
David Koch - Kochie - is a household name, respected and beloved for his cheerful character and financial advice. I like Kochie, as most people do. But Kochie's latest article makes him an enemy of the Aussie battler.
The Article
Kochie makes the case in this article that times are tough for the Aussie homeowner and small businesses. The RBA, by giving no indication that it will cut interest rates, is causing a 'crisis in confidence' that is destabilizing to the Australian economy:
The problem is that businesses large and small need to be able to plan ahead, and Stevens’ appearance on Friday gave little reassurance. All Stevens said is that it is a good thing to “sit still and do nothing” in such rocky times, but that is of little comfort to our struggling business owners. It has arguably got to the point that the RBA’s secrecy is causing a serious crisis of confidence in the broader economy, and this can lead to a destructive cycle in which fear feeds on itself, causing employers to shed jobs and cut back on investment. Indeed, the 9,000 jobs that have been lost in the past month suggest this is already happening.
Kochie, as indicated by the title of his article 'Why the RBA needs to cut interest rates', wants to run the printing presses to save the Australian economy. He disregards the real economists naysayers crying 'inflation' in the night with a quite amazing statement:
A cut in interest rates now would have no effect on the factors which are causing inflationary pressures, such as utility bills, food and fuel. Most of the inflation in our system is beyond the control of both the RBA and consumer spending.
This statement reflects a sad truth that Kochie doesn't really understand what inflation is and how it works. Because of this, he does not understand the consequences of printing money and it's role in stimulating the business cycle within the economy.
He continues:
Mervyn King, the former head of the Bank of England, once famously said that 'good central banking is boring.' What he meant is that it is better for everybody if the central bank is predictable, and does not have surprises hidden up its sleeve.
Predictability, it seems, means that the RBA should print money and misdirect the Australian economy on demand.
Governor Stevens should pay attention. While the RBA has done a pretty good job over the past couple of years, it went too far in the run up the the GFC in 2008 when raising the cash rate to 7.25%, pushing typical mortgage rates to 9.6%. It resulted in a glut of repossessions and unnecessary job losses. That took the market by surprise. We don’t need another surprise like that. Give us some transparency and let our small businesses get planning with some peace of mind.
The conclusions that Kochie makes in this paragraph again represent a lack of understanding as to the causes of the financial crisis. Moreover, transparency doesn't mean printing money and keeping the inflation party going ad infinitum.
Why Kochie is wrong: Inflation
Inflation is typically understood as a rise in the price of goods and commodities. It is more accurate to call this phenomenon 'price inflation'. It is the job of the economist to understand WHY things take place in the economy... to ask questions regarding market processes that everyone takes for granted. In this case, why is there a general rise in the prices of commodities, goods and services in the economy, especially when there is a strong tendency within the free market to lower prices?
The answer is: monetary inflation, which leads to price inflation.
Let's imagine that there is a shortage of coconuts. We can understand that the 'marginal utility' of coconuts has increased - or in other words, the number of coconuts available for individuals to satisfy their wants has decreased. This means that individuals will value coconuts higher than before as there are fewer coconuts available to satisfy 'lower order' wants.
For example, imagine that Robinson Crusoe is living on a deserted island where the only food available is coconuts. His uses for coconuts may look something like this (in order of priority):
1. Eat for survival and health
2. Use the shells to make shelter
3. Use the shells to make shoes
4. Throw them into the ocean for fun
If the island is super-abundant in fresh coconuts, so that Crusoe can collect 2000 coconuts a year. Crusoe eats about 1000 coconuts a year. Because of his productivity and the availability of coconuts, Crusoe doesn't have to ever worry about starving or being malnourished. This leaves him with 1000 extra coconuts to satisfy less important uses. Crusoe can use 500 coconuts to make himself some himself a nice hut. This still leaves with 500 extra coconuts to the 2 remaining uses. To make shoes for walking around the island, he needs 300 coconuts a year to make a new pair every 2 weeks (the approximate durability of coconut shoes). Crusoe is left with 200 coconuts to throw into the ocean for fun.
If a cyclone comes and causes significant damage on the island, so that Crusoe can only collect 1700 coconuts a year. If he wants to survive, this will force Crusoe to give up some of the uses for coconuts that he has. He can't throw 200 coconuts into the ocean that year otherwise he want have shoes to walk around the island in. Coconuts now are more valuable to Crusoe; he can't just waste a few here and there as he did before.
As I said, this simple thought experiment is used to explain the concept of 'marginal utility'. Now imagine that Crusoe wasn't alone on this island, that he had a neighbor called Ug the Ogre on the other side of the island. Crusoe trades 100 coconuts for chickens with Ug. This means that Crusoe’s uses for coconuts are (in order of priority):
1. Eat for survival and health
2. Use the shells to make shelter
3. Use the shells to make shoes
4. Trade for chickens (5 coconuts/chicken)
5. Throw them into the ocean for fun
This means that Crusoe only has 100 coconuts left to throw into the ocean for fun. One day, a storm comes and wipes out 200 coconuts from his stock. This means that Crusoe doesn’t have any coconuts to trade with Ug or use for leisure. Ug is upset; he really wants coconuts from Crusoe.
At the current exchange ratio, 5 coconuts will get Crusoe 1 chicken. So in other words, the price of a chicken is 5 coconuts. Ug tries to trade with Crusoe in vain. Ug realises that he needs to reorder Crusoe’s priority list for using coconuts. Ug changes the price of chickens to 1 coconut/chicken.
This makes all the difference in the world for Crusoe. The value, from his perspective, of having 300 chickens a year is greater than the value of using coconuts to make shoes. Crusoe’s use of coconuts now changes (in order of priority):
1. Eat for survival and health
2. Use the shells to make shelter
3. Trade for chickens (1 coconut/chicken)
4. Use the shells to make shoes
5. Throw them into the ocean for fun
Let’s imagine now that the opposite happened. Crusoe finds a long rod of bamboo that increases the number of coconuts he can harvest to 4000/year. Now Crusoe has more coconuts than he knows what to do with. Crusoe decides that since he has more coconuts to trade, he wants more chickens. Ug still has the same number of chickens and is only willing to part with 300 in a year. Crusoe tries to get the chickens at a price of 1 coconut/chicken, but Ug is no fool. He knows that Crusoe has many coconuts. He refuses and only accepts a price above 5 coconuts/chicken. Crusoe accepts, knowing that he can afford to pay a premium on coconuts without any consequence to the other more important uses he has for coconuts. Or maybe Ug doesn’t know about Crusoe’s ‘coconut inflation’ and is just plain unhappy with parting with 300 chickens for 300 coconuts because he has a higher value for chickens in that place and time. The price of chickens must go higher (i.e. inflates) in order for him to trade. In either case, Crusoe can afford the trade because of the inflation in the number of coconuts. The coconut inflation led to chicken price inflation.
So in this example we have seen that changes in the abundance of goods alters their marginal utility and value in the eyes of individuals. What these individuals are willing to trade for other goods (i.e. prices) will also change. Replace chickens for everyday items that you purchase like food, petrol, cars and homes. Now replace coconuts with money, or dollars in your wallet. If you have a greater supply of dollars in your wallet, you can afford to pay more for goods and services. In other words, monetary inflation leads to price inflation.
Monetary inflation is an increase in the supply of dollars in your wallet, or credit on your card. Monetary inflation is significantly controlled by the actions of the RBA through interest rate policy and open-market activities. When the RBA lowers interest rates, it lowers the price at which banks can borrow money from them. How does a bank borrow money from the RBA? The RBA creates the money out of thin air (i.e. synonymous with printing money) by crediting the bank’s account. It’s like me logging onto the computer records of your bank and changing the balance from $1,000 to $10,000; this would be $9,000 worth of monetary inflation. The bank does the same thing to you when lending money for a home, car or credit card loan. It will create the money out of thin air, an accounting entry essentially. You can read about how this happens routinely and lawfully in Professor Jesus Huerta de Soto’s book ‘Money, Banking and Economic Cycles’.
So if the interest rate is lowered, banks can borrow more money from the RBA to cover more loans to entrepreneurs and other individuals within the economy. This artificial increase in the money supply inevitably causes widespread malinvestment within the economy, the same way a travelling circus can do to a local town it stops in. The circus brings fresh new money into the town, which may cause a restaurant owner to mistakenly believe that there is a permanent increase in business. The restaurant owner buys the property next door and builds an extension to accommodate the growth in customers. He can afford these additional costs so long as these new additional customers keep coming. Eventually the circus leaves town and the restaurant owner faces the harsh reality that the monetary inflation brought by the clowns is now over, and all he is left with is debt he can no longer afford.
The clowns at the RBA have indeed been shopping at every business, printing and lending money to more and more people through the fractional reserve banking system. This has tricked entrepreneurs and individuals around Australia to invest in various bubbles, namely the housing and building sector, thinking that the party will never be over. Well it is over, and not because the circus has left town, but because the debt-servicing burden has exceeded the consumption and savings capacity of the economy. The solution to this problem is not to increase the levels of debt in the economy to stimulate more debt-fuelled consumption. This can only make the problem far worse than it is, threatening the stability of our currency and decreasing the affordability in the cost of living for Aussie battlers. An increase in the money supply without real growth within the economy only raises the prices of goods and services faster than wages can adjust. The RBA can and is trying as hard as they can to hide this in their official inflation numbers, through the voodoo of hedonics etc. The average Australian family already know that their heads are just below the water of rising prices.
So Kochie, the trusted financial advisor of Australia, thinks that this is all a good thing. More money printing, more debt, higher prices and further economic ruin… for predictability’s sake at least. As long as Kochie advocates the policies of economic suicide, he will remain an enemy of the Aussie battler.
To understand the finer details of my analysis and opinion, I recommend the following reading list:
1. Money, Banking and Economic Cycles – Jesus Huerta de Soto
2. The Ethics of Money Production – Guido Hülsmann
3. The Evil Princes of Martin Place: the Reserve Bank of Australia, the Global Financial Crisis, and the Threat to Australian’s Liberty and Prosperity – Chris Leithner
God bless,
Washo