QED

Today’s Economics vs. Common Sense

The Reserve Bank (RBA) reduced the cash rate to one percent on July 2. The cash rate, for those who don’t know, is the rate at which banks borrow from and lend to each other overnight. What has that to do with interest rates which apply more generally in the market place. ‘It depends’ is the answer.

It depends on banks having a captive market of depositors and acting collegiately (a kinder word than collusively) to raise or lower rates. So, when the RBA lowers the cash rate, which has nothing directly to do with funding costs, banks all dutifully act together to lower their deposit rates and, lo and behold, their funding costs fall. Stuff depositors. Political pressure, and the costs they face in raising funds other than through deposits, then determines the degree to which their lending rates move in sync with the cash rate.

When interest rates are bought down depositors suffer – particularly those with limited savings and those in retirement who are understandably reluctant to risk their capital and, potentially, end up aging on Queer Street. However, depositors have little political clout. Borrowers get the attention. And among borrowers, by political consensus, first homebuyers form an especially needworthy class.

Lowering interest rates has an economic rationale. The theory is that economic activity will be stimulated, unemployment will fall and wages rise. So, depositors suffer for the greater good.

Economics is complicated. It’s like quantum theory. No-one knows really knows what’s going on.

Take one. I think I know that halving interest rates from ten to five 5 percent will tend to make worthwhile investment projects more bankable. Economic development will follow and more goods and services will be produced. But, remember that increases in investment must have counterpart in savings whether sourced domestically or from abroad. You can’t spend your time building a boat on a desert island unless you’ve saved some coconuts to eat or someone from a nearby island paddles across and lends you some.

Take two. I don’t know at all whether halving interest rates from two to one percent will make worthwhile investment projects more bankable. Is an investment which can only jump a one-percent interest-rate hurdle worthwhile? Probably not, I’d say. In any event, it seems unlikely that there are any material investment projects which have not already gone ahead when interest rates were just two percent. Hence, we have desperation among Europeans which has produced negative interest rates in some jurisdictions, in the forlorn hope that their economies will respond. They haven’t.

Never mind, theory continues to triumph over conflicting experience. Or, perhaps more to the point, it is now hard, to put it mildly, to wean bond and share markets off negligible to negative short-term interest rates. An apt enough analogy: it might have been best to get Uncle Bill off the turps before he became a chronic tosspot.

How do we bystanders put it into perspective? First and foremost, resort to common sense. Here’s a clue. Does what you earn and save contribute to your wealth or what you spend?

Understand the powers that be are all allegiant to a wrong-headed theory called Keynesianism. This is Philip Lowe, governor of the Reserve Bank, speaking on July 2 about the need to supplement monetary policy with other government action after the RBA had lowered the cash rate.

One option is fiscal support, including through spending on infrastructure. This spending adds to demand in the economy and – provided the right projects are selected – it also adds to the country’s productive capacity.

Leaving aside for the moment his comment on infrastructure, he notes the need for “fiscal support” which “adds to demand in the economy.”

This is from the RBA press release of July 2.

The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in growth in household disposable income is expected to support spending.

Economists in government service do not seem to understand that wealth comes only from what we produce, not from what we spend. Keynes gave emphasise to spending and demand in 1936 and his misguided legacy lives on in the minds of present day economic ‘experts’.

The world looks like a different, commonsensical, place when we ask this pertinent question: What are the conditions which will promote saving and productive investment and thereby make us rich? Just maybe those conditions are not untowardly-low interest rates which penalise saving and which do not properly distinguish between high-value investments and those able to scrape over a very low borrowing hurdle.

Finally, to infrastructure spending, which apparently everyone favours, including the RBA. Be wary when everyone favours something.

Infrastructure projects take a long time to plan and to build. They should never be used in an attempt to offset temporary (cyclical) weakness in the economy. Weakness in the economy is best tackled by removing artificial impediments to development and growth – like the vexatious delays to Adani and lumbering industry with increasingly costly power. Deregulation of commodity, product and labour markets is the key to getting the best out of a nation’s resources

Infrastructure projects do not belong to a single class. Some, partly or wholly, will directly pay for themselves by the application of usage fees – like airports and ports and some major road and rail links. Others add might bring an indirect economic benefit – like improved suburban roads and bridges. Others simply add to general wellbeing – like public buildings and parks.

Overall, infrastructure spending usually results in a large charge on the budget. The only way to pay for that is to get the private sector to make, and go on making, more and more goods and services. Making not spending makes us rich and also able to pay additional taxes for infrastructure. For that we need patriotic capitalism freed from the dead hands of governments, from environmentalists and from union leaders stuck in cloth-cap days of yore. Most of all we need economic experts who understand that and preach it.

12 comments
  • Bill Martin

    The content and tone of this very informative article reminds me once again just how fortunate the Americans are to have Donald Trump as their president. Such a shame that there is no-one remotely like him available to us.

  • en passant

    Peter,
    In the 1970’s I saw the light sufficiently early that I never finished my degree in Economics. I got through the early sensible stuff and economic history (which I enjoyed), but when we got to macroeconomic alchemy, economic rationalism dreamtime astrology (thanks to the Marxists of the London School of Economics) and econometric horrorscopes, I rebelled.
    My essay on macroeconomics parodied globalism by suggesting that as Oz was not the best at anything (except sport) and as everyone else could make, do and produce things cheaper than we could we had no right to exist. It did not go down well, but I got a “C” for ‘original thought’ – which bemused me even more.
    I have kept my essay on ‘economic rationalism’ called ‘Kill All the Whales’ on the grounds that this would be the rational thing to do as it would increase the stocks of krill, we could then harvest it to stave off Ehrlich’s ‘Population Bomb’ famine for a few years. My Tutor wrote “But what about the ethical aspects and social responsibility?” to which I wrote back “What’s that got to do with economic rationality?” He could not figure out if I was a rabid fascist or a rabid socialist, when in fact I was just being an anarchist because that was more fun and drove him crazy. I was eventually told NOT TO READ anything other than the authorised texts. So much for free thought and new ideas at a university …

    Econometrics was the final straw as it could not predict the past, but was supposedly able to predict the future with absolute certainty (provided all the inputs and assumptions were correct) and then explain with absolute confidence why every prediction was wrong because of [insert here up to ten items].

    Economics was not ‘the dismal science’ it was reputed to be: it was not a science at all, but a priesthood of the ignorant reciting incantations couched in such obscure terms that the random result of whatever actually happened was claimed to be what had been predicted. Sounds like Michael Mann’s Magical Mystery Mathematics of the climate hoax Hockey Stick exposed by Ross McKittrick.

    Now you know where all the current crop of climate pseudo-scientists learned their fraudulent techniques …

    Much better to read Adam Smith, David Hume, Hayek, Ayn Rand (600 of the 800 pages are boring), Dilbert, Alex and my radical essay the Giffen Effect has on fish farming. The last essay is truly gripping stuff and all you will ever need to know about economics.

  • Biggles

    I have never understood why ‘economists’ who have any regard for the prosperity of their fellow men continue to believe in and promote discredited Keynesian theory in view of his following statement; ‘By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of its citizens’.

  • Bwana Neusi

    The economist’s favourite statement is “On the one hand “X” = “Y’, but on the other hand….”
    Then they qualify any statement with “All other things being equal (which they never are)”

  • Bwana Neusi

    Governments on the other hand (see that qualification again) figure that if you create demand and supply in equal amounts, ie build School halls or other infrastructure, that mythical factor called the “Multiplier effect”will take care of the rest.

  • Alice Thermopolis

    An economist colleague once said that economics was about as much use as the white cane used by a blind person, of either gender, attempting to cross a busy street in peak-hour traffic, ceteris paribus,

  • ianl

    Keynes simply cloaked the Robin Hood myth in language impenetrable to the greater mass of people, thus allowing it a modicum of priestliness.

    Social engineers cling to Keynesianism because taking other people’s money is much easier than increasing productivity – and emotionally much more satisfying for the beast of envy.

  • Nezysquared

    Peter – might have been more informative for some if you had included the broken window fallacy….

  • STJOHNOFGRAFTON

    I am one of the growing number of Queer Street residents of low political clout. I use my hard-earned savings, earning a lousy one per cent interest rate, to help the banking industry fund low interest rate housing loans to borrowers on Struggle Street. But then, why bellyache. I should be grateful that I help keep the economy afloat.

  • Necessityofchoice

    This question is the crux of the matter.
    ‘Does what you earn and save contribute to your wealth or what you spend?’
    If your answer to wealth accumulation is anything other than earn and save, you obviously identify with the Govee, for whom assets are acquired by Taxing , Borrowing and then Spending. Given this, the slight of hand that sees Govt expenditures included in the measurement of GDP renders it a misleading farce.

  • Alice Thermopolis

    No surprise that an economist – whose theories urged more and more government spending – would consider the gold standard to be a barbarous relic.

    There’s another reason. When Britain returned to it in 1925, it did so at too high a rate. British goods became uncompetitive abroad and caused a domestic financial crisis. There were speculative attacks on the pound. They eventually forced it off the gold standard on September 19, 1931. Keynes celebrated the event in a radio broadcast:

    “It is a wonderful thing for our businessmen, our manufacturers and our unemployed to taste hope again. But they must not allow anyone to put them back in the gold cage, where they have been pining their hearts out all these years.”

    He probably had a glass or two of French champagne that evening with his wife, the Russian ballerina Lydia Lopokova.

    That said, it may well be time to “GO FOR GOLD”, given central banks have debased fiat currency to a “worthless” (zero interest rate) token, much to the delight of fans of crypto-currency.

  • Louis Cook

    Permit me to control the money of a nation and I care not who makes the Laws – author unknown but it is clear BIG FINANCE is above government. So much for democracy!

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