Mr Market is never wrong

I am one of the strongest advocates of free markets among people that I know. When I hear of the left, the cronies, the globalists and the common or garden rent seeker claiming the need for state coercive intervention owing to ‘market failure’, my response is invariably “there is no such thing as market failure, but there are outcomes that you don’t like: don’t get those two confused.”

Really?

In this case, without proclaiming the market is wrong, I can’t see how it can be right. Ordinarily, higher interest rates will not curb inflation until the real interest rate is positive. So, we’ll see if Mr Market is merely sorting cards on the table and still making up his mind.

In the business pages

It’s sometimes refreshing to get a laugh out of the business press, especially when much news is rather gloomy. 

First up today is James Glynn (writing in the Australian) who attempts to defend the Reserve Bank of Australia. His headline says it is unfair to rage against the RBA. Long time readers of this blog will know that I have been a harsh critic of the RBA for many years, so I naturally expected this piece to start my day on a humorous note. James did not disappoint. 

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Aren’t these guys meant to know better?

Way back in June 2020 when Guy Debelle was still employed by Australia’s Reserve Bank (RBA), he made a speech in response to market jitters over the unprecedented expansion of bank credit. He said it would not lead to inflation.

In November 2021, the RBA Governor Lowe said he wasn’t expecting inflation to hit the 2% to 3% pa target range until late 2023 and so there would be no interest rate increases in 2022 but maybe there would be in 2023.

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Stock markets

Price inflation data for May 2022 was released yesterday in the US. Over the full year to end May, the consumer price index increased by 8.6%. The AFR reports that this is the highest 1 year increase in 40 years. The stock markets reacted badly. The Dow Jones industrial average lost 2.7% and the NASDAQ lost 3.5% in value.

That stocks have been broadly overvalued is well accepted. Part of the reason supporting high valuations was low discount rates. A year ago, the average P/E ratio on stocks in the S&P500 was over 37. Today, it is 21.5. That reduction will have been largely driven by recent market sell offs and revaluations with higher discount rates as yields on debt markets increase. But 21 still looks expensive. I’m not sure I want to pay $21 to buy a future earnings stream of $1pa. With the high likelihood of further increases in discount rates plus risks to underlying earnings owing to economic malaise, the P/E ratios are under pressure both on the top line and bottom line.

I’d expect there is more red ink to come.

How to get monetary policy completely wrong

There is a difference between the prevailing rates of interest in the money and credit markets and what can be loosely called the natural rate of interest. When the rates diverge, problems emerge.

The central bank in Australia (the RBA) conducts the management of monetary policy, independently of the Government of the day but to a stated aim of constraining inflation between 2% – 3%pa. It has just manipulated down market interest rates twice in two months. Prior to that, the official cash rate (the benchmark the RBA uses to influence all other rates) was held ‘at emergency low levels’ for 3 years. If the old rates were at emergency levels, then what are they now being lower still? The official cash rate is now 1%pa.

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Gathering voices

Some months ago, I posted a piece here saying that the problem with the economy had nothing to do with high interest rates. Cutting interest rates further would not work. Since then, the Reserve Bank of Australia has cut the official cash rate from 2.5%pa to 2.0%pa.

If only a few more economists would make their views known, such as here, and a few more would stand up to the uninformed mainstream economics doctrines* taught mostly everywhere since the death of Keynes, then we would begin to see an improvement in public policy. Let’s hope.

* To help kickstart thinking, how many borrowers pay 2%pa on their borrowings? What is your mortgage rate? What is your credit card rate? What is the cost of capital under a debt finance model for a small business? There are thousands of interest rates in the market, not just one with stepped margins. Why would that be? What does that mean for the IS/LM model and ‘the’ interest rate?

Economists, groupthink and dark clouds

The official cash interest rate in Australia is 2.5%pa. According to business press surveys of “leading economists”, most believe that the Reserve Bank of Australia should cut the official rate very shortly. Weak economic growth and rising unemployment worry the economists and their policy response recommendation is to reduce interest rates. We shall find out soon enough if the RBA takes that approach, but if the business press is correct, what is it about these economists that makes them unable to see that if interest rates are already at low levels and economic growth is insipid, then the problem is not likely to be a high interest rate. Can’t they see what happens in other countries where official interest rates have approached zero and it has not spurred economic activity?

So-called leading economists who argue that more artificial credit expansion, in an environment that has already suffered more artificial credit than is reasonable, are firstly demonstrating that they have no clue as to what has caused the mess nor how to get out of it. Secondly, they cling to each other and reinforce their collective group-think views because they have little else to comfort themselves that they know what is going on. This fear on their part and their response to argue for more policy medicine along the same lines that is making the patient sick is leading to ever increasing dark storm clouds looming on the economic horizon.

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