Saturday 30 June 2012

The Australian economy

Buckle up, Australia: recession is coming
Think Australia is immune to global downturn, depression and despair? Remy Davison from Monash University says we should think again.

By Remy Davison, Monash University

29 June, 2012

Think Australia is immune to global downturn, depression and despair? Think again.

One would be plundering the depths of naïveté to believe that Australia can continue to exist in an oasis of economic tranquility, while the global economy plunges into turmoil.

If you don’t believe me, then perhaps you’ll believe the chief economist of Deutsche Bank Australia? Or JP Morgan research? Maybe the Housing Industry Association?(Admittedly, HIA spruik for their own cause; but you can’t deny the figures.)

Commentators recognise that constant conjecture about recession can become a self-fulfilling prophecy. However, for most analysts, the objective is to examine the economic data dispassionately and base predictions upon a reasonable interpretation of the available evidence.

If certain data point to a Australian recession, potentially, this in itself raises important public policy issues:
1. How well prepared is Canberra for a major downturn in taxation revenues?
2. What budgetary scenarios are being modelled by Treasury in the event of a significant downturn in Australia’s growth?
3. What strategies does the Commonwealth government have in place to deal with the impact of a (worst-case scenario) “GFC II”, or a longer-term global recession followed by a slow, weak recovery? (the likely scenario).
4. How does the federal government plan to deal in the longer term with the emerging “multi-track” economy, characterised by a booming resources sector (WA and Queensland), a white-collar recession (scroll down to Macquarie’s research report on pages 3–4), a declining and hollowed-out manufacturing sector (Victoria and South Australia), and a declining housing market (national).
What are the key indicators suggesting Australia is destined for recession? Here’s the case for the prosecution.


Stock exchanges are not only a real-time measure of market confidence, but they also have a delayed-reaction impact upon the real economy. It’s axiomatic that business investment, private-sector job creation and the profitability of the retail sector, personal investment incomes and superannuation industry dividends are ultimately determined by the relative performance of local and global stock markets.

In early June, $20 billion was rudely wiped off the Australian stock market, on the back of another $35 billion lost in August 2011. The falls continued in September-October, as the ASX200 dipped below 3900 points.

The fall wasn’t as severe in June, but it was still coming off a 2012 high of over 4400. But it was the deepest trough since the market collapse of August 2008 and January 2009 – the apex of the GFC.

The market ebbed and flowed, but recovered for about 18 months from early 2010 until August 2011. Monthly market volumes were reasonably steady, and the market did not dip below 4400 until August 2011, losing 5.5% on August 8.

Reflective of weak global demand, the Tokyo stock exchange hit a 28-year low in early June. This was largely a consequence of slowing Chinese manufacturing output and weak US jobs growth – only 69,000 jobs added – in May.

The China Syndrome

Reality is about to bite Beijing: China sent a fraction under 20% of its exports to the EU and the US in 2009. So approximately 40% of all of China’s exports went to the world’s biggest markets. And that is mainland China alone.

Factor in Taiwanese figures (firms like Foxconn and Hon Hai build your iPhone and iPad in southern Chinese mainland factories, like Huizhou), plus the entrepôt port known as Hong Kong, and the figures rise appreciably. (However, hard statistics are difficult to come by, given the level of intra-Chinese imports and re-exportation.)

But in 2011, Chinese export unit shipment growth slumped by 60% year-on-year in the September quarter of 2011.

The entire model of the PRC’s economic growth and development is premised upon export-oriented industrialisation (EOI). Put simply, this means that the economy is export-geared predominantly to produce value-added consumer durables at low prices in sufficient volume to be sold-on in more affluent markets.

But when those affluent markets deflate rapidly in the wake of unsustainable debt positions, foreign direct investment (FDI) dries up, export orders decline significantly, and Chinese firms are compelled to confront the international politics of surplus capacity.

Surplus capacity is the problem that two of the most eminent political economists, Roger Tooze and Susan Strange, analysed in 1981. This book proved to have such longevity, it was republished in 2010, as the problems it studied from the era of stagflation in the 1970s, remain pertinent, eerily, today.

Meanwhile, China’s central bank has a currency problem. The yuan renminbi (RMB) retains a crawling peg, meaning it tracks US dollar movements within a certain band of adjustment. But US borrowing, particularly since 2008, combined with a “near zero” target range in the US Fed’s funds rate, has seen the yuan appreciate slowly by around 7.5% (or 10%, factoring-in inflation), although the RMB remains vastly undervalued. But every time the US Fed engages in quantitative easing (QE), yuan appreciation costs China – a lot.

Follow the money

The Reserve Bank knows recession is coming. That is why the RBA has cut official rates by 75 basis points in the last two months, in the hope of engineering a soft landing. The legacy of Bernie Fraser’s dithering in 1989-90, while Australia burned to the ground, lingers long in the memory of Martin Place, the RBA’s HQ.

But the blunt instrument of monetary policy is an insufficient and inefficient policy tool to induce adequate demand, investment and consumption growth in the face of tripartite pressures comprising Chinese economic slowdown, European austerity and American deficit reductions.

The US Fed is reportedly considering QE3 – a third round of quantitative easing – as a stimulus to the US economy, which produced weak growth and jobs figures in May, after posting positive results in the first quarter of 2012.

Beijing is watching the Fed carefully, as another stimulus would result in further US dollar depreciation and potentially harm the Chinese economy. The Beijing leadership is also reportedly considering an additional stimulus.

Over in Washington, Obama is in a quandary. Another US stimulus could be damaging politically in an election year, and positive economic outcomes arising from QE may not be clearly evident by November. For example, when George H.W. Bush went to the polls in November 1992, the recessed US economy was already recovering, but the results were not manifest, and Bush lost. Badly.

Economic forces beyond our control

What does all of this mean for Australia? The fact is that Australia’s economic fate will not be decided in Canberra; it will be determined in Washington, Beijing and Berlin. The future of car manufacturing in Victoria and South Australia will be the subject of executive decisions in Tokyo, Dearborn and Detroit, just as the decision to close Mitsubishi’s plant in Tonsley Park in 2008 was made in Stuttgart by Daimler Chrysler.

Mining tax or not, BHP, Rio and other resources firms are likely to scale back their investments and output in the short-to-medium term. Even with major resource projects in the pipeline, there are tonnes of stockpiled iron ore sitting in Chinese granaries, as warehouses bulge. Copper prices are falling, and this is never a good sign: copper always has an inverse price relationship with gold, which is what investors flee to when stockmarkets plummet.

Even China runs up against the brick wall of international surplus capacity. In a global economy characterised by continuous competition and super-saturated markets (how many flat screens can you really buy?), not every country can grow at the same time – plain and simple.

There are high-growth and low or negative-growth economies; there are surplus and deficit economies. At present, China and Australia are in a mutually-complementary growth cycle, while the US, Japan and the EU (except Germany) are deeply in deficit and in low (US) or negative (UK) growth cycles.

Do not believe the snake-oil salespeople (some of whom reside in Treasury and DFAT), who argue that the Australian economy is delinked from the US economy; it is not. As the 2008–current GFC proved beyond reasonable doubt, the global tsunami that emerged from the wreckage of the US sub-prime mortgage crisis created a ripple effect that extended far beyond the North Atlantic. Had China not injected 3 trillion yuan into the PRC economy, Australia would have drowned with the rest of the PIIGS.

There is No Plan B

Now is not the time for Canberra to gloat complacently to the rest of the G20 that its economy is the envy of the world because someone will have to eat crow, eventually. Certainly, the rest of the world envies Australia’s abundance of mineral resources and the efficiency with which it extracts them.

But the rest of the world does not admire the Dutch disease that afflicts Australia’s government and business elites, and leaves them in a state of suspended delusion, transfixed by the belief that the resources boom can never end.

The commodities bubble of the late 1970s and early 1980s ended in 1982, forcing the Hawke government to address the drastic deterioration in Australia’s terms of trade. Australia’s share of world trade halved between 1973 and 1983. Hawke and Keating regarded the Australian dollar float (1983), financial market deregulation (1984), industrial restructuring (from 1987) and East Asian market integration (APEC, 1989) as the only means by which Australia could escape banana republic status.

None of these initiatives prevented the Australian economy from relapsing into recession in 1990. Why? Because the global recession – not the domestically-induced high interest-rate regime – did the damage. Certainly, domestic monetary policy caused the recession to be longer and deeper, but, fundamentally, it did not cause the recession; the complex economic interdependence ingrained in the global financial system caused it.

What strategies would the federal ALP government, or prospectively, a Coalition government, implement in the event of GFC II and a significant fall in Chinese growth and demand? Neither side of politics wants to address this thorny issue, as tax cuts and middle-class welfare dominate a poll-driven agenda and will continue to do so for the next 12 months.

Foreign borrowing aside, to which strategies could a Commonwealth government resort in the event of financial crisis?

Former Prime Minister Paul Keating weighed into this debate recently, arguing that federal governments could utilise Australia’s $AUD1.3 trillion pool of superannuation funds, rather than offshore borrowing.

We don’t have the space here to discuss the lunacy of this proposal: allowing profligate and irresponsible federal governments, irrespective of their political flavour, to get their hands on the superannuation cash register?

Keating clearly isn’t in Kansas anymore. Loading up the banks with hard-earned pension funds truly is the road to serfdom, as super funds have scarcely beensuperior performers of late. Anyone from the tertiary education sector in the Defined Benefit Scheme will understand that only too well. Superannuation funds crises are an accident waiting to happen, but that’s a story for another time.
In the “dismal science” of economics, there is only one joke and one joke only: economists have successfully predicted 13 out of the last 2 recessions.

I, for one, would be perfectly happy to be proved completely wrong on this occasion.

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