Saturday, January 26, 2008

Saturday Forum: Making sense of this week

Just when it looked as if everything that could go wrong had gone wrong this week along came a rogue trader who cost Societe General more than $8 billion – the biggest loss in banking history.

It was that sort of week.

By Tuesday the worldwide share rout had cut 23 per cent off the value of Australian shares from their November peak.

It didn’t seem to matter that many of the companies whose shares were being sold were extraordinarily profitable or that Australians were handing money to them hand over fist.

The inflation data released on Wednesday showed that the price charged for clothing had actually increased in the three months to December despite movements in the dollar making clothes much cheaper to import.

If was as if we had stopped caring about prices...

In just the last twelve months Australians have bought more than one million new cars (1,050,000 according to the figures released on Thursday) and a hard-to-credit nine million mobile phones.

They are extraordinary totals for a nation of 21 million people – totals that make Wednesday’s sharp jump in inflation look unsurprising (and make the Coalition’s election slogan ‘Go for Growth’ look plain silly).

The recklessness with which we’ve been spending our money has pushed our inflation rate to a 16-year high –well beyond the Reserve Bank’s target band - and seems set to push it higher.

Chris Richardson of Access Economics said this week the figures were “ugly” and that the Reserve Bank would have no choice but to push up interest rates – for the third time in six months – to bring them down.

But the Reserve Bank board always has a choice and right now it is probably glad that it doesn’t have to make a decision until its next scheduled meeting, due in ten days time.

As things were looking at the start of the week it probably wouldn’t have hiked: Australian and world stock markets were in free-fall, in our case for the twelfth consecutive day.

The global freefall matters for rates because it could be signaling a worldwide economic downturn, which would pretty quickly cut the amount of money Australians have to spend.

The Australian freefall matters because it is making Australians less wealthy. Someone whose wealth has been cut by 10 to 20 per cent is likely to spend less.

And as even high-flyers like the man who last year organised a takeover bid for Qantas, David Coe this week, a falling share market can rob you of your money instantly. Like many Australians he had borrowed heavily to buy shares. When the share price of his company Allco Finance started to tank his lenders demanded an instant top up of his collateral. The only way he could raise the cash was to sell many of the shares, pushing their price down further still.

It’s a scene that’s been repeated over and over again this week. Toward the end of each day thousands of Australians have been receiving phone calls or text messages demanding that they top up their collateral.

Those people are likely to be suddenly less free to splash around their cash. Their enforced sudden restraint is likely to do much - perhaps all, perhaps too much - of the Reserve Bank’s work for it.

Or that’s how it seemed on Tuesday.

By Wednesday when the full ugliness of the inflation figures had become apparent it seemed as if the Reserve Bank would have to step in.

And it almost certainly will have to.

But when. One argument is that it doesn’t have to be at its first board meeting in 2008. The Bank is charged with controlling inflation in the medium-term, not immediately.

It has always had the discretion to exercise judgment in taking its decisions. That’s why it makes them rather than some sort of machine following an automatic rule.

Its board minutes show that it believed rates needed to be hiked in September but held off because of concern about a “protracted credit crisis around the world” which it felt would cut global economic growth by 2 percentage points and Australian non-farm economic growth by 1.5 percentage points.

It’s possible to argue that that has just happened and at least until the extent of the damage becomes clear it should do nothing.

The counter argument is that if it waits for another month and then another month it will have done nothing. If it thinks it will need to push up rates, it may as well do it.

The previous Reserve Bank Governor Ian Macfarlane described his decision-making process at these moments this way in an interview with the ABC’s Maxine McKew shortly after he left the job.

“Mentally what you have to be doing all the time is saying to yourself: when I look back in two years time, what can be the biggest mistake that I can identify being made now, and try and avoid that mistake.”

What would be the biggest mistake right now? Its hard to say, but by the end of the week raising looked less risky than it had.

The Australian share market bounced back 4 per cent on Wednesday, 3 per cent on Thursday and 5 per cent on Friday, undoing a fair chunk of its 23 per cent slide.

And on Friday came news from China that its economy was still growing very strongly - by 11.4 per cent throughout 2007. While its export income was decelerating, spending by its own citizens was accelerating. It looked as if it would be bidding up the price of Australian iron, coal and gas for some time to come.

The Australian government is doubtless happy to leave these dilemmas to the Bank. It means The Bank will get blamed for whatever it does rather than our elected leaders.