authority meaning that the risk of future lax regulatory enforcement and ongoing misconduct by the banks (including inappropriate approvals of mortgage and other debt products) remains significant;
• address the problem of ‘too big to fail’ institutions through structural separation, meaning that the Royal Commission has reinforced ‘moral hazard’ within Australia’s largest banks which in turn will likely result in banks taking greater risks in chasing profits (including ignoring legal obligations and community expectations) knowing that they are immune from market discipline.

RBA is Expecting Canberra Delivers a ‘Fiscal Response’

On the fiscal policy front, the RBA Governor has urged Federal Parliament to get the Government’s finances in order, given that, as claimed by the Governor, Australia will require a ‘fiscal response’ if an economic downturn were to eventuate.

It is clear that the RBA, as part of its national macroeconomic strategy, is fully anticipating that the Federal Government (irrespective if the Coalition or Labor is in power) will launch a major counter‑cyclical fiscal stimulus package, (similar to the Rudd Government in 2008), in the face of an economic or financial shock in order to:

• soften any fall in economic activity;
• prevent widespread business collapses or closures (especially institutions within the banking and finance industry);
• limit any rise in unemployment; and
• prevent any widespread systemic default of household and other debts.

However, the quantum of required government spending and on what will the money be spent on are details yet to be determined.

Such calls for fiscal stimulus are consistent with approaches that seek to prevent debt bubbles from collapsing by transferring private sector debt to the balance sheet of the public sector (i.e. socialising the losses from economic failures).

Such policy approaches are alarming given the implication that the long-term trajectory of Federal Government finances are larger deficits for longer periods of time and ultimately higher levels of public sector debt.

This ultimately does not bode well for the long-term sustainability of Australia’s public finances and therefore will have negative implications for domestic long-run economic growth.

Implications

There can be no doubt that the RBA’s core philosophical approach to economic policy is an embrace of ‘Keynesian bubble economics’.

The RBA will continue to simultaneously inflate the debt bubble for as long as possible, while seeking to avoid acknowledging that a domestic or global debt bubble exists.

By implication, the RBA will seek to avoid any responsibility for the economic and social consequences that are currently playing out in terms of significantly high levels of mortgage stress, rental stress and negative housing equity as well as the emotional stress that these forces are placing on Australian households.

Simultaneously, the RBA is currently preparing the ground for a new major wave of monetary and fiscal stimulus that will seek to prevent the debt bubble from fully imploding which historically has led to catastrophic economic depressions.

Australia’s economic and political establishment will continue to downplay the economic risks that monetary and fiscal policy stimulus measures will have on the medium to long term health of the Australian economy.

Economic history informs us that such approaches will eventually devastate the purchasing power of the Australian dollar and thus Australian living standards, especially for those Australians who have not taken up appropriate forms of monetary insurance.

[1] In September 2007, the then RBA Deputy Governor Ric Battelino stated publicly that debt throughout the Australian economy in 2007 was unprecedented in Australian history and the closest experience was the 1880s and 1920s, the two periods prior to when Australia experienced two economic depressions. See following link: http://www.abc.net.au/pm/content/2007/s2043185.htm

[2] https://blogs.imf.org/2019/02/05/cashing-in-how-to-make-negative-interest-rates-work/

[3] See my specific article on the Royal Commission Final Report: https://www.adamseconomics.com/articles/australia-needs-a-royal-commission-to-investigate-the-royal-commission