Macfarlane pointed out that wages have risen in the last 12 months and businesses are now reporting labour scarcities. Also worrying to him is the unpalatable fact that the CPI has is up to about 3 per cent in the last few quarters, rising faster than he expected. No doubt this was one of the reasons for hiking the rate to 5.75 per cent. This is the sixth rise since May 2002. Macfarlane’s comments indicate to me that he has no real idea of where the economy is going let alone what it is doing. And in my ever humble opinion the Treasury is no better.

A closer look at the labour market is necessary. One of the failures of orthodox economics is to treat labour markets as an aggregate. If this aggregate is expanding it means unemployment must be falling. Always a good sign, or so say our economic commentariat. But what matters is not the aggregate but its composition. This is a fact that the economic boffins at the Treasury and the RBA are completely unaware of.

This brings to mind the thoughts of Tony Pensabene of the Australian Industry Group when last October he admitted to being dumbfounded by what was happening in the economy. He expressed the view that

… something different is going on in manufacturing. In the 12 months to August, the overall economy added 352,000 jobs. In the same period, manufacturing lost 46,800 jobs.

But unknown to Pensabene he was echoing what Steve Slifer, chief economist at Lehman Brothers, said about the US economy in January 2001:

It’s really an odd-looking slowdown. The manufacturing sector is, in fact, in a recession but not the overall economy. At least not yet.

What is puzzling to Slifer and Pensabene is the fact that an economy can be rapidly increasing the number of jobs at the same time as manufacturing is shedding them. If Pensabene had been properly advised he would have known that what the Australian economy was experiencing — and still is — is precisely what happened to the Clinton economy. (I hasten to add that I do not blame Clinton for the recession, even though it began under his watch). The patterns are identical and closely follow the classical boom-bust cycle.

US Manufacturing was hit first, forcing it to curtail output and shed jobs, even as consumption raced ahead. This process induced schizophrenia in our economic commentariat who, despite their high salaries, could make neither head nor tail of it all.

What most of the commentariat still do not know is that consumption actually accelerated during the US recession. Not once did consumer spending falter. It was, as any classical economist would have pointed out beforehand, the investment-side of the economy that felt the full force of the recession, just as I had predicted in my article Economic clouds are turning black for US economy (The New Australian, 6 December 2000).

As any classical economist would have said: “The demand for commodities [consumption good] is not the demand for labour”. It was considered the mark of a good economist who understood what was meant by this passage. Unfortunately modern-day economists shake their heads in bewilderment when confronted by it. Yet understanding this passage is a key to understanding why focusing on consumption as a solution to recession and unemployment is so dangerous.

Let us take a look at PricewaterhouseCoopers’ report for April. We know that manufacturing jobs have been falling, but this report tells us that manufacturing unemployment actually accelerated in April. The report’s employment index for April 6 stood at 45.6 as against 51.0 in April 6 2006. (The rest of the report’s figures are for the same period). Production had fallen from 50.0 to 49.3 while input prices had risen from 68.6 to 73.6.

It’s important to note that nearly all of those sectors reporting growth are consumer based. So we have an accelerating decline in manufacturing while industries close to the consumption stage of production expand output. If it were not for the consumption stages the Group/PricewaterhouseCoopers Australian PMI would be way below 50 rather than the present 50.3.

Despite this data Macfarlane and others are worried that tight labour markets will fuel unemployment. It is loose money supply that fuels inflation not tight labour markets, which are a symptom of inflation.

Sellers need buyers and buyers need money. So where is the money coming from? Although monetary policy appears moderately flat, a look at the RBA’s figures show money supply has been loosened. From February 2005 to February 2006 we find that currency has been basically flat. However, M1 increased by 6.5 per cent and bank deposits by about 8.5 per cent. These figures clearly show that the expansion has been through credit. Moreover, the same period saw the RBA’s assets leap by 38 per cent. The RBA acquires assets by issuing cheques and by doing so it expands the money supply.

This explains the acceleration in credit growth in recent months and the signs that household spending is on the rebound. Part of this rebound can be seen in the record demand for credit cards. (I fear that many people are foolishly borrowing to payoff other debts). Recent data shows that there were nearly one million applications for credit cards in the first quarter of this year. This is 27 per cent more for the same period last year when money supply was tighter.

It is being pointed out in parts of the media that during 2001 the RBA cut rates from 6.25 per cent to 4.25 per cent, a full two per centage point and so prevented unemployment jumping from 6 per cent to 7 per cent. This is all very superficial and far from anything approaching economic analysis. What these commentators didn’t bother to find out is that during this period M1 rose by 22 per cent and credit exploded by 25 per cent. Given the current situation I just don’t see the RBA giving us a repeat performance.

This reminds me of 1990 when commentators assured us of a soft landing created by investment in the resources sector. My response to this irresponsible nonsense was to point out that we were heading for a hell of a fall. And that’s what happened.

Today we are told that China’s demand for resources will keep the economy steady. Don’t count on it. From March 2004 to February 2006 China’s money supply expanded by 34 per cent. March 2004 to February 2006 saw a modest 13 per cent rise. From October last year to last March the money supply expanded by 8 per cent. China’s central bank is driving the commodity boom. So we could end up with commodity exports still surging while the rest of the economy tanks. In any case, China will have to slam on the monetary brakes at some point. It’s just a question of when. In the meant time, Australian commentators are worrying about wage rates.

Note: The Australian economy has, like so many other since WWII, been on a monetary roller-coaster. It is these continual monetary expansions that cause the boom-bust cycle, not some mysterious force inherent in capitalism.

Gerard Jackson is Brookes’ economics editor