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The Australian economy is looking super — but is it a mirage?
Gerard Jackson
If it's not one thing it's another. First we avoided recession — which we did not — and now we have to worry about skilled labour shortages, emerging bottlenecks, a ballooning trade deficit and an overheating housing market. Aren't we the Luck Country. What is missing from our economic commentary is anything resembling an economic analysis. Now it is argued that spending the surplus saved the economy. Not so. Last May I argued to the contrary, stressing that there is no way that running up debt could have prevented recession. Moreover, despite the mainstream view, it should have been clear that the economy had slid into recession last year. This would have been abundantly clear if spending on intermediate goods were included in the national accounts. (The notion that including this spending would be double counting is a fallacious one.)
My principal point was that monetary policy was still tight, with M1 having remained flat for sometime. In these circumstances, the effect running down the surplus would be similar to a sudden and temporary monetary expansion that would quickly wear off. From a Keynesian angle a sustained increase in the money supply is what was really needed. (Just ask Bernanke.) At that stage there was no indication of a monetary expansion. (The Reserve's monetary figures are always two months behind, unlike the US Fed.) However, the latest monetary aggregates reveal that M1 began to quickly expand April, as shown by the chart below. M1 grew by 5.6 from April to September, giving an annual average growth of 11.2 per cent, a very significant figure and one that probably accounts for the continued rise in house prices.
BrookesNews.Com
Monday 14 December 2009
Rudd's fiscal policy stimulated consumption with the result that the demand for foreign consumer goods rose. Now any increase in imports due to spending the surplus should have been temporary. But we find that the trade account went from being virtually in balance in the June quarter to being $5.4 billion in the red for the September quarter. It is perfectly true that there is no reason per se for foreign trade to always balance or even be the black. The point, therefore, is not the deficit but how it is acquired. It seems very likely that Reserve's return to a loose monetary policy is playing a significant role in driving the deficit. And of course, accumulating current account deficits leads to a rise in foreign debt and interest payments.
Reserve Bank board member Warwick McKibbin is reported to have warned that Rudd's $42 billion stimulus package — which included an $8.4 billion cash handout amounting to about 3 per cent of GDP — could raise the exchange and choke off exports. But one should have expected the package to have forced down the exchange rate in response to the increase in the demand for imports. So what happened? Why should the exchange rise if there has been no change in domestic purchasing power? This strongly suggests that the dollar is now overvalued. In other words, there is a divergence between the currencies purchasing power parities. There is nothing unique about this situation. With respect to exchange rates Bresciani-Turroni observed that
there is no doubt that an appreciable divergence can be established in certain conditions and maintained even for a considerable time between the external value of a paper currency and its internal value, measured by the prices of domestic goods. This divergence is, besides, often the symptom of a situation which, though it may last for a considerable time, is likely in the long run to develop some counteracting tendencies. (Constantino Bresciani-Turroni, The Economics of Inflation, John Dickens & Co LTD, 1968, p. 118.)
Unfortunately, the "long run" can be long enough to devastate manufacturing. Australian manufacturers could therefore find themselves in a position where they are once again coming under increasing pressure from an overvalued currency, a situation that, for some peculiar reason, our economic commentariat are choosing to overlook.
We could see a situation develop where manufacturing as a proportion of GDP shrinks further but what is left becomes overly oriented to serving the mining industry in response to China's growing demand for our minerals. Something like this could be already happening. For example, there is the case of Westplate, a Perth-based heavy steel plating fabricator that supplies iron ore processors to Pilbara towns. The owner says his business if "flat out" as are other business that have come to rely on developmental projects. The problem would not be one of development or mineral exports but that of monetary policies that distort the pattern of production, including the pattern ofr international trade
Then there is the so-called problem of government projects. These are supposed to force the private sector to increasingly compete for skilled labour and other inputs and so raise prices thereby compelling the Reserve to head off inflation by raising interest rates further, a risk that would be heightened by Rudd's aim to reduce labour market flexibility. The idea that genuine borrowing can generate inflation is absurd. Borrowing changes the composition of demand, it does not raise it because real borrowing is the transfer of purchasing power from one party to another. If so-called borrowing appears to have caused inflation it's only because the government used an expanding money supply to fund it.
Gerard Jackson is Brookesnews' economics editor