Subscribe to BrookesNews’ Bulletin
Australia, recession and our boom
Gerard Jackson
Last week I pointed out that every recession, like every economy, has its own characteristics and that the Australian economy was no exception. Moreover, it is not immune to recession, irrespective of what Mr Costello and some of his advisors might think. Now a couple of sharp-eyed critics think they found a flaw in my analysis.
The Austrian approach explains that the boom-bust cycle is triggered by the central bank forcing down the rate of interest which then deceives business into thinking the amount of real savings has increased. To make it brief, there takes place a process of overinvestment in the higher stages of production relative to the lower stages, thus distorting the production structure.
These critics rightly point out that this means that the consumption stages must continue to expand for a time even as the higher stages start to contract. If this is so, they declare, why have the textile, clothing and footwear industries contracted even though manufacturing seems to be operating at full capacity?
This criticism highlights my observation that recessions have their own characteristics even though the underlying economic forces remain the same. What these critics missed is that the demand for TCF products has not fallen. What contracted was domestic production. The difference was made up by imports. This accounts for the TCF industries’ steep fall in gross operating profits since about April last year.
Therefore, once we take imports into account the Austrian analysis still hold up very well. When the principles of the Austrian trade cycle were first laid out by Ludwig von Mises (The Theory of Money and Credit, first published in 1912 and now available in paperback) the world was on a gold standard. This meant that a country that triggered a credit boom would suffer a gold drain, forcing the central bank to raise the discount rate to reverse the drain. Naturally, this policy also terminated the boom.
The gold standard meant that not only could a country not maintain an overvalued currency but that the international monetary system remained stable. A world of fiat moneys, however, means that money stocks are always changing relative to each other. This destabilises the international monetary system, creates over-valued and under-valued currencies while generating unnecessary uncertainty and speculation.
In these circumstances, a country undergoing a classic boom could therefore sustain it much longer than if it were on a gold standard. It also means that it could find itself in a situation where the currency becomes over-valued which could force some of its industries to contract and become more domestically oriented. The TCF industries might very well be an unfortunate example of this process. Such a monetary disturbance could also be used to explain Australia’s 7 per cent current account deficit.
What my critics also missed is that business reports that capacity utilisation has reached record levels with shortages of materials, equipment and transport and distribution services imposing capacity constraints on production. As bottlenecks become more pronounced wages should rise as productivity falls. Guess what? August figures show wages are up 4 per cent in the year to June while productivity has dived further during the past year than at any time in the previous 19 years.
Jeff Oughton, head of domestic economics at National Australia Bank, called this situation “our own little conundrum”. But there is nothing puzzling about it at all. As more people become employed productivity falls as the labour supply moves down the demand curve. (On a number of occasions I have used the effects of the Black Death on the labour force in fourteenth century England to illustrate this point).
However, in a non-inflationary situation a movement down the demand curve would result in lower wage rates. Only in an inflationary state can wages rise as unemployment and productivity fall. This is another symptom of a classic boom situation. Even Karl Marx observed that “…crises are precisely always preceded by a period in which wages rise generally and the working class actually get a larger share of the annual product intended for consumption”.
In the presence of emerging bottlenecks we should therefore expect manufacturing profits to fall. TFIA Business Services Pty Ltd reports exactly that, with gross operating profits for manufacturing peaking in the December quarter for 2004 and then trending down.
So-called capacity restraints, usually called bottlenecks, can then be considered another sign that the boom may very well have peaked. While orthodox theory explains bottlenecks in terms of shortages, Austrian analysis explains them in terms of discoordination created by credit expansion. The consequences of discoordination are malinvestments which have to be liquidated by an unavoidable recession.
Once again, the question is not if but when.
Australian economy, recession and the trade cycle
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 29 August 2005