Julia Gillard’s claim that the high dollar is the leading fringe of an economy-wide transformation, with its accompanying "growing pains" is "nonsense," according to Professor Steve Keen, one of a handful of economists who had predicted the 2008 global financial crisis as early as 2005.
Keen told New Matilda that the Reserve Bank’s high interest rate was a major factor in driving the high dollar price, and that he finds it "remarkable that none of the politicians or official economists will admit to its existence."
He says the RBA should slash interest rates to avoid the further decline of the Australian manufacturing, services, education and tourism sectors and to avert a worse, US-style crisis when our housing bubble bursts.
"Since we have the highest interest rates in the OECD region plenty of people and plenty of organisations and countries with much lower interest rates see a perfect arbitrage. They borrow money in their own currency, very low rates of interest, they sell that currency and buy the Australian dollar to invest in Australian assets returning much higher rates," Keen told New Matilda.
The result is a "double whammy" where the Australian dollar increases in value as a result of demand, resulting in further capital appreciation. "The bottom line calculation is that if you can borrow in your country at 1-2 per cent, and invest in Australia and get 6 per cent, as long as you’re not afraid of a currency risk it’s a no-brainer to jump over."
In order to retain that investment interest rates must remain high, because a reduction in the differential between foreign and Australian interest rates would reverse the flow. The strong Australian economy is also providing a "subjective element" to buy our currency, Keen said, as traditionally strong currencies like the US dollar and Euro decline.
The Reserve Bank maintains a high interest rate to combat inflation, but Professor Keen’s dissenting economic theory, derived from American economist Hyman Minsky, diagnoses the real problem as "the growth of private credit and the bubble that’s caused in assets in the rest of the world and Australia."
"The danger starts when the private debt grows faster than income does. That’s been happening in Australia since the mid 1960s. We’ve gone from having a debt level of 25 per cent of GDP — private debt — to virtually 160 per cent. Now we’re going the other direction. When that was rising and in particular mortgages were rising, that lifted house prices as well. Now we’ve reached the stage where mortgage debt has reached a maximum. It’s gone from 17 per cent of GDP in 1990 to last year peaking at around 89 per cent. It’s now heading down, and as it heads down, just like it inflated prices on the way up it’ll deflate them on the way down."
We’ve avoided the worst of the global recession so far because we’re still experiencing rising debt, Keen says. Now that we’ve reaching the peak, he predicts that house prices are likely to fall around 40 per cent over the next 10 years, with a fall of 6-10 per cent this year. "That will affect the credit backing of the banks — giving us a mini-version of what America went through in 2007-2008. Only under those circumstances would the reserve bank move [to cut interest rates]" as people begin to pay down their debt.
"I think they’ve got to be aware that’s likely to happen and just standing back and letting the dollar reach levels like it has now is destroying what’s left of our manufacturing sector and putting the service sector under a lot of strain as well. It really is standing by while Rome burns to ignore a dollar moving towards $1.10 when at competitive levels it shouldn’t be above 70c!"
Unfortunately we have to wait for the bubble to burst because governments have abdicated their responsibility for monetary policy to the RBA, Keen says. Both major parties are wedded to the current economic orthodoxy that sees inflation as the key threat to the economy, and raising interest rates "is political suicide… So the best thing for them is to hand it over to a so-called independent third party that makes it on policy or theory grounds alone rather than political considerations, and they can wash their hands of it."
As long as the "figures are ambivalent," a change in thinking isn’t likely to be forthcoming. "It’s not really a case of changing one policy. We need to change the whole mindset of how economics is understood. Both the Reserve Bank and both major parties are a long way from doing that."