It is time we intervened to hold back the dollar

OUR problem is the dollar. You can pontificate until you're blue in the face about productivity, or business taxes, or the carbon tax or cautious consumers and they're all important. But what is putting otherwise viable Australian businesses at risk now is the fact that our dollar is too high for them to compete.

On the broadest measure, the Australian dollar is now 72 per cent higher than it was a decade ago. Against the US dollar, it has almost doubled. At $US1.05 or more, it is 50 per cent higher than its long-term average of US70?, between 1985 and 2005, before the mining boom drove it up.

A high dollar makes Australian exports more expensive in the rest of the world. It makes imports cheaper here. It makes it cheaper for us to spend our money abroad as tourists or consumers and more expensive for the world to spend its money here.

If you lower the dollar, the other problems become second order issues. If you can't lower it, and it keeps going higher, then business and government may have to move hard and fast to find ways to save enterprises and the workers they employ.

That is the reality the Reserve Bank highlighted in its quarterly statement on monetary policy last week. It is the reality that has made its former board members Warwick McKibbin and Adrian Pagan urge it to try new ways to stop foreign demand for Australian dollars driving up its price.

In March, I wrote on this page that we need to talk about the high dollar, suggesting the Reserve should drop its hands-off policy, and intervene to cap its value, as the Bank of Switzerland has capped the value of the Swiss franc. That conversation has now begun, and about time.

The stakes are high: not only for our trade-exposed enterprises and their workers, but for both sides of politics. On July 1, we began living with the carbon tax that Tony Abbott has told us over and over will be "like a wrecking ball through our economy". It has become the defining issue of our politics, the prime mover for Abbott's rise in the polls and Julia Gillard's fall. Now the rhetoric of both will be put to the test.

In July, the wrecking ball failed to wreck anything. Last week the Bureau of Statistics estimated that seasonally adjusted employment grew by 14,000, and private analysts TD Securities and the Melbourne Institute estimated that inflation rose by just 0.2 per cent.

Of course, these are early days, and survey data can be wrong. But it was a preview of the potential damage to Abbott's credibility if the carbon does not wreck the economy. The polls show he himself is unpopular; if his campaign against the carbon tax turns out to be hollow, the political balance could swing sharply against him.

But the argument cuts both ways. If the economy goes badly in 2012-13 and I mean the economy of south-eastern Australia, where Labor has 60 of its 72 seats in the House of Representatives then Labor and its carbon tax will be blamed, regardless of whether or not it really caused the slump.

The Age economic survey last month found an overwhelming consensus among private forecasters that Australia would do well in 2012-13. Virtually none think the carbon tax to be a wrecking ball through the economy.

But the economic tides now are very uncertain. Even the Reserve Bank, with its well-documented tendency to be over-optimistic, now concedes the big risk is that the economy in 2012-13 will go worse than expected, not better.

Part of the reason for that, as the Reserve sees it, is Europe's inability to solve its problems. It is sanguine about China, although the anecdotes from there point to a more alarming slump than the statistics admit to. But it is also worried that the rising dollar is doing more damage than its models have forecast and in Australia too, the anecdotes point to deeper problems than the statistics so far show.

Most observers expect the Reserve to do nothing more than voice concern. It has never intervened in the markets to keep the dollar down, only to push it up. Deputy governor Philip Lowe said last month it was hard to make a case that the dollar was overvalued. But then, the International Monetary Fund disagrees, estimating that in June, when the $A was roughly at parity with the $US, it was already overvalued by 5 to 15 per cent.

What could we do? Two options stand out:

The Swiss solution: impose a cap on the Australian/US exchange rate, maybe at parity, and print dollars to sell whenever the cap is threatened. There is no limit on the Reserve's ability to create Australian dollars only the risk that they will end up back here adding to inflation, and the risk that it will become a huge holder of US dollars and other currencies.

The McKibbin solution: since the main surge in demand for Australian dollars is from other central banks buying them as safe investments, the Reserve should sell them directly to its cousins, printing dollars to meet their needs, and so taking pressure off the dollar in the markets.

I'll say it again: we need to talk about this. We should not let fear of trying something new cost us good enterprises and good jobs.

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At last, our dollar worries the Reserve Bank

THE Reserve Bank's view of the year ahead foresees the economy growing at trend, against a background of grey clouds: a two-speed economy, with little growth in jobs, and a lot of downside risk from Europe, and the high dollar.

It sees the carbon tax having surprisingly little impact on underlying inflation: just 0.25 percentage points in 2012-13, then no more. It sees mining investment peaking in 2013-14, barely a year away, and detracting from growth thereafter.

If you think that's easily replaced, the Reserve points out that in 2011, even net of imports, mining investment made up most of the growth in our GDP.

The Reserve is troubled by Europe. It's on edge about the US, and the partisan impasse over the budget deficit. But it's relaxed about China, seeing its economy as having hit bottom and about to rebound as stimulus measures take effect.

Part of its concern about Europe is that it sees the investor exodus from European bonds ending up here, and pushing up the Australian dollar at a time when falling commodity prices should be driving it down.

What is new in yesterday's Statement of Monetary Policy is that for the first time, the Reserve accepts that a persistent high dollar could do more damage than it expected to businesses exposed to global prices which now includes much of the economy, as the internet spreads global competition to our service industries.

The Reserve does not canvass possible solutions, such as the Swiss policy of setting a cap on the exchange rate, and printing money to keep it there or in other ways, as advocated by its former board member Warwick McKibbin.

But it sees the high dollar forcing trade-exposed business to lift productivity sharply. That implies weakened jobs growth "in the near term" and a risk of "labour shedding across a range of industries", as the high dollar combines with the housing slump and deep spending cuts at federal and state levels.

It expects unemployment will "edge higher", wage growth will slow to 3.5 per cent, and inflation even with the carbon price to remain within its target band of 2 to 3 per cent.

Yesterday's statement does not imply an interest rate cut around the corner. But it implies that the Reserve is leaning that way. It sees the risks as mostly on the downside, but is sitting back to watch what unfolds, ready to hit the trigger if its fears are realised.

Commonwealth Bank's economics team summed it up as "cautiously optimistic". Yes, but it is more cautious than it was, and less optimistic than it was.

Some analysts interpreted the rise in its growth forecasts for 2012 as indicating stronger growth ahead. Wrong. It reflects stronger growth behind us, due to the Bureau of Statistics' surprisingly high first estimate of 1.3 per cent growth in the March quarter.

The Reserve assumes this will not be revised down much, but will lift the starting point for future growth. That could be optimistic. In the past, on average, high initial estimates of growth have been revised down by 0.4 percentage points. The bureau has already revised its estimate of March quarter retail spending by that much.

The key fact is that the Reserve has left its growth forecast to June 2013 unchanged: between 2.5 per cent and 3.5 per cent. And it has cut its forecast for growth in 2013-14 by half a percentage point, to the same range.

That is, the Reserve forecasts the growth rate over the next two years to be around 3 per cent, plus or minus half a percentage point. It describes this as "around trend". Good. There is a widespread but outdated assumption that our trend growth rate is 3.25 or 3.5 per cent; that was in the days of rising debt, and the Reserve believes those days are gone.

On Thursday, assistant governor Guy Debelle forecast that credit growth will remain subdued for years. He tipped it to grow "at the pace of nominal [GDP] 5, 6, 7 per cent most likely, for the next few years. I'm pretty sure we're not going back to double digit rates."

If he's right, that will have profound implications across the economy especially for growth in house prices, and for investments that depend on them rising at the pace we saw when housing credit was growing at double-digit rates: as it did, with two short breaks, from 1964 to 2008. Stable house prices will be good for first home buyers, bad for investors.

Second, slow growth in credit will have profound effects on banks, retailers, new housing and renovations, tourism, restaurants and discretionary expenditure of all kinds.

For all our talk of "cautious consumers", households have barely begun the task of deleveraging. The ratio of household debt to disposable income has shrunk only from 156 per cent at its peak to 150 per cent. It is still three times as high as it was 20 years ago.

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So why aren't we feeling confident?

GLENN Stevens and Wayne Swan want Australians to feel confident about the economy; we refuse. Why?

Look at the fundamentals, our leaders say. In a troubled world, our economy is growing at trend rates. Unemployment is only 5.1 per cent, jobs at record levels. Inflation is negligible. The government has low debt and, with a few fiddles, claims to have a budget surplus. The Reserve Bank's cash rate is near its historical low. So why aren't we confident?

There are many reasons, and we may differ as to how much weight each of them has. They reflect our fears for the future, from the global economy to the carbon tax. They reflect other economic fundamentals that the Treasurer and the Reserve Bank governor are less keen to mention. And they reflect the corrosive impact of the poisonous political partisanship and lack of common purpose in our fast-degrading democracy.

Let's take the global economy first. The narrow victory for the two mainstream parties, New Democracy (right) and Pasok (left), in Sunday's Greek election clears one hurdle facing European leaders. It buys them time to change course and set sail for growth. But Europe is awash with debt: too many governments and banks have taken on too much of it; too much time has been lost by bad decisions; and too many interests remain in conflict. There is a real risk that its great recession will turn into a depression around the world.

Even in Greece, Sunday's vote was anything but a clear mandate. New Democracy and Pasok shared just 42 per cent of the vote, compared to 46 per cent for the four main anti-bailout parties on the far left and nationalist right. Their majority came only from the 50-seat bonus given to the biggest party. The big shift since last month's poll is that the right has regrouped behind the pro-austerity New Democracy, while the left has regrouped behind anti-austerity Syriza, which will now await its time.

Still, a win is better than a loss. It is now up to Germany and the European Union to drop their hard line and admit what everyone knows: that their deficit reduction targets cannot be met by countries in deep trouble, such as Greece and Spain, without taking them into even deeper trouble. Julia Gillard is right: to reduce deficits of this order, you need growth. That requires not only a growth package, but a much slower timetable for deficit reduction.

Most Australians don't spend time thinking about Europe's problems (or those of the US, which by December could eclipse them if Democrats and Republicans can't agree on how to reduce its deficit). We have lost confidence mainly because our real economic situation is less rosy than Swan claims, and because 2? years of non-stop strident partisan politics has corroded confidence in everything: government, opposition and the economy.

Stevens highlighted one key factor. In the past our boat raced along, helped by the tailwind of rapid growth in debt. The ratio of household debt to disposable income almost doubled under Hawke and Keating, from 37 per cent to 70 per cent, and then more than doubled under Howard, to 156 per cent. In 25 years, the amount we owe relative to the amount we earn quadrupled. Some of us have argued for years that this was not sustainable. We now welcome the Reserve Bank to the club as a new member.

Rapidly growing debt felt good. It fuelled our house prices, which created the illusion of rising wealth. Between 1995 and 2005, Stevens said, household assets per head rose by 6.4 per cent a year, mainly due to soaring house prices. As a result, we spent more: on average, each of us bought 2.8 per cent more goods and services every year. And since consumer spending makes up 60 per cent of GDP, that produced strong growth: on average, GDP per head rose 2.5 per cent per head each year.

Contrast that with the years since 2007. In real net terms, the average Australian today owns almost $30,000 less than they did in 2007. Since the GFC sent stock markets crashing, our real wealth per head has shrunk at the rate of 3.25 per cent a year. GDP per head has grown by just 0.3 per cent a year. Growth in real consumer spending per head has halved to 1.5 per cent. Stevens welcomes that as necessary adjustment to the reality that we can't increase debt forever. But, he says, we resent it, and it is primarily that loss of wealth that makes us grumpy.

He is right, but there are two other keys to this story. First, we remain massively in debt. Since December 2007 household debt has grown by a whopping $310 billion. In December 2011, the ratio of household debt to household income was still 150 per cent. Mortgage bills still ate up 11.2 per cent of our disposable income, only slightly less than in 2007. Relative to our incomes, our debt was almost as big as ever and so were our interest bills.

Then shouldn't the Reserve's interest rate cuts lift our spirits? No, because of the banks. Since the end of 2007 the Reserve has cut its cash rate from 6.75 to 3.5 per cent, yet barely half of that has been passed through to households, and even less to small business. The other half has gone to the banks, whose profits, on average, have grown at double-digit rates each year since the GFC began.

Whenever the Reserve cuts rates, the good news is stolen by the banks appearing to grab more for themselves. Some of that was justified, but the bottom line is excessive. Essentially, the banks have looked after themselves, not their clients. So their clients are angry.

Another problem is that there is not one Australian economy any more. Mining is running red hot, some sectors such as health and finance are prospering, but a lot are not. Spending in the mining states is growing at 10 per cent a year. Spending in the south-east, where most Australians live, is growing at 2 per cent, and unemployment is rising. When policymakers ignore the reality around them, people get angry.

Then there is the corrosive effect of Tony Abbott's relentless war on everything Labor does. Politically, it has been very effective; helped by the Murdoch press and some right-wing radio shock jocks, the country's mood outside Victoria now resembles that of 1975. But one of the casualties is confidence in the economy. When Abbott and his troops tell us day after day that the carbon tax will wreck the economy, many people believe him and plan for the worst.

Successful economies tend to be those with a sense of common purpose, where compromise is not a dirty word and opponents are not enemies. Australia had that under Menzies, lost it in the Whitlam years, regained it under Hawke, and has now lost it again. It would help if we could get it back again.

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Productivity. Poor answers from the Commission

LIFT productivity, or die. Stop whingeing about the high dollar, falling asset values, sluggish demand. Instead, adapt to it, by raising productivity.

That was half of Glenn Stevens' message to this week's economic forum in Brisbane. (The other half was to tell us again that we are doing better than we think.) And the Reserve Bank governor hit a theme with many friends.

The government says productivity growth is one of its key priorities. Its forum focused largely on key areas for raising productivity: innovation, infrastructure, skills, and deregulation.

The Business Council and others are focusing their advocacy on their priority areas for lifting productivity.

And while productivity is not the only source of growth, or of competitiveness, it is clearly a crucial one.

The data shows Australia losing traction. In the "jobless recovery" of the 1990s, productivity grew rapidly. Then, in the benign 00s, job growth accelerated, but productivity growth slowed. If you believe the national accounts, in the four years to March 2011, GDP per hour worked grew just 0.1 per cent. (And then in the year since, productivity shot up 4 per cent, but hours worked rose just 0.4 per cent.)

Few economists believe all this. Stevens thinks part of the slowdown stems from timing issues rising from the mining boom, part reflects "a material slowing in productivity growth", and part is just inexplicable. Merrill Lynch chief economist Saul Eslake sees the slowdown largely as a product of the good years.

Companies themselves have the most ability to lift productivity. What government can do is to remove barriers to firms working at their full potential.

The Keating government's dismantling of centralised wage fixing in favour of enterprise bargaining was a classic example.

But policy debates focus on what governments can do. And while some options are obvious governments can lift productivity by rolling out high-speed broadband, or removing level crossings on busy roads making a priority list of reforms is a lot more subjective. Stevens flick-passed it to the Productivity Commission, saying it had published a list of reform proposals. Governments, he said, should "go get the list, and do them".

Sorry, governor, but the commission's last reform wish list was published in 1996. Its chairman, Gary Banks, has named some fields ripe for reform in recent speeches "labour market policies . . . the taxation system . . . business start-ups, development approvals and land-use changes . . . red tape" but Banks has survived 14 years as chairman by speaking fluent nuance, rather than unnerve governments with his own reform agendas.

The OECD, far away in Paris, has no such inhibitions. Every year it publishes a list of reform priorities for its members. For Australia, its 2011 list was:

Infrastructure: build more, but choose it more carefully. Project selection should follow "rigorous and published cost-benefit analysis".

Foreign investment: remove screening for investments under $1 billion, and be more transparent about why decisions are reached.

Tax reform: Cut income tax rates, cut corporate tax rates, and raise the GST. Reform state taxes on housing.

Participation: Encourage workforce participation by lifting the threshold for income tax (as the Labor government has since done) and reduce effective marginal tax rates.

Childcare: Lift benefits for children under school age, but limit them to parents who are employed or searching for work.

But the benefits of these may be long-term. And for many companies, the crisis is now.

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Productivity: Easy to say, hard to do

Stop complaining about the economy, start adapting to it - and adapt to it by raising productivity.

That's the gist of Glenn Stevens' ideas for Australia, and it's pretty much the same message that Julia Gillard and Wayne Swan are delivering to the Government's economic forum.

Last week Stevens declared that Australia's glass is "more than half full", contrasted its growth with the stagnation of Europe, Japan and the US, and suggested that much of Australia's glum economic mood was due not to the high dollar and the mining boom that caused it, but to the end of the extraordinary rise in wealth delivered by three decades of debt - and particularly, the decade to 1995.

Today he repeated all that, with a further twist: arguing that the high dollar was really not all that high if you look at it in a very long term perspective.

In real terms, the Governor said, the dollar is now back to where it was 100 years ago, relative to the US dollar. In nominal dollars, it's even better: 100 years ago, ten shillings (the equivalent of our dollar today) would buy you $US2.40.

Even in Stevens' own lifetime, he recalled, the dollar had been $US1.40 before the high inflation of the Whitlam and Fraser era.

Well, true. But then, as Keynes said: "In the long run we are all dead".

That distant past is irrelevant to the problems we face now. And to the extent that the Governor conceded that the high dollar is damaging large swathes of the Australian economy, his advice was simply: adapt. Learn to cope with it, by making your business more productive.

How? he was asked. He waved it on to the Productivity Commission, whose chairman, Gary Banks was in the audience. The commissioned has published a long list of proposed reforms, Stevens said. His advice to governments was: "Go get the list, and do them".

"They're not popular. They're politically very difficult", he conceded, pointing to reform of Federal/State relationships as an example. "They're very hard to do, and it's grinding work." But that was his only suggestion.

A Reserve Bank governor has to be careful in what he says. Anyone else might add that politically, reform agendas become virtually impossible when politics becomes as polarised as it is now.

Many of the problems facing the Australian economy - highlighted in the past two days by surveys showing business confidence at a three-year low, and consumer confidence showing virtually no gain from the recent interest rate cuts and budget handouts to households - are worsened by us living in an environment of constant negativity and attacks on whatever course the government decides on.

Tony Abbott's war against everything has made good government in Australia very difficult, and courageous reforms almost impossible. Labor's main contribution has been the carbon tax, and Abbott has taken a blood vow to undo that reform. Whatever it proposes, he opposes.

Look at the United States, and India, where partisan politics has ruled out any serious attempt to reform even the most obvious problems. Australia is now in that state.

Australia would not have been able to achieve the reforms it did in the 80s and early 90s if John Howard, Andrew Peacock and John Hewson had adopted Abbott's take no prisoners approach to the job of Opposition Leader.

They did oppose a lot of things that Liberals now accept - compulsory superannuation, Medicare, indigenous land rights, to name a few - but they waved many of Labor's reforms through. Had they not done so, we wouldn't have had the benefits those reforms have brought since. A war against everything ends up becoming a war against us.

But Labor is also playing partisan games where it ought to be trying to create a bipartisan agenda.

Last night behind closed doors, Swan flatly rejected a call by Victorian Premier Ted Baillieu for a Productivity Commission inquiry into Australia's construction costs. That was a serious step backwards, after Gillard had appeared supportive of the proposal when Baillieu raised it earlier this year at the Council of Australian Governments summit.

The issue is of huge importance to raising productivity. One of the main ways of raising productivity is to invest in better infrastructure - that's exactly why we're building the NBN - and Australia has an estimated backlog of $700 billion of infrastructure projects which could raise productivity significantly if they were built.

But they can't be built because construction costs are so high. Victoria is looking at a $100 million bills on average to replace each of Melbourne's 175 level crossings. Asian cities are racing ahead of us in this area.

Baillieu is the only Liberal premier to accept his invitation to the forum. His proposal was a sensible, modest first step to trying to bring down construction costs.

At worst, it could do no harm. At best, it could do a lot of good. But Labor depends financially on donations by the construction unions, who do not want the Productivity Commission investigating their turf. So no inquiry - and none of the productivity gains that might have resulted from it.

Productivity remains a word that easy to say, hard to do.

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Stevens: Why it doesn't feel as if we're doing okay

GLENN Stevens has three messages for us.

First, the economy is going better than we think: our glass is "at least half full".

Second, don't blame the mining boom for the rest of the economy growing slowly: rather, it's the hangover from our binge during the decade of debt.

And third, the days when "the effortless way to get rich was to gear into rising house prices" are gone for good. House prices and debt will not rise like that again. The Reserve Bank will not act "to pump up speculative demand for assets".

And we might draw a fourth message from the governor's speech in Adelaide: don't expect more interest rate cuts soon, unless things in Europe get really ugly.

The first message is hard to dispute after this week's bonanza of strong economic data even if Stevens hints gently that, like other economists, he takes the estimate of 4.3 per cent GDP growth with a grain of salt.

"The underlying pace of growth is probably not quite that fast, but it is quite respectable, something close to trend," he says. "If the recent data are taken at face value, the non-mining economy has grown at about 2 per cent over the past year."

Yes, but with the population growing at 1.5 per cent, economic growth of 2 per cent does not leave much new money to spread around.

And if the GDP number is revised down, as big growth numbers usually are, it leaves less again. Still, he's right: our glass is half-full.

The second message is his central one. Stevens is puzzled by why Australians don't see their economy as the island of growth it seems to outsiders.

He thinks much of our dissatisfaction really stems from the fact that household wealth is now going backwards, after a decade in which it averaged real growth of 6 per cent per head per year. But its growth was fuelled by sharply rising debt, and that had to end.

As we save more and spend less, Stevens says, real growth in consumer spending per head has roughly halved, but our financial position has strengthened: "A certain degree of thrift" is good for us.

His key point is that that thrift is a return to normal. It was the years from 1995 to 2007 that were unusual.

Retailing, banking, real estate and housing investors won't see those times again.

We need more confidence, he says, but "it has to be the right sort of confidence".

Our growth from here should be based on productivity, "doing things better, in 1000 different ways" not on speculation.

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Reserve wrong and must move on

THE Reserve Bank wanted low inflation. Now it's got it. Strip away the statistical static, and for the last three quarters, underlying inflation has been running at 1.8 per cent, the lowest level for almost 50 years.

But in 1963-64 we had the best of both worlds: inflation of 0.9 per cent and growth of 7 per cent. Now we have growth of just 2.5 per cent, and most of it in outback mines. The 80 per cent of the economy not driven by mining is treading water.

This is not what the Reserve forecast. It thought the economy would be booming, and inflation around the top of its target band of 2 to 3 per cent. Instead, mining is booming, the rest of the economy is flat, and since mid-2011, underlying inflation is below the bottom of its target band.

The Reserve made a mess of it. It kept overestimating growth. It kept overestimating inflation. It raised interest rates far too high, and has kept them too high. It has no more excuses. It must now fix the problems it created.

Next week it has two choices. It can cut its losses, fix the problem quickly, and move on to the next page. That means cutting interest rates by at least 0.5 percentage points now, and by more ahead if the economy continues to underperform.

Or, if its priority is to preserve its pride, it could make just the usual cut, of 0.25 percentage points, and go on issuing rosy forecasts as if nothing had gone wrong. That would be irresponsible, but not unlikely.

The economy needs a decisive lift; a small rate cut will not give it. Mortgage rates are now at 2005 levels, appropriate for an economy growing fast. Small business overdraft rates are at late 2007 levels, appropriate for an economy overheating. Now we are slow, and cold. Even a 0.5 percentage point cut assuming the banks pass it on would still leave rates too high.

We've now had three quarters of inflation data since the Bureau of Statistics updated its index weights to reflect actual household spending. In that time, in annualised terms, headline inflation has grown at 0.9 per cent; seasonally adjusted inflation at 0.7 per cent; and underlying inflation (the trimmed mean) at 1.8 per cent.

There were times in the '90s when inflation got as low as that, but only because the index was then dominated by mortgages, so rate cuts also cut inflation. This time prices have been flattened by three things: falling fruit and vegetable prices, the high dollar cutting import prices, and the weak economy cutting retail margins.

Yes, say inflation hawks, but look at the prices of non-tradeable items: up 1 per cent in the March quarter, 3.6 per cent in a year. The Reserve can't relax its grip, because if the dollar falls, these will drag inflation back up.

Relax, hawks. The March-quarter figure is high because it includes the annual rises for health and education fees. The annual data matters. But it shows six items created 80 per cent of net price rises in the past year and not one is an area where prices are sensitive to interest rates.

The six are rents (up 4.4 per cent in the past year), health and medical services (5.1), petrol (5.9), electricity (9.9), private school fees (6.0), and cigarettes (6.3). High interest rates did not stop these prices soaring in 2007-08, or in 2011-12. If you stop to think about why, the reasons should be obvious.

The Reserve has run out of excuses. It was wrong. It needs to cut its losses and move on.

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Dry powder: Why the RBA didn't

THE Reserve Bank is optimistic about Australia and the world economy, more optimistic than most. That's why it did not cut interest rates yesterday, defying the expectations of most, and a run of predominantly weak data.

The Reserve thinks growth is running "close to trend", and likely to remain so. Inflation is "close to target" and likely to remain so. The world economy looks bad, but not as bad as it did two months ago.

The interest rates borrowers pay are "close to their medium-term average". So interest rates are "appropriate for the moment".

It concluded: "Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy. The board will continue to monitor information ... and adjust the cash rate as necessary to foster sustainable growth and low inflation."

If the Reserve's optimism proves right, that will imply a better year for us. If it doesn't, then its board has left the door open for interest rate cuts. It reads like "decision postponed" rather than "rate cuts ruled out".

Whether the European crisis moderates or worsens is one key factor. What happens in China is another. But the data for Australia itself is also crucial.

This is the fifth year in a row that I can recall the Reserve starting out more optimistic than most of us. So far, it's been right one year in four. Let's hope 2012 lifts its average.

Yesterday, governor Glenn Stevens gave a selective reading of the main economic indicators, quoting those that look promising and ignoring those that don't. It didn't inspire confidence in the bank's judgment.

But we are not in a crisis, and there is a good case for saying the Reserve should hang onto its ammunition for when it really needs it. There is also a good case for arguing that if the banks want to further increase the margins they charge us above the cash rate, the Reserve should make them do it openly.

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Column: The big banks' marginal case

LAST weekend I got around to digging up my long-neglected veggie garden, and discovered why the silver birch tree is doing so well. The soil that once grew my veggies was permeated with new root growth, nourishing that beautiful big tree. Tough luck, I told the silver birch as I hacked them off: you'll still be a handsome tree without them.

Right now Australia needs a gardener to do something like that to our beautiful big banks. Since the global financial crisis more or less killed off their competitors, they have been spreading their roots into the soil that nourishes the rest of the economy. We want healthy banks; but we do not want them sucking nutrients from the rest of the economy.

It's a matter of having the right balance. The banks will be healthier long term if they have healthy customers. But that balance has been lost and there is no good reason for the banks to worsen it by using their market power to take even more from their customers.

Today the Reserve Bank is expected to cut its cash rate by another 0.25 percentage points. It might not do so - there are good arguments to cut, and good arguments to wait - but most of the economy is clearly weak. More nutrient, such as lower interest rates, would help it survive, if not thrive.

But the big banks are flagging that they may hold back part of any rate cut from their customers. They point out, rightly, that the cash rate has little relevance to what it costs them to borrow money. And they say their costs have risen, so don't expect to see the Reserve's cut reflected in your mortgage rate.

Let's hear their case. The Australian Bankers' Association says 60 per cent of the banks' funding comes from bank deposits, 20 per cent from short-term bonds (less than a year) and 20 per cent from the long-term bond market. It is the last one that has risen: the extra cost of our banks borrowing long-term from the market rather than each other rose about half a percentage point in the second half of 2011.

The association's chief executive, Steven Munchenberg, pleads for understanding. ''Banks do not underestimate the anger many borrowers will feel if all RBA rate cuts are not passed on,'' he says. ''For these reasons, banks have been absorbing the higher costs of bank funding for over six months now, and have not passed these costs on to borrowers.

''But banks need to balance the interests of borrowers, on the one hand, with the interests of lenders, including retail depositors and superannuation funds, on the other. In globally uncertain times, Australia's banks need a clear signal to investors around the world that our banking system is solid and healthy. A vital sign of this is the profitability of our banks.

''If investors become concerned with Australia's strength, they will charge more for the money they lend our banks, compounding bank funding cost pressures. In the worst case, banks would not be able to raise enough money to meet demand, resulting in a credit squeeze.''

Steve, you can rest easy. Shareholders may fret if the banks' profits stop growing: some of them seem to think bank profits should keep growing even if the economy goes bust. But Australia's bank profits are already in the stratosphere, whether compared with global banks or other service industries in Australia.

As the ratings agencies point out, the main risk to the ratings of Australian banks is their dependence on a property market widely seen as overvalued. If the banks hold back the full RBA rate cut, that would increase the longer-term risks they face, not reduce them.

But the biggest problem with the banks' case is that their main funding source is not the global market. Most of their funds come from ordinary Australians, through our bank deposits. And the rates the banks pay depositors have shrunk in recent months as the rival options, the share and property markets, slid sideways and downwards.

In the six months to last month, the Reserve Bank reports, the average rate the banks paid on term deposits fell from 4.5 to 4.2 per cent. The average rate paid on ''special'' deposits fell from 6 per cent to 5.35 per cent. The banks also cut the rates they paid on cash management accounts, bonus savings accounts, and online savings accounts.

Their funding costs have risen? Show us the evidence.

As Reserve deputy governor Ric Battellino pointed out in December, the banks in fact reduced their market borrowings in 2011; their deposits rose by more than their lending. It adds up to a very weak case for the banks to make off with the relief the Reserve wants to give to those who actually need it.

Why do the banks behave this way? Because they can. As the graph shows, since 2007 they have taken from mortgage customers the equivalent of five interest rate cuts. Some of that was necessary, especially in 2009. But there is now a good case for them to start handing it back - to give customers bigger cuts than the RBA offers.

The worst victims of the banks' greed are small businesses. Since 2007, the margins banks charge them above the cash rate have shot up from 3.45 per cent to 6 per cent - the equivalent of 10 interest rate cuts. Again, some of that was necessary, but it has become excessive and counterproductive.

Julia Gillard and Tony Abbott should unite to tell the banks: hand it back. A healthy garden needs more than four healthy trees.

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Do we need industry when we have a mining boom?

THE drastic cuts at BlueScope Steel raise two key questions. Does it matter to Australia if we have a steel industry or not? And if it does, is it worth trying to keep it?

We could ask the same questions about whether Australia should keep making cars. We could ask the same questions about whether we should keep manufacturing anything.

The record dollar is slowly driving Australian manufacturers out of business. With each cent the dollar rises, their import competitors become cheaper and their exports more expensive.

From 1985 to 2005, the Australian dollar averaged US75¢. It has now risen 40 per cent above that to around $US1.05.

That shift has made imported goods 30 per cent cheaper - and our exports 40 per cent more expensive. Australian manufacturing is slowly being crushed. Why has the Australian dollar risen so much? Firstly, because our mineral export prices have risen to record levels and the Australian dollar tends to rise and fall with them.

Secondly, our interest rates are now far higher than in other AAA-rated countries, offering investors juicy returns. Also, the Reserve Bank keeps hinting that it will raise rates higher still.

Thirdly, while most Asian countries (such as China) keep their currencies low to boost local output, ours floats freely. The Reserve at times has intervened to stop the dollar falling, but never to stop it rising.

Nor would it. The Reserve is obsessed with the mining boom and thinks the big threat to Australia is inflation. To contain prices, it is reining back the other 90 per cent of the economy. Its hints of more interest rate rises keep pushing the dollar higher.
Does it matter if Australia becomes, in Kevin Rudd's words, ''a country where we don't make things any more''?

Treasury and the Reserve say it doesn't. They think mineral prices will stay high for decades, keeping the dollar too high for manufacturing to survive. They say we will ship out so many minerals, we won't need it.

Others see that as reckless. Mineral prices could fall sharply. But when factories close, they don't reopen.

To avert that would require big policy shifts, not Band-Aids. The risk is that we will lose manufacturing permanently for a mining boom that turns out to be only temporary.

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The CPI is not a credible basis for policy action

TOMORROW the Reserve Bank board will decide whether to raise Australia's interest rates, lower them, or leave them unchanged. The consensus among economists and markets is that it will leave them unchanged. You hope they're right but it's not certain.

There is no data the Reserve focuses on more than the consumer price index. Its job is to keep inflation low, and the economy growing. The CPI measures whether or not it is succeeding. If inflation starts climbing too fast, it signals that interest rates need to rise.

Last week's CPI figures seemed to send that signal. The CPI climbed 0.9 per cent in the June quarter, and 3.6 per cent in the year to June well above the Reserve's target to keep inflation, on average, between 2 and 3 per cent over the long term.

Banana prices had a bit to do with that. But what really mattered was that the Reserve's measures of underlying inflation rose 0.9 per cent in the June quarter, after similar rises in March. The annual growth in underlying inflation was within the target range, at 2.7 per cent, but in the first half of 2011 it grew at an annualised 3.5 per cent again, well above the target.

Bankers Trust chief economist Chris Caton summed it up well. If this was the only data you had on the economy, he said, the Reserve would have a clear-cut case to raise interest rates. But it is not the only data we have. And the closer you look at it, the less clear-cut the case is.

The other data tells us that the economy is in a weak condition, outside mining and mining investment. That means the surge in underlying inflation is more likely to be a passing blip a rebound from very low rises in 2010 than the start of a dangerous rise.

A close look at the inflation data confirms this. The weightings given to items in the CPI are based on an old survey of household spending. But the Australian Bureau of Statistics changes them to reflect price rises and falls, assuming that we keep buying the same quantities of goods regardless of price changes. That defies reality, and over time, creates a bias that overstates the inflation rate, as the index increases the weight of items that rise in price, and decreases the weight of items with falling prices.

(We leave aside the third reason to be wary of pulling the interest rate trigger: the slowing global economy, and the serious risks facing it as a result of the prolonged budget standoff in Washington, and inevitable debt defaults by governments in Europe. This is no time for crazy braves.)

What do we know about the economy that should make the Reserve sit and watch for now? Plenty. The strength is largely confined to mining and mining construction. Weakness has now engulfed most of the economy. The broader-based the indicator, the clearer it is.

Jobs growth has slowed to a virtual halt. Even on the smoothed trend figures, the bureau estimates that Australia added just 38,000 jobs in the first half of 2011, compared with 188,000 in the second half of 2010.

There is no light on the horizon. The ANZ job advertisements index says job ads have been shrinking since April. The bureau's employer surveys report job vacancies shrinking since February.

The Reserve's own figures show credit growth has fallen to recession levels. In the first half of 2011, credit basically, the amount we owe the banks rose at an annualised rate of just 3 per cent. Even borrowing for housing is growing at just 5 per cent. Borrowing by business is flat.

Consumer confidence has fallen back to GFC levels. Business confidence is below sea level. In this environment, you need a very, very good reason to raise interest rates and the CPI is not it.

It shows inflation is low in most of its 90 sectors of consumer spending. In the year to June, a third recorded falling prices, a third recorded rises within or below the target, and a third recorded price rises above 3 per cent.

It is a similar story even in the first half of 2011. The unweighted median price rise of those 90 items was well inside the Reserve's target zone. But the weighted median was outside it, partly because the index over time overstates our spending on items with rising prices, and understates spending on those with falling prices.

Take bananas and computers. When this series began in 2005, fruit and vegetables comprised 2.1 per cent of our spending, and computers 1.5 per cent. But fruit and vegetable prices have soared since cyclone Yasi, while computers now pack far more power than in 2005.

But the bureau assumes we still buy just as many bananas, even at $12 a kilo, and buy 2005-strength PCs very cheap. So the CPI is estimated on the basis that fruit and vegetables now comprise 3 per cent of our spending, and computers just 0.5 per cent. And that is wrong.

Likewise the CPI seriously overstates our spending on tobacco, and understates spending on mobile phones. And when the weights are wrong, that means the data itself is also wrong.

The Reserve faces a tough call. But it must not jump at shadows. This is a weak economy; it has time to wait. The next CPI figures will be based on a 2009-10 survey of household spending. That will restore the CPI as a credible basis for policy action.

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Good news for bad reason: rates tipped to fall

THE Reserve Bank will cut interest rates four times over the next year or so, as Australia slumps into a marked slowdown, with unemployment rising and consumers saving instead of spending, Westpac has forecast.

Breaking ranks with other economists who forecast rate rises and a boom year ahead, Westpac's chief economist, Bill Evans, said growth would remain stuck in second gear in 2011 and 2012 - forcing the Reserve to take back its last four rate rises.

''Interest rates are too high in Australia, given the state of the non-mining sectors of the domestic economy,'' Mr Evans said. ''A downward adjustment is required to avert a damaging round of contraction.''

His forecast comes as ratings agency Standard and Poor's warned there is now ''at least'' a 50 per cent chance that it will downgrade $14 trillion of US government debt unless Republicans and Democrats agree on a $4 trillion deficit reduction package.

If the stalemate over the deficit is not resolved by August 2, the US will run out of money and default on debt repayments. Analysts say this would trigger a second global financial crisis.

US President Barack Obama wants to cut $US4 trillion from forecast deficits over the next 10 years by cutting spending and closing off more than 150 tax loopholes. Republicans are insisting that the loopholes remain.

Mr Evans predicts that global growth will be below average in 2012, with Europe possibly in recession. Slow global growth will slash Australia's export prices and send the Australian dollar back below the US dollar.

He forecast that the Reserve would take time to concede that it had overdone the monetary tightening. But Westpac expects the first rate cut in December, to be followed by cuts every three months or so in 2012. If it is right, that would cut $250 a month off the cost of servicing a typical $300,000 mortgage, saving home buyers $3000 a year.

But what would be welcome relief for home buyers would also see widespread job losses, particularly in retailing, wholesale trade, manufacturing, non-mining construction and finance.

Westpac predicts unemployment will rise from 4.9 per cent now to 5.7 per cent within a year. That implies 100,000 more people unemployed.

''The Reserve Bank has made it clear that it welcomes softer activity in the household/housing sector to create [spare] capacity for the mining boom,'' Mr Evans said.

''We assert that it will see it is over-achieving, given that consumer spending and housing investment represent 60 per cent of economic activity, while mining investment is around 4 per cent.''

He said concerns over the carbon tax have contributed to a slide in consumer confidence, now at its lowest level since the global financial crisis.

Mr Evans said a similar slump before the GST came in lasted until some months after it had taken effect. ''With the carbon price not due to be introduced until July next year, it is likely to remain a drag on confidence for some time yet,'' he said.

The sharpest fall is in households' perception of their own financial situation. Mr Evans said households' forecasts of where they will be in 12 months' time is ''at extremely weak levels, only recorded on three previous occasions - during the recessions of the early 1980s and early 1990s, and in mid-2008''.

His grim forecast sent the Australian dollar plunging half a cent in half an hour on financial markets yesterday. Futures markets are predicting one or two rate cuts in coming months, but a Bloomberg survey found most market economists still predicting a rate rise by November.

David Jones chief Paul Zahra this week blamed the carbon tax debate for causing the worst conditions for retailers in 20 years.

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Reserve Bank risks a bust to stop boom

THE markets think there is only a 16 per cent chance that the board of the Reserve Bank will lift interest rates today. You hope they're right - but it's far from certain.

Our central bank is on a mission. It believes Australia is springing into a new boom that threatens to lift inflation. Its job is to stop inflation getting out of hand, and its one real weapon is interest rates.

And the boom it foresees is not ''five minutes of sunlight'', as John Howard memorably called the post-recession growth bounce in 1994 (of which, more later). The bank believes we have entered a new era in which global supply of minerals will be unable to meet the booming growth in demand, driven by China and India. And that will entrench high minerals prices for years, and possibly decades.

How does that change life for you and me? Well, high minerals prices over time will mean we also get full employment, and more: a high Australian dollar over a long period, making many producers uncompetitive, and the perennial risk of high inflation - which the Reserve will shield us from by high interest rates.

And if you're in debt (as most households are), that could make life uncomfortable. If the minerals boom unfolds on the scale its advocates envisage, life could become very uncomfortable.

Essentially, the Reserve and Treasury believe the other 90 per cent of the economy will have to shrink - in relative terms, and in some parts, in absolute terms - to free up the resources for the minerals sector to fulfil its destiny to dig up Australia's rocks and sell them to the world.

We are not talking about small tweaks here. The Reserve's most uncritical fans among market economists predict that in the next 15 months, it will deliver at least four interest rate rises, and possibly five. If they are right, that would wreak big changes in the Australian economy.

Many companies would shut down, especially in trade-exposed areas such as manufacturing, tourism and higher education. Many workers would lose their jobs. That would not be accidental ''collateral damage''. It is how the policy works.

The Reserve and Treasury believe (in my view, wrongly) that we are close to full employment. The mining companies say they plan to double their investment in 2011-12 from current levels. Even if that is exaggerated, the Reserve sees its role as ensuring that the companies do not bid up wages so high they create a wages breakout that would spread across the nation, and create the inflation it is there to stop.

To be blunt, it sees its role as to create unemployment - or at least, slow employment - in the rest of the economy, so that more of our scarce skilled workers go to build and operate the mines, where their work will bring the greatest return.

As Treasury secretary Martin Parkinson argued last month in a speech in Sydney, this is structural change. The factories and tourist ventures they close will not come back. In their view, the long boom in mineral prices means Australia will not need them. Others are less sure.

These rate rises would have damaging consequences for many, in a wide range of areas. Melbourne, and south-eastern Australia, would take the brunt of the damage, if firms here are shut down by high interest rates and an ever-higher dollar. Ross Garnaut is right: if the Reserve follows this course, then the carbon tax is a minor issue. Firms will be shut down anyway.

We need to talk about this - and before the Reserve jumps the gun by lifting interest rates for the eighth time in less than two years. Is there a better way to handle the problem? If so, what?

The first step for the Reserve is to guard against hubris. It is not enough to convince itself that it knows what lies ahead. It was right in 2009 when it said the recession would be short and shallow. But forecasting the future is fraught with danger and, recently, the Reserve has got more calls wrong than right.

A year ago, its forecasts significantly overestimated both non-farm growth in 2010 (by a full percentage point) and underlying inflation (by half a percentage point). I don't blame the Reserve for not foreseeing things that few if any saw coming, but look back at its forecasts at this time in 2009, or 2008, or 2007, and you can see its crystal ball is all too fallible. It needs to tread warily. In 1994, it ended that ''five minutes of sunshine'' with three big interest rate rises. Some of us warned this was overkill, and we were right. Unemployment stopped falling, and remained stuck around 8.5 per cent until late 1997, after the Reserve had relented. Let's not repeat that mistake.

As Oliver Cromwell put it: ''I beseech you, in the bowels of Christ, think it possible you may be mistaken.''

There are alternatives. If our choice is between giving mining companies a free hand to import the skilled labour they need, or shutting down growth in the rest of the economy in the hope that some of the displaced workers will migrate to the Pilbara, the first is obviously a better solution. With the Immigration Department predicting net overseas migration to be just 170,000 to 180,000 a year from now to 2014, there is room for more.

We seem to have lost the best option: a comprehensive, well-designed tax on mining profits that would keep the mining boom in check. A golden opportunity to do that was blown away: first, by the Henry review, which proposed an excessive, impractical tax that required taxpayers to pay for mining companies' losses - and then by the Gillard government, which backed down so far that it stripped the tax of any bite or universal coverage.

But the Reserve should try a strategy that parents use (within limits): let nature take its course. If mining companies and contractors get into a bidding war over wages, fewer mines will be built. The risk of a wages breakout in the Pilbara triggering breakouts in Melbourne or Sydney is remote. Let them solve their own problems. Don't shut down the rest of the economy to try to solve their problems for them.

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Reserve's deja vu forecasts

A YEAR ago, the Reserve Bank forecast that non-farm GDP would grow by a buoyant 3.25 per cent in 2010. In fact, it grew 2.1 per cent. The RBA predicted underlying inflation, its key target, would grow 2.75 per cent. In fact, it grew 2.2 per cent.

Those erroneous forecasts drove the Reserve's decision to raise interest rates four times in 2010, while the private banks exploited the lack of competition to boost their profits with what amounted to a fifth rate rise.

Now, we seem to be in deja vu. The Reserve's new forecasts yesterday assume that the growth in output and prices that didn't happen in 2010 will show up in 2011. And its concluding comments clearly flag an interest rate rise ahead.

It estimates that the floods in January will send GDP backwards in the March quarter. That implies non-farm GDP growth for the year to March of just 1 to 1.5 per cent. Yet despite that, the RBA predicts growth for 2011 at 4.2 per cent, and non-farm growth of 4.5 per cent, with underlying inflation rising to 3 per cent.

Well, that implies an annualised GDP growth rate of 6 per cent over the three quarters to December, including this one. And that's with the dollar dragging down trade-exposed industries; consumers saving, not spending; housing in a slump; job growth slowing; business confidence flat; and the risks to global growth still significant.

But wait, there's more. The final section of yesterday's Statement on Monetary Policy warns that the biggest risk to that forecast is that the economy will grow even faster, and put even more pressure on prices. Its central forecast is for a 2011 boom, with a big risk that the boom will get out of hand.

Well, it's possible. The Reserve has picked some long shots before. And yes, mining is booming, but the economy is not.

A year ago, the Reserve forecast GDP growth in 2010 and 2011 combined at 7.1 per cent, with inflation at 6.1 per cent. Despite all that has happened since, yesterday its two-year forecasts were exactly the same. It simply shifted into its 2011 forecasts the growth it wrongly predicted for 2010. With the data pointing elsewhere, this suggests a touch of hubris, that might be insulating it from the reality on Main Street. The data we see presents no credible case for a rate rise. Last year the Reserve jumped the gun, delivering too much restraint, too soon. The risk now is that it might repeat that mistake.

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Reserve rises may have missed the point

If yesterday’s GDP figures are right, then the Reserve Bank has misread the economy, and given us interest rate rises we don’t read.

If the figures are wrong — and their startling revisions to 2009-10 data don’t inspire confidence — then they are just a bit of static we can disregard. But don’t assume it.

For once, Wayne Swan did not come out yesterday with graphs showing how Australia is leaving the ‘‘major advanced economies’’ for dead. And no wonder. All except France and Italy are now growing faster than we are.

With growth of 2.7 per cent, we are now being left for dead by Germany (3.9 per cent), Japan (4.1) and Korea (4.5).

But The real bottom line is growth in GDP per head. The Bureau of Statistics estimates it rose just 0.8 per cent in the year to September. It is still below 2008 levels.

How can that be when we’ve seen so much growth in jobs, our mineral exports are booming, and even after yesterday’s revisions, the Bureau of Statistics estimates that real national income grew 7.2 per cent in the past year?

Surely that makes us richer? Which means we spend more?

Well, some of us. The key to the puzzle lies near the back of the book, where the Bureau examines the sources of household income.

Over the past two years of crisis and rebound, it estimates, total wage income grew by just 7 per cent - including inflation, including all those 400,000 extra jobs.

Average income per employee grew just 3.6 per cent. Inflation grew 4.1 per cent. That means that on average, households depending on wage income are now marginally worse off.

Household income is growing: but the part of it that is really growing is the income of households who invest. Our income from profits, dividends, rent and interest shot up 16 per cent in the same two years. So households with significant investment income are much better off.

But investor households are more likely to reinvest their windfalls than spend them. That’s reflected in the Bureau’s stunning revision of its story on what happened in the last year. It has cut its estimate of household spending in 2009-10 by a cool $27 billion, and trebled its estimate of household saving from $23 billion to $68 billion.

Its picture of Australia’s growth now is extremely patchy. In the past year, almost half of all non-farm growth was in mining, mineral processing and construction. Most of the rest was in the finance sector and professional services (lawyers, accountants etc). The other two-thirds of the economy is growing little, if at all.

Many economists, inside government and outside, don’t believe this. They point to the stunning jobs growth of the past year, to the Bureau’s record of revising up past data, and dismiss yesterday’s figures as at most a ‘‘speed bump’’ on our road to the boom the Reserve predicts.

They may be right. But in my mind, these figures add to concerns that, as in early 2008, the Reserve may have misread the game. It has focussed on the needs of one industry in one state — mining in WA — when its job is to set interest rates for the entire economy. There is a risk that it has done too much, too soon.

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Crazy-brave Norris calls Swan and Hockey's bluff

COMMONWEALTH Bank chief Ralph Norris must be crazy-brave. As our political leaders compete to show themselves tough on banks, he has invited them to do their worst.

The decision by Australia's biggest home lender to raise its interest margin by 0.2 percentage points on top of the Reserve Bank's 0.25 percentage point rise gives Wayne Swan and Joe Hockey the perfect excuse for reforms to make the big four banks face real competition.

Norris has bet that, in the end, their bank-bashing will be mostly talk, little action. And he is probably right.

The big four are now a firm oligopoly, controlling 87 per cent of housing loans. Since the mid-90s, our competition regulators have allowed them to gobble up their main rivals, and the global financial crisis saw off the rest.

Joe Hockey's nine-point plan has some good elements such as a new financial system inquiry but let's be frank: their impact would be marginal.

There's only one way to create serious competition to such a strong cartel: do what Prime Minister Andrew Fisher did in 1911, when he set up the Commonwealth Bank as a government-owned competitor. Our politicians won't do that.

The Commonwealth claims its borrowing costs have risen more than its mortgage lending margins. That may be, but its business lending margins have grown sharply, and Reserve Bank figures show the big four's total lending margins are now at their highest level since 2004.

Let's test the banks' good faith. If they regard their pre-GFC interest margins as sacrosanct, will they now commit that when funding costs fall as they will they will pass on all that fall to their customers?

If not, then this is simply a selfish use of market power. The banks are charging us more because they can get away with it. Shareholders pay Ralph Norris $16.2 million a year $310,500 a week to do just that.

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Reserve chooses wisdom over the chatter of economists

THE Reserve Bank board made a wise choice yesterday. And by doing so, it reminded us that its nine members set interest rates, not the bank's senior officials.

A year ago the board raised rates for the first time in this cycle despite market economists tipping no rise and News Limited columnist Terry McCrann saying it was "all but certain" rates would stay on hold.

This time the board left rates on hold despite economists tipping a rise, and McCrann telling us a rise was "all but certain".

The board did its job. On one hand, it would have heard the bank's senior officials argue that rates must rise to head off inflationary pressures they foresee if the resources boom develops as fast as they expect.

They may well be right, at some point. But the board also sees the data suggesting six interest rate rises in the past year have had a heavier impact than the bank had expected. Housing approvals have plunged, retail sales are lukewarm, as is business and consumer confidence.

The board knows that confidence in global financial markets is fragile and that inflation in Australia is falling, not rising. Why move now?

A rate rise yesterday could not have been based on what economic data is telling us, but only on what Reserve staff think is around the corner. The board was right to ask for more evidence before moving.

It meets next on Melbourne Cup Day six days after the release of September quarter inflation figures. If they show underlying inflation in check, a rise would be a hard sell.

The last meeting this year is on December 7, after the national accounts figures are released. That could be a good time to reassess the risks, when there is more data on how we're travelling, and maybe clearer signals on the world economy. .

Glenn Stevens's statement yesterday warns: "If economic conditions evolve as the board currently expects, it is likely that higher interest rates will be required, at some point."

That's true. What we don't know is whether conditions will evolve as the bank expects.

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Housing slump may help keep rates on hold

AUSTRALIA'S housing recovery has vanished. Dwelling approvals plunged again in August to their lowest level in a year, throwing serious doubt on the prospects of another rate rise soon.

With the federal government's stimulus programs coming to an end, the banks turning away builders, and six rate rises in the past year deterring buyers, seasonally adjusted housing approvals fell 4.7 per cent in August to 13,049.

In just five months, approvals have crashed by 24 per cent, after hitting a high of 16,835 in March. Half that crash is due to the Rudd government's social housing initiative winding down, and half to a slump in private sector activity.

The crash has come overwhelmingly in New South Wales, Queensland and Western Australia with Victoria, South Australia and Tasmania islands of strength in a drifting continent.

So far this financial year:

More than 40 per cent of Australia's private sector housing approvals have been in Victoria which has just 25 per cent of the population.

More homes were approved in Melbourne alone than in Sydney, Brisbane, Perth and Canberra combined.

The Bureau of Statistics reports that 8728 new homes were approved in Melbourne in July and August, but just 3420 in Sydney, 2652 in Perth, and 1863 in Brisbane.

Non-residential building also remains very weak. The federal government's school building program has wound down, while private sector activity is still bumping along the bottom.

The figures suggest that the Reserve Bank's six interest rate rises in a year have dampened the economy's prospects more than the Reserve has been willing to admit.

Financial markets, which had been pricing in a further rate rise when the Reserve board meets next week, yesterday slashed the odds of a hike to 50/50, amid mounting evidence of economic weakness.

The Reserve itself reported that business credit slumped by another 0.6 per cent in August, while credit to people buying their own homes in the past quarter grew at the lowest rate on record.

The HSBC bank's new chief economist Paul Bloxham until recently one of the Reserve's senior economic analysts predicted that the Reserve would hold off raising rates again until it had more data to justify a rise.

"One of the least good outcomes would be that the Reserve Bank is in a position where it has to reverse a decision quickly," Mr Bloxham said. "This would be disruptive for both the economy and the financial markets."

The IMF also sounded a warning note in a new report on Australia, released yesterday. It forecast only average growth in 2011, with a risk that a deteriorating world economy could slow the economy further.

The government had hoped rising housing activity could help reduce the shortfall of an estimated 200,000 homes.

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Tread warily on rates: IMF

AS HOME owners brace for an expected rate rise next week, the International Monetary Fund has challenged the Reserve Bank's forecasts that the economy faces a boom ahead, and implied that it should wait and see before acting.

In its latest report on Australia, released at midnight, the IMF also endorses the government's timetable for reducing the deficit now under fire from leading economists and Treasury itself.

The IMF does not directly criticise the RBA. But in pointed comments, it suggests the economy's future is more clouded and uncertain than the Reserve implies. It forecasts that Australia's growth next year will be between 3 per cent and 3.5 per cent, not the 3.75 per cent forecast by the RBA.

Moreover, the IMF says, the risks from the global economy "are tilted to the downside", so there is more chance that Australia will end up below its forecast than above it.

"It was appropriate for the RBA to start withdrawing stimulus in late 2009," it says. "However, capital market turbulence generated by European sovereign debt concerns has increased uncertainty about prospects for a world recovery next year.

"With lending rates in Australia close to their recent historical averages, and economic activity responding quickly to cash rate adjustments, the RBA has scope to wait for the outlook to become clearer."

Following a series of bullish speeches by RBA chief Glenn Stevens and other senior officials, the markets now expect the Reserve's board to raise rates again on Tuesday its seventh rate rise in a year.

Private bank economists are also tipping an eighth rate rise before Christmas, as the central bank tries to offset inflationary pressures from a boom in mining investment in WA by slowing the rest of the economy.

The IMF warns Treasury and the government that "the growing dependence on mining may amplify the business cycle", with bigger booms but also bigger busts when commodity prices fall. It advises them to be ready to move in either direction.

The IMF also backs the mining tax in principle, but says the original version of the tax was better than the watered-down version. In particular, it urges the government to extend the tax to all minerals, not just iron ore and coal.

Macquarie Bank economists, meanwhile, criticised calls for faster spending cuts, pointing out that existing deficit reduction plans, if delivered, would see the fastest cut in the deficit since records began.

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A tale of two economies: it's all in the figures, Guv

"Yes, I think it is going to be a two-speed economy . . . I think all those issues of geographical differences and industry differences are likely to re-emerge with a vengeance. The relative price of resources is high, that of manufactures is low. There are structural adjustment implications of this for our economy . . . they will, I think, probably intensify in the years ahead."

- Reserve Bank governor Glenn Stevens, February 19

"While some events can lead to a divergence in economic conditions across Australia, overall these differences have not been especially large in recent times . . . What is remarkable, in fact, is that the differences are not, in the end, larger."

- Reserve Bank governor Glenn Stevens, September 20.

IN MY next life, I want to be a central bank governor. People fawn on you, whatever you say is taken as gospel, and others rarely challenge it.

In Shepparton on Monday, Glenn Stevens had two messages. The first was to restate the Reserve's big-picture view of the future: a "fairly robust" mining-driven upswing ahead, requiring monetary policy action, better known as interest rate rises.

No argument there. Far more striking is the blunt language in the minutes of the Reserve board's September meeting, declaring that if that big picture is right, "it was likely that higher interest rates would be required". That means soon.

But his second message was more tendentious. The Reserve chief played down the risk of that resources boom dividing Australia into a two-speed economy. Indeed, he tried to persuade his audience that this hadn't happened, and wouldn't happen.

The only evidence he presented was a handful of graphs demonstrating that over a 10-year or 15-year time period, movements in prices and unemployment rates had differed less in the six Australian states than in the 50 states of the US or the 27 countries of the European Union. You don't say. I wonder if that might have something to do with the fact that states are always more alike than countries. Or that six units of anything offer less scope for differences than 27 or 50.

The Guv's choice of time frame also missed the point. We were not a two-speed economy 10 or 15 years ago. This emerged in the past five years, as mining investment and export revenues grew exponentially, the Reserve responded by driving up interest rates, which drove up the dollar, which made significant parts of our manufacturing, agricultural and tourism industries uncompetitive.

That is why the two-speed economy became an issue. It is why we in Victoria fear the consequences of an even larger mining boom, and an even higher dollar, ahead.

It is why Stevens himself warned just seven months ago that the problems of a two-speed economy "are likely to re-emerge with a vengeance" and "will probably intensify in the years ahead".

Look at the data for the past five years, as shown in the adjoining table, and you see why. Inflation, on average, was within the Reserve's band of 2 to 3 per cent in NSW, Victoria, South Australia and Tasmania. Only in the resource states was it over the Reserve's limit, yet that dictated interest rates for us all.

Or look at where the demand pressures on the economy were generated. In round figures, demand grew 45 per cent in WA, but 18 per cent in Victoria and NSW, and even less in SA and Tasmania. The overheating the Reserve feared did not happen here, yet the Reserve's response to it higher interest rates and a higher dollar pushed businesses here to the brink. Or take average weekly earnings: growth in WA over the past five years was almost double the growth in Victoria. The overheating was not happening here.

Take industry growth: over the five years to 2009-10, manufacturing output actually fell, albeit marginally, while growth in the hotels and restaurants sector averaged just 0.1 per cent a year. That's the real cost of a mining boom, and it's what people fear ahead.

Remember: the slowdown in the Australian economy began in the first half of 2008. It was not a consequence of the global slump: it began as our export revenue soared to a new high. It was the consequence of the Reserve's interest rate rises and the higher dollar they created.

Our fear is that is going to happen again now, with a vengeance, and intensify as Glenn Stevens forecast in February. The new Glenn should listen to the old one.

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