September 2, 2004
Believe it or not, Australia has the highest rates of all the major developed economies, writes Kenneth Davidson.
"The whole objective of having a low rate of interest is in order to do things. But if you begin to think it is wise to stop doing things in order to lower the rate of interest, you are standing upside down."
- John Maynard Keynes, 1931
Is John Howard standing upside down? His whole political strategy is built around the proposition that Mark Latham can't be allowed to spend money on nation-building because of the risk that this might push up interest rates.
But what sort of prime minister does Australia need? A builder, or a miser who hides his lack of vision behind his claims to financial rectitude?
We know now what Howard means by "trust". It's not about truth, it's about the Coalition's ability to keep interest rates lower than Labor over the next three years.
Believe it or not, Australia has the highest interest rates of all the major developed economies. Look at the comparative tables in The Economist: Australia's short-term rates are low at 5.43 per cent but they are 180 times higher than Japan's, 3.3 times higher than the US's and 2.5 times higher than Canada's and the Euro areas.
So why are Australia's interest rates so high relative to the rest of the world? Is it because of the two recent rate rises imposed by the Reserve Bank? No. Australian rates were the highest on The Economist's developed country table well before the Reserve Bank began to push up interest rates to curb the inflation in house prices (which was fuelled by government subsidies to home buyers and the negative gearing and capital gains tax rorts available to property speculators).
Interest rates have declined under Howard, but not because of his miserly policies that slashed investment in human capital, sold public assets and increased the tax burden.
What sort of PM do we need? A builder, or a miser who hides a lack of vision behind claims to financial rectitude?If there was an inverse relationship between interest rates and the level of government debt, Australia would have the lowest interest rates in the world and Japan would have the highest. Australia's net debt is close to zero and falling thanks to asset sales; Japan's is more than 90 per cent and rising.
In fact, there is a better case for arguing that increasing government debt to finance social and economic infrastructure, where the yield on the investment is higher than the borrowing costs, is a powerful force in lowering interest rates. This is because it generates a virtuous circle of rising productivity, competitiveness, growth and real incomes, which in turn lead to lower inflation, increased capacity to repay debt and increasing willingness by lenders to fund the debt at competitive rates of interest.
In business parlance, the Howard Government is running a "lazy balance sheet" because it fails to invest in upgrading the skills of its workforce (education), in upgrading the quality of its products and processes to meet the competition (research and development), and in speeding up communications with its customers and suppliers (telecommunications and transport infrastructure).
Any fool can sell assets to reduce debt, but it is a way of becoming uncompetitive and eventually going out of business. Since 1996, the Howard Government has sold infrastructure and cut spending on higher education. Its stock of assets has depreciated at a faster rate than gross investment, and programs designed to upgrade industry, such as the 140 per cent R&D allowance, were slashed - all in the name of reducing the deficit.
For the want of a few hundred million dollars a year to maintain these programs, business R&D, which was growing about 18 per cent a year in the decade up to 1996, has now slowed to a virtual standstill and the deficit on Australia's trade in elaborately transformed manufactures has blown out.
As a consequence, Australia's external current account deficit now stands at 5.4 per cent of GDP, and foreign debt is far larger than any other major industrial country apart from the US. (And keep in mind that the US is in the luxurious situation where its dollar is a reserve currency, which means that the US can pay for its imports by printing more greenbacks - at least until the OPEC countries pluck up the courage to follow Saddam Hussein's example and demand payment for their oil in euros.)
In globalised financial markets, national interest rates are determined by the world rate, adjusted for inflationary expectations and the exchange rate. Fundamentally, Australians must pay more for their money than the people of most other countries because the Australian dollar is rightly seen as carrying a bigger exchange risk than most other countries, not only because of the huge current account deficit and foreign debt, but because the dollar is rightly seen as a commodity currency dependent on the fluctuating world demand for agricultural produce and raw materials, rather than the sophisticated products and processes associated with the knowledge-intensive post-industrial era.
Howard has truncated the industry policies of the previous Labor government, which were designed to promote the export of elaborately transformed manufactures.
He did this on the grounds that these programs contributed a few hundred million dollars to the budget deficit, but the decision has resulted in billions of dollars being added to Australia's external debt - which is the reason Australia's interest rates are likely to move even higher relative to the rest of the world in the years ahead.
It is a tragedy for Australia that Labor has been so spooked on the debt issue that Latham promises to never-ever run a budget surplus, irrespective of the state of the economy.
This promise will prevent the implementation of the massive nation-building program of infrastructure investment that is required to contain the growth in Australia's foreign debt.
Kenneth Davidson is a staff columnist.
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