Spin doctors

Emperor, new clothes, RBA… you know the story.

This week I was reminded of experiences I had as a kid. When I was ill, my mother would take me to the doctor who would write a prescription and say something like “try this and see how it goes”. Invariably, the medicine would be an inky red fluid in a bottle and was almost undrinkable because of the frightful taste.

This would be followed by another trip with the report that I was no better and this was met with another prescription which looked and tasted the same and was equally ineffectual. Gradually, I got better, not because of any of the prescriptions but simply because nature took its course.

The Reserve Bank just dropped interest rates by 0.25%. My goodness! What a prescription for people who have experienced an almost doubling of interest rates on their mortgages over the past few years. This wonderful concession came with a warning that there might not be another but then again there might. Does this ring a bell? It is like the doctor saying “try this”.

Since 2002 there have been 12 increases in interest rates inflicted by the Reserve Bank representing a 60% increase on the 2002 rate. Why? Because the country was sick. There were too many people in employment, too many people buying homes, too many people buying stuff like refrigerators, motor vehicles and TV sets and goodness only knows what else.

The Reserve Bank acted as our doctor and protector and had to protect us from inflation. Aren’t we really lucky to have these bankers caring for our well being and looking after the health of the country?

However, simpleton me had a problem with increasing interest rates to curb inflation. Inflation, as I understand it, is a phenomenon when the cost of goods and services increase. One day an apple might cost 10 cents and a bit later it might cost say 12 cents. The cost of apples has increased by 20%. That is inflation.

So, why would the cost of apples increase? One reason is that we don’t produce enough apples to meet demand and so the cost goes up. However, another reason that costs increase, so we are told by the Reserve Bank, is that the cost of producing something increases. Wages increase and so the cost of wages has to be passed on to the consumer. That is said to be inflationary.

The cost of energy increases and this cost has to be passed on to the consumer. That is inflationary.

So the way to cure us of this terrible ill is to increase interest rates. What does that do? It increases the cost of money and as we know, as soon as there is an increase in interest rates by the Reserve Bank, it is passed on to the consumer.

Maybe I am missing something.

If an increase in the cost of energy is inflationary and an increase in the cost of wages is inflationary why isn’t an increase in the cost of money inflationary. If you just look at the simple data you will find that with every increase in interest rates inflation has increased (the first increases were said to be “pre-emptive”, meaning that we didn’t have inflation at the time but by increasing interest rates early enough it would prevent inflation). That is not surprising given that the cost of money is a cost of doing business or simply living. If increases in costs are inflationary, then increases in interest rates have to be inflationary.

“However” say the economists “this is a simplistic way of looking at the issue”. There is a point where the cost of things becomes so high that no one will buy the product. That is fine with oil as we can catch the train, but once we have purchased a house, we simply can’t give the loan back to the bank; we are stuck with the higher cost.

So, what are all these quarter percentage increases in interest rates and now the quarter percentage decrease in interest rates? Why can’t the Reserve Bank fix a rate that is neither inflationary nor deflationary?

The answer is that each time they prescribe an increase or decrease in interest rates; they are saying “try this and see if it works”. Well, hell, it doesn’t. We have a roller coaster ride as rates go down and then get caught like a rat in a trap when they go up. Then everyone is hurting so badly because it is necessary for our health, that we start the roller coaster again.

When I heard the story of the “Emperor’s new clothes” as a child, I used to imagine my doctor naked as he sat there writing his prescription for me to try. I look at these guys at the Reserve Bank and am tempted to have the same cynical thoughts (but I can’t imagine wanting to see them naked) but surely with this incessant messing around with interest rates they have exposed themselves as people who really don’t know what they are doing. I certainly don’t want them looking after my economic health. If they could just leave things alone, nature will take its course and we will all live happily ever after.

This weekly thing that I write is supposed to be about growth. Well, it is well established that the two ingredients to growth are the low cost of energy and the low cost of money. We have seen both go through the roof, and unfortunately the cost of money has been manipulated upwards by our friends who want to protect us from economic catastrophe. As they say “when you have friends ….. etc”.

Interest rates will be “eased” as will the price of energy, as will inflation – and then the wonderful doctors at the Reserve Bank will tell us how we have been saved from a fate worse than death. Then the good times will roll again and we will start growing, and then too many people will have jobs and be buying cars and TVs and…! Well, you know the story.

Louis Coutts left law and became a successful entrepreneur. His blog examines the mistakes, follies and strokes of genius that create bigger, better businesses. Click here to find out more.

To read more Louis Coutts blogs, click here .