An unconventional RBA

Tuesday, September 10th, 2019

The Australian Financial Review reported last week that the Reserve Bank of Australia (RBA) deputy governor Guy Debelle had suggested it is possible that interest rates could fall to almost zero and the RBA may resort to unconventional stimulus measures in order to “achieve our objectives”.

Asked following a speech in Canberra how low the cash rate could potentially fall, Dr Debelle said international experience suggested it could ultimately drop to between zero and 0.5%.

“We’ve done a fair bit of thinking about that,” he said. “If you look at what happened in the US, Canada and the UK when they got down to their lows it was somewhere around about zero, a quarter, half a per cent. So, I think that gives us some sort of guide to what the equivalent might be here.”

Apart from this gem, there were two other media reports that particularly caught our attention last week. Both of which are examples of how crazy the analysis of financial markets has become.

First, there was a quote from a Japanese central bank policymaker, Mr. Hitoshi Suzuki, who seems to have invented a new term in monetary policy analysis. He contended that negative Japanese borrowing costs had not reached the “reversal rate” level. That is the point where negative interest rates reach “the level at which the demerits of low interest rates exceed the benefits”. He forms his view from the sanctity of the Japanese bureaucracy, as it would not be shared by someone who has retired and is living off their depleting savings.

The second report we sighted was a media commentary suggesting that the United States Secretary of the Treasury (Steven Mnuchin) had become emboldened by the failure (in his view) of the German Treasury to raise 2 billion euros of zero-coupon 30-year bonds. However, the Germans did manage to raise 824 million euros (equivalent to USD $0.95 billion) in this Harvey Norman type bond issue. Yes, no repayments and absolutely no interest till 2049!

Mnuchin suggested that the Germans had failed because there is a better yield to be had on US treasuries. The media now reports that the US Treasury was working on a secret plan to issue both 50 year and 100-year US bonds, so that President Trump can fund his US$1 trillion deficit with debt that will not be repaid. Well maybe in 100 years time!

With apologies to Alfred E Newman
 

What to make of this crazy world?

All the above and the constant craziness exhibited across Europe leads us to drift into a facetious view of a future RBA board meeting. We apologize if any reader or RBA director is offended.

Let’s begin …

Not that far in the future, at a place somewhere nearby, the RBA board will meet to review a most momentous proposal from its executives.

(The following may be a transcript of this historic RBA meeting.)

Chairman and Governor – “The next item on the agenda is a recommendation by the RBA executive to introduce a range of unconventional monetary policies. I propose to speak to this proposal in my position as Governor. The deputy governor and I will be pleased to take questions from Board Members.

I have circulated a paper titled “Proposed Unconventional Policy Settings” prior to this meeting. That paper outlines our (the RBA executive) conclusion that we must follow our international peers and trading partners. They have persistently undertaken policies involving quantitative easing or policies of intervening in money markets to reduce interest rates to or below zero.

The following table outlines the extent of negative interest rates across the world which have resulted from “unconventional” monetary policy settings.

You can see there is more RED than GREEN. That is more negative than positive interest rates.

We have extensively thought about and reviewed the policies of our central bank peers. Recently I joined many of them at Jackson Hole for a central banker conference which was titled “Unconventional Monetary Policy – it’s not that scary or strange”.

At that conference, it became both obvious and indeed a little embarrassing to note that the RBA stands out for adopting conventional rather than unconventional policies. It is our view that it is conventional policies that cause Australia to be regarded as less relevant than, say, Greece, Bulgaria or indeed Slovenia.

We have come to the view that it is essential that the RBA appeases market participants and adopts policies that are supportive of markets. We believe that unconventional policies are what market participants – particularly index bond managers – are seeking from us.

Bond managers will continue to buy hideously expensive and low yielding bonds if they are convinced that we will always bail them out. Look at the chart (on page 132 of your pack) to see how this works across the world.

Unconventional policies will ensure that our interest rates – whether on government borrowings, corporate debt or household mortgage debt – will decline to levels whereby the interest costs either become negligible or nonexistent.

A result of the absolute compression of market interest rates will be that market participants will fall into three categories. They will either pay back debt (even though there is no real incentive to do so), rollover existing debt at rates that will be historically low or nonexistent or borrow extensively and excessively for (we hope) productive rather than speculative purposes.

To confront debt, we propose to encourage more debt – but at no net cost to anyone who takes out that debt. Debt is therefore smothered.

We recommend the policy to the Board. We, therefore, seek your ratification of its implementation and the attached news release which has already been leaked to the Australian Financial Review.

Are there any questions from Board Members?

Board Member A – “Mr. Chairman and Governor, thank you for your paper and clarifying comments.

I do have a question, and it is this. I note the reference to “Unconventional Monetary Policy Settings” throughout your illuminating paper. However, it seems to me that what may have been unconventional some 8 or 10 years ago – for instance, quantitative easing, known as QE – has now become quite common or normal and thus may better be described as conventional. I wonder as to whether you would agree with my observation?

Chairman and Governor  “That is a very good question and observation. If anything keeps me awake at night, it is the definition of monetary policy.

I have contemplated exactly what you suggest, and I maintain that our proposal is not an adoption of conventional policy. Nor is it “normal” which in my view better describes a cycle on a washing machine.

No, I think it would be unconventional and particularly for us in Australia.”

Board Member A – “Thank you, Governor. But I would like a follow-up question if I may?

Whilst I take your point regarding washing machines, it seems to me that you are proposing that Australia adopts the same policies that have been adopted by virtually every other major central bank. They are policies promoted by all central bankers.

Therefore, are we adopting what could be described as a Jackson Hole convention?”

Chairman and Governor – “No, I think you are confusing convention with conventional.

I strongly recommend (if I may) that we maintain the use of the term “unconventional” because it has become well accepted and understood by market participants. It is a comforting description used for active monetary policy. A pivot in our terminology to “conventional” could cause market distress or price volatility.

I note that today’s leak to the AFR focused on the use of “unconventional monetary policy,” and I am pleased to advise that bond yields have crashed to zero, and the AUD has weakened against all major currencies.

It will be the consequences of these that should create a higher pulse beat for inflation which is one of the key focuses for the RBA executive team. As you know, a key KPI for the team is to create inflation between the range of 2% to 3%.

Any proposal to redraft our press release and to redact the use of unconventional and replace it with conventional is not supported.”

Board Member B – “Thank you, Governor. Whilst I, too, am a little perplexed by the terminology, my question has a different focus.

When I read through your proposal and background information, I could not find any evidence that the unconventional policies of QE or zero bound cash interest rates had achieved any positive economic outcome (for instance, accelerated economic growth) for those economies that adopted it.

Your proposal describes what has been done overseas, and suggests that we follow along the same path – seemingly based on hope rather than conviction. Am I correct or have I misread your analysis?

Chairman and Governor – “Unconventional monetary policy is still a work in progress.

Whether it be QE or zero-bound interest rates or 100-year bonds or currency printing or helicopter drops of money, it is neither a proven nor a disproven policy response.

It is our view that it is too early to tell if it, or any variation of it, will work. But it is better to be seen to be doing something rather than nothing.

Our primary concern is market sentiment, which sustains lower market price volatility. That is driven by the perception of us doing something rather than wild speculation that we are sitting on our hands.

It is our view that the alternative of doing nothing may not work as well. Whilst doing nothing and watching our interest rates and currency decline, (like they have done over the last year and under their own weight), may seem superficially attractive, we would caution against complacency.

Doing nothing will have unforeseen consequences and this Board needs to contemplate what they may be before dismissing unconventional monetary policy.”

The RBA duly lowered cash rates and commenced a bond-buying program and market participants rejoiced!
 

What would be a better unconventional policy?

It should be clear to the RBA that a QE program that focuses on buying Australian government bonds will reward bond owners for owning expensive bonds. The RBA would be paying a premium, above both the issue and redemption price, to bond owners, many of whom are foreign.

The Australian ten-year bond (for instance) has rallied to 0.9% yield and has done so without QE in Australia. Our bond yields have been driven by monetary policy madness adopted across the developed world. Interest rates in Australia are extremely low already, and lower rates will not benefit our economy. Further lower rates destroy savings and eventually the returns from pension funds.

If unconventional monetary policy is to be utilized in Australia, we should not be scared to create our own policies for our own benefit. As a great US President once said – “We must think anew and act anew”

Some policies worth contemplating include ensuring that our massive superannuation savings are utilized for our benefit and generate positive returns. We must ensure that our pension and super funds do not become underfunded, like pension funds across Europe and the US.

  1. Issue infrastructure bonds that can only be held by Australian residents or taxpayers. A premium yield can be paid because the interest flows back into the Australian economy;
  2. Use QE appropriately as a mechanism for ensuring a liquid banking system. Rather than buy government bonds from foreigners, buy mortgages held by Australian households or loans of small businesses to ensure they are not foreclosed, should the world economy suffer a sharp recession;
  3. Build stronger trade relations throughout the developing Asian trading bloc, with a focus on China and India. Push back against tariffs; and
  4. Ensure that fiscal policy is consistent with monetary policy and allow the natural budget stabilizers to operate. A small expansionary deficit is absolutely desirable to stimulate a slowing economy.

It is time to stop the madness and commence with a range of strategic initiatives that take control of our monetary policy for our long term benefits.

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