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A recession is coming, but don't blame debt; The income squeeze that's draining the economy
Topic Started: 4 Sep 2014, 10:09 PM (616 Views)
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A recession is coming, but don't blame debt

Adam Carr

Yesterday’s GDP numbers confirm that the Australian economy is in excellent shape. Indeed the figures show that once again, the nation’s economy is growing comfortably above trend -- as it has done consistently for these past three years. Importantly, economic growth is well above where the Reserve Bank of Australia thought the economy would be earlier in the year. So far so good.

Now that hasn't stopped the usual negative commentary on the economy, which revolves around the notion that growth has slowed sharply or it showed our standard of living falling etc. This is fiction (Shifting gears: Is Australia going backwards or forwards? August 22). It must be viewed in the broader context of commentary these past five years. Many Australian commentators and economists have spent the best part of that time anticipating recession -- or some form of crisis. Seemingly even craving it.

Much of that analysis is based on the view that debt is at records levels, and the premise this is a grave danger to the country going forward. I dealt with this view in my piece (Why Garnaut is wrong about Australia's debt challenge, July 22). It’s not that I disagree that debt is high. It clearly is in some respects. Yet that by itself is not sufficient to cause a recession. Debt was at records a decade ago too -- for the times -- and of course as we know, that didn’t cause a recession. Debt can’t cause recessions.

In modern economics debt simply works as a defining parameter -- in the sense that monetary policy, instead of controlling debt, ends up controlled by it. This isn’t by policy design but it is what ends up happening. Policy is shaped by it and central banks work actively to accommodate whatever the existing level of debt is. They have too.

Consider that in any given downturn, a central bank cuts rates in an attempt to boost spending, get credit flowing and avert or alleviate recession, to promote growth. The higher the level of debt, the lower rates must go to get the process moving. But as confidence returns and credit flows again debt levels rise. This is the usual transmission mechanism. However as time goes on, in each cycle, what you tend to find is that as these debt levels rise, we get ever small peaks in rates and ever lower troughs.

Recession is coming though, this I don’t doubt. But if it’s not going to be caused by debt, then what? The slump in the terms of trade is often thrown up as another candidate, but this too is not probable.

Remember the terms of trade is not a real economic variable -- it’s only an indicator variable for the demand for Australian exports and moves in national income. Usually if the terms of trade slumps, then that means the demand for our exports is weak and national income will fall. Right now that isn’t the case.

The terms of trade is falling, yet demand for our goods is strong, and rising. It’s giving false signals. More to the point, a fall in the terms of trade has never caused a recession or downturn. Sure, it’s been associated or correlated with them, but it’s never caused them.

That really only leaves two main domestic candidates for the next recession, baring some external shock.

1. Financial instability or;

2. Inflation.

The choice that policymakers have made to keep rates at ultra-low levels -- on a permanent basis -- virtually ensures one or the other or both. It will exacerbate the hunt for yield and increase appetite for risky investments. This is happening in real time. That will and is encouraging a misallocation of resources and there are only two outcomes from this: financial instability as bubbles eventually deflate -- and/or inflation. Even attempting to treat the second will probably cause the first.

This is what we saw in the lead up to the GFC, and markets can panic. Economic systems can panic and unfortunately, financial instability and inflation often go hand in hand. Indeed, the fact is, in modern economic times, pretty much every recession has been caused by inflation.

So don’t go looking for debt or the terms of trade to cause our next downturn. They can’t and won’t. The cause will be a little more traditional, and on the current policy trajectory, it is guaranteed.

Read more: http://www.businessspectator.com.au/article/2014/9/4/economy/recession-coming-dont-blame-debt
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The income squeeze that's draining the economy

Robert Gottliebsen

Australian chief executives and top managers are going to have to be a lot smarter in the next few years, especially since the yield boom has boosted share prices for many of them. Those looking for widespread rises in non-mining and non-housing corporate capital expenditure to drive the economy are being very optimistic.

Since the 1970s, national accounts data shows Australian incomes have grown steadily by about 2.3 per cent a year. There have been tough times but our per capita national income has always bounced back.

That steady growth in national income per head meant that as long as companies did not run out of money, they could ride out the tough times.

But in the last budget Treasury dropped a bombshell on corporate Australia. In the June quarter, Treasury’s long-term forecasts are being proved to be chillingly accurate.

In the budget Treasury showed that future national per head income growth was in grave danger of slumping to nil over the next decade.

We have been able to maintain a 2.3 per cent per head growth rate over such a long period because of better terms of trade and productivity growth. With an ageing population and no immediate likelihood of a rise in the terms of trade, we would need to lift productivity by 3 per cent a year -- twice the historic average -- to maintain a 2.3 per cent per head growth rate.

That’s a huge task. In the June quarter, as Callam Pickering points out, real disposable income per head fell by whopping 0.6 per cent (Population growth can’t fuel the economy forever, September 3).

Figures like this seem remote from the real world. But in reality we are seeing outcomes you would expect.

In many areas of the economy, salaries are not increasing because revenues are not lifting. Companies are achieving profit rises by reducing costs. Strange things are happening. Clubs and associations are seeing falls in membership, football attendances are down, and small cafes cannot pay award weekend penalty rates, so to survive they are doing 'under the table' deals with their staff.

These are surface indications of an underlying income squeeze as forecast by the Treasury graph. Consumers are being a lot more careful about how they spend their discretionary income. Retailers are on the frontline and all too often are losing the battle for diminishing per capita discretionary dollars to services. They blame the budget, but relatively few people have been hit by the budget. Most of the budget blows take place well down the track.

What we are seeing is the effect of stagnant incomes and rising costs, particularly from the government sector. Thankfully we have abandoned the crazy carbon tax, which will help. The latest superannuation change will also help, but I suspect many struggling enterprises will pocket the non-required payments rather than pay staff.

But such matters are relatively minor when you see a trend like the one that has been alerted to us by Treasury. Enterprises trying to seek the discretionary dollar or supplying those who are chasing it are going to have to be very clever because the pool is being reduced.

The days of governments being able to suddenly announce huge expenditures (such as Gonski) and be able to afford them from underlying revenue growth are gone, unless there is a big game-changer like Andrew Robb’s vision for northern development (The one minister who has a vision for Australia, August 19).

Remember that the terms of trade in iron ore, coal and gas which have driven Australian wealth have very much turned the other way (The shifting balance of power will test our miners, September 3).

Read more: http://www.businessspectator.com.au/article/2014/9/4/australian-news/income-squeeze-thats-draining-economy
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The challenges underlying retail's rebound

Callam Pickering

Retail trade has rebounded somewhat over the past couple of months but can the household sector overcome declining real wages and rising unemployment? Similarly, while exports improved during July, that market isn’t without its challenges. Can our smaller iron ore producers overcome falling commodity prices and keep their heads above water?

Retail trade

The value of retail sales rose by 0.4 per cent in July, consistent with expectations, to be 5.9 per cent higher over the year. Annual growth remains reasonably strong, supported by solid growth last year, but the near-term outlook is still fairly soft. Annual growth should ease to around 4.5-5 per cent by the end of the year.

Our dining boom continued in July, with spending at cafes and restaurants rising by 1.4 per cent in the month, to be 10.8 per cent higher over the year. Food retailing, which accounts for 41 per cent of total retail trade, increased 0.5 per cent in July.

Growth continues to be driven by New South Wales and Victoria. Our two biggest states have accounted for almost 80 per cent of the rise in household spending over the past year. By comparison, retail spending in Western Australia remains subdued, highlighting the slow but steady shift in economic activity towards the east coast.

The outlook for retail sales will largely be determined by income growth and conditions in the labour market. At the moment, real wages (wages adjusted for inflation) are declining modestly and putting some pressure on household budgets. The unemployment rate is also at its highest level in a decade, and is causing particular problems for younger Australians, who tend to spend a higher share of their income than other age groups.

The terms of trade is also weighing on household budgets and declined by a further 4.1 per cent in the June quarter. With commodity prices easing further in recent months and the iron ore price dropping to a five-year low, conditions for the household sector are likely to ease further before they improve.

International trade

Australia’s trade deficit narrowed slightly to $1.36 billion from $1.56bn in June to continue a fairly ordinary stretch for international trade. The result follows yesterday’s national accounts, which saw net exports subtract 0.8 percentage points from real GDP in the June quarter (Population growth can’t fuel the economy forever, September 3).

The value of exports rose by 1.0 per cent in July, to be 2.1 per cent higher over the year. Growth has suffered in a large part due to falling commodity prices, combined with the Australian dollar remaining stubbornly high.

The Reserve Bank’s commodity price index has declined by 15 per cent this year but it did tick up slightly in August, providing some upside risk for exports next month. However, that may prove to be a brief reprieve for our resource sector, with more recent developments indicating that export prices will continue their descent in September.

Exports to China, which account for 33 per cent of total merchandise exports, rose in non-seasonally adjusted terms but are down 1.4 per cent over the year. Growth in July was largely driven by the UK, where exports more than doubled during July. I expect this unusual result will correct itself next month.

It almost goes without saying that the main risks to exports centre on China. Of particular concern is the Chinese residential property market, an area that ought to be reported on more frequently in Australia.

It is early (and certainly not without precedent), but that market is looking increasingly shaky. If that persists then it will quickly feed through to Australian exports and prices and genuinely represents an existential threat to our smaller resource producers. The Reserve Bank recently said: “At current prices, there is a sizable amount of coal and iron ore production that is unprofitable”.

Both indicators posted reasonable gains in July but the bigger challenges are ahead. Can the household sector overcome falling real wages and higher unemployment? And how will the mining sector respond to lower iron ore prices and conditions deteriorating in China’s property market? The answer to both these questions will dictate how successfully the Australian economy rebalances and what the Reserve Bank does next.

Read more: http://www.businessspectator.com.au/article/2014/9/4/australian-news/challenges-underlying-retails-rebound
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