RBA needs massive overhaul

The RBA is hierarchical, insular, supercilious, hubristic, and resistant to outside influence.
Christopher Joye

Coolabah Capital

First a shout-out to the UFC’s pound-for-pound king, Alex Volkanovski, for retaining his number one position across all weight classes following his fight in Perth with Islam Makhachev, which this column previewed.

I am confident that the UFC’s featherweight champion, who hails from the mean streets of Wollongong, will comfortably prevail over the Dagestani in their inevitable rematch and claim his deserved double-champ status.

Now, to another cage match: Reserve Bank of Australia governor Phil Lowe’s battle versus the rest of the world.

This is really a sad situation that I am honestly at pains to write about, and have avoided doing so for some time.

For the record, it is worth making a few preliminary points. The RBA is equipped with hundreds of extremely talented analysts that pour a great deal of energy into advancing our understanding of the economy.

Phil himself has been an absolute superstar for much of his career, and is regarded as extremely honest, diligent, bright and focused on serving the best interests of the people.

For decades this author has argued that the RBA would benefit a great deal from external leadership. Having worked briefly there, the central bank is immensely – and I really mean extraordinarily – hierarchical, insular, supercilious, hubristic, resistant to outside influence, and exceptionally slow to recognise and respond to its own mistakes.

The RBA’s leadership, culture, and organisational structures are all desperately in need of a massive overhaul. And this can only be executed by a highly experienced and respected leader that does not originate from the organisation itself.

What dynamics created these problems?

Golden years

First, you have a circa two-decade period from the early 1990s to the 2008 global financial crisis where Australia was blessed with extraordinary productivity, prosperity, and price stability after the deep 1991 recession, the advent of China flooding export markets with cheap goods, and as a consequence of the boom in commodity prices, which was also driven by China.

Australia’s antipodal position obviously helped as did the fact that our sleepy banks were simply a few years behind their US and European brethren in aggressively embracing sub-prime lending. It did not, however, stop Adelaide Bank modelling itself on Northern Rock in investor presentations.

These factors conspired to enable Australia to uniquely avoid a recession during the GFC– and its worst ravages – which encouraged bankers, politicians and policymakers to confuse extreme luck with skill. The myth of Aussie banking exceptionalism quickly emerged.

Another influence was the 1990s and early 2000s propensity to lionise central bankers, like Alan Greenspan, as all-knowing and all-seeing monetary prophets.

The human tendency to luxuriate in this acclaim was amplified by the central bankers’ fixation with their perceived “credibility”. The idea here was that central bankers wanted their statements about maintaining low inflation to be credible with the public: if they were not, expectations regarding future inflation pressures could become unmoored, resulting in a self-fulfilling bout of even higher actual or realised inflation outcomes.

Credibility was confused with an inability to ever admit a mistake. Until the pandemic, Australia had not had a technical recession since 1991. The RBA had overseen the transformation of what was described during the 1980s as a “banana republic” into what The Economist has repeatedly characterised as the “wonder down under”.

Almost 30 years of uninterrupted growth combined with inflation almost always at or below the RBA’s 2-3 per cent target band.

Dysfunction and resistance

But from inside the RBA, it was obvious that this was an incredibly dysfunctional organisation riding on the coattails of what was mostly pure providence. The RBA’s intense resistance to change, hubris, and insularity has been exacerbated by a governance structure that is largely disembowelled.

The board is mostly dominated by individuals who have little expertise in financial markets and/or economic policymaking. And the chairman and CEO of the board are one person: the governor.

For decades the joke was that the board was a rubber stamp, although this does appear to have shifted to a much more inclusive and consultative process under the highly amiable and affable Lowe.

Another challenge has been the implicit contract that the RBA strikes with the media, whereby it will relentlessly feed favoured journalists with highly sensitive information on its thinking in exchange for compliant coverage. (This does not always work.)

The final problem is that life as an academic and/or economics researcher is exceptionally poor training for life as a hugely pressured decision-maker making uber-complex judgments under circumstances characterised by acute uncertainty and duress.

Many will argue you need an economist to successfully run the RBA, ideally one with heavy postgraduate qualifications. While these attributes undoubtedly help, the truth is you want someone who has a deep, practical understanding of both the economy and financial markets, and, crucially, an individual who has exceptional experience managing large teams and making complicated decisions under stressful circumstances.

If you question for a moment those beliefs, consider the enormously successful current boss of the US Federal Reserve, Jay Powell, who studied law and spent his entire career as a lawyer, investment banker, and private equity specialist.

He never worked as an economist nor studied advanced degrees in economics. And Powell has frankly ran rings around most, though not all, global peers in many respects, especially in his belatedly forceful response to crushing the biggest inflation crisis the Fed has faced in over 40 years.

I think it would be a mistake to replace Lowe with someone from the RBA, a former RBA executive, or an individual from the Commonwealth Treasury.

It has been 30 years since the RBA has had external leadership, and Bernie Fraser, arguably the best governor the RBA has ever had, was still a highly political Treasury appointment.

What we need is a clean slate led by fresh leadership, almost certainly from outside Australia. There are numerous capable candidates that fit this bill.

The RBA’s reputational capital has been very deeply damaged with the community, its peers overseas, and most badly with the global bond markets that are ultimately responsible for pricing the cost of capital that it is seeking to influence.

The Albanese government should work to cauterise this problem as soon as possible, ideally announcing Lowe’s replacement promptly after the delivery of the independent review on March 31.

There is nothing stopping them putting that person in place within the next few months alongside Lowe as he transitions on to a very well-deserved retirement.

Inflation problem

On the subject of problems, allow me to conclude with a final one. Core inflation in the US posted another 0.4 per cent increase in January, in line with market expectations. So core inflation has slowed, but not by as much as had been previously thought (past data has been revised upwards).

Significantly, all the common measures of underlying inflation are still well above the Fed’s 2 per cent target. As one example, trimmed mean inflation, which captures the breadth of price changes across the CPI basket of goods and services, has improved a lot over the past year. But in recent months it has actually picked up a little to an annualised trend rate of almost 6 per cent in January.

This column has argued that we would see a big improvement in underlying inflation this year. Yet the pace and size of that improvement, and whether it will quickly converge back to the central banks’ pithy 2 per cent targets, remains highly uncertain. At the margin, this means more hikes, and interest rates that are held higher for longer, which translates into greater economic adversity.

The central bank is hierarchical, insular, supercilious, hubristic, resistant to outside influence, and exceptionally slow to recognise its own mistakes.

It also means we will likely get the biggest default cycle since 1991, although it is likely many lenders will claim that borrowers who are missing their debt repayments are not, in fact, in default by restructuring their loans.

This week Westpac sensationally revealed that $212 billion of its home loans, or 45 per cent, were made assuming interest rates will end up at a lower level than they will be once the RBA finishes its rate rising cycle.

Put differently, Westpac approved loans to borrowers without testing their capacity to service their mortgages at interest rates higher than the 2.5-3.0 per cent “serviceability buffer” that was very reasonably applied at the time. (The RBA has raised rates by 3.35 percentage points thus far.)

The bottom line is that a world of pain is coming. And the jump in Australia’s unemployment rate during the week from 3.5 to 3.7 per cent might have been one of the more recent signs following on from the plunge in public confidence and plummeting asset prices.

First published in the AFR.  

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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