“Adhering to the outdated ideas of thinkers such as Mises, Hayek and Friedman”

Having looked at Ben Eltham’s uninformed analysis of my article which was published in the Australian Financial Review in 2010, in which he had stated that I was “adhering to the outdated ideas of thinkers such as Mises, Hayek and Friedman”, I thought I might also put up the article I wrote then. I still think the RBA is far and away the best central bank in the world and I say this even though they have brought official interest rates to their lowest level since 1959 (or so I think I read). It is a reflection of their judgment on how dead in the water the Australian economy is. My AFR article was however published in November 2010, a more hopeful time for the economy when government plundering was at its height. And for you Keynesians out there, the analysis I use in this article is the same Wicksellian analysis Keynes used in his Treatise on Money.

It was pleasing to see the RBA raise interest rates, and the economy will be all the better for it as well.

The trouble with all that free stuff governments like to give out is that it isn’t really free after all. The true cost of government spending comes out of our collective wealth in a process almost invisible to the naked eye, with the frequent aim of governments to keep it as invisible as possible.

Australia is amongst the few economies where official interest rates have been rising. Nor is it a coincidence that the Australian economy has been amongst the better performing economies of the world. Raising rates has been an essential part of the reason why the economy has performed as well as it has. It is a cause as well as a consequence of our relative economic success.

The rate of interest is the price paid for resources made available for investment. When people save, they may think what they are saving is money but this is in many ways an illusion. They have produced goods and services, received an income for their efforts but chose not to buy everything their income would have allowed them to buy. Unspent income is saving, and to the individual saver these savings come in the form of money.

But that is to look at things from the perspective of the individual saver. From the economy’s perspective what savers do is leave for others the goods and services they had produced but did not themselves consume.

They have transferred to others, for a price, the right to use the output that has been made available by their decisions not to immediately buy as much as their incomes would have enabled them to.

They have postponed their own purchases until a later date but in doing so have provided an opportunity for others to make use of those unused resources to build productive assets through investment programs of their own.

Without saving there can be no investment. All investment is the product of saving and however much or little there is, you cannot invest more than what you have saved.

But it is not just private firms who seek access to these savings. Governments, too, absorb huge amounts, taking these in as tax revenues and then borrowing more to finance projects of their own.

Rising rates are a reflection of the supply and demand conditions for private savings. What’s left after the government has taken what resources it has decided to use up is what’s left for the private sector to divide amongst itself.

The advantage the government has in getting its hands on the savings of a nation is that when it borrows lenders know they will get their money back, governments get to print money when they cannot borrow all they want, and they can run deficits without immediate concerns about where the money to repay their debts will be coming from.

But here is the trick. Borrowing almost invariably comes in the form of money. A nation’s real savings, on the other hand, come in the form of actual resources which can be applied in building investment projects.

Of money there is an almost endless supply. There is as much as a government is prepared to create.

As to the availability of underlying real resources, the supply is finite and strictly limited. The core task for a central bank is to make sure the flow of dollars entering an economy is matched by an available flow of real resources the money can be used to buy.

Too much money relative to the resource base of an economy and we have inflation. It is this the RBA is determined to stop.

Interest rates are rising because the government is using resources even before they reach the private sector. The government may be able to provide school halls, install insulation and now the NBN. But if you think you are getting all this for free, you should think again.

The RBA is continuing to raise rates because the government is taking up domestic savings more rapidly than we are able to generate those savings through productive activity.

In this economy at this time it is the government that is the single most important cause of rising rates. The RBA is only doing what it can to ensure the resources available for investment are properly priced.

The pressure on rates therefore remains upwards and will continue to remain upwards so long as the government continues its relentless take up of our productive resources.

But if you don’t like higher interest rates, there is no point in blaming the RBA or for that matter the private banks. It is the government that is absorbing our national savings and raising the cost of capital. So long as it continues to do so, the pressure on rates will remain.

As a side note, The Age this morning ran a front page splash on how the banks are gouging their customers based on the economically illiterate notion that the central bank sets the rates for everyone else.

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