The power of the American dollar is driving up interest rates in Australia, as the Reserve Bank continues its unfounded approach to cutting inflation. By Mike Seccombe.
How the US is unleashing a recession on the world
When elephants fight, the grass gets trampled. The African proverb seems particularly apposite right now as three global elephants drive the world towards recession.
China continues to fight Covid-19 outbreaks by sporadically locking down millions of its people, thereby cutting the output of the world’s factories, exacerbating supply chain issues and fuelling inflation, long after other governments have told their populations to get vaccinated and get back to work.
Russia continues to fight Ukraine, and by extension Europe and the rest of world, using oil, gas and grain as weapons, thereby causing global energy and food crises, and also fuelling inflation.
And the biggest elephant of all, the United States of America, by aggressively lifting interest rates in the hope of squashing its domestic inflation problem has instead succeeded in exporting it to the world.
That is a big problem, particularly for those of lesser economic means, including many Australians. They are the grass that gets trampled.
Sharp rises in interest rates, intended as a cure for inflation, could prove to be the wrong medicine and worse than the disease, as the World Bank warned in the middle of last month. Central banks around the world, it said, were “raising interest rates this year with a degree of synchronicity not seen over the past five decades – a trend that is likely to continue well into next year”.
World Bank Group president David Malpass warned that rate hikes of sufficient magnitude to rein in inflation could themselves push the world into recession.
“To achieve low inflation rates, currency stability and faster growth, policymakers could shift their focus from reducing consumption to boosting production,” he said. “Global growth is slowing sharply, with further slowing likely as more countries fall into recession. My deep concern is that these trends will persist, with long-lasting consequences that are devastating for people in emerging market and developing economies.”
A week later, on September 22, the US central bank, the Federal Reserve, or Fed, raised its benchmark interest rate by a whopping 0.75 percentage points, for the third time in a row.
From a strictly American viewpoint there are good reasons why the Fed has been jacking up interest rates.
As recently as May 2020, at the height of the Covid pandemic, US inflation was just 0.1 per cent, well below the Fed’s target of 2 per cent a year. The fear then was that the economy was stalling. Like many others, the US government was desperately trying to stimulate the economy. The Fed was holding interest rates effectively at zero.
But as the pandemic subsided, the US economy roared back. As in Australia, unemployment fell to very low levels, about 3.5 per cent. But unlike Australia, wages growth shot up as a result – to nearly 7 per cent by June. That added fuel to inflation, which reached 9.1 per cent that month.
Inflation has since slowed to just above 8 per cent, but wage pressures continue. And the Fed chair, Jerome Powell, insists he will not stop raising rates “until the job is done” to curb inflation.
What makes this a global problem is that the US dollar is essentially the world currency – the “reserve currency”. International trade is overwhelmingly conducted in American dollars; financial institutions and corporations transact their business in them, contracts for goods and services are denominated in them.
And when the US hikes its interest rates, the value of the dollar increases relative to that of other currencies. Right now, the greenback is stronger than it has been in decades.
This, in turn, has put pressure on other central banks to raise their rates, lest their currencies fall, which in turn makes imports more expensive and fuels their inflation rates. It’s a vicious, global cycle.
As journalist for The New York Times Patricia Cohen put it last Friday, the Fed’s dramatic rate hikes have caused “economic turmoil in both rich and poor nations”.
Among the consequences she ticked off:
“In Nigeria and Somalia, where the risk of starvation already lurks, the strong dollar is pushing up the price of imported food, fuel and medicine. The strong dollar is nudging debt-ridden Argentina, Egypt and Kenya closer to default and threatening to discourage foreign investment in emerging markets like India and South Korea.
“Last week, Argentina, the Philippines, Brazil, Indonesia, South Africa, the United Arab Emirates, Sweden, Switzerland, Saudi Arabia, Britain and Norway raised interest rates.”
Meanwhile, the cost of imports to US consumers has fallen sharply. Cohen cited a couple of quirky examples of how the stronger dollar was calming US inflation: “Last year, a £12 tin of tea from Britain cost $16.44, and today it costs $13.03. A €50 box of Belgian chocolates has gone from $58.50 to $48.32.”
But it’s not just tea and chockies. The strong dollar makes all sorts of things cheaper for Americans. There have even been suggestions that the falling price of petrol in America has been a major factor in the rebounding political popularity of President Joe Biden and Democratic congressional candidates ahead of next month’s mid-term elections.
It’s probably no comfort to Australians – who are paying through the nose for rental accommodation if they can even find any, or new homeowners whose mortgages have lately become less affordable and whose biggest asset is now worth less than they paid – but their suffering is at least helping the US Democratic Party get re-elected.
Almost all of us are suffering financially to some extent. Even before the spike in inflation, average wages were barely keeping up with prices for a decade. Now they are going rapidly backwards. And the putative cure for high inflation – higher interest rates – has seen the price of houses fall, for those of us lucky enough to own one.
The RBA has been hiking strenuously to keep up with its global counterparts. It’s already raised interest rates 2.5 percentage points since May, taking the cash rate from an all-time low to 2.6 per cent. The pace appears to have slowed, with a quarter-point increase this week following four consecutive half-point moves, but governor Philip Lowe said further rate increases were “likely”. The smaller than expected increase this month allowed time to assess “the outlook for inflation and economic growth in Australia”.
We are faring better than many other countries – the Australian dollar has fallen only about 11 per cent against the US currency in the past year, far less than some. Inflation has been much lower, the economy still is growing solidly and unemployment is near a 50-year low.
But the suffering from inflation and interest rate rises has been very unevenly distributed.
Moreover, as a result of the long period of low rates up until March, and the money handed out by the government during the Covid period, many households have built up what Lowe called “large financial buffers”.
Not all people are in the same cashed-up boat, however.
“For new borrowers, it’s going to be really tight, because people have borrowed four, five, six times their annual income. A lot of them are going to really feel the squeeze,” says Brendan Coates, economic policy program director with the Grattan Institute.
It will be felt more intensely, too, by those who bought a property to live in, compared with those who bought one as an investment, because the latter can take advantage of negative gearing.
“Those that have mortgage deductibility … depending on what their marginal tax rate is, could wipe off 30 to 47 per cent of the cost of the rate rises by claiming them as deductions against their income,” says Coates.
The other thing property investors can do, of course, is whack up rents.
And they have.
“Capital city average level rents are up 20 per cent, just over the last 12 months,” says Louis Christopher, managing director of property market analysis firm SQM Research, which surveys advertised rent prices every week.
In 2021, he says, housing prices were rising faster than rents, but even since the housing market downturn, rents – and yields to landlords – have continued to rise, interest rate increases notwithstanding.
The standard tenancy agreement, he notes, runs for 12 months, and then month-to-month after that.
“So if you’re on a 12-month lease, and then you’re looking to go back into the market, you can expect to pay essentially 20 per cent more on a like-for-like property,” he says.
That’s if you can find one. The current vacancy rate is at a record low of 0.9 per cent nationally, he says, and worse in some areas.
The tightening of supply might seem counterintuitive, given Australia’s closed borders during Covid. A partial explanation lies in the fact that people working from home wanted more space. The result was fewer people per home.
Another factor is the rapid growth of short-term accommodation, provided by the likes of Airbnb.
“That’s a biggie,” says Christopher. “The market share of short-term leasing has rapidly expanded compared to the long-term leasing market, even though the absolute numbers are broadly the same.
“There are actually more Airbnb properties on the market in Melbourne and Brisbane now than long-term leases.”
The major driver, he says, “is landlords feel more in control of their property in the short-term leasing market”. For renters, he says, times are “grim, absolutely”.
We can’t blame “big business” for this predatory behaviour – at least not directly. According to Grattan figures, about 85 per cent of rental properties in Australia are owned by landlords who have three or fewer properties.
What we can point to is a chain of causation: the pandemic that caused global supply chain chaos, the Ukraine war that caused the energy crisis, the energy companies that profiteered, the central banks that jacked up interest rates, on down to the mum and dad investors who seek to offset their declining real wages and increased borrowing costs by exploiting those in need of a place to live.
Some blame, too, can be attached to government. Before the 2019 election, Labor promised to reform negative gearing and capital gains taxes. Had it won, the rental crisis might not be so dire.
Instead, Australia elected the Morrison government, whose answer to the growing housing crisis was, in the words of Kate Colvin, to give would-be homeowners “a bit of extra money to compete against everyone else”, which only served to drive up prices.
“It was policy vandalism,” says Colvin, who is the spokesperson for Everybody’s Home, a coalition of housing, homelessness and welfare organisations set up in 2018 to push for change to make housing more affordable.
Australia’s housing market is “pretty fundamentally broken”, she says.
“Twenty years ago, the private market basically worked to deliver housing product to low-income renters, particularly in regional areas. Twenty years ago, 50 per cent of even one-bedroom places were affordable to someone on [the equivalent of a] JobSeeker payment. Now no rentals are affordable to someone on JobSeeker,” she says.
And the recent decline in housing prices has done nothing to make things easier for either renters or new buyers.
“So the cost of houses and units has decreased, but only because interest rates have increased, meaning housing was actually no more affordable.”
What is desperately needed is more public and affordable housing.
There are some positive signs, but only small ones, Colvin says. The new Albanese government has committed to building 30,000 social and affordable properties over five years. A number of the states also have made commitments to increase supply, most notably Victoria, with $5.3 billion over four years to build 12,000 social and affordable rentals.
“But it is still the lowest proportion of social housing of any state, and they really need to keep investing beyond that or investment will sort of run out in 2024.”
And the commitments to increased supply “following decades of underinvestment” are nowhere close to meeting demand.
“The current shortfall is more than 430,000 properties for social housing, and if you add in affordable, it’s more than 600,000. So it’s huge.”
One encouraging development, says Colvin, is that after five years in which the previous government did not even bother to sit down with the states to discuss the crisis, the new government has had “federal and state housing ministers sitting around the table together, discussing these challenges”.
It is a social crisis for those involved, of course, but also an economic crisis for the nation, Colvin says.
“It’s a social crisis because you can’t get on with the daily business of ordinary life and going to work and stuff when you’re living in a tent. But it’s also an economic crisis, because every community needs low-paid workers to function.
“You need supermarket workers, you need disability support workers, aged-care workers, childcare workers, all of those human services, and communities can’t recruit those kinds of workers because they can’t afford to live locally.”
The human costs of unsustainable housing costs are many and varied, says Kasy Chambers, executive director of Anglicare Australia.
“Rent is not elastic,” she says. “You can’t just pay half the rent. You have to cut other things that are.”
So people don’t go to the dentist or doctor, or don’t fill prescriptions for medicines.
“Those are some of the first [expenditures that] tend to go. Car insurance, that kind of stuff. We’re talking to people who are doing things like turning off [their] hot water to save money, going to bed very, very early. Cold is a big issue.”
And that’s for people who have somewhere to live – Chambers says Anglicare is seeing “more and more people who just can’t afford rent, couch surfing with friends, moving into tents, cars, that kind of thing. And it’s a very difficult road to come back from.”
Increasingly, these people also go hungry or rely on food banks for meals.
Anglicare has just completed a survey of its national network of emergency care providers, which help out with things such as food hampers or vouchers, transport or medical costs, utility payments, rent and, in some cases, employment subsidies. Demand was sharply up everywhere since the beginning of this year, in some cases by 50 per cent or more.
The new cohort of people needing help includes home owners and the “working poor” who are struggling to pay for food and utilities, as well as more single parents and people on disability support and aged pensions.
These are not the sort of people with whom central bankers, or other world leaders, or the heads of multinational corporations, or even mum and dad property investors, usually consort. They are the grass that gets trampled as the globe’s biggest battles – to contain a virus, to crush an independent country, to save a US president – rage on.
This article was first published in the print edition of The Saturday Paper on October 8, 2022 as "How the US is unleashing a recession on the world".
For almost a decade, The Saturday Paper has published Australia’s leading writers and thinkers. We have pursued stories that are ignored elsewhere, covering them with sensitivity and depth. We have done this on refugee policy, on government integrity, on robo-debt, on aged care, on climate change, on the pandemic.
All our journalism is fiercely independent. It relies on the support of readers. By subscribing to The Saturday Paper, you are ensuring that we can continue to produce essential, issue-defining coverage, to dig out stories that take time, to doggedly hold to account politicians and the political class.
There are very few titles that have the freedom and the space to produce journalism like this. In a country with a concentration of media ownership unlike anything else in the world, it is vitally important. Your subscription helps make it possible.
Select your digital subscription