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Bleak days ahead for the Australian economy?
Gerard Jackson
The May Performance of Manufacturing Index (PMI) for the Australian economy makes bleak reading and strongly suggests that the Treasurer Peter Costello will find himself wiping more than egg of his face.
The PMI is produced by the Australian Industry Group & Pricewaterhouse Coopers Australian Performance of Manufacturing Index. It shows that Australian manufacturing is hovering about 50 mark on the index. Anything below 50 shows manufacturing is contracting. When this happens it is a clear signal that the economy is in recession, irrespective of the level of consumer spending.
The index is not as straightforward as it appears. A closer look at manufacturing output over time indicates a murky mosaic. It is clear that since last December the production of machinery and equipment, fabricated metals, basic metals, chemical products and transport equipment has declined. This fact seems to have escaped our economic commentariat.
One factor that has complicated the picture is that this six-month period included Christmas and Easter. Shutting down factories or simply reducing output for a general holiday period is bound to cause fluctuations. Nevertheless the pattern is now clear.
At this stage of the boom one should expect a profits squeeze to have set in (something I have been predicting for some time) as production costs continually rise. This is exactly what happened – until recently. According to the Australian Bureau of Statistics an appreciation in the exchange rat against major currencies contributed to a slight fall in the cost of material inputs for the March quarter. This offset a -0.9 per cent fall in prices for their products.
Moreover, once a boom reaches its peak there is a tendency for productivity to fall. Shortly before America’s post-WW I boom collapsed productivity dropped significantly. This phenomenon was well known to classical economists. The same thing appears to have happened in Australia. The Bureau of Statistics reports that private-sector productivity fell by 2.5 per cent over the year to March. This is the biggest drop in annual productivity since December 1986.
As the effects of a tight monetary policy begin to make themselves felt at the higher stages of production competition for factors of production should diminish thus reducing pressure on input prices. If we look at other major manufacturing countries we can see that their PMIs, with the possible exception of Japan, have also been falling, indicating that recession could very well be on the way.
I’ve pointed out numerous times that a mismanaged monetary policy can also have very damaging consequences for domestic manufacturing. If the exchange rate is overvalued this obviously makes imported goods cheaper than the domestic product. Perhaps it’s no accident that the March quarter that saw a dollar appreciation lessen pressure on producer prices also experienced a savage reduction in demand for the products of the clothing and footwear industries.
What our economic commentariat always ignores is the role of money in the economy. They are so infected with Keynesianism that they even believe that the existence of so-called “money substitutes” means we cannot define money. And because we cannot define it we cannot control it. This thinking leaves the Reserve Bank with no other option than to focus on interest rates.
But this is all nonsense. Walter Boyd demolished this line of thought 204 years ago when he wrote:
By the words ‘Medium of Exchange’, ‘Circulating Medium’, and ‘Currency’, which are used almost as synonymous terms in this letter, I understand always ready money, whether consisting of Bank Notes or specie, in contradistinction to Bills of Exchange, Navy Bills, Exchequer Bills, or any other negotiable paper, which form no part of the circulating medium, as I have always understood that term. The latter is the Circulator; the former are merely objects of circulation.
Acting on Boyd’s insights we find that M1 (currency and bank deposits) is close to enough to his definition to serve our purpose. So what do we find? M1 has been flat for months. Furthermore, so have the Reserve’s total assets on average. In other words, monetary expansion has virtually ceased.
A short time ago I said that I cannot see how you can spend years flooding an economy with credit and then slap on the breaks without having a recession. I also wrote the same thing in June 1990.
Even though every “business cycle” might have its own characteristics it is still driven by the same economic laws to varying degrees and is subject to the same underlying economic forces. Austrian analysis has been highly successful in isolating and explaining those forces. Without a doubt the current economic situation falls well within the Austrian paradigm.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 13 June 2005