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It is a pretty sorry state
of affairs when economic commentators can write of consumer spending and debt
driving the economy without once referring to monetary policy. It is even
worse when the same commentators write about monetary policy without even alluding
to the money supply. This is akin to writing about botany without referring
to plants.
A typical approach used by
our commentators has "a consumer spending boom" operating in two
ways. First, money is borrowed to buy a house or a car, for example. The
seller then spends the money, the expenditure of which ripples through the
economy as each recipient spends in turn.
Second, one can borrow
against one's collateral, a house for instance. The borrowed money then
ripples through economy as it is spent. Judging the situation from this angle
commentators then write of a debt-driven boom. Sometimes even praising it as
helping to sustain a strong economy and stimulate jobs growth. Eventually the
spectre of higher interest rates appears to threaten this process, as is
happening now.
However, these Pollyannas have a simple (I should say simpleminded)
response. The Reserve won't raise rates to the point where they would burst
the debt bubble and cause a severe
downturn. The other argument is that so long as inflation appears confined to
the 2-3 per cent range there is no need to raise rates. What is that even if
the CPI is within the 2-3 per cent range a point will be reached when the
Reserve won't have a choice. Whether we have reached
that stage is for the Reserve to determine.
Let us now take a look at
these commentators' economic logic, according to which borrowing —
particularly by consumers — has been driving economic growth. If, for
example, I borrow $1000 dollars from my neighbour how can this act help expand
demand? A classical economist would be quick to point out that borrowing is a
process whereby purchasing power is temporarily transferred from one person
to another, thus leaving total spending unchanged.
Yet current crop of
commentators seriously argue that borrowing in itself expands demand. How can
this be? The answer is that these borrowed funds are not coming out of
savings but out of a rapidly expanding money supply. This is something
classical economists, at least the early ones, would have pinpointed. Central
banks believe that can use interest rate policy to control inflation and
economic growth by forcing down the "cost of capital". This is
sheer mercantilism and always ends in tears.
The immediate result of
forcing down rates is to expand the money supply which in turn stimulates
output. From March 1996 to January 2008 currency grew by 110.7 per cent, bank
deposits by 186 per cent and M1 by 169.2 per cent. This reckless expansion
borders on the criminal. Any old time economist would have had no difficulty
in relating our housing boom, current account deficit and foreign debt to the
Reserve's reckless monetary policy.
The massive increase in
bank deposits created a massive borrowing boom. Therefore it is not debt that
has been driving the boom but an unsustainable monetary policy for which we
can than Keynesianism.
The results
of this irresponsible monetary policy has been documented, though
barely understood. By March 2004, for example, debt levels had set a record
with household debt being more than 400 per cent its 1991 level. Furthermore,
real estate values nearly doubled in the four years to 2003. April 2003 to
April 2004 experienced the highest annual growth in household debt ever
recorded. Up to June 2004 year household debt was rising by 17 per cent a
year. These figures are a symptom of racing inflation and make a mockery of
the claim that the CPI was under control.
No wonder Reserve Bank
governor Ian Macfarlane expressed concern about the situation. Well,
notwithstanding the former governor's concern, the situation has only
worsened. Unfortunately, Glenn Stevens, the Reserve's current governor,
performance is on par with Macfarlane's sorry record. Ignoring the Reserve's
reckless monetary policy some commentators blame deregulation for the boom in
borrowing and real estate values, suggesting that the 1980s banking reforms
are the principal reason for the debt explosion. This is very bad economics.
There would be no debt problem if the debt had been funded by genuine savings
instead of monetary growth. (I should point out that this stage that savings
diverted to consumption become dissavings).
It has also been argued
that the debt problem cannot be completely laid at the banks' doors because since 1990 a great deal of debt comes from outside
the banking system. So what? If borrowing comes from individual savers then
it is not part of the problem. Nevertheless, when rates are raised these
borrowers would also feel financial pain: A fact that many borrowers have
recently become aware of.
In any case, this argument
overlooks the reality that currency has more than doubled during the last 14
years, which in itself is sufficient enough to expand the lending capacity of
non-banking financial institutions. Be that as it may, there should be no escaping
the fact the real problem is a dangerous lack of understanding of the nature
of money and the microeconomic consequences of monetary expansion. Until
greater monetary understanding is acquired, we can still expect the Reserve
to repeatedly issue vain warnings about the growth of household debt and the
need to curb it.
Gerard
Jackson
Brookesnews.com
Gerard
Jackson is Brookesnews Economics
Editor
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