Recession signals for the Australian economy
Gerard Jackson
Of particular interest for the Australian economy is that business investment took a rapid turn for the worst in early 1999. In June the PMI (performance manufacturing index) peaked, declining from just over 55 to under 45 in December 2000. This sequence strongly suggests that sudden changes in investment are quickly followed by declines in manufacturing.
From March 2001 the PMI started to climb until it exceeded 50 in June after which it fell to about 46 in July before rapidly rising to nearly 60 in September. It then fell to 54.4 in December. (Australian Industry Group & Pricewaterhouse Coopers Australian Performance of Manufacturing Index, December 2001). Later statistics showed that manufacturing had contracted by 2.2 per cent.
It was pretty clear that a grim picture of the Australian economy was swiftly emerging. On the 13 January the National Australia Bank released its survey of business. It was not an encouraging document. Manufacturing was clearly slowing down along with agribusinesses, and profitability levels were also down.
As if to ram home the gloomy prognosis Smorgon’s Steel admitted that its margins were coming under intense pressure. The situation was so bad regarding margins and output that the company reckoned that the situation was as bad as the 1991-92 recession. No wonder the December 2000 quarter figure for GDP was so bleak.
Let us now look at some figures that appear unrelated to the PMI slowdown. At about the same time as business investment dropped in 1999 spending on new homes suddenly levelled off. Then in June 2000 spending dived. The introduction of the GST was blamed for this unexpected downturn. However, another force was also at work.
Later in the year spending once again rose rapidly only to fall just as rapidly. This was followed by another burst of spending.
What is interesting here is that changes in spending on new housing strongly correlated with changes in the PMI. They in fact moved in tandem. These changes were preceded by changes in bank deposits, the most important component in M1.
The following are year-on-year figures from December to December that were obtained from the Reserve’s monetary aggregates. Even though their accuracy is questionable at this stage, there is no doubt that there have been significant changes in Australia’s money supply.
Virtually all monetary changes have occurred on the deposits side — and this is where it gets interesting. From 1994-95 bank deposits grew by 8 per cent (all figures have been rounded off), from 1995-96 and 1996-97 respectively bank deposits grew by 17 per cent and 15 per cent.
The PMI peaked in July 1994 at about 62 and then steadily fell until it reached about 44 in December 1995, by which time the 17 per cent monetary expansion was underway. The PMI started to rise early in 1996 peaking at about 52 in June 1997.
Throughout 1997 it hovered above 50, supported by the previous expansion in bank deposits. However, severe reduction in annual growth in deposits to 6 per cent that took place in 1998 caused the PMI to fall from just over 50 in March to about 48 in June.
Once again the Reserve turned on the monetary spigot causing bank deposits to increase by a massive 27 per cent between June 1998 and December 2000. This held the PMI above the 50 point level until September 2000 after which it fell to about 44 in December.
Although it is easy to see the strong correlation between significant changes in bank deposits and changes in economic activity, particularly manufacturing and the housing sector, it does nothing to explain how movements in bank deposits (bank credit) brings about these changes.
The first thing to note that even the simple annual changes in credit expansion can be misleading as this approach conceals the annual changes that are calculated on a monthly basis. (Monetary figures would show year-on-year changes in the money supply)
Furthermore, these monetary changes demonstrate that a slowdown can emerge even when there has been a huge monetary expansion, as happened from June 1998 to December 2000. This is something that monetarists, Keynesians and post-Keynesians cannot explain.
Austrian analysis of the problem recognises that money is not neutral. It goes on to show how the pattern of production is therefore distorted by artificially lowering interest rates. These distortions take the form of malinvestments whose existence can only be maintained by continually injecting ever larger amounts of credit into the economy. Without these ever expanding injections the economy will begin to slow.
Irrespective what most economists think, the crisis can emerge even when the price level is comparatively stable, as was the case in the US during the 1920s. This brings us to the unfortunate dilemma in which the Reserve has placed the Australian economy.
A flat money supply has helped bring about the slowdown that is on every economic commentator’s lips. (The Reserve’s total assets have remained comparatively stable since last June, suggesting that M1 is accurately reflecting the state of the money supply). Now can we reverse this slowdown as easily as we appear to have been able to reverse the last one?
As I opined in my article The Australian economy: is a recession approaching?:
“Further monetary injections at this point might very well be too late. Even if they do succeed in lifting the economy it would be basically no different from trying to save a drunk by giving him another shot of whisky”.
The bank is not only facing a slowdown but growing net foreign debt and a deteriorating current account deficit that already stands at about 7 per cent of GDP. There is also the question of rising incomes.
In 2004 Australians’ incomes rose 5.4 per cent in actual dollars, and this trend appears to be continuing. What can this mean when combined with souring imports, which have jumped by nearly 50 per cent since last June, and the changes in manufacturing output?
Consider that the Australian Industry Group & Pricewaterhouse Coopers’ March report showed that “Growth was strongest in clothing & footwear, wood, wood products & furniture and construction materials” while the output of fabricated metals, basic metals and machinery and equipment was still contracting. In other words, demand has increased at the lower stages while falling in the higher stages of production. Not a good sign.
The report also stated: “Input cost pressures strengthened for the second successive month in March, rising by 4.4 points to an unadjusted 77.9 -- the largest monthly rise since June 2004”. According to the same report, input prices for last March were 77.9 against 63.5 for March 2004, a 22.7 per cent increase.
The Austrians know, as did the classical economists, that real wages tend to rise at the peak of a boom even as the costs of inputs increase and output in the higher manufacturing stages contracts. This is why the continuing rise in incomes is not a good omen.
It is obvious that the subject needs to be dealt with in far more detail than is possible in this short article.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday16 May 2005