Wednesday, September 15, 2004

At any rate, we're on borrowed time

There's a real economic debate taking place in Australia, and there's a fake one, concocted for the sake of the election.

The fake debate concerns interest rates. You can sample it on the National Party website. There you are asked to key in the size of your home loan and are rewarded with a box outlining your likely repayments under three scenarios.

They were: "Coalition 7 per cent", "Labor 10 per cent" and "Labor 12 per cent".

The Nationals are honest enough to admit that these scenarios "should not be used as a substitute for professional financial advice". Too right. But why have they been used at all? In part because, like all good fables, the myth that the Labor Party inevitably brings with it higher interest rates contains within it an element of historical truth.

In November 1989, in a last, desperate bid to rein in what he felt was runaway spending, the then treasurer, Labor's Paul Keating, personally oversaw a hike in the cash rate to 18 per cent. His principal adviser said later he could hear the economy snap. Australia slid into recession. Banks and financial institutions collapsed.

In making that sort of decision Keating wasn't alone. In 1960 the Liberal prime minister, Robert Menzies, and his treasurer, Harold Holt, imposed a disastrous credit squeeze; in 1973 Labor's Gough Whitlam and his treasurer, Frank Crean, did the same; and in 1982 Liberal Malcolm Fraser and his then treasurer, John Howard, pushed up money market rates to a peak of more than 20 per cent ahead of the recession of that year.

But Keating was the last political leader able to do so. In January 1990 the Reserve Bank grabbed control of the process and never handed it back. It took a decision to cut interest rates and issued a press release in its own name saying so. It has decided on and announced every adjustment since. The Treasurer, Peter Costello, granted it formal independence with an exchange of letters in 1996.

As it happens, the Reserve Bank's decisions have been kind to the Coalition... In the final years of the Keating government the Reserve's then governor, Bernie Fraser, increased interest rates and kept them high to squeeze out inflation. He began cutting rates within months of Howard taking office. As the Macquarie Bank's Rory Robertson puts it, Howard had low inflation and low interest rates handed to him on a platter. Robertson asks: "Wasn't it Woody Allen who said 80 per cent of success in life is just showing up?"

Put five economists together and the odds are that none of them will be able to think of a likely scenario under which the Reserve would be forced to push rates higher under a Labor government than under the Coalition. Labor's $3.5 billion family and tax centrepiece is hardly inflationary. It is funded by 18 separate savings measures. And while Labor's industrial relations policy will increase the bargaining power of some workers, wage explosions are a thing of the past in the Western world. There is too much competition from China and India.

In any event, mortgage rates in the teens are unlikely in the years ahead precisely because we have got used to single-digit rates. They have helped double the price we are prepared to pay for houses. Reserve Bank figures show the typical mortgagee now devotes more of his or her income to mortgage payments than was the case when rates were at their highest at the end of the 1980s. (Memo to John Howard: remember that the next time you are about to claim, as you did on Sunday night, that paying off a home is easier now than it would have been had the old rates remained.)

The increased difficulty of meeting mortgage payments means that Australians are now very sensitive to even a small lift in interest rates. If the Reserve Bank wanted to cause us real pain, it wouldn't need to push rates much higher to achieve it.

Which brings us to the real economic debate, unmentioned in the campaign. The big shift in house prices has been devastating for Australians not yet in their own homes. It has slashed the value of their lifetime earnings.

But it's made the larger number of us who own or who are buying our homes feel suddenly wealthy - consumer confidence is near an all-time high - and act wealthy - 60 per cent of us now say it's a good time to buy a household appliance.

And we don't need to wait until we have earned the money. Refinancing allows us to dig into the equity in our homes and spend more than we earn.

Australian households have been spending more than they have earned for the past two years. The household saving rate is minus 3.2 per cent. Compare that with the crazy days of the late 1980s when the Coalition was driving "debt trucks" and issuing dire warnings about us living beyond our means. Then the household savings rate was positive - 8 to 10 per cent. We can't and won't go on forever spending money we are not earning. When we fall to earth we are likely to get hurt.

The Treasury warned in its pre-election statement on Friday that our rising household debt made us more vulnerable to shocks.

It's the real economic debate that we're unlikely to hear much more of until the election is out of the way.