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Is the Australian economy heading into recession?
Gerard Jackson
What is striking about recent economic commentary is its lack of consistency and any reference to money supply. I believe that the absence of any mention of money supply is directly linked to the lack of consistency.
The so-called economic reasoning that has driven the former underground is responsible for the current confusion. There is, however, one underlying theme that links most economic commentaries and that is — as expected — consumer spending.
The argument that consumption drives the economy is one of the oldest of economic fallacies. Commentator after commentator tells us that consumption is about 66 per cent of total demand, meaning spending. It is nothing of the kind. The classical economists knew that consumption spending added nothing to economic growth, and I’ve yet to come across a sound refutation of that view.
What matters is not merely total spending but the pattern of spending. The more that is spent on production relative to consumption the more living standards will rise (at least in a free market) and vice versa.
The problem is that GDP omits spending on circulating capital, those intermediary goods that pass down the production structure from one stage to another until the finished product reaches the consumer, on the grounds that it would be double counting to include them. Can you imagine what would happen to any business that ignored the total costs of its activities, concentrating only on the value added end?
The effect of ignoring intermediary spending has been to inflate spending on consumption to the degree that every economic commentator in the country seems to think that it is the engine of economic growth.
If, for instance, GDP only measures 50 per cent of total spending then consumption actually accounts for 33 per cent of economic activity and not the 66 per cent bandied about by newspaper commentators and an assortment of economic analysts. This is not difficult to grasp once we realise that total production spending on most goods exceeds their price by a considerable margin.
We can conclude from this line of reasoning that squeezing spending between the stages of production would have catastrophic economic consequences. In addition, it should be clear that stimulating consumption can worsen the situation by squeezing these profits margins even further, paradoxical as that might sound given the prevailing orthodoxy. (For a more detailed description of this approach see Profits, Interest and Investment by the late Friedrich von Hayek).
It follows from this argument that GDP cannot tell the whole story.
Irrespective of what some commentators think recessions need not be preceded by a rise in inventories. Nevertheless, when inventories do start piling up it’s usually a good indicator of an impending recession, unless the central bank tries to avert it by accelerating monetary growth.
Tim Colebatch pointed out that “In 2003 and early 2004 business kept increasing its stockpiles — then ran them down as 2004 went on” (The Age, Figures suggest Reserve is right, 3 March 2005).
Mr Colebatch seemed to find this situation inexplicable. But I think that once we realise that in 2002 bank deposits plummeted by -12 while M1 fell by -9 per cent that the inventory build-up was due in part to a monetary contraction which the Reserve Bank quickly reversed by once again cranking up the money supply.
Now a continuing rise in inventories can still emerge even in the absence of any monetary slowdown. This would happen when firms found that rising production costs were squeezing their price margins. Interesting enough, the producer price index shows that input prices started to rise in late 2000 until beginning a slight decline in December 2002.
I think the above shows that Mr Colebatche’s little “oddity” was created by a combination of rising producer prices and a monetary contraction.
At the moment current economic indicators are not looking too good for the Government. “Manufacturing growth eased in February, impacted in exports and weaker domestic demand. The Group — PricewaterhouseCoopers Australian PMI fell by 4.1 points to a seasonally adjusted 50.8”. (Australian Industry Group survey, February 2005.
It is obvious that though this slowdown cannot be attributed to the recent interest rates rise. This leaves, in my opinion, monetary policy. M1 grew in 2004 by 2.4 per cent against 10 per cent in 2003, a fall of 76 per cent. Even more interesting is that deposits dropped from 11 per cent in 2003 to 1.5 per cent last year. This is a 95 per cent drop.
A closer look at the monetary figures reveals that in December 2003 currency was 19.4 per cent of M1 and in December 2004 it 19.5 per cent, demonstrating that the major monetary changes are taking place through credit expansion.
So it seems that the monetary squeeze is well and truly on, assuming that the Reserve does not lose its nerve.
Giving more thought to media economic analysis has forced me to conclude that it has been one of unrelenting mediocrity resting on economic fallacies that would make classical economists’ blush with embarrassment. Unfortunately the media is not alone in pushing economic fallacies.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 21 March 2005