Gold News

Are Low Interest Rates Helping Australia?

Credit has never been cheaper. But what benefits there are go only to asset owners...
 
SO OVER at Martin Place in the heart of Sydney, the Reserve Bank of Australia on Tuesday had a bit of work to do before they made their way to a Melbourne Cup luncheon, writes Greg Canavan in The Daily Reckoning Australia.
 
Making their monthly decision to set the price of credit, they reckon an overnight price of credit of 2.5% is about right. In the absence of any compelling information suggesting it should be otherwise, they'll continue to think that way. For the next month at least.
 
We have no idea how they know what is the optimal price of credit for an economy as big and complex as Australia's. Right now official interest rates are around historic lows. This is a boon for the banks, who stand at the front of the credit creation process and get to clip the ticket as any new money comes into existence.
 
You can see that quite clearly in the performance of the Commonwealth Bank (ASX:CBA). Official interest rateswere 4.75% in 2011 before the rate cutting cycle got underway in November and December of that year.
 
Then in May and June of 2012, rates fell a further 75 basis points, with more cuts in October and December, making 125 basis points in interest rate cuts for 2012. So far in 2013, the RBA has gifted the banks another 50 basis points of lower rates, bringing official rates to just 2.5%.
 
As you can see that has been a godsend to the big banks, best exemplified by the share price performance of CBA. The rate cutting cycle, which began in 2011, has led to a massive boost in the share price.
 
 
Have lower interest rates translated into wider economic wellbeing?
 
If you own a property, then yes it has...for now. If you don't, then no it hasn't. More generally, economic growth remains sluggish and the forecast for next year is for weak growth.
 
Monday's retail sales growth data of 0.8% for September beat expectations of 0.3%, but annual sales growth of 2.9% is well below the long term average so lower interest rates don't seem to be helping the 'consumer'.
 
Ironically, the better than expected monthly result was largely due to a pickup in discretionary spending. At the same time, one of Australia's largest discretionary retailers, Coca Cola Amatil (ASX: CCL), warned the market that pre-tax earnings for 2013 would be around 5-7% lower than in 2012. It's share price fell around 3%.
 
CCL is quite a few steps removed from the money creation process. By the time the new money created by the banks emanates to the 'consumer' end of the economy, the ripple effect is less noticeable. In fact, by the time any benefit comes through it's usually accompanied by the 'other' effect of new money entering the economy...higher prices.
 
The credit creation process is the most important thing to consider when thinking about how an economy works. Yet it's given the least bit of attention by the business media. Credit creation is the process of how money comes into existence and how it flows through an economy...enriching some and impoverishing others.
 
The 'system' we have at the moment, both in Australia and internationally, is no longer working very well. Its sole purpose is to promote debt growth. It cares not what the debt is used for, which is why an increasing amount of debt is unproductive and needs further debt growth to support it.
 
The system we have strenuously avoids facing up to this cancerous unproductive debt. We ignore it and refuse to write it off, hoping that by lowering the cost of it, it will magically turn it productive.
 
But it is a system that has passed the point of any remediation. It will grow until it collapses under its own weight. This process is happening much faster than people think or understand. Rising asset prices have dulled the senses and killed off critical thought.

Greg Canavan is editor and publisher of Sound Money, Sound Investments, a weekly financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. Formerly editor of Australia's market-leading finance newsletter, Greg has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as LewRockwell.com and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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