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What Australia should fear most?

While most people in the world are scratching their heads in confusion and expressing their disgust at the election of Donald Trump as the next US president, there was one important issue raised during the campaign that received little attention and which has thus far been ignored.

Macroeconomics is not very sexy and not something one would associate with Donald Trump, but in an article in the Financial Times on 28th September 2016, the author, Judy Shelton, put the case that Trump had, “broken a cardinal rule in US presidential campaigning by openly questioning the effectiveness of the Federal Reserve.” 

Shelton reports that during one of the presidential debates, Trump suggested that the US Federal Reserve had been engaging in politics by suppressing US interest rates. The Fed had been “doing political things” with their interest rate policy and “creating a false economy.”

Trump’s comments were seen by right wing conservative economists as supportive of their claims that the Fed was conspiring against them, forcing them to take on riskier positions which, if rates were to rise, would cause their investments to fail.

It’s easy to see why such an issue would not gain traction with a media soaking up all the juicy titbits that were flying high during the campaign. But if true, the ramifications would have important consequences for the US economy and certainly go beyond the media’s interest in Trump’s more exciting personal life.

Trump’s comment is important because it raises the issue of future central bank independence. At the moment, sovereign currency issuing Governments impose, under political pressure, a series of voluntary restraints on their behaviour that mimic the actual restraints they faced when we had a convertible currency, i.e. before we abandoned the gold standard and floated our currency.

In short, it continues to issue debt to cover net spending. It’s all about fiscal discipline. They just don’t like thought of the central bank monetising the net spending. But in reality the so-called national debt, about which so much deceit is practiced, is no more than a voluntary restraint.

untitledBut if ‘The Donald’ feels that ‘The Fed’ is deliberately suppressing interest rates against the interests of Wall Street, i.e. the US Fed is not being independent of the politics of running the economy, he might move to limit its power by assuming greater control over monetary policy.

If Trump is able to grasp the power of a fiat currency, he could well envisage his popularity soaring if he were to bring an end to the escalating debt by firstly, instructing the Fed to stop issuing bonds and monetise deficit spending.

He could then go one step further and instruct the Fed to gradually absorb the $20 trillion-odd on issue (America’s national debt) and present himself as America’s “debt saviour.”

It would amount to no more than juggling a few accounts at the central bank and it would give him sufficient goodwill to appease Wall Street with a lift in interest rates.

He could then have the US Treasury assume much greater responsibility for monetary policy which, in a democracy, it should have anyway. It is high time our politicians faced up to their electors and called the shots, rather than appointing an unelected body to do their dirty work for them.

But, in the area of debt, they would face a new obstacle. The debt issuance (bond sales) is not used to fund deficit spending. It is a place for Wall Street to take out some insurance by buying government bonds. The bonds enable their money to be safely parked in a risk free environment, albeit low return investment portfolio.

So, the final act would then be to instruct the Fed to create a term deposit facility for the banks and bond buyers to park their reserves and be paid interest at a rate that would lessen the pressure on Wall Street to look at riskier investments; a win-win, so to speak.

interest-ratesBut here’s the kicker. If the US Treasury were to assume greater monetary control and the new US administration was more willing to offer Wall Street a higher return in a term deposit thus enabling investors to avoid meddling in riskier products, it’s not hard to see what an increase in interest rates would do to a mortgage belt still recovering from the GFC. This would have far more serious consequences for the Australian economy than it would for America.

An increase in rates in the US would see international bond buyers’ desert Australian bonds in favour of term deposits available in the US. Australian bonds have always been an attractive investment and this should not mean a rise in rates here, but our Treasury Department, fearing the worst, would feel obliged to react and raise its bond rates anyway.

A rise in the bond rate would give commercial banks an excuse to raise mortgage rates.

And here is the ticking time-bomb. A rate rise here that impacts on a mortgage belt that is already seriously over committed, would be disastrous for our economy. We already have a government hell bent on limiting spending, forcing the private sector to make up the difference by taking on more debt.

debtAdding yet more pressure with a rate rise would be, for many mortgagees, the straw that breaks the Camel’s back. With private debt currently at 180% of GDP, the pressure could be explosive.

Such are the possibilities of a Trump presidency. Doubtless, there will be many more. If he can see a way to broaden his popularity with the masses by eliminating the debt while at the same time appeasing Wall Street, it may be an opportunity too good to resist.

If you are a subscriber to the Financial Times, here is another recent article on the same subject entitled, “The end of the era of central bank independence”.

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17 comments

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  1. David

    Nice thoughts John, but you will remember that previous US Presidents have attempted to reign in the FED? The only one who survived the assassination was Andrew Jackson. Trump is smarter than people realize because he is not afraid of negotiating a deal. He will do what is best for Trump, which may turn out to be best for USA. Even President Reagan recognized Trump’s ability to wield power and presence when they met over 30 years ago.

  2. Jack Straw

    Let her ripp let her ripp I say! House prices in Australia are 45% overvalued as it is. We have allowed Residential Property to turn into a stock market type of investment. They go up and they go down.

  3. Sean Stinson

    Trump has been gunning for the Federal Reserve all through his campaign and before. Ironic tho isn’t it, that in doing what is basically a sensible thing, he could now crash Australia’s economy. I read somewhere that Trump is also a fan of Warren Mosler. A quick search on the terms Trump MMT turns up some interesting results.

    Interesting times.

  4. Sean Stinson

    @Jack Straw

    Absolutely agree. A house should be treated a consumer durable, not an investment asset.

  5. Harquebus

    Fiat currencies are proven failures. Only precious metals hold their value and deny governments from stealing our wealth by stealth.

    “By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner that not one man in a million can diagnose.” — John Maynard Keynes

    “This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.” — Alan Greenspan

    “If we went back on the gold standard and we adhered to the actual structure of the gold standard as it existed prior to 1913, we’d be fine. Remember that the period 1870 to 1913 was one of the most aggressive periods economically that we’ve had in the United States, and that was a golden period of the gold standard. I’m known as a gold bug and everyone laughs at me, but why do central banks own gold now?” — Allan Greenspan

    Still don’t get it do you John Kelly?

    Cheers.

  6. Ross

    It may be a little off topic but didn’t Costello try to pay off Australian government “debt” but was told by the bond market it would be a very bad idea and anyway it couldn’t/wouldn’t last for any length of time?
    I may wrong but didn’t it turn out they were correct, irrespective of what Costello claims?

  7. John Kelly

    Ross, not quite. After the net debt had been paid down, Costello didn’t want to have Treasury issue any more bonds. They convinced him that the bonds were necessary to control interest rates and so they were allowed to continue issuing them. That was the deception and Costello wasn’t smart enough to see that a term deposit facility would have been just as effective.

  8. John Kelly

    Harquebus, I have no problem with a return to the gold standard. I just don’t think it will ever happen while the neo-Libs are in control.

  9. Peter F

    Ross, the Khemlani affair, while totally mismanaged, was also aimed at ‘buying back the farm’. No wonder Gough had to be removed.

  10. Andreas Bimba

    The famous economist Steve Keen has publically announced that he expects the Australian property bubble to burst in the near future, probably this year and he made this announcement before Trumpet was elected. He said the same will happen in a few other overvalued property markets but that Australia was the worst or 2nd worst.

    Ongoing investment by Chinese investors into Australian property could I suppose keep inflating the bubble indefinitely but all the conditions are there for a crash.

    It would be a pity if more rational or looser macroeconomic policy is blamed for any crash and the MMT economists need to be ready for false blame being attributed to them for what is in reality a failure of monetarist neoliberal policy in allowing this mad speculation in a commodity called property.

    It is good that Trumpet is shaking things up and some good may come out of his Presidency but it is certain a lot of bad things like on fighting global warming will also arise.

    I think Trumpet’s team has seen some of Bernie Sanders good economic policies such as good macroeconomic policy (fiscal stimulus), spending on infrastructure and some trade protection to reduce off shoring and has now claimed them as his own.

    What a pity the corrupt Democratic Party blocked Bernie Sander’s presidential nomination.

  11. Kyran

    The ‘duck’ had another interesting foray into American bonds during the campaign, accusing China of using its investment in American bonds to artificially deflate the value of the yuan, giving China an ‘unfair advantage’ in terms of international trade. China held about one third of America’s bonds but have been selling ‘aggressively’ for the best part of two years now. Adding that dynamic into his comments about the independence of the Fed, if they increase the rates it would, presumably, enhance China’s ability to manipulate international currency rates.
    With regard to increased rates attracting investment from Wall Street away from ‘riskier investments’, I’m not so sure. Wall Street has been addicted to the ‘greed is good’ philosophy for decades now. Post GFC, they have become emboldened by the fact that they are too big to fail. A fact not only endorsed by government’s around the globe, but reinforced by statutes. The remedies we, the people, were promised, never eventuated.
    Stock markets have a closer resemblance to a casino than a place where stock’s are traded based on their worth. The use of computer systems that will react instantaneously to a share or currency move (up or down) by buying or selling without reference to any facts applicable to that share or currency has only heightened the systems weaknesses in terms of error and manipulation.
    Not satisfied with that little earner, they created a ‘futures market’. As best as I can tell, it’s a new form of gambling on what investors think a share may or may not do in the ensuing 24 hours.
    These ‘masters of the monetary universe’ are very conversant with MMT. It’s the mechanism whereby they get in the doo-doo and governments print money to get them out of it.
    The American government debt is a tad over $19 trillion and their GDP is about $18 trillion. The two areas the ‘duck’ wants to spend on are infrastructure and defence. As far as I can tell, he has not yet announced if this will be through bonds or money printing.
    The Australian situation has several differences worthy of mention. Our personal/private debt is, as you say 180% of GDP, far higher than America’s. As Mr Straw pointed out, we have property ‘overvaluations’ in the order of 40%. The problem is that that is currently occurring in Sydney and Melbourne. It previously happened in Perth, Darwin, Brisbane, and many regional areas, all of which were associated with the ‘mining boom’. The ‘bust’ has had some nasty casualties. Thankfully, not our banks. Notwithstanding APRA’s changes to liquidity requirements, they are increasing their provision for bad debts. All four major’s have taken big hits on their bottom lines to allow for the defaults largely associated with the ‘mining bust’. From the reading I have done on their ‘bad debt’ provisions, they all seem to be retrospective, accommodating the ‘mining bust’. We currently have about $32 billion in credit card debt. This is unsecured debt. After several decades involvement in debt collection and debt purchase, my observation is that banks normally bundle this debt and sell it at around 10% of face value. It’s normally ‘recovered’ at about 30 cents in the dollar. None of this is provisioned, from what I’ve read, in the banks P & L’s.
    That is only a minor part of the equation. Personal earnings are down, both in terms of hours worked and remuneration paid.
    Taking the American aspect out of the equation, we are in for a world of pain. If the Henry tax review had been adopted, we may have had a chance. Given the ensemble of clowns currently occupying the front benches, the situation will be exacerbated by their inadequacies.
    Apologies for the rant, Mr Kelly. My suspicion is that a lot of good people are going to get really hurt and the governments and corporations will walk away, whistling. Thanks for the read. Take care

  12. Andreas Bimba

    No more bank bailouts. Depositors can be compensated but not banks. Let market forces operate.

    State owned rural, sustainable development and housing loan banks should be created.

  13. Harquebus

    John Kelly
    I was all ready to have a big rant but, you just floored me.
    I wouldn’t bother with the standard and just go for the gold.
    Cheers.

  14. Kaye Lee

    Longtime Donald Trump supporter and activist investor Carl Icahn confirmed on Tuesday that the president-elect is looking at Wall Street veteran Steven Mnuchin as his choice for treasury secretary and billionaire Wilbur Ross for commerce secretary.

    “If Mnuchin is confirmed for the Treasury role, it could save him millions in taxes. A 1989 rule allows him to sell stock tax-free if he reinvests the proceeds in Treasuries or in government-approved funds. The loophole was designed for executives who need to sell shares to comply with conflict-of-interest rules.

    Mnuchin owns $97 million of CIT Group, according to a February ownership filing, the latest available. Because he received most of those shares when CIT purchased OneWest Bank in 2015, the exact cost basis that would be used to calculate his taxes isn’t immediately clear.

    Previous Treasury secretaries have taken advantage of the rule. Hank Paulson was eligible to save about $48 million on roughly $495 million of Goldman Sachs shares when he was nominated to run the department in 2006, the New York Times reported at the time.”

    http://www.bloomberg.com/politics/articles/2016-11-14/trump-advisers-said-to-recommend-mnuchin-for-treasury-secretary

  15. Matters Not

    Andreas Bimba re:

    famous economist Steve Keen

    For most followers of ‘current affairs’, Keen’s claim to fame is rooted in a very silly bet. Which he lost, in a blaze of publicity, followed by a very public humiliation. But like any good ‘publicist’ he ‘never let a chance go by’. Any publicity is good publicity seems to be his guiding principle. He is now overseas.

    Doomsayers like the economist Steve Keen mistakenly predicted a collapse in house prices – as much as 40 per cent – in 2010 and ended up famously losing a bet with the former Macquarie banker Rory Robertson. Keen’s penalty was walking up Mount Kosciuszko wearing a T-shirt saying he was “hopelessly wrong”.

    The grim prophecies have continued on, year after year. More often than not, these “experts” have a book to sell ..

    And Keen is still at it according to your post (and repeated elsewhere). When I read about Keen’s latest ‘doomsayer’ prediction I am reminded that for the last three decades or so ‘pundits’ here, there and everywhere have predicted a ‘recession this year’. Of course, they will eventually ‘jag’ a dire outcome. And in so doing, they will boast of their great foresight. Again, never let a chance go by.

    If I had followed the advice of all the ‘weeping prophets’ (Jeremiahs) over the years – and not invested – then I would be ill prepared to live through a recession which logically must come.

    In the last decade or so, I have listened carefully to the advice of an investment firm called ‘The Fat Prophets’. When they say – sell. I buy. When they advise – buy. I sell. (But this is just general advice – and not to be taken seriously.)

  16. Pingback: What Australia should fear most? | THE VIEW FROM MY GARDEN

  17. economicreform

    ” So, the final act would then be to instruct the Fed to create a term deposit facility for the banks and bond buyers to park their reserves and be paid interest at a rate that would lessen the pressure on Wall Street to look at riskier investments; a win-win, so to speak. “”

    John, Treasury securities (bonds and bills) may be thought of as a form of term deposit already. So, what is the difference? – JH

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