The
Australian

June 30, 1989

Why our Interest Rates should Tumble

Mr. Martin Armstrong, of Princeton Economics International, offers a surprisingly optimistic outlook on our economy.

Richard Gluyas reports

Princeton Economics International, founded by Mr. Martin A. Armstrong, now 40, opened for business in 1970. It has offices in New Jersey in the United States, London, Sydney, Tokyo and Canada. The size of Princeton’s data base, which forms the basis of its forecasting and advice to clients, is said to be unsurpassed, even by the World Bank. As an example of the group’s dedication to gathering information, several years ago eight Princeton researchers spent a year in the British Library tracking international currency movements since the turn of the century. The group’s annual October economic conference is attended by about 200 representatives of central banks, governments and leading institutions.

It is the economic equivalent of Mission Impossible, we are told—a painless solution to Australia’s burgeoning foreign debt problem.

The Hawke Government claims to have the answer—tight monetary policy and high interest rates—but very few would describe the experience as pleasant.

And the monthly current account deficit figures—a recurring nightmare for ther Treasurer—are worsening.

So perhaps it’s time for a change. Why not deliberately lower interest rates and see what happens?

As ludicrous as this may sound to the Treasury boffins, there is one pocket of economic wisdom that seriously advocates such “heresy.”

It comes from Princeton Economics International Ltd., a think-tank and international economic advisory unit based in New Jersey in the United States.

Its record includes forecasting the October 1987 sharemarket crash in August of that year. Princeton recommended full hedge positions in August and outright short positions for those enjoying a punt.

Closer to home, it forecaast the decline in the dollar to US58c in 1986 a year in advance and its recent surge to US90c.

It was also called in by the Brady Commission—headed by the now US Secretary of the Treasury, Mr. Nicholas Brady—which investigated the cauases of the sharemarket crash in the US.

The chairman of Princeton, Mr. Martin Armstrong, has frequently been called on to donate Princeton’s research to, and advise, various US administrations.

Mr. Armstrong recently spent time in Australia renewing links with clients that include the Sydney-based broker Bain & Co and several of Australia’s top 10 companies.

He firmly believes the worldwide obsession with monetary policy, namely the use of interest rates to regulate inflation and demand, is misguided, and in a recent circular to clients described it as “voodoo” economics.

His solution to Australia’s economic woes, particularly the current account deficit, is disarmingly simple and characteristically forthright: “Lay off interest rates!”

About $1.2 billion of last month’s current account deficit figure of $1.8 billion comprised interest payments on offshore loans and divdent payments.

“Of course Australian corporates will borrow offshore when there’s such a huge discrepancy between your interest rates and offshore rates,” Mr. Armstrong told The Financial Australian.

“They could probably stand a 3 per cent differential over US rates (now about 9 to 10 per cent) and even if they were 16 per cent here you might find some loans coming back onshore.”

Mr. Armstrong believes prime rates would settle at 13 to 14 per cent if the market were permitted to have its way, instead of 20.25 per cent.

Existing policy aside, he wearies of the importance placed on the current account, which he says presents a distorted picture of a country’s trading position.

High local interest rates encourage offshore borrowing, the repayments on which are included in the curent account, yet the same rates encourage capital inflow, which is included in the capital account of the balance of payments.

Basically, this means any foreign invesmtent will increase the current account deficit.

The monthly current account statistics also ignore the asset side of the equation—the assets that are being bought with the offshore loans.

“The current account is meant to balance the capital account, and this is being ignored,” Mr. Armstrong said.

“It’s as if you are looking at your cheque book one week and saying ‘Oh my God I’m broke; I’ve spent $1000,’ when during the same period you deposited $3000.”

Contrary to popular belief, Australia is not squandering its debt, according to Mr. Armstrong.

Hard assets are being bought and it is not an Argentine situation where money is borrowed to fund social programs, or a case of conspicuous consumption of “fur coats, French wines and Lamborghini motor cars.”

Mr. Armstrong is firmly opposed to a tax on luxury goods, saying it would send the wrong signal to trading partners and citing the Lamborghini, which already costs $400,000 in Australia compared with $120,000 in the US.

“What would another 3 per cent on top of that achieve?” he asks. “I’ve only seen one of them in Australia in three years anyway.”

Ignoring its distortions, the current account by itself was a relatively meaingingless figure.

“Australia’s obsession with it is as misguided as it was for the US in 1987,” Mr. Armstrong said.

“The deficit hasn’t changed much since then but the US dollar has risen 40 per cent. So no one tends to look at the current account anymore. These things tend to be fashionable.

“And with gross domestic product (GDP) in the United States at $US4.6 trillion ($6100 billion) a trade deficit of $US140 billion does not appear so important. And we have a trade deficit with Japan of $US55 billion. Big deal.”

A more accurate representation of an economy’s health was its debt- servicing abilities, in particular the proportion of government expenditures used to pay off debt.

This was becoming an increasingly important matter, for example, in the US, with 30-year government bonds yielding 3 per cent being rolled over into instruments now yielding 9 per cent.

In Canada, the debt servicing figure is 30 per cent, which falls to 23 per cent for Japan, an average of more than 20 per cent for Europe, 13.4 per cent for the US, and, only 10 per cent for Australia.

Here—and elsewhere—lies the reason behind Mr. Armstrong’s remarkably optimistic prognosis for Australia during the next 10 to 15 years.

He believes Japan and West Germany have run their economic race and Australia’s fortunes are on the upturn, despite the optimism that pervades the former two countries and the pessimism that dominates the latter.

“When I speak there and say their currencies are going down, they say: ‘Oh no, our currency is going up forever,’” Mr. Armstrong said.

“But when I speak here and say your currency is going up, everyone says: ‘Oh no, it’s going down forever.’

“The Japanese and West Germans had the best of both worlds when commodities prices were going down and their currencies were going up because they are 100 per cent reliant on importing raw materials.

“They may have looked like heroes for a brief shining moment, but they cannot be (economic) leaders of the world unless they are self- sufficient.

“That is why the US has retained a position of dominance; it is self- sufficient to a large degree, although not so much with oil now.”

The situation is similar in Australia, which Mr. Armstrong sees as having unparalleled growth opportunities “like, the US in the early days.”

He sees the Japanese economy—without a self-sufficient domestic economy—as naturally prone to volatility.

The money it makes from trade is pouring out of the country into Queensland and New York real estate, reflecting the dearth of local investment opportunities.

This should not be of any concern to Australians or Americans, he says, because if the experience of the Organisation of Petroleum Exporting Countries and its petro-dollars is any indication, the Japanese will buy at the top of the market and sell at the bottom, losing a lot of money in the process.

So Australia, relatively self-sufficient and resource-rich, should not seek to mimic Japan and West Germany and become obsessed with trade, according to Mr. Armstrong.

Both those economies are heavily dependent on a healthy US economy for their exports—40 per cent of West Germany’s gross national product is export related—and both experience significant declines if there is a relatively minor hiccup in US demand.

We should instead strive for greater self-sufficiency and broaden our economic base.

“Everyone I speak to overseas says Australia is a great place,” Mr. Armstrong said.

“Australia is going to be one heck of a boom area over the next decade. The Pacific rim is going to be the next major area of economic growth in the long term, and Australia is the best place to position yourself for it. There’s not doubt about that.”

There is one caveat, however, and that relates to the Government’s “obsession” with monetary policy.

If higher interest rates cure inflation, then why haven’t they worked in Argentina?

“The, central banks only have one policy tool and that’s interest rates,” he said.

“They raise them to fight inflation, they raise them to support currencies, they raise them for anything and everything.”

In economics, nothing had changed, Mr. Armstrong said. “Adam Smith (the free marketeer) had all the answers in 1776 but economists have argued for centuries over what money is,” he said.

“Marx said it was labour. Well it’s not that, otherwise China would be the richest nation on earth. The mercantiles said it was gold. Well the US had the largest gold reserves in the world, lost them, and is still a world power.

“It is the combined productive forces of a nation—people, land and resources—brought efficiently together.”

Australia, he believes, is well endowed in relation to most of those criteria.