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A Fool's Errand

Fixing the price of money, if it must be done, should start with judging demand and supply...

LOTS OF DATA due out this week in Australia, writes Dan Denning for The Daily Reckoning.

   The big story is still with interest rates. The Reserve Bank meets on Tuesday to decide whether to leave the cash rate at its 12-year high of 7.25% or raise it.

What would you do if it were your job to set the price of money? We'd quit. It's a fool's errand.

The trouble is, looking at data doesn't tell you enough to make a wise decision. If were fixing the price for a given thing, you'd look at supply and demand. But demand for what?

The obvious answer is demand for money! And the RBA released data on Friday showing that demand for credit is growing less fast.

Housing credit grew by less than a tenth of a percent and business borrowing didn't grow much either.

Isn't this a good thing? By raising the price of money (with the cash rate) the RBA has reduced the growth in demand. You can't spend what you haven't borrowed. However, keep in mind that overall demand for credit is still growing. Housing credit grew by 9.5% in the last year. And demand for all credit grew by 14.1% since last April.

That is not exactly a slump, is it? So what should the RBA do? It can wait for the GDP figures to come out later this week. Those will probably that the economy is growing at less that 3% a year, while inflation is still running above 4%. How can you still have rising prices with slower economic growth? It reminds us of the old U2 song, running to stand still.

Well, here's one possible answer: the RBA can influence the demand for credit in Australia, but it cannot influence the demand for Australian resources. It's careful formula for calculating the price of money is ruined by a variable which is beyond its control. Don't you hate it when that happens?

A month or so ago, we pointed out that that higher prices for coal, iron ore, and bulk commodities were leading to record favourability in Australia's terms of trade. That is a problem for the RBA.

When the terms of trade improve, you get more money for what you sell and pay less for what you buy. So you have money flooding into corporate and, eventually, personal coffers. That money can be accumulated as cash balances by corporations. Or, it can create wage pressure in the economy.

And remember, unemployment is at 33-year lows. There is already wage pressure.

It's not that complex when you break it down. With the resource sector booming, the increase in activity and terms of trade is highly stimulating. Foreign demand for Aussie exports directly influences domestic demand in the form of wage pressures. What can the RBA do about that?

Frankly, we're not sure it can do anything. We're even more sure that global central banks are either unable or unwilling to take steps that might lead to a lower oil price. Hiking rates would slash global economic growth, and inevitably lead to lower oil demand. And there's also the fact that the oil price – like all commodity prices – is closely correlated with money supply growth.

Cut the growth in broad money supply and you knock at least one leg out from commodity prices. But after a week of watching the noxious garbage on CNBC, we find it hard to believe the U.S. Fed will be raising rates any time soon. Wall Street would raise a hue and cry like it did in August of last year. The ECB might raise rates just to show it can.

But it's unlikely.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

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