Comment: time to sack the RBA governor?

By Mark Westfield*, ninemsn Money
March 2008

The share market is indicating that Australia will go into recession in the next 12 months or so.

After two months of heavy falls in share prices, the market it has moved into a dangerous new phase. Initially driven by fear of rising debt and recession in the US, investors are now seeing falling corporate earnings and are pricing shares accordingly. The banks are being hit particularly badly. Rising debt and funding costs squeeze margins. Many of the banks' customers will go broke.

The initial stages of the share market turmoil have wiped approximately $200 billion in value from investor portfolios. This is more than the gross national product of a small country like New Zealand. It cannot help but shock the system. The rising number of bank seizures of properties and bankruptcies are sure indicators that the crisis afflicting the highly geared financial and property groups at the big end of town will infect the household sector on a large scale during 2008.

What is truly surprising is that in this spooked and worried market in which billions of dollars are wiped off values daily, the Reserve Bank of Australia continues to lift interest rates. Every other major economy, in particular and US and UK, are cutting rates to help delay or even stave off recession.

The RBA's decision to lift its 'cash' rate again this month without waiting to gauge the impact of the rate rise in February, or the one before that in November last year, suggests the RBA is hell bent on bringing the economy to its knees.

The effect this will have on jobs, investment, and on millions of households, is unthinkable.

After the 1987 share market crashes around the globe, central banks everywhere, including Australia, pumped billions of dollars into their economies and cut interest rates to try to offset the huge loss of wealth. In a situation at least as bad in 2008, the RBA is increasing rates.

The RBA Governor, Glenn Stevens, and his deputy governors, think they know better in the face of a gathering wave of concern over their zealousness.

The interest rate tool is too blunt and imprecise to play around with like this. What if he's already pushed rates too high and sends the economy into a slump. How high will unemployment go? How many businesses will go broke and how many tens of thousands of workers will lose their jobs?

The real question to be asked is this: is inflation that much of a problem that Stevens and his bureaucratic cohorts need to wreck the economy to achieve a single, narrow goal?

Former Reserve Bank governor, Ian Macfarlane, set an informal inflation target of 2-3 percent at the time the previous Government formally declared the Reserve Bank's independence in 1996 — when inflation globally was falling. Macfarlane retired in 2006 and will go down as one of the great Reserve Bank governors. The same will not be said of his successor.

These are the issues:

• Inflation today is 3.5 percent adjusted to remove volatile elements, and three percent unadjusted
• Australia is experiencing a resources boom in two states
• Oil has doubled since 1996 to trade over $US100 a barrel
• The Reserve Bank says inflation will spike briefly then fall back to three percent next year
• Inflation is not out of control
• Rate increases are driving up the value of the Australian dollar (US94c and trending higher), hurting Australia's manufacturers, tourist operators, and even our resource exporters, whose $A earnings suffer because they are paid in $US
• The US Federal Reserve is cutting rates to prevent a slowdown in the US
• The RBA caused the ''recession we had to have'' in 1990 after it lifted rates to the point where the economy finally snapped
• The Reserve Bank uses old figures and doesn't know what is happening until after it has happened
• The Reserve Bank's officials live in a bureaucratic bubble

The Reserve Bank Act 1959 sets down this charter:

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the bank ... are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

• The stability of the currency of Australia
• The maintenance of full employment
• The economic prosperity and welfare of the people

Stevens is going in entirely the opposite direction. He is doomed to repeat history rather than learn from it. He is unelected and unaccountable. If he stuffs up, then it's just too bad for the millions of Australians who will suffer unnecessarily as a result.

Unfortunately, the new Labor Government is allowing Stevens to indulge himself. It will stand by and watch a re-run of the early 1990s recession and blow-out in unemployment. Interest rate policy is far more powerful than the Federal Budget.

If Kevin Rudd and his treasurer had any gumption they would sack Stevens and replace him with someone who can read and understand the RBA's charter and use the powerful interest rate weapon at his disposal with an understanding of its effect in the real world.

*Mark Westfield is former financial commentator and director of C|T Financial

His new weekly column will appear in ninemsn Money's new Business Class section, launching soon.