by Patrick Byrne and Brendan RodwayNews Weekly
Policy 2: Using the Reserve Bank to boost capital investment
, June 13, 1998
With leveraging, there will always exist a possibility, however remote, of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked.
“Only a central bank, with its unlimited power to create money can with a high probability thwart such a process before it becomes destructive. Hence, central banks will of necessity be drawn into becoming lenders of last resort.”
— Chairman of the US Federal Reserve, Alan Greenspan, in his speech to the 34th Annual Conference on Bank Structure and Competition (May 7, 1998)
One of the worst consequences of Australia’s foreign debt blowout has been 15 years of high real interest rates that have strangled small business and farmers. Such a regime has made long-term capital investment uneconomic while encouraging a “casino economy” with short-term speculative investment in the property, stock and bond markets.
If Australia can wind back the foreign debt in a few years, then like Singapore, Japan and Taiwan it can run its own economy. If we are less reliant on inflows of foreign capital, then we can manage our own money supply and interest rates, without seeing foreign financial capital flee the country.
In that debt-free environment, it makes good economic sense to make low interest credit available for capital investment, so that businesses and farmers can borrow domestically for long-term productive investment.
Fundamental to this process is the Federal Government’s reasserting control over the Reserve Bank to make low interest credit available for lending to small business and farmers, and to finance a program of public works for the expansion and renewal of Australia’s deteriorating infrastructure.
It is important to remember that such credit is a loan not a grant. It is to be used for capital investment, to expand real production and then to be repaid with interest. It is not for recurrent government expenditure and welfare.
Alan Greenspan is the Chairman of the US Federal Reserve Board and, as such, is the most powerful central banker in the world. He has made it clear that the creation of low interest credit by a Reserve Bank for any purposes specified by a government — in very large amounts if needed — is just a standard operational practice of any central bank.
In a speech on “Central Banking and Global Finance”, January 14, 1997, Dr Greenspan spelt out the role of a reserve bank, which is in stark contrast to the attitude of the Australian Government and the Reserve Bank of Australia towards the management of our own monetary system. Dr Greenspan said:
“Let me begin with the fundamental observation, that a nation’s sovereign credit rating lies at the base of its current fiscal, monetary, and, indirectly, regulatory policy. When there is confidence in the integrity of government, monetary authorities — the central bank and the finance ministry — can issue unlimited claims denominated in their own currencies and can guarantee or stand ready to guarantee the obligations of private issuers as they see fit …
“Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit.”
Dr Greenspan emphasised that because a government can guarantee the currency it issues, “a government cannot become insolvent with respect to obligations in its own currency” and because the currency is guaranteed, a government “can produce such claims [i.e. issue currency] without limit.”
Of course, he added the qualification that no government would want to overdo it and flood the nation with money. “To be sure, if a central bank produces too [much], inflation will inexorably rise as will interest rates, and economic activity will inevitably be constrained by the misallocation of resources induced by inflation.” This is what the Whitlam government did in the 1970s when it pumped up the money supply and inflation rose to around 20%.
On the other hand, Dr Greenspan warned of governments going to the other extreme: “If [a central bank] produces too [little], the economy’s expansion also will presumably be constrained by a shortage of the necessary lubricant for transactions.”
Despite Dr Greenspan’s clear statement of the power of a Reserve Bank to issue low interest credit in considerable volume, our Federal politicians claim that issuing such credit would be inflationary. That may be the case when the economy is experiencing full employment (i.e. defined as 2%-3% unemployment); but when there are well over a million people either unemployed or wanting more work, credit can be expanded for increased investment that creates real jobs, without causing inflation.A new People’s Bank
The Federal Government should establish a new “People’s Bank”, with specialised sub-divisions for savings and lending to small business and farmers. Low interest credit from the Reserve Bank could be lent to small businesses and farmers.
It is not a novel idea. It was an original aim of the Commonwealth Bank.
A variation exists in Germany where the Kreditanstalt für Weideraufbau (KfW) was established to provide small and medium-sized businesses with cheap, long-term loans to help establish themselves or to expand their operations. The KfW is widely respected, has a gold-plated credit rating and is seen as pivotal to Germany’s post-war resurgence.
A “People’s Bank” would run ‘parallel’ to the private banks, as the KfW does. Its guiding philosophy would be similar to that of the KfW: long-term, low interest rates are the best guarantee that small businesses will take root. The same thinking prevails for agriculture where it was noted years ago that the variable nature of the industry required a unique form of finance.Major Projects
Low interest Reserve Bank credit is also needed for a program of public works at Commonwealth, state and municipal levels to revitalise and expand the nation’s deteriorating ports and harbours, railways, roads, bridges, electricity and water supply systems.
This is an area which holds little attraction for the markets although businesses large and small could benefit handsomely from such a program.
Government involvement need not be ridiculed. After all, why is the United States leading the world in high-tech developments?
American journalist William Pfaff explains (International Herald Tribune, October 20, 1997):
“The United States itself provides the most convincing current example of successful industrial policy. It is called defence procurement.
“For half a century, defence procurement has been an engine of American industrial growth and the principal sponsor of high-tech research, development and production. It has been America’s unknowable Keynesianism, its secret socialism, a state program of industrial intervention and subsidy.”
Not only is this injection of funds into infrastructure long overdue, but it would have the effect of providing employment to the most seriously affected group in the Australian population — unskilled, long-term unemployed and underemployed men, particularly in rural areas.
From 1913-1917, low interest, long-term credit was provided by the Commonwealth Bank to finance the construction of the Transcontinental Railway. It advanced £17 million at 1% p.a., and got it back.
It was also the way Australia financed its commitment in the First World War. The Commonwealth Bank loaned the Australian Government £325 million, interest-free. Indeed, until as recently as 1984, the Reserve Bank of Australia paid only 1% on government working balances and advanced money to the Federal Government at 1% for its working operations (Campbell Committee Report, p.29).
Australia now needs a massive expansion of its infrastructure to develop its resources and to exploit huge trade potential with Asia.
Emeritus Professor Lance Endersbee is the former head of engineering at Monash University. He has worked on many large development projects around the world, including the Snowy Mountains project.
With a vision of taking Australia into the 21st Century, he has laid out a series of projects which are technically feasible but require a political commitment to see them through.
Historically Australian governments have played a major role in economic development by patient long-term investment in public infrastructure. Unfortunately, over the past 25 years governments have cut such expenditure in half, reflecting their uncertainty about their own role in the planning of public works, and uncertainty about the nation’s future.
This must change. Infrastructure projects involve long lead times, long periods of construction and a long operating life of 40 to 60 years. It makes good economic sense for such long-term projects to be paid off over the same length of years by the generations that benefit. For such investments, long-term low interest credit is ideal. It keeps costs at reasonable levels and does not put excessive repayment burdens on successive generations.
Although the Federal Government has a constitutional problem in directly undertaking infrastructure works, it can finance such projects as joint ventures either with the states or with private enterprise.
Professor Endersbee has outlined five major infrastructure projects all of which deserve discussion. They are designed to reorientate Australia to the fastest developing, most populous region of the world. There are almost two billion people within seven days sailing time from Broome, Derby, Wyndham and Darwin.The Asian Express
In the not too distant future some of our leading primary exports, like wheat and beef, are likely to face strong pressure from foreign producers like Argentina and potentially Ukraine. Wheat and beef are products that could survive long distances and delivery times to overseas markets.
But Australia has the potential to develop a whole new range of much higher value horticultural products substantially to replace these products. Two things are required: a fast and reliable transport delivery system (which is fundamental to winning Asian markets) and better use of our irrigation waters.
A very fast Asian Express railway from Melbourne to an expanded, high tech port of Darwin would open up the Murray-Darling Basin, Goulburn Valley, Murrumbidgee irrigation area and the Darling Downs for such products.
This would increase the value of land and irrigation waters of these regions. It would also make it economic for farmers to switch from flood irrigation to less wasteful methods such as drip irrigation. More economic water usage is the key to solving the salinity problems of the region.
The Asian Express would also give mineral and manufactured exports from the three eastern states and the Northern Territory rapid access to Asia.
A two track Asian Express rail would cost about $10 billion, equivalent to the interest Australia pays on its foreign borrowings in one year.The Clarence and Macleay river diversions
The returns on new high value crops of the Murray Darling Basin could be further increased in value by the diversion back across the Great Divide of the seaward flowing waters of the upper Clarence, Nimboida and Macleay Rivers. The water could be delivered over the ranges at no cost using cheap, off-peak power to pump the water to the top of the ranges, and released down the western slopes of the Divide to generate hydro-electric power at peak times.The Northern Rivers Irrigation Project
The Fitzroy River region and other regions in the north have high potential for production of a wide range of tropical and semi-tropical crops and processed food products, on a huge scale.
Australia is one of the few places in the world where it is possible greatly to increase production of supermarket type foods in high volume and low cost, given its availability of cheap land, favourable climate and unused fresh water.
Australia is often regarded as a dry continent. This is a misnomer. Most of our usable fresh water is above the Tropic of Capricorn. We use only a fraction of our available fresh surface and ground water.
To achieve this potential, there is a proper role for government in creating the basic infrastructure of dams and mainline distribution works so that the private sector may develop irrigation properties to suit particular market needs.Musgrave-Pilbara development road
There is substantial and increasing geophysical and geological evidence that the entire region from the north-west of South Australia (Gawler Block) to the Pilbara is highly prospective for major mining development. A major constraint is the remoteness of these areas.
The construction of an access road through this extensive region of mineralisation is unlikely to be undertaken by any one mining company, but would be a proper task of governments. In this case the project requires the collaboration of the South Australian, Western Australian, and Federal governments.Inland diversion of Melbourne’s waste water
Almost all of Melbourne’s waste water from sewers, drains and creeks is discharged into the sea, yet this waste water could be very valuable if it were to be pumped over the Great Divide into the Murray-Darling basin. The dividing range is virtually at the edge of Melbourne’s metropolitan area, and there are low saddles which would permit easy diversion inland.
The project is similar in concept to the proposed Clarence diversion, and uses overnight pumped storage and peak generation to keep power charges to a minimum.Australian ring rail proposal
This project is a complementary development to the Asian Express project, and involves the extension of the route through to Perth. The likely freight volumes on the various sectors of the route indicate that the entire connection could be economic.