Show host Gene Tunny and Morgans Chief Economist Michael Knox explore the recent insights Reserve Bank of Australia Deputy Governor Andrew Hauser shared on monetary policy at the 2024 Economic Society of Australia (QLD) business lunch. They examine the RBA’s data-driven approach to interest rates, the equilibrium real interest rate concept, and the impacts of Quantitative Tightening (QT). Michael is one of Australia’s leading market economists and RBA watchers, and he led the Q&A session with the Deputy Governor at the lunch.
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What’s covered in EP250
- Introduction. (0:00)
- RBA’s monetary policy decisions and the influence of high US debt on interest rates. (4:13)
- The equilibrium real interest rate. (10:29)
- Monetary policy, inflation, and interest rates. (14:16)
- Central bank balance sheet unwind and its potential impact on interest rates. (21:42)
- US budget deficits, bond yields, and quantitative tightening. (27:09)
- Chinese RMB’s decline in international reserve currency status. (34:18)
Takeaways
- RBA’s Data-Driven Approach: The Reserve Bank of Australia relies on actual data more than forecasts when making interest rate decisions.
- Criticism of Overconfidence: RBA Deputy Governor Andrew Hauser criticised the unwarranted confidence with which some commentators argue for monetary policy moves.
- Implications of Quantitative Tightening (QT): The recent period of quantitative easing has complicated the relationship between government budget deficits and bond yields. However, there are concerns that as QT continues and deficits remain high, this relationship could reassert itself and lead to higher long-term interest rates than otherwise.
Links relevant to the conversation
RBA Deputy Governor Andrew Hauser’s Beware False Prophets speech:
https://www.rba.gov.au/speeches/2024/sp-dg-2024-08-12.html
Chris Joye’s article ‘Arrogant RBA boss should stop trying to muffle opponents’:
Kevin M Warsh: Financial market turmoil and the Federal Reserve – the plot thickens
https://www.bis.org/review/r080415e.pdf
Transcript: RBA Deputy Governor’s ‘Beware False Prophets’ talk: Reactions w/ Michael Knox – EP250
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Gene, welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene, Tunny, I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode. Please check out the show notes for relevant information. Now on to the show. Hello and welcome to the show. This episode features a conversation that I had with Morgan’s chief economist, Michael Knox, it was about a recent event that the Economic Society of Australia, Queensland branch held with the Reserve Bank of Australia. Deputy Governor, Andrew Houser, it was a business lunch on the 12th of August 2024 in Brisbane. And given that I’m the current president of the Queensland branch of the society. I had to welcome everyone and Michael, he introduced the deputy governor and led the Q and A Michael had that role because Morgan’s sponsored the lunch. In his address, the deputy governor spoke about the challenges of setting monetary policy when there’s so much uncertainty, he suggested that some Australian commentators are overconfident in their assessments of what the central bank ought to do. We’ve had some commentators say the reserve bank hasn’t lifted interest rates enough, and we now have some commentators saying the reserve bank should be cutting interest rates because the economic outlook is so bad. Michael and I start off this episode talking about the deputy Governor’s speech, before we move on to a couple of meaty questions that Michael asked the deputy governor. These questions were about the equilibrium real interest rate and the effect of so called quantitative tightening. I get Michael’s reactions to the answers that the deputy governor gave him I should note that both Michael and I were impressed by the Deputy governor’s remarks, but the deputy governor has received some severe criticism in response to them. One of the strongest bits of criticism has come from well known financial economist and fund manager Chris joy. He’s written in the Australian Financial Review the following the newly appointed English Deputy Governor of the Reserve Bank of Australia, Andrew Hauser, apparently has a proclivity for lecturing Aussies on the history of our penal colonies, arrogance, overconfidence, and the importance of Never daring to criticize our supercilious central bank. Okay, so it’s, it’s a speech that has that’s got everyone talking and I mean, as President of the Economic Society of Australia, Queensland on, I am, I’m happy that people are talking about it. People have taken notice of what the deputy governor has said. What do you think about what he said. I’ll be interested in in your thoughts on it. If you want to get in touch, please do so. My contact details are in the show notes. I’d love to hear from you about the deputy Governor’s speech or his responses to Michael’s questions, or any ideas you have on how I can improve the show. I’d love to hear from you. Okay, without further ado, let’s dive into the episode. I hope you enjoy it. Michael Knox, good to be catching up with you. Good to see you too. We had a great economic society of Australia Queensland Business lunch earlier this week with the RBA deputy governor, Andrew Hauser, and you did a great Q and A session with the deputy governor. So I thought what would be good is to just catch up on that, and you know your reactions to his responses, because at least one of them, I think, was not, probably not what you’re expecting, certainly wasn’t what I was expecting. So just interested in your your thoughts on that. But to start with, what did you think generally of the deputy governor’s talk about the wearing urging us to be what is it? Beware of false prophets?
Michael Knox 04:12
Well, when I got up, I asked I before I asked him the scheduled questions that he and I had talked about before the presentation, I said to him, so it’s really true that the RBA makes its decisions on monetary policy on an inter rated basis, one step at a time. At every meeting, they are looking at the data. They are looking at where employment is. They are looking at what the inflation data is saying, and they and they’re looking at all the other variables and then, and then they’re making the decision on the data a step at a time, yes, yeah. And he said, and he said, Yes. He said, does that mean? I. Don’t have to answer any of your other questions.
Gene Tunny 05:06
Yes, I think that was actually something that the Kook, Steven kookis reacted to on Twitter, like when he heard the speech, his initial like he I think he liked the speech, but his reaction to it was, look, the RBA is confirming that they’re only going to move on hard data. They’re not going to move on, you know, people in the business community saying things are tough and you should cut rates now. They’re not going to move on forecasts from market economists as to what’s going to happen. They’re going to be solely focused on hard data, at least that’s what he took out of it.
Michael Knox 05:37
Yeah. Well, I think that, though, what he talked to me about before, before we were when he went up, was the the influence, and not so much the influence. But I think the annoyance of people like Warren Hogan and other economists saying that the rate should, rate should go up, yeah, or another people saying that rates should go down, and they’re more having their own theory on it, yes. And whereas the he felt that they were looking pretty much at everything that they needed to look at and making the decision the right way. And I think the presentation was about how is about? Was about false positives. Yeah, yeah. People make decisions on a view of what the RBA does, which is their view of what the RBA is doing, but the RBA is actually operating in a different way. Yeah,
Gene Tunny 06:28
yeah. I think so too. I think that gave us a really great insight into how the RBA is thinking about the cash rate decision. I thought that was I thought it was really useful. Can I ask you about the questions that you asked the deputy governor. So the first one you asked about was regarding the equilibrium real federal funds rate. Wasn’t it you were asking, you’re talking about, well, Larry. Was it? Larry Summers had argued that because of the Highland Olivier Blanchard and Olivia Blanchard, right? So some pretty heavy hitters, right? Yeah, real heavy hitters. And you are. They’re arguing that the because of the high level of US debt, you mentioned, that sovereign, net sovereign debt for the United States is going to get to 100% of GDP, of their GDP. And what that means is that the equilibrium federal funds rate nominal is 4% which means, in real terms, it’s 2% have I got that? Right? That’s
Michael Knox 07:29
exactly right, right? That’s what they’ve said. And if you look at the Peterson Institute, they in fact, have five published research papers, not just from them, but for other people who’ve done for the Peterson Institute and and they done over time and their empirical research, and they actually come up with the number of each 1% increase in net G debt to GDP increases the the the equilibrium Fed funds rate by a little over four basis points. So you get Right exactly. You get 450 basis points. Is the equilibrium level of of the Fed funds rate at 100% of GDP, the now the now the net debt of 100% of GDP, that’s a forecast from the International Monetary Fund. So if you go on their their quarterly database, and you’ll see the updated forecast for that 100% of GDP. Very interestingly, Andrews come from the Bank of England, yes, and the UK has exactly the same debt problem that their debt, net debt, is now 100% of GDP. So all of that debt that they paid back from North Sea oil and Margaret Thatcher and all of that kind of thing, they blew it all again, and maybe Boris blew a good bit of it, by the look of it. And and so they’re now in as much debt as they’ve ever been. I
Gene Tunny 09:02
mean, it’s like with all the, you know, many advanced economy governments after the financial crisis, there was, we just took we had the view, oh yeah, we’ve got to spend money to deal with this crisis, and then we don’t really have to worry about debt anymore because interest rates are so low. Larry Summers had secular the secular stagnation hypothesis. I think that’s part of it. There’s some changed attitudes. I mean, I don’t agree with that, but that’s what would you should we go over what? How Andrew responded?
Michael Knox 09:34
Okay, Andrew, so the first question was, in your presentation of 27 June, you showed that historically, Australia has been an importer of capital. And I remark that two noted economists, Larry Summers and Olivier Blanchard of the Pearson Institute, have suggested that the high level of us net sovereign debt to GDP, which reaches a. 100% of GDP next year, according to the IMF estimates, will generate an equilibrium Fed funds rate. This is, according to Larry and Olivier, an equilibrium Fed funds rate of not less than 4% that is to say a real rate of around about 2% so does this mean that the equilibrium real short rate in Australia is likely to move to higher a higher level going forward?
Andrew Hauser 10:29
So I think the this concept of equilibrium real exchange rate [NB he means equilibrium real interest rate] is a bit like the supply capacity number in my speech. It’s a latent variable. You can’t go and look for it anywhere, right if you if someone we Bank of England joined the first week. He wrote, and he said, Can somebody tell me where the measure of the equilibrium interest rate is? And some whip rope out? He says, the same place as the NAIRU, you know, and the sustainable level of output. In other words, who knows? And so that’s an important point to start with. Nobody knows the answer to that. Larry Summers is quite good at saying he does know the answer, although sometimes, if you look back over its forecasting record, it’s not quite, doesn’t always follow quite the certainty of his, of his predictions when you so there’s huge uncertainty about what this number is. It is interest when he when he says real rate of 2% he’s been provocative, right? Because if you look at the fomc.so called dots, for example, at the estimate of FOMC members, that’s us monetary policy makers estimates for the long term real interest rate, they have a number like half a percent. It’s quite low the John Williams estimate. John Williams is head of the New York Fed, the US, who’s made a bit of a name at running various models on this is probably somewhere between nought point five and one. So the two is a higher number, and that’s your point, or his point that he thinks it’s going to be higher. There are enormous number of different drivers of this number, right? I mean, ultimately, our star as it were, sorry to use the phrase, our star equilibrium. Real rate is the outcome of equilibrium in the savings and investment market. And if you think about all the things that could drive that, those who think that number, including John and others, is relatively low, will put weight on things like, well, demographics. People get their countries are getting older, so they’re having to dissave Rather than save they’ll put weight on things like productivity. Whereas when, you know, in Australia and elsewhere, productivity rate, growth rates in most Western countries, not the US, actually, but most countries, have been quite low. And we’ll say, Well, look, actually, I don’t buy this number like 2% it’s a lot lower than that. There’ll be others like summers and others who say, Well, look, you know, there’s new shocks and new issues around I mean, I think in talking about the US debt, he must be talking about a risk premium, if that’s right, which is to say, look, there’s so much debt that the US and the 7% deficit of GDP is pretty impressive. Sometimes there’s some they’re issuing so much debt, at some point there’ll be a wobble. There may even be concerns about default risk premium will go up and that our number will go up as people start charging up to lend to the US. And you could think of other reasons too many people who will think that the energy transition, for example, is going to lead to higher investment demand, which will raise that number. You know, who knows? Is the honest answer, whether it’s 2% 1% or half. You asked a question about Australia, and because it’s actually difficult to take no view on this at all, we have a swathe for our own equilibrium, short rate, equilibrium rate, which is similar to that swathe of numbers that I showed you for unemployment. And actually that’s all that has a central point of something like three and a half, three and three quarters in nominal space. Obviously, our current cash rate is a little bit above that. So I think you pay your money and you take your choice. I wouldn’t want to be someone actually trying to invest on the basis of these numbers. Summers may be right, but it may be wildly wrong.
Michael Knox 13:58
Okay, so what I’ve said about that is, if you go to the Peterson Institute website, you’ll find five studies, different done at different periods, and the most recent one is actually that you get, it’s actually four and a half percent, 450 basis points, 100% of GDP. That’s where you concluded. But what the real test of this when Larry Summers was and actually, Larry Summers did this talk last year, yes. So I’d actually saved this question up for a year, because I’ve been, I’ve been I model bonds myself, and I use deficits and that kind of things in my bond models. But the position that Larry Summers was putting when he talked about this last year, was that when the Fed started cutting rates for 535 basis points, it would be difficult to sustainably cut it below 400 basis points. Yeah. Okay, and so when you got to 400 basis points or lower. Up or you got below 400 basis points, there would be some reaction, either in inflation or the US dollar, which might would make it difficult to continue to cut rates to where the Fed that currently projects they’ll get to, which is 250 basis points, sometime at the end of 25 or 26 Yeah, is where they think on the summary of economic projections, yeah, but they put out every quarter, so, yeah. So expectations of the Fed, of interest rates falling down to two and a half percent might crash into the reality of net debt as proposed by Larry Summers and leveling a Blanchard on the way down, we’re going to find out, yeah, that’s one of the part of the adventure of economics, yeah?
Gene Tunny 15:44
So this equilibrium nominal cash rate, or federal funds rate, so the overnight money market rate, yeah, this is the rate that they believe is, is essentially that it corresponds to neither a monetary policy stance that is neither expansionary nor contractionary. It’s a, it’s a neutral monetary policy, stand. It’s
Michael Knox 16:06
a neutral monetary policy, but it’s, it’s the basic problem here is that there’s the net debt to GDP goes up in the United States. Yeah, the real rate has to rise to attract the inflow of savings to finance that higher level of debt. So the real rate, nominal rate, plus your inflation target goes up, okay, as net the jet to GDP, right? That’s the that’s the problem.
Gene Tunny 16:33
And what did you think of his like the the RBA view? So their view of the neutral cash rate in Australia, in nominal terms, is, was he saying three and a half or three and three quarters percent? Does that sound
Michael Knox 16:46
well, where they’ve where, where it is thought to be. Okay. So when Michelle Bullock, when she herself, presented in the Hilton for us two years ago when she was also deputy governor. At that time, she then thought that the equilibrium real rate in Australia was 50 basis points. That’s what she said at the time. Now, the commentaries of the of the RBA that I’ve read and the surveys they’ve read, so that’s now increased to 75 basis points. So instead of an equilibrium short rate of inflation at two and a half percent plus 50 basis points, saying that 3% is where the equilibrium short rate is, now that’s risen to 325, basis points, or 350 right? So in the surveys they put out in part of their publication in the quarterly outlook for the summit of their not the summary of economic projections, but the statement on monetary policy in their detailed section they they look at, they do a forecast of the detailed cash rate, and they see the detail they in that detailed forecast they see in 26 December, 26 the real cash rate will get down to three and a quarter percent, but that means the inflation of two and a half percent plus 75 basis points for the real rate. They now therefore see that that real rate is 75 basis points. So
Gene Tunny 18:35
real rate 775 basis points and a target, the inflation, the target band of two and a half percent, so that gives us three and a quarter percent. That’s where they expect it to be at equilibrium, right? Gotcha. Okay,
Michael Knox 18:50
so Larry Summers are saying, but I mean, our debt to GDP is half or less, yeah, debt to GDP is half or less what it is in the US. So summers and Blanchard suggest that their equilibrium will be higher,
Gene Tunny 19:03
yeah. Okay, yep. Now that all makes sense. Okay, very good. We might go to the next question that the second question you asked, also an excellent question. So we’ll just, we’ll just play that and then we’ll catch up on that one.
Michael Knox 19:19
So the second question is Kevin Warsh. Kevin Warsh is a previous member of the Federal Reserve Board of Governors, and now he’s he did that job for five years, and now he’s a visiting distinguished fellow at the Hoover Institute at Stanford. In an article on in Wall Street Journal on the 28th of July, Kevin Warsh said that US inflation and interest rates would be rising if the Fed was not reducing the size of its balance sheet. And if it’s reducing the size of its balance sheet, it’s reducing the money base and. Or that’s what’s driving inflation down. So my question is, the RBA is currently running down its balance sheet, and it’s quantitative tightening, and you can see this in the RBA chart book. So is this one of the reasons that the RBA has not have had, has not been forced to increase interest rates.
Andrew Hauser 20:21
So could I give you a one word answer, which is, no, you might not like that quite as much as you like my previous answer. So let me sort of elaborate a bit on that. The reason why people ask this question is obviously when interest rates were at zero or the effective lower bound during the covid period and beforehand in the UK, central banks had to find other ways of expanding of easing policy. And as you know, they did it in the most part, by buying assets, and actually also by lending to banks at longer than normal maturities, both of which the RBA also did before I before I arrived here. But certainly the Bank of England did a great deal of this as well. And it was fairly commonly felt that that effectively added to the amount of monetary stimulus in the economy, that, if you like, the effective short term interest rate went negative to some extent, right? So the thought underpinning the Kevin argument, I guess, is that if it worked on the way in, why wouldn’t it work on the way out? The trouble with that is that, by and large, and people are looking at this very carefully, can’t really find any material macroeconomic effect of unwinding the balance sheet at all, maybe a few basis points here or there, but no major central bank that’s doing it really considers that To be any part of its monetary policy strategy. We’re all watching in case that view learning turns out to be wrong. But our central estimate is that it’s likely that QE unwind, or so called Qt quantitative tightening, actually a bad phrase, right? Because the T implies more of an impact of the kind you’re describing than is actually the case. But there’s the most the central estimate at the moment across countries is the multiplier of the kuti effect is very, very small. Now, I have a particular personal engagement in this, because the Bank of England was one of the very few central banks. In fact, I think the only one that ran down its balance sheet, not only by allowing assets to mature, but by actively selling them back to the market. The New Zealand, RBN said, has been selling assets back to its own debt management agency and the RICS bank. The Swedish central bank has been doing active sales more recently. But when we first announced we had to do this, a reason we felt we had to do this is that the average maturity of the debt stock in the UK is very long, and we faced the prospect of having to hold gilts, government bonds, UK gun bonds, more or less forever, unless we started actively selling. Whereas for most countries, including Australia, the average maturity of bonds is far shorter. You can just let them roll off. We felt we had to do those active sales. I still think we had to do them. But the market, financial market, through its hands up in horror and said, This is a nightmare. You’re going to bring the market, the world to an end. You’re going to drive interest rates up in exactly the way that Warsh is describing, that will cause mayhem in the financial markets. And they were very pleased to say that prediction was another overconfident prediction of mayhem that turned out to be completely wrong. There is very little evidence so far that balance sheet unwind has driven market interest rate rates up materially, though we must continue to watch. So no, it’s not one of the reasons why the RBA has not had to lift rates. There’s one other reason before I finish, which is actually the big unwind in the balance sheet of the RBA that’s happened over the past six or 12 months has not been primarily allowing bonds to unwind. But as you probably know, it’s the maturity of the so called TFF, the term Funding Facility, which is a lending facility to banks. Again, I think there was a considerable concern here. It was, largely before I arrived, that that unwind might cause difficulties. It’s a very sharp reduction in the stock of money in the in Australia. But it has gone by practically without a whimper. So so far so good. At some point, if you keep reducing your balance sheet, you the stock of reserves will hit the demand for reserves. And if you hit that at two sort of sharpen angle, you may find that financial, you know, these relatively calm financial conditions turn into considerable instability again, and a lot of central banks are watching for that moment, but it hasn’t come yet.
Michael Knox 24:28
Okay, so, Kevin Warsh, yes, yes. I think I’ve always loved Kevin Warsh as a character, but particularly when he’s on the Fed, yeah, and he gives a speech, which you can google. Kevin Warsh, fish don’t know they’re wet. And it’s one of the great speeches I’d given at the worst part of the financial crisis about the need for liquidity and the fish. He’s describing other people in the financial market who don’t know that they’ve been swimming in this sea of liquidity until it’s. All gone, and then they they’re all flapping on the flapping on the beach in totally unable to cope with the situation. So I think that’s something you should read. Kevin Warsh fish don’t know they’re wet on the which is a speech of his when he was part of the Fed. So I think the problem, I think the problem that Andrew Hauser is talking about, when you examine this hypothesis now it’s difficult to measure it empirically. Yeah, and I think that’s true, but it doesn’t mean the fact that you can’t measure it empirically doesn’t mean that Kevin wash is wrong. I think Kevin Warsh is right, but talking about the problem of measurement, I’ve been running bond models for Australian bonds and US bonds for a couple of decades now, okay? And I know in that there’s a really big response to increases in decreases in deficit. Yeah, I remember back in the 90s at an Australian economist conference, which was in Tasmania. And at that time, bond yields, the Australian 10 year bond yield, was 9% yield was 9% Yeah. And I showed a model of based on forecasts of where the US budget deficit was going to go, because at that time what was under Clinton, yeah, and Gingrich, the US budget deficit was going back to balance. Yeah, it was extraordinary. And what I said is that that would reduce the budget reduction of budget deficit would drive bond yields down to 5% and I remember at this conference, doing this speech and being met with absolute disbelief that Australian 10 year bond yields, and us 10 year bond yields could ever fall again to 5% I mean, there was, it would be both miraculous and absurd if that, if that occurred. But it is, in fact, exactly what happened when the US balances budget deficit so but what’s happened is, but during the recent period, if you’ve got, if you’re running big budget deficits, at whiz we have in the last couple of couple of years, and at the same time, you’ve got quantitative easing, yeah, it’s what’s actually driving the market. Is not the theoretical level of the deficit, it’s the actual flow of funds, yeah, into the bond market, correct out of the bond market, yeah. And if you’re the Treasury, US Treasury, or the Australian treasury, is issuing a lot of debt, but at exactly the same time they’re being bought by the Central Bank, they’re having no effect upon the upon the bond yields, yeah, some interest rates, yeah. So it’s what happens is that that whites out this effect, which in previous periods you can see very strongly in the relationship between budget deficits and and bond yields. In this period because of quantitative easing and tightening, it’s wided out because you’ve got this influences of what the Reserve Bank is doing in each country, the reverse of what the Treasury is doing and but, but I confidently would suggest that as we go forward and we find that you’ve got big budget deficits, and the Fed is winding down smell and shoot the same time, bigger supply of bonds coming forward to the market in the next couple, one or two or three years time, that will begin to have significant effects upon bond yields. So what we saw two years ago was the lowest level of US Treasury bond yields since Alexander Hamilton invented the US Treasury bond in July 1799 and I believe he had it passed by two votes, maybe one, but I think it was a very small majority for passing the US Treasury bond back in July 1799 I’ve stood on the same floor of the old Congress building in in Philadelphia, where the bill was passed, you know. And I thought at the moment, you know, but as we go forward and we’re trying to the US is trying to finance these big deficits and yeah, and unwind the balance sheet at the same time, I think we will see that those low bond yields two years ago won’t probably be repeated for another 200 years.
Gene Tunny 29:46
Okay, so the Federal Reserve’s going to start or everyone expects them to cut. So we’ll see cuts in the federal funds rate, and so therefore longer term yields should theoretically go down as well. But. You’re saying that if you’ve got this quantitative tightening happening as well, they wouldn’t go down as much as otherwise. Is that? Is that how you’re thinking about it?
Michael Knox 30:07
Well, in the bond models, the bond models are a composition of different variables, yeah, things like budget deficits, things like inflation, short rates, are there. Yeah, capital inflow is really important, also in the early part of this century. So there’s a whole bunch of things in those bond models, but Well, firstly, what you would find is, if Olivier Blanchard and Larry sums are right, the Fed funds rate can’t go down as far as was previously thought. It doesn’t get to two and a half percent. It just gets to 4% or three and a half or something like that. And then they run into a wall for some reason. And that provides a floor in the model that will fly the floor to the to the US Treasury bond yield. And in addition that, what’s if we look at the IMF forecasts for the US budget deficit going forward to the end of this decade, you’ve got average deficits between six and 7% of GDP. Yeah, they have, and they’re really there because of the size of the debt and the amount that has to be refined, yeah, every year. And so you’ve got those two things so that’s supporting in my bond models, that itself is supporting the higher yield for us, treasuries and the and it’s working back in the Larry Summers thing, giving you a higher Fed funds rate. So both of those things will push up the equilibrium yield for the US 10 year bond over the next 10 years. So I think that, in short, the best way of looking at it is we had a bull market in bonds from 19, from when Paul Volcker was around in 8132 until about 2020, and that was a great bull market in bonds. But if you look at what happened during the 60s and the 70s, that was a bull market in bonds was followed by a bear market in bonds of about 15 years. Yeah. So I think the US Treasury bonds and our bonds are going to be in a bear market for about 15 years. And I think that’s the problem that is visitors upon us by the belief that you can spend money on whatever you like, particularly during the Biden Harris period or Biden Harris administration, and run big deficits forever, and it’s never going to cost you anything. And I think that’s wrong, and I think Larry Summers and Olivier Blanchard are right,
Gene Tunny 32:42
yeah. I agree with you about what the Biden, Biden Harris, or the Biden administration has done with inflation Reduction Act, I think that looks excessive. But I mean, if Trump gets in, he’s going to have a big tax cut, isn’t he, so that’s going to have a similar impact on the deficit, isn’t it? I mean, it’s going to potentially blow out the budget deficit, yeah,
Michael Knox 33:00
but empirically, if you actually look at the Trump period, yeah, Trump cut tax corporate taxes during that period. Yes, he put up import taxes on on China. And there was one other thing that he did, but if you remember it, I’ll, I’ll talk about that as well. And these are the things that are supposed to be inflation. But in fact, the average rate of inflation in during the Trump period was 1.9% which was one of the lowest rates of inflation of any presidential period since 1953 on the other hand, Biden and Harris didn’t do any of those things, but they had, I think it was four really big spending programs for which the inflation Reduction Act is the tiniest of those. I think there were four other ones, the American rescue plan, and all over a trillion dollars for each of the each of the those bills. Yeah, and it’s that combination of big budget deficits. It’s not just the big budget deficits, which is not was, wasn’t just short term relief spending. They built out major programs which are going out to the end of the decade. You know, they increased education spending on the on the premise that over the next 12 years there’ll be bigger school rooms and lower bigger school rooms, and therefore lower teacher student ratios in in public schools. And the reason, of course, for that was that if you had graduate dispersion of people in the in the classroom, you’d have lower, lower passage of covid, you see, because Okay, gotcha, and everything had to be Okay, gotcha. So there’s always. Endless spending, and in the inflation Reduction Act, as I’ve noted, the subsidies for making electric cars are only provided to work sites or companies that employ workers that are part of the United order Workers Union, yeah, and the International Brotherhood of electricians too, by the way, interestingly enough, both of these are significant donors to the Democratic Party. And interestingly, the and this is the subsidies for making electric cars. And interestingly, Elon Musk, who in Tesla, is the biggest single manufacturer of electric cars, receives none of these subsidies because he doesn’t employ workers who are part of the United order Workers Union or the International Brotherhood of electricians, and so his employees are not necessarily donors for the Democratic Party, so He doesn’t get a subsidy. So I think there’s that kind of thing built into a lot of these Biden Harris spending bills,
Gene Tunny 36:07
right? Michael Knox, it’s been a pleasure. I’ve really enjoyed your reactions, reflections on the the excellent Q and A session you had with Reserve Bank of Australia deputy governor, Andrew Hauser, anything before we wrap up? Anything else?
Michael Knox 36:23
You didn’t ask me the question about the run on the Chinese RMB,
Gene Tunny 36:28
oh, if we’ve got time for it, tell us what’s happening with the run on the Chinese RMB, please.
Michael Knox 36:33
Well, it’s very interesting that the RMB is, it is China’s announced plan to make it a dominant reserve currency, yeah, in the international monetary system. And it does appear that from by 2020 there was $230 billion worth of bonds held in the international monetary system, RMB bonds, and that was rocketing up. And by the end of 2024 that had got to about $340 billion worth of bonds. And in comparison, at that time, the level of bonds held in Australian dollars was about 215 billion, and the level held in Canadian dollars was about two 70 billion. And that so it rocketed well past the international reserves held in Canadian dollars and Australian dollars, which, by the way, are at that we are at the minnow end of international reserve currency. Yes, yes, but it’s a great thing that the RBA is an international reserve currency and but since that time, what’s actually happened is that the level of international reserves held in RMBs, in fact, crashing. There’s been a run on the RMB and it’s now fallen from about $340 billion at the end of 24 to about 200 less than $240 billion at the end of so the peak was at the fourth quarter of 21 Yeah. And now, at the in the first quarter of 24 it’s fallen from three and $40 billion to $240 billion and is now less than the amount of international reserves held in the Australian dollar. So the question is, why is that run happening? Yeah. And that was my one of my questions. And I said, Is it, is it just because of the trust that people put in the Reserve Bank of Australia that they prefer to hold Reserve Bank of Australia bonds rather or Australian bonds rather than Chinese bonds? And why do why do they trust the RBA so much? Yeah, my unanswered question. But having looked at it, it’s really nothing to do with any of that. It’s really just the fact that at the end of 21 international bond yields, US bond yields, Australian bond yields and Canadian bond yields, with a very, very low yield, the lowest yield for decades, if not, if not centuries. Yeah. And since then, those yields have been going up, whereas the yield on RMB bonds peak. Back then, there’s now, we now bonds are paying 4% RMB bonds are paying a little over 2% so that’s right, and that’s the reason the demand for RMB is forward. It’s just the market, just the market, and the fact that they’ve got a managed exchange rate rather than a floating exchange rate, yeah, so has an effect, but we might talk about that again another time. I think we’ll have
Gene Tunny 39:33
to, I think, yeah, we’ll have to come back to it. But you figured it out. You didn’t need Andrew Hauser to know to answer it in the
Michael Knox 39:40
just wondered what he thought about it. Yeah,
Gene Tunny 39:44
okay. Michael Knox, Chief Economist at Morgans, it’s been a pleasure. We’d better wrap up there. Thanks again. Thank you. You.
Credits
Thanks to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts and other podcasting platforms.
