Wednesday, October 7, 2009
Australia's central bank earlier this week surprised the industrialized world by raising its target interest rate—they were the first major central bank to effectively declare an end to the financial crisis that plunged the global economy into recession in 2008. Australia already had by far the highest target rate of any of the major industrialized economies, with the next highest being the ECB with a 1% target rate, followed by the Bank of England with 0.5%, Canada with 0.5%, and the Fed with 0.25%
Meanwhile, our Federal Reserve has gone to great lengths to assure the world that short-term interest rates will stay very low for a very long time. The Fed worries that raising rates too soon might jeopardize what many view as a fragile and tentative recovery.
The Aussies, by contrast, have taken the bull by the horns, as it were, and raised rates. This proved to be good for the stock market, and good for the currency. Note in the first chart that the Aussie central bank first decided to stop following the Fed's lead in 2002, by raising rates instead of lowering them. They have subsequently kept their rates higher than ours consistently. As a result, as the second chart makes clear, the Aussie dollar has appreciated by an almost unbelievable 80% against the U.S. dollar. Australia has kept its interest rate higher, and for much longer, than the U.S., and as a result its currency has surged. And with its latest move, the Aussie central bank has once again asserted its independence of political considerations, preferring to protect the value of its currency above all else.
As a supply-sider, I believe that a strong currency is always better than a weak currency. Strong currencies are strong because a) they are well-managed by their central bank, and b) the world's investors have confidence in them. It's a supply and demand thing: the central bank is cautious about supplying its currency to the world (which usually means keeping interest rates a little higher than might be called for by the politicians), and investors and corporations that use the currency prefer to hold it instead of weaker currencies because they trust the central bank and they like the prospects for the currency's economy, both political and economic. Strong currencies are like magnets for investment (as is anything that consistently holds its value), and because they attract investment that helps keep them strong. Lots of investment means a productive workforce, a growing economy, and rising standards of living. It's a win-win for everyone.
So I have one request of Mr. Bernanke: won't you please follow the lead of the Australian central bank? Higher interest rates are not always bad, and in fact they can be very good. If the Australian economy and currency can cheer an interest rate of 3.25%, surely the U.S. economy can support a much higher rate than we currently have. Artificially low interest rates are a fool's game in the end, since they only weaken a currency and discourage investment.
Posted by Scott Grannis at 11:38 PM