Central Banks Firing Blanks — Is the RBA Out of Firepower?

Wow…what a week!

As I write this on Friday, the US election race is still undecided, with both candidates firm on their belief they’ll be occupying the White House.

On the other side of the world, Australia–China tensions have ramped up after our rock lobster, timber and wine exports into China have run into problems to enter the country.

Closer to home, things are starting to look up for Victoria with no COVID cases in the last week. Good news for us here in Melbourne.

Earlier this week too, the Reserve Bank of Australia decided the economy needed more support and released a package to stave off the crisis.

They decreased interest rates to 0.10 basis points down from 0.25. They also said they would follow on other central banks around the world and start their quantitative easing program.

The RBA is looking to buy $100 billion in government bonds over the next six months on the secondary market. This would triple the size of their balance sheet from the beginning of 2020 by the time they’re done.

The main goal is to lower the cost of debt. In particular, the governments to make debt payments easier. But as the RBA pointed out, this also lowers everyone’s cost of debt.

The RBA is not providing finance to the government, but our actions are lowering the cost of government finance. I should point that our actions are also lowering the cost of finance for all other borrowers in Australia, whether they are a household buying a home or a business wanting to expand. This lower cost of finance for everybody is supporting the recovery from the pandemic.

Is the RBA Out of Firepower?

One thing that caught my attention about the RBA’s announcement is that they posed ­— and answered — the following question: Is the RBA now out of firepower?

And this is something I wanted to focus on today.

The RBA’s answer, in short, was a resounding no. There’s plenty of things they can do.

But with interest rates at pretty much zero and quantitative easing already in place, the question is how effective any of this will be…and how long they can keep it up.

I mean, looking at Japan who’s been at this for a while, this can go on for some time, but the results have been low growth and high debt.

Another effect of this is that it’s made cash more appealing. 84% of people in Japan still use cash for small purchases.

And on this note, let’s shift attention to a couple other pieces of news that may have flown under the radar with such a busy week.

The RBA released a small note saying they were partnering with Commonwealth Bank, National Australia Bank and ConsenSys, a blockchain technology solutions company to look at a central bank digital currency (CBDC).

These are quite different to cryptos like bitcoin who are decentralised. Instead, CBDCs would be centralised and managed by the central bank.

It would be on the Ethereum DLT platform, and at this point a wholesale CBDC (that is, available to deposits that financial institutions have with a central bank). But as I’ve written before, this could pave the way for retail use.

This follows onto the European Central Bank, who last weekend began asking Europeans if they want a digital euro. That began a public survey on issuing a digital euro.

As ECB’s president Christine Lagarde said in a tweet:

We’ve started exploring the possibility of launching a digital euro. As Europeans are increasingly turning to digital in the ways they spend, save and invest, we should be prepared to issue a digital euro, if needed.

And added on the video with the tweet:

‘[C]onsumers and Europeans can actually express their preference and tell us whether they would be happy to use a digital euro just in the way they use a euro coin or a euro banknote knowing that it is central bank money that is available and that they can rely upon.

If you’ve been following the weekend edition of The Rum Rebellion, you’d know that I’ve been following the story of CBDCs lately.

Central banks are starting to ramp up their efforts after China tested their digital yuan in October. You can read more on that here.

By the way, China isn’t the pioneer here but this year the Bahamas released their own CBDC, the sand dollar.

Central banks have given plenty of arguments for CBDCs. Financial inclusion, in case there wasn’t enough cash around for households, as a way to provide a safe alternative to prevent bank runs as it allow central banks to hold people’s money directly.

They’ve also been concerned about the alternatives popping up, like bitcoin and stablecoins.

But digital currencies could also give central banks more firepower and relevance.

There’s plenty of reasons to be concerned about CBDCs.

There’s the privacy issue, but also the fact that it would make it easier to impose things like negative interest rates. Central banks have said that CBDCs would run along cash, but we could see an exchange rate between both to discourage holding cash.

CBDCs may narrow our alternatives.


Selva Freigedo Signature

Selva Freigedo,
For The Rum Rebellion

PS: In a brand new report, market expert Vern Gowdie warns of the dangers waiting in a post-COVID-19 world. Plus, he outlines the steps you should take now to protect your wealth. Learn more.

Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

The Rum Rebellion