One of the biggest risks facing both the United States and Australia is that the central banks of both countries have been sidelined, and monetary policy is not working.

Maybe it will work eventually, so that the Australian economy screeches to a halt next year while the US rebounds, but the two central banks need something to happen yesterday, not in 2009-10.

The Reserve Bank’s latest 0.25 per cent push on the string yesterday was accompanied by a light pat on the back: “There is tentative evidence that some moderation in household demand is beginning to occur,” said the statement by Governor Glenn Stevens.

But that’s more likely to have been brought about by the 20 per cent fall in the sharemarket than by monetary policy. After all, everyone is an investor these days via compulsory superannuation and most retail investors are in the banks, which have dropped by 35 per cent in line with a global sell-off of financial stocks.

More worrying (for the Reserve Bank) is that the two things that have been working against monetary policy for the whole six years that the RBA has been ineffectually raising rates – that is, political tax cuts and the China-driven terms of trade – are going to work even harder against monetary policy this year.

The biggest ever tax cut yet is coming on July 1 this year, with Kevin Rudd sticking resolutely to his own tax cut programme, and the terms of trade (export prices minus import prices) looks like accelerating this year, not moderating.

Despite the US-based credit squeeze and fears of a global slowdown, metal prices have risen substantially since mid December and the LME index is within 5 per cent of its all time highs, on worries that mine supply problems will cause shortages.

Power shortages in China and South Africa have cut base metal production surpluses and, on their own, have raised concerns about shortages developing. (South Africa looks likely to be stuck with power shortages until 2012.)

Energy prices – thermal coal and oil – are surging, steel demand is pushing up the prices of iron and ore and metallurgical coal, and the weak US dollar has taken the gold price to $US1000 an ounce. Silver is also at a record high of around $US20 an ounce.

So while the market’s reaction to yesterday’s statement by the RBA was to cut back the chances of another rate increase in May, that view is unlikely to persist. Unless both the GDP numbers this week and the first quarter CPI surprise on the downside there is likely to be one shove on the string by the RBA to 7.5 per cent before it gives up.

Meanwhile in the US, the Federal Reserve Board is getting nowhere as well.

It is now five weeks since the Fed administered what it hoped would be a life-saving electric jolt to the economy’s chest by cutting the Fed funds rate by 1.25 per cent in three weeks.

Yet the US stockmarket is now lower than it was then and, in fact, back at its January lows after another 1.7 per cent drop this morning, although it has rallied in late trade. All types of credit spreads have blown out to new highs. The US dollar is in free fall and there are growing fears that the all-important foreign providers of credit the US are going on strike.

Last night the Fed chairman Ben Bernanke said in a speech that he expects home foreclosures to get worse before they get better. Bank analysts are now busily raising their forecasts of bank write-offs from the current actual number of $US160 billion to $US400 billion and beyond.

I attended an off-the-record address by the CEO of one of Australia’s big four banks yesterday; he said he thought US banking write-offs would end up at $US1 trillion.

Consumer sentiment has collapsed in the US and consumer spending is about to follow. The recession there could well be long and deep.

In both the US and Australia the forces at work are beyond the control of the central banks.

Perhaps in each case they are pulling on elastic rather than pushing on string, so that eventually monetary policy will work with a snap, producing a sharp slowdown in Australia and an equally sharp bounce in the US. But for the moment Glenn and Ben’s wheels are spinning.

Peter Fray

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