Ian Macfarlane, AC, was Governor of Reserve Bank of Australia from 1996 to 2006. He is a Director of ANZ Bank, Woolworths and the Lowy Institute for International Policy. He is a member of the International Advisory Board of Goldman Sachs and the International Advisory Board of the China Banking Regulatory Commission.
This is Part 2 of an edited transcript of a Q&A session at the Morningstar Investment Conference on 15 May 2014.
Q. On the emerging markets other than China, what do you see as the investment paths and which countries do you favour?
This is more a story about last year than this year. When people started realising that at some stage, the US would return monetary policy to normal, there was an outflow of capital from emerging market economies, their exchange rates and share markets went down. There was a lot of alarmist talk. For some people, their only frame of reference was the Asian crisis of 1997-1998. It was wildly alarmist, it was never going to occur anything like that. I think by early this year, the smart money was moving back into Turkey, South Africa, Brazil, India and Indonesia. Many of their currencies have gone up this year. Let’s put it in perspective – the developing world is still growing a lot faster than the OECD, twice as fast, so I’m reasonably optimistic.
A broader point is that since the financial crisis, we have tended to exaggerate every story or problem to think they are worse than they are. I think it’s because the financial crisis itself, concentrated in the final quarter of 2008, was worse than anyone expected. That mindset has continued when every pothole comes along. Small problems are really exaggerated. The financial press and others tell a far more compelling story about a crisis than the ‘muddle through’ story. People who have held a steady course have done a lot better than people who are too influenced by the scare stories. I do a lot of talking to people and my story is more a ‘muddle through’ story and I think people are disappointed. They think I should be some stern moralist telling them all the problems they face and the errors of their ways.
Q. Can we focus on Australia and the banking system? Does the concept of ‘too big to fail’ apply in Australia and to the government guarantee on banks?
IM: … on deposits, not banks. Australia is in a unique position. No depositor in Australia has ever lost a cent. And no regulator has ever had to spend a cent to bail out an Australian bank in all the time since Federation. So on the basis of our track record in Australia, you would not change anything. But of course we are signed up for the Basle rules, tightened because of the disastrous performance of the North Atlantic banks, so we all need higher capital and liquidity ratios.
What about ‘too big to fail’? The first point is in Australia, it’s a relatively recent concept, and secondly, it’s not a policy, no regulator has such a policy. It is a public perception. The public is probably right, but it is just a perception. You cannot credibly say that in the next financial crisis, we’ll let the big banks fail. Even if you say it, nobody would believe it. What do you do about it? In 2008, people took money out of small banks and building societies and put them with the big banks. They were awash with cash. Some people say they should pay a fee, but it’s not a government policy. It’s a perception. We’ve settled on a half-way house where the big banks have to have a higher capital ratio. Does it make sense? The ones who are safest now have a capital penalty, widening the gap even further between the safe and less safe. In so doing, you’ve reinforced the concept of ‘too big to fail’. That’s where we’ve ended up today.
Q. Australia had little stimulus during the GFC but we contracted only half a percent. Isn’t fiscal policy as dead as monetary policy?
IM: I disagree, we did have fiscal expansion. And it was quick, the first part was very successful. The money came out in the fourth quarter of 2008 and early 2009. Where fiscal policy has a bad name is instead of doing the simple things the government decided to make it sound much more responsible, we need to help education, we need to help the environment. So we ended up with all these school classrooms being built, whether they were needed or not, and I believe they are still being built. And we also did the pink batts thing. But there was fiscal expansion in Australia.
If you look at patterns around the world, there was a good recovery in late 2009 and into 2010, but then Greece came along and the whole debate shifted to ‘we have too much debt’, and so some countries who’d had a period of fiscal expansion went to fiscal contraction. For many countries with debt to GDP around 100%, after a brief flirtation with expansion they went back the other way, leaving too much weight on monetary policy.
Q. Why are you not concerned by the expansion of the Fed’s money supply?
IM: I would be concerned if I thought it would lead to inflation. I also believe it will not be that hard to reign it back. The first step is to stop buying these bonds, which is what tapering is. They have reduced the buying. The next step normally would be to start selling what you’ve already bought, push it back out there. Reduce the cash in the system, and eventually the cash in the system is back to where you want it. Then you squeeze a little bit and interest rates go up. That’s the normal. The risk in the US is that they have bought so much, their balance sheet is so big, it will take so long to push the bonds back out. The Fed has announced they will raise interest rates long before they’ve got rid of the extra cash. How do they do it? They pay interest on the cash that the banks hold with the Fed. It should not be difficult for the Fed to restore rates to where they want them to be.
Q. What are your views on a potential residential property bubble in Australia?
IM: I think we faced a risk in 2003, not 2014. In 2003, we had lending for housing and prices rising at 20%, half of it speculative lending, negatively geared. There were seven prime time television programmes on how to get rich in property. Since then, on average, house prices have risen at the same rate as household income. For that reason, I don’t think we have a bubble. We do have an affordability problem, it makes it tough for young people to acquire a house in a desirable area. This is characteristic of every major city in the world that has desirable job opportunities. London, Paris, Berlin, New York, Hong Kong, Singapore. Some of our policies make that worse, such as the extreme leniency we show towards negative gearing, but I don’t think it’s a bubble.
Footnote: There has been one case in the last 100 years where bank depositors lost a negligible amount of their deposits – Primary Producers Bank, 1931. If you are interested in reading more about the history and robustness of Australia’s banking system, see the Australian Bankers’ Association fact sheet.