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The Australian economy continues to contract
Gerard Jackson
George Megalogenis, an economic writer for The Australian, is an excellent example of what is wrong with our economic commentary. In his view Rudd's reckless spending binge is working. As evidence points to the building industry increasing its demand for labour. Then there was the $20.1billion in handouts that boosted consumer spending. Taking a swipe at critics, Megalogenis declared that Rudd's "spending is best defended in the macro, not the micro". (Let reality do the talking, George Meganomics, The Australian, 20 June 2009).
And here have another gross error that plagues current economic thinking. Like the rest of our economic commentariat Megalogenis does not understand that macro-economics usually overlooks — despite some protestations to the contrary — the microeconomic foundations of the economy with the result
that the micro-economic foundations from which... macro-economic forces must be supposed to spring are largely ignored. (Ludwig M. Lachmann, Macro-economic Thinking And the Market Economy, The Institute of Public Affairs, 1973 p. 39).
Failure to grasp the micro-economic consequences of monetary expansion is what got us into this mess in the first place. Despite the evidence that changes in monetary policy do not have a uniform effect on the economy economic pundits still write as if this is case. Let us first deal with housing. Last week a Herald Sun headline read: First-home sales through the roof. John Lenders, Victoria's Treasurer, bragged that the state was,"with assistance from the government", enjoying a first-home buyer scheme boom. And it really does look like housing records are being smashed. However, some ten days earlier the same paper correctly reported that "business investment is plunging".
Terry McCrann is not the best economics commentator I have come across but he does at least understand the simple fact that you cannot be enjoying a genuine economic recovery if investment is going down the toilet. Therefore, without realising it, Megalogenis pinpointed the fundamental flaw in the thinking behind Rudd's "economic stimulus" — the belief that consumer spending drives the economy. Promoting consumption at the expense of investment will actually retard recovery*. (Those who argue otherwise ignore the fact that economic growth is fuelled by forgone consumption). The likes of Megalogenis also ignore monetary policy. The Reserve's monetary figures have been signalling a recession since last year, as shown by the chart below, and yet these commentators saw absolutely nothing of any significance in the figures.
The Reserve revised the March figure for M1 upwards from 239.7 to 246.4
The chart shows that from December 2007 to the following May M1 began to contract with the result that the Reserve quickly jacked it up again in June, after which it remained comparatively flat. Last October M1 stood at 242.2 and 243.6 in April. Apart from a sudden surge to 246.4 in March we can see that M1 has remained with an extremely narrow band. We can also see that the Australian Industry Group's PMI peaked in December 2007 at 57.6, falling to 51.2 May 2008 and then 33.4 in March 2009, a drop of 38.54 per cent from December to 2009.
Production clearly followed the same trend, falling by 47.5 per cent. The chart reveals that after the monetary surge the PMI and the production index stabilised from July to September. However, once the surge worked itself out the downward trend continued. In addition, we should note the rapid fall in input prices. Orthodox economists ignore spending between firms on the grounds that to include them in the national accounts would amount to double-counting. (This is fallacious thinking that no businessman in his right mind would subscribe to).
The contraction in manufacturing must have caused a severe drop in spending on intermediate goods. I think that the fall in input prices reflects this drop in business demand. It follows that if the national accounts included this spending then it would prove beyond doubt that the country was in recession. Now the National Australia bank reports that "capacity utilisation fell back to 79.2 per cent, near its cycle low". But the AIG report for last month has manufacturing utilisation down to 66.9 per cent, 0.6 per cent down on its April level. It's pretty obvious that the higher stages of production are suffering the most. We should expect that in this situation profit margins would be squeezed. This is exactly what the Westpac–ACCI Survey discovered. (Australia & NZ weekly, 22 June 2009).
On 2 June Genn Stevens, the Reserve Bank Governor, publically admitted that capacity utilisation had dropped and that it would "decline further over the rest of the year". Unfortunately he and the rest of the Reserve still have no idea of what is really going on in the economy.
*It is its place in the production structure that defines a good as either a producer good or a consumer good and not durability. Housing cannot be a capital good because its services are directly consumed. The length of time required for the total consumption of a good is therefore irrelevant.
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 22 June 2009
