This week the Reserve Bank dropped interest rates by 50 points. And this is both a wonderful and a terrible thing. There will be people cheering tonight that they are paying less on their home loans. There will be people looking forward to the effects that a lower Australian Dollar will have on their business. And there will be a very few feeling the sadness that I do tonight, knowing that today’s decision marked the end of an era.
For today, the RBA threw in the towel. It gave up its stand against the swirling vortex that threatens our financial system, here and overseas. It let go of its stand that provided sufficient return to make international investment here an attractive option, and has reached instead for its own inherent capacity to print money and wash away the pain of the situation we have found ourselves in.
But isn’t a reduction in rates a positive event for an economy? Don’t people then have more money to spend? Well, sort of, and yes. Sort of because normally the increased expenditure an increased debt levels resulting from it overwhelm the inflation that inflating the money supply induces. So what is different this time?
The difference now is that people aren’t (to the same extent, on average) going to spend that extra money. There is such a degree of indebtedness, and such concern about the future that most of the extra will go into paying off existing debt. So we get a drop in debt ( resulting in a depressed economy ) and inflation at the same time, leading to a double whammy.
Unfortunately for us, in this situation there are really only two outcomes possible. One is a long drawn out depression over 20 years or so as we inflate and pay debt off. The other is a short, hard reset in a year or so, induced by raising rates sufficiently. Neither is pleasant, but both are the inevitable result of our level of personal debt.