"If the world interest rate changes, we have to change ours too," said Philip Lowe, the head of the Reserve Bank of Australia. Photo / Getty Images
Australia's economy is experiencing its 28th year of a record-shattering expansion, with strong employment growth and high economic potential.
But the Reserve Bank of Australia cut rates to a record low last month — a development that underscores how intertwined the global economy has become and how big a threat President Donald Trump's trade war poses in such an environment.
On paper, there is no reason Australia's economy should be in big trouble.
The country has seen rapid, immigration-fueled population growth, something many developed markets lack. It seems to be weathering the fallout from a domestic housing market cool-off, and while slow wage gains are weighing on consumer spending, pay increases have been lagging partly because workers are pouring into the job market and keeping competition for employees at bay. Crucially, the nation has little exposure to global manufacturing supply chains, a fact that insulates it from the early fallout of America's trade fight with China.
But the central bank's ability to goose pay, achieve steady price increases and keep the job market expanding hinges partly on interest rates in other countries. More than 30 central banks have cut interest rates this year in response to slowing global growth, Trump's trade war and other geopolitical turmoil.
"If the world interest rate changes, we have to change ours too," Philip Lowe, who heads the Reserve Bank of Australia, said over the weekend at an economic symposium in Jackson, Wyoming. "If we don't, the exchange rate will appreciate, and it will have adverse consequences for our inflation and employment goals."
Lowe's central bank cut interest rates to 1 per cent in July, and is expected to lower them again before the end of the year. It was a bid to shore up domestic demand, which has been weak, but Lowe said that global rates had also "been a consideration in our recent thinking."
That even Australia cannot remain an island of untroubled prosperity amid a fraught global backdrop — one made more so by Trump's announcement last week that he plans to further escalate America's trade war with China — speaks to the broader challenges facing the world's economy.
From the Oceanic nation, with its strong demographics and high growth potential, to Japan and Europe, with their aging populations and weaker prospects, the level of interest rates that a healthy economy can sustain without slowing down has fallen. So, too, have inflation and the level of unemployment that stokes faster wage growth.
Those changes owe to aging in many advanced-economy populations, a heightened appetite for low-risk saving options and globalization. Financial markets, which have become larger and closely interwoven, ensure that the trends are shared across economies.
"International linkages have risen dramatically over recent decades," Mark Carney, the head of the Bank of England, said at the Jackson Hole gathering, an annual meeting hosted by the Federal Reserve Bank of Kansas City. And because America's currency and debt markets are so central to the global financial system, the nation's political and economic dramas guide the world's.
"The global financial cycle is a dollar cycle," Carney said. Bank of England research indicates that increases in America's policy interest rate have twice the effect on foreign growth that they did back in the 1990s, even though America now makes up a smaller share of the global economy, Carney said.
When the Fed moves interest rates or Trump ramps up trade tensions, it echoes across the world through currency repricing and slower growth.
There are hazards to such an integrated global monetary and financial system. It leaves central banks with low interest rates to begin with, and then little ability to diverge from their trading partners' monetary policy settings. At the first sign of trouble, many nations may lower rates in tandem.
That seems to be happening now. As the United States, the eurozone and Japan reorient toward rate cuts and other forms of monetary economic help this year, central bankers across emerging markets have slashed their own borrowing costs. Monetary authorities could enter the next recession with relatively little ammunition, heightening the risk that a garden-variety economic slowdown could turn into a drawn-out, painful global slump with widespread costs to jobs and prosperity.
And while the global economy's brittleness is rooted in slow-moving economic fundamentals, Trump's trade war could be the spark that sets off the time bomb.
Trump looks at a tightly intertwined global economy and sees a winner-take-all game in which the United States can and should prosper at the expense of other countries. He has criticized the Federal Reserve for not cutting rates more quickly, saying the central bank is putting the United States at a disadvantage to other nations that are ushering in low rates.
"Our Federal Reserve cannot 'mentally' keep up with the competition - other countries," Trump said in a tweet on Wednesday. "At the G-7 in France, all of the other Leaders were giddy about how low their Interest Costs have gone. Germany is actually 'getting paid' to borrow money - ZERO INTEREST PLUS! No Clue Fed!"
Just as central bankers spent the weekend discussing how countries' economic fates have become closely tied at their Jackson Hole symposium, Trump announced on Twitter that he would put additional tariffs on China and would look for ways to stop domestic businesses from operating there.
He is still contemplating tariffs that would harm German carmakers, and earlier this year, Trump threatened tariffs on Mexico as a way to pressure the country to stop the flow of migrants across the southern border.
Trump's next steps are clearly top of mind going forward in Australia.
"Australia has been a major beneficiary from the rules-based global trading system over many decades," Guy Debelle, deputy governor of the Reserve Bank of Australia, said in a recent speech. "The current threats to that are clearly a major risk for the Australian outlook over a longer horizon."
While drawn-out trade battles are hurting Chinese growth and weighing on global manufacturing, central bankers around the world generally echo Debelle: They are less worried about the direct effects than about the uncertainty caused, the prospect of escalation and the potential for a paradigm shift.
"The combination of the structural imbalances at the heart of the international monetary system and protectionism are threatening global momentum," Carney said.
And a wave of rate cuts that work partly through making domestic currencies cheaper are an imperfect fix to the continuing trade tensions.
"If all central banks ease similarly at around the same time, there is no exchange rate channel," Lowe said over the weekend. "We trade with one another, not with Mars."
The pain may even be spilling back into the United States itself in ways that the Fed will struggle to offset. Factories are slowing in the United States, as is the case around the world, and consumer confidence showed early signs of softening in preliminary August data.
"While monetary policy is a powerful tool that works to support consumer spending, business investment and public confidence, it cannot provide a settled rule book for international trade," Fed Chair Jerome Powell said last week.
The global backdrop could take some oomph out of Fed policy. The central bank cut interest rates for the first time in more than a decade in July, but as uncertainty slows investment and pulls down the global interest rate setting that neither stokes nor slows growth, it could also lower the dividing line between stimulus and restrictive policy in America.
"More than in the past, the Fed is always going to feel like chasing a moving target," Adam Posen, the president of the Peterson Institute for International Economics, said in an interview.
And that could leave it struggling to lower rates fast enough to bolster the economy.
"Fed policymakers still risk lagging behind," Joachim Fels, a global economic adviser at Pimco, wrote in a research note this weekend. Appropriate policy settings, he wrote, are increasingly "hobbled by global fetters."
Written by: Jeanna Smialek
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