Nothing to Fear But Rising Rates

Or so central bankers in Australia, like everywhere else, agree...

SO, AUSTRALIA's monthly interest rate hype has come and gone for, well, another month, writes Greg Canavan in The Daily Reckoning Australia.

Boss Stevens, of course, left interest rates on hold Tuesday at 2.75%. If anything the absence of a cut saved us from the hysteria about how it will be good for consumption/housing/building/retail and whatever else presumably benefits from more credit creation and less saving.

Commentators like to ignore the fact that a long term campaign waged against savings destroys the economic system. They don't see it, until it is too late.

While the decision by the Reserve Bank of Australia to keep rates on hold was not surprising, the vibe of the RBA board's statement was. We struggled to make out what it said because of the muffled tones emanating through the sand. But it appears as though interest rates are on hold for the time being.

There was no mention of the drop off in mining investment expected to flow through in the next few years, and no mention of China. Not that there needs to be we suppose, but given the past contributions to economic growth from these areas, their subdued future doesn't seem to be much of a concern to the central bank.

The statement noted the effects of past interest rate cuts and said it expects more benefits of those cuts to flow through in the future. In other words, "We'll keep rates around here until we're proven wrong." Meaning it seems the RBA is sticking to the old adage that there is nothing to fear except fear itself. Good luck with that.

Getting back to the topic of interest rates, Australia hasn't yet completely destroyed its class of savers. Official interest rates at 2.75% aren't great but they're not zero. And don't expect them to get there by the way. Our foreign creditors will take their cash and run long before the RBA can hit the 'zero bound'.

How much cash? Well, according to yesterday's update to Australia's international investment position, we had a net foreign liability as at 31 March of A$877.1 billion. Put simply, that means that foreigners have lent us, on a net basis, A$877.1 billion. This is up from A$697 billion in the June 2008 quarter, just before the global financial crisis hit.

Clearly, Australia's credit is good. And no doubt robust iron ore prices and our proximity to China have helped us to maintain such a good financial standing in the international community. But this credit card tab doesn't come cheaply. It cost us A$8.5 billion to service during the quarter, which is an annualised cost of just under 4%.

So it's going to get ugly when (not if) interest rates start to rise again. And if Bill Gross's latest investment outlook is any indication, we need higher interest rates sooner than later.

Gross argues that low interest rates are killing the US economy. This is not a particularly stunning insight. It's pretty obvious really. But Gross clearly explains why this is happening...how low interest rates and the distorted price signals they send lead economic actors to make decisions that are to the long term detriment of all.

It may just provide a window into why the Fed is all of a sudden talking about 'tapering' its bond purchases, when the US economy is clearly no stronger than it's been at any time since the Fed began its QE monetary madness back in 2009.

The law of unintended consequences is poised to strike again. It could have major repercussions for markets, and for your portfolio.