By David Prattent

MarketWatch is in the process of watching one of those historical dramas that British programme makers are so good at.  Life, he reflected, was far less complicated then.  If you wanted to convey a decision, you wrote to someone.  They would read it and write back to you.  The process could take weeks, even months.  Crises could take place at a comfortable pace, allowing for decent breaks for meals and perhaps a small glass of red.  Now, one tweet, and its goodbye to the world as we knew it.

Australia is doing reasonably well on this front although sometimes politicians behave as if they actually want a crisis.  We have just signed up to the Regional Comprehensive Economic Partnership along with 14 other countries in the Indo-Pacific region, including China but, unfortunately, not India, which may or may not join later.  This is getting a lot of hype but, as with all trade agreements, the proof will not be available for a few years.  China and Australia have started being nice to each other again which is a good thing.  Our ability to have working relations simultaneously with both the US and China is always going to be a balancing act.  Domestically, retail sales are going at a pace that makes snails look like Usain Bolt lookalikes.  Resource exports are growing but consumer confidence is at a 5-year low.  Interestingly, the Australian dollar movements and the yield curve (remember the yield curve?) are behaving as if a recovery is on the way.

Last month, we looked briefly at the somewhat limited options available to get growth going.  At the heart of it is whether we rely on monetary policy or fiscal policy.  But what does this actually mean?

At this point, as he sips on his red, MarketWatch must apologise for teaching some of you to suck eggs, but it is important to get back to basics.

Monetary policy is managed by the Reserve Bank.  In its most basic form, it is the setting of the interest or cash rate.  The RBA have a target to keep inflation in a range of 2-3 percent.  The principle involved here is a little bit of inflation encourages growth in prices and wages and the economy goes at a steady pace.  The interest rate is used to deter (high rate) or encourage spending (low rate).

Fiscal policy is managed by the government of the day.  It involves two key activities; government spending and tax policy.  The theory here is that, for example, a reduction in tax rates encourages consumers to spend and companies to hire.

These two aspects of economic management have served the world well for a couple of centuries or so.  But following the Global Financial Crisis (‘GFC’), something broke, and nobody is quite sure why.  As we have noted before, interest rates are at record lows.  Consumer spending is sluggish, wage growth is low and inflation is running at an annualised 1.7%, below the RBA target.

And there is a catch with very low interest rates.  While they theoretically help with consumption and investment, they also encourage debt accumulation which can cause later pain.  And savers, particularly retirees on fixed incomes, also suffer.

Given that interest rates are at an all time low, is there anything left that the Reserve Bank can do?  Yes, there are two or three things, which are not new, and are in place elsewhere.  None of them seem to be a magic bullet but they may well be here to stay.

The first is negative interest rates.  This is a weird concept which, in essence, says if you borrow money, instead of paying interest, the lender pays you to borrow.  There is such enthusiasm for this that there is now US$17 trillion (yes, folks, trillion) worth of debt around the world which is earning a negative return.

Negative rates theoretically weaken a currency because it makes investment a less attractive proposition.  If you put the boot on the other foot, and think back to when we talked about bond yields, negative rates mean that if I buy government bonds as an investment, I have to pay the government to hold them instead of earning money.  The government is the borrower and I am the lender.

But a weaker currency makes you more competitive internationally which is good for farming and resources, but not flash if you are importing.  And as we don’t manufacture much, it pushes up the cost of imports and dampens consumer expenditure.

And if you think low interest rates hurt savers, then check this out.  Germany’s second largest bank, the Berliner Volksbank , recently announced it was passing on negative rates to some of its retail customers.

Its hardly surprising the RBA is unenthusiastic about negative rates.  But, realistically, even if you lose a bit more off your savings, they are probably safer in a bank than anywhere else.

MarketWatch is not sure how we can unwind ourselves from this position.  In the long run negative rates cannot be sustainable, but they have 17 trillion supporters right now.

The second option is to try “quantative easing” (‘QE’) aka “unconventional monetary policy”.  God, it sounds sexy and technical but it is also quite a simple principle.  As we know, as the yield on bonds goes up, so does the demand to buy them.  A central bank sets out to buy back as many bonds as possible. It’s a simple supply-demand issue; if demand is high prices tend to go down, if supply is low, prices tend to rise.  By increasing demand for bonds by buying them a bank hopes to drive down the bond yield to the point that commercial banks find lending a more lucrative pastime.

Effectively, the bank has printed money to buy the bonds.  The money does not go directly to the economy where it could have some unwanted effects such as hyperinflation.  It just offset the buying activity and enabled other banks to re-purpose money they already had.

During the GFC our Reserve Bank was more direct and offered banks really cheap loans to encourage them to lend to businesses.  This a just variation on a theme.  Another one is to print money and send out cheques to taxpayers.  Although the recent tax distribution using this method was not for this reason, it is pretty clear that highly indebted households take the opportunity to pay down debt rather than spend so may not be a good option.

The third way rejoices in the title of “jawboning”.  Basically, the Reserve Bank would provide a constant stream of what are known as “forward guidances”.  Probably the most dramatic example of this is to look at how the head of the European Central Bank acted a few years ago when, as part of his regular guidance speech, he stated that the Bank would do “whatever it takes” to manage the euro crisis.  Those three words boosted confidence and started the recovery of the euro.

QE, however, is not for the faint-hearted for if you go down this path, you are telling the world you are in trouble.

Getting everything moving again is proving to be difficult and will will continue to be so.  In his next piece Marketwatch will look at where we are a month on and whether fiscal policy might help.

But, in the meantime, to comfort himself, MarketWatch has turned to an oldie but a goodie. The Pepperjack Shiraz is a reasonably-priced drop from the Barossa that, like all the others from this range, is amazingly consistent.  If you can get the 2014, it is really good. But the 2016 is very drinkable too.

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