Trump’s world

At least holidays to the US will be cheap for a while.

It is hard to know where to start with a Trump presidency.

Will he really rip up NAFTA, start building a wall on the Mexican border, toss out ‘illegals’ and block Muslim immigrants?

Or will wiser heads prevail once he grabs the reins of power and the full implications of his various outrageous and incoherent policy announcements become apparent?

The terrifying thing is that no-one knows.

Who knows how a bullying, narcissistic and misogynistic demagogue is going to behave in the White House.

But if he lives up to even a bit of his rhetoric, both the US and the world are in form some very ugly times.

Here’s just a sampling of the changes a Trump presidency may usher in, and how they would affect the world, and Australia.

In line with his much less internationalist view of America’s role, Trump is likely to oversee a reversal of Obama’s pivot to Asia.

Asia Pacific allies like Australia, Japan, South Korea, the Philippines and Thailand will be left to do more of the heavy lifting in regarding regional security. Some might be tempted to move closer to China.

China itself faces great uncertainty.

Trump has indicated he wants to throw up the tariff barriers to Chinese imports. It is a move that will not only impoverish many who voted for him in the first place, by denying them access to the cheap goods that have softened the impact of stagnant wage, but could be very destabilising for the Chinese Government.

Though China has been trying to engineer a change in the economy toward consumption-driven growth, it is still a work in progress, and much of its prosperity is still tied to exports. If Trump was to pull up the shutters on China’s biggest market, the consequences would be dire – not just for China, but also Australia, which depends on Chinese demand for much of its export sales.

If Trump sparks a trade war of the kind that preceded World War Two, when trade barriers went up around the world, the political and economic damage will be huge. The post-war world order that has driven unprecedented prosperity – billions propelled from poverty, disease and malnutrition abating – could be shattered. We would all be the much poorer for it.

The fissures within the US itself that have been exposed by the hate-filled campaign of the last 12 months may widen, instead of narrow, particularly as the fortunes of the have-nots deteriorate further.

Then there is the worry that comes with a nuclear arsenal capable of killing us all many times over being in the hands of one that seems so volatile and unstable.

It is a grim outlook.

But there are at least two threads of hope.

One is that this becomes the high water mark for the craziness that has gripped the world this year. The so-called anti-establishment crowd (who seem very disparate except, maybe to themselves) have had their Brexit, and they have populated the Australian Senate with fringe-dwelling nutters.

But under the pressure of actually trying to do something, and reconciling interests that are increasingly at odds, the coalitions of resentment and anger that have propelled such outcomes may evaporate, and the promises of better times that they sold will be seen as the flimsy soundbites they were.

The second hope is that Europe will cleave to its moderate sensible course and thrive as smart money exits the US and China sees it as an increasingly attractive place for investment.

It may become a salutary lesson for the naysayers in the US and Britain of what they gave up for their collective fit of pique.

In the meantime, can someone please keep Trump away from that button!

 

Leave a comment

Filed under Analysis

Are we running out of ammo?

The world’s major central banks have thrown just about everything at trying the limit the effects of the global financial crisis and support the subsequent recovery.

In their efforts to prevent what the northern hemisphere calls the Great Recession turning into another Great Depression, they have not only slashed official interest rates to extraordinarily low levels, but have been printing enormous sums of money and even, in some cases, setting negative rates – measures that only a few years ago were barely thinkable.

The concerted actions of central banks and national governments in the immediate aftermath of the Lehman Brothers collapse in September 2008 succeeded in preventing the economic downturn turning into something far worse.

But almost eight years later the recovery is still struggling to find traction. The World Bank recently downgraded its 2016 growth forecast to just 2.4 per cent[1], and the crunch on revenue is making it harder for many governments to wean themselves off debt and deficit. In the United States, public debt as a proportion of GDP is almost 105 per cent[2], while in Britain and France it is touching 100 per cent and in Japan it has topped 250 per cent.

Major central banks, meanwhile, are grappling with the legacy of ultra-low interest rates and ballooning balance sheets. The official interest rates of most are close to (and in Japan’s case, below) zero, and total assets held (excluding the People’s Bank of China) has reached US$11.8 trillion[3].

It is little wonder the International Monetary Fund recently warned that if there is another severe global downturn, “the needs could exceed the collective resources available”[4].

And the risks are not small.

A febrile world

The World Bank warns that the global economy is facing “mounting risks” from slow growth in advanced economies, stubbornly low commodity prices, weak global trade and diminishing capital flows[5] – concerns echoed by IMF Managing Director Christine Lagarde[6].

Even US Federal Reserve Chair Janet Yellen, who has generally adopted an optimistic tone about the outlook for the US and global economies, sees risks aplenty, including Europe or China “taking a turn for the worse”, a spike in oil prices, a resumption of the slide in commodity prices or a non-economic shock.

“In the current environment of sluggish growth, low inflation and already very accommodative monetary policy in many advanced economies, investor perception of, and appetite for, risk, can change abruptly,” Yellen says[7] – underlining Yale University economist Robert Shiller’s point that it is how people perceive, and respond to, such events that will be crucial in transforming something like an oil price hike into “a truly virulent economic disruption”.

What are the chances?

Former US Treasury Secretary Larry Summers puts the odds of the United States sliding into recession in the next year at one in three, and believes it is a better-than-even bet in the next two years.

The United Kingdom-based Resolution Foundation is similarly downbeat. It reckons that, based on the pattern of past business cycles, Britain has a one-in-three chance of enduring a downturn in the next five years, increasing to an 80 per cent chance by 2025[8].

This may be too pessimistic, but economists reckon there are several good reasons to expect that, sooner or later, there will be another downturn.

What to do?

Given how much central banks are already doing to support activity, worried policymakers are thinking hard about what else they can do.

One answer is to do more of what they are already doing – holding interests rates very low, expanding their quantitative easing programs, and providing forward guidance on the direction of interest rates.

But former US Federal Reserve chair Ben Bernanke warns there are limits to how low interest rates can be pushed, and the effectiveness of such a policy is likely to diminish over time, while the risks it brings with, such as property bubbles, are likely to increase[9].

There has been discussion of whether inflation-targeting central banks should raise their aim, lifting their goal from 2 per cent (in the case of the Bank of England) to create additional rate setting room. However, not only does this run the risk of cutting loose inflation expectations and undermining the hard-won credibility of central banks, it is not obvious how this would help stimulate the demand necessary to lift prices[10].

Copter cash

For almost 50 years the idea of ‘helicopter money’ has been kept in a box labelled ‘only open in case of emergency’.

Now, it is being dusted off and talked about seriously by influential economists including Bernanke and former UK Financial Services Authority chair Adair Turner.

The idea, first articulated by Milton Friedman in 1969, is to fund expansionary fiscal policy, such as a personal tax cut or government investment in infrastructure, from the balance sheet of the central bank, rather than by issuing interest-bearing bonds, as would normally be the case.

For Bernanke, the idea is appealing because the stimulus can be directed through multiple channels at once – funding public works, increasing household income and boosting inflation – without adding to the future tax burden.

“It is extremely likely to be effective, even if existing government debt is already high, and/or interest rates are zero or negative,” he says.

The fear has always been that, once helicopter money starts flowing, it will be hard to make it stop. If politicians get the whiff that they can fund pet policies without driving up taxes, the thinking goes, governments and central banks will struggle to ever turn off the tap.

But Turner says dividing responsibility between governments and central banks should help ensure it is only used in moderation, and in a way that is safer, and with fewer side effects, than running negative interest rates and huge quantitative easing programs.

Missing in action

Helicopter money is often talked of in terms of what more central banks can do, but in reality it is a cross-over policy that requires monetary and fiscal policy to work in concert – something that has rarely happened since the GFC struck in late 2008.

In the ensuing eight years, governments have left most of the work of rescuing economic activity to central bankers.

In the US, Europe, Australia, Canada and elsewhere governments, spooked by ballooning levels of public debt, have been intent on holding spending down rather than loosening the purse strings to help stimulate demand.

In more normal times, bodies like the IMF and the OECD would laud such restraint.

But the weight of economic advice is shifting and government austerity is out. In its place, governments are being urged to consider tax cuts, handouts, investments and structural reforms.

The fear is that if they do not, the world will become locked in a low-growth, low-inflation trap such as has ensnared Japan for the past 25 years.

Open the taps

Summers believes the major economies, particularly the US, Europe and Japan, are already experiencing what he calls secular stagnation, characterised by persistent shortfalls in demand due to long-term developments, particularly an aging population. As population growth slows, businesses and governments scale back investment, holding down employment and wages which, in turn, restrains consumption.

To break out of the cycle, he says, governments need to act.

“Fiscal policy is now important as a stabilisation policy tool in a way that has not been the case since the Depression,” Summers says[11].

As chief economic adviser at Allianz, Mohamed El-Erian put it, “central banks can’t go it alone anymore”.

“Officials of advanced countries increasingly are acknowledging that the problems facing their economies require a new response to take over from the overlong use of narrow, short-term tools,” El-Erian says.

The change in mood has been reflected in the acceptance by European creditors that Greece needs debt relief, as well as Germany’s warning against over-reliance on central banks, and policy prescriptions from the IMF and the OECD that urge governments to take on much more of the burden of supporting economic activity.

The IMF’s Lagarde says monetary policy needs support. While accepting that countries with high debt and low public sector savings need to work on consolidating their finances, “those with fiscal space should commit to ease fiscal policy further,” she says. Even those with tight finances could aim for a more “growth-friendly” mix of taxes and spending, particularly increased investment in infrastructure.

The OECD sounds an even more urgent note.

The global economy is stuck in a low-growth trap and “comprehensive policy action is urgently needed”, according to OECD Secretary-General Angel Gurria. “Reliance on monetary policy alone cannot deliver satisfactory growth and inflation”.

“Almost all” countries have scope to redirect public spending to more growth-friendly projects, he adds.

Money well spent

But it is not simply a matter of shoving money out the door.

Governments need to work out ways to ensure the funds they pump out are used here and now, when the economy needs it most, rather than being stockpiled and used in sunnier times, when they could amplify inflation risks.

They need to overcome the propensity of consumers and businesses to cut back on their spending when uncertainty reigns.

Households nervous about the economy and fearful for their jobs tend to save rather than shop. And without a lift in demand, businesses have no incentive to hire and invest.

There are also more traditional objections to government stimulus measures – that they crowd out private sector investment, often take too long to take effect (and becomes pro-cyclical), and that much spending is unproductive, swallowed up by bloated bureaucracies and diverted into political pet projects.

But Princeton University economist Alan Blinder, a former Federal Reserve Board member and Presidential economic adviser, finds none of these are insurmountable[12].

When an economy is weak, he says, the risk of government crowding out private sector activity is implausible.

Some argue that fiscal stimulus merely brings forward demand and does nothing to increase aggregate supply.

Blinder questions whether this is the case, pointing out that if it pulls more people into the workforce or results in productivity-enhancing innovation or investment, it deliver a permanent boost to capacity.

A thornier issue is what form government stimulus should take if it is to be effective.

Blinder says recent US experience gives some good pointers to what works and what doesn’t.

Tax cuts often top the list when politicians think of ways to stimulate growth, but Blinder’s research shows striking differences in their impact.

Tax relief aimed at consumers, particularly lower income households, like child tax credits, payroll tax holidays for employees and earned income tax credits added between US$1.24 and US$1.38 to GDP for each US$1 of tax cut during the depths of the recession in 2009, compared with just 32 cents for every US$1 from a permanent cut in the corporate tax rate.

Even more effective were transfers and payments like food stamps and the Cash for Clunkers program. The temporary boost in food stamps, directed at low income households, delivered an extra US$1.74 to GDP for every US$1 outlaid, and Cash for Clunkers (under which owners of old gas guzzlers were paid a subsidy to trade their car in for a new vehicle) was almost as effective – US$1.69 for every US$1.

The lesson, says Blinder, is that temporary measures targeted at liquidity-constrained consumers can deliver a big bang for the stimulus dollar.

This is not just a US phenomenon. Between October 2008 and May 2009 the Australian Government directed almost $21 billion in welfare payments and tax bonuses to low and middle income households.

It has been estimated around 40 per cent of households spent the money[13], and Australian Treasury estimated the handouts added more than 0.3 of a percentage point to GDP in the last three months of 2008 and 0.8 of a percentage point to growth in the first three months of 2009[14].

Well-targeted tax breaks and transfers, Blinder says, can help an economy strongly and quickly.

But, he adds, the longer a recession continues the more governments must look to other measures, like infrastructure investment.

Capital spending is typically viewed warily as a stimulus measure. Infrastructure projects can take a long time to get going, often a chunk of the funds is absorbed by intermediaries like state and local governments, and the money is spent slowly.

But Blinder says the longer a downturn persists, the more such support for activity comes into its own.

It has led some to suggest that governments maintain a list of infrastructure projects ready to go at a moment’s notice.

Breaking the chains

Governments are being urged to put their shoulders to the wheel not only through well-targeted spending, but also undertaking much-needed structural reforms.

In downturns, the instinct of politicians is often to try to save jobs by putting up tariffs, manipulating the currency and erecting other barriers to international competition.

But economists warn the benefits of such policies are illusory. By pushing up the cost of imports and slowing the transfer of skills and technology, the undermine competitiveness and productivity.

Instead, organisations like the IMF, OECD and the Resolution Foundation advise governments to resist intervening in exchange markets, foster competition in domestic markets, combat the effects of aging by boosting workforce participation and increase investment in productivity-enhancing infrastructure.

Bank of Queensland chief economist Peter Munckton says European governments, in particular, “should be working very hard in cleaning up their banking system”, which still labours under a huge overhang of debt.

El-Erian warns the longer politicians prevaricate, the worse the situation becomes.

“Today’s growth shortfalls become harder to reclaim even as tomorrow’s growth potential is undermined,” he says. “Every quarter [governments] wait to enact credible and comprehensive measures adds to the difficulty of removing the impediments to inclusive growth, and makes the political context even more complicated”.

Muckton says that, in the name of prudence, governments should act now: “We should be doing the backburning before the next firestorm arrives”.

* An edited version of this post was published in the August edition of In The Black. It can be viewed at: https://intheblack.com/articles/2016/08/01/is-the-world-prepared-for-the-next-economic-downturn

[1] http://www.worldbank.org/en/news/feature/2016/06/07/global-growth-forecast-again-revised-lower

[2] https://research.stlouisfed.org/fred2/series/GFDEGDQ188S

[3] http://www.yardeni.com/pub/PEACOCKFEDECBASSETS.pdf

[4] http://www.imf.org/external/np/pp/eng/2016/022216b.pdf; http://www.bloomberg.com/news/articles/2016-03-17/next-financial-crisis-could-overwhelm-world-s-defenses-imf-says

[5] http://www.worldbank.org/en/news/feature/2016/06/07/global-growth-forecast-again-revised-lower

[6] http://www.imf.org/external/np/pp/eng/2016/041416.pdf

[7] https://www.bis.org/review/r160607d.htm

[8] http://www.resolutionfoundation.org/publications/renewed-interest-the-role-of-monetary-policy-in-crisis-and-beyond/

 

[9] http://www.brookings.edu/blogs/ben-bernanke/posts/2016/04/11-helicopter-money

[10] http://www.resolutionfoundation.org/publications/renewed-interest-the-role-of-monetary-policy-in-crisis-and-beyond/

 

[11] http://larrysummers.com/2016/05/24/responding-to-the-next-recession/

[12] http://www.hamiltonproject.org/papers/fiscal_policy_reconsidered

[13] http://andrewleigh.org/pdf/FiscalStimulus.pdf

[14] http://www.treasury.gov.au/PublicationsAndMedia/Publications/2011/Economic-Roundup-Issue-2/Report/Part-1-Reasons-for-resilience

Leave a comment

Filed under Uncategorized

Want jobs and growth? Forget business tax cuts

On the face of it, the idea that you can increase employment and pump up economic activity by reducing corporate taxation sounds straight forward and uncontroversial. After all, the less company revenue that goes to the tax man, the more should be on hand for things like hiring more staff, buying new equipment and the like.

Ultimately, the thinking goes, the boost to employment and growth will make everyone a winner.

It is the deceptively simple idea that lies at the heart of the Coalition’s economic plan to boost jobs and growth by implementing $48 billion worth of business tax cuts over the next 10 years.

It also happens to be wrong.

Many have already pointed out that the benefits of stronger growth and increasingly profitable businesses don’t necessarily “trickle down” through more and better-paid jobs, as some naively believe.

The widening gulf between a small group of high-income “haves” and the rest of society is evidence of that. In Australia in 2013-14, 62 per cent of all household wealth was concentrated in the top 20 per cent, while the bottom 20 per cent held just 1 per cent of all wealth. Ten years earlier, the wealthiest 20 per cent owned 59 per cent of all wealth.

As The Economist reported this week, the proportion of working poor in the UK is increasing – 10 years ago about 40 per cent of those in absolute poverty (income less than 60 per cent of the national median, after housing costs) lived in households where people were in some sort of employment. Today, that proportion has risen to more than 50 per cent.

Try telling workers whose wages have yet to recover to pre-GFC levels even while house prices soar, and it is little wonder that an election pitch centred on business tax cuts is a hard political sell job.

But added to well-founded scepticism about who will actually benefit from business tax cuts is an even deeper problem that makes them a poor prescription for jobs and growth.

The searing experience of the GFC and its aftermath has provide a wealth of information to digest about what works and what doesn’t in trying to support economic activity and employment at times of low or stagnant growth.

Among those who have taken a close look at the effectiveness of government stimulus measures is Princeton University economist Alan Blinder.

Blinder, who is a former Vice Chairman of the US Federal Reserve’s Board of Governors and served on Bill Clinton’s Council of Economic Advisers, has run the ruler over the various actions taken by the US Government in the wake of the Lehman Brothers collapse, from welfare handouts and the Cash for Clunkers program to infrastructure and defence spending and business tax cuts.

His findings (http://www.hamiltonproject.org/papers/fiscal_policy_reconsidered) will hearten Keynesians and should give those who spruik business tax relief as the first and best policy response to a downturn pause for thought.

What Blinder found was that the most effective action taken by the US Government was to target temporary handouts to low income households through the Supplemental Nutrition Assistance Program (formerly known as food stamps).

In the first three months of 2009, for every $1 directed by the government through SNAP, $1.74 worth of economic activity was generated.

Extending unemployment insurance benefits had a 1.61 multiplier effect over the same period, while a temporary boost to work-share programs had a 1.69 multiplier effect.

Even increasing infrastructure spending was found to have a significant multiplier effect, though Blinder said the time lags involved in commissioning and undertaking capital projects meant that it was a stimulus measure more appropriate for prolonged downturns rather than shorter ones.

But, effective as some of these spending measures proved to be, there was great clamour from more conservative members of Congress for tax cuts as the tonic the ailing economy needed.

Here, Blinder found the evidence was mixed.

While temporary tax cuts and credits targeted at “liquidity constrained” (read, hand-to-mouth) households had appreciable multiplier effects (like Child Tax Credits, 1.38 times; Earned Income Tax Credits, 1.24 times), permanent tax cuts were much less impressive in their effectiveness.

The multiplier effect of permanent cuts to dividend and capital gains taxes was 0.39, and for a permanent cut in the corporate tax rate, it was just 0.32.

Not only were corporate tax cuts much less impressive as a stimulus measure, but they were prone to getting hijacked by the business lobby and turned into something whose prime purpose was to plump profits rather than fuel economic activity.

As evidence, Blinder cites the experience of an accelerated (“bonus”) depreciation measure included in a 2002 tax cut bill.

The change, which had the effect of putting investment goods “on sale” for a limited period of time, was originally due to expire after 18 months. This short duration was considered key to its effectiveness as a stimulus measure.

Instead, business lobbied hard to have the bonus depreciation extended…and extended… and extended…so much so that last year legislation was passed to keep it going until 2019.

“Ironically, we may have destroyed the usefulness of bonus depreciation as a countercyclical tool by making it permanent,” Blinder says, and advances what he calls a general theorem of political economy: “Business tax cuts artfully designed by economists for maximum bang for the buck will be altered by lobbyists to achieve maximum revenue loss instead”.

The reason is that “business lobbyists don’t care about ‘bang’, but care deeply about getting more ‘bucks’ for their clients, and lobbying almost always overpowers economic logic”.

 

The lesson, says Blinder, is to be wary of using investment incentives as a stimulus measure.

Many might object that American business and politics is a lot different to that in Australia and, anyway, we are a long way from the dire economic circumstances that confronted policymakers in late 2008 and early 2009, so Blinder’s analysis has little to tell us.

But the real question is, is a company tax rate of 30 per cent stifling activity, and would cutting it to 25 per cent over the next 10 years unleash a wave of investment and jobs growth?

The evidence suggests the answer to both questions is no.

As the Reserve Bank of Australia has observed, what has been holding growth down in Australia has been the plunge in global commodity prices and the fall in resources investment.

This has been partially offset by the effects of low interest rates and a weaker currency, which has encouraged growth in services exports and housing investment – both oif which have helped support an improvement in consumption to around its decade-long average of 3 per cent.

Arguably, what has been weighing on hiring and non-mining investment for the last few years has been soft demand and uncertainty about the outlook.

A $48 billion company tax cut might help firms capitalise on the improvement in consumption, but it is hard to see how it would drive it. Unless there is a compelling reason to hire and invest (read: an opportunity to make money), businesses are unlikely to make an outlay, regardless of whether the tax rate is 30 per cent or 25 per cent.

Instead, much of it could find its way into the bank accounts of lawyers and bankers devising M&A activities or pumping up shareholder dividends.

 

Leave a comment

Filed under Analysis

Why a bigger deficit is not all bad

The Federal Government’s financial position continues to deteriorate.

The latest monthly snapshot of Commonwealth finances shows the deficit reached $35.48 billion in the 12 months to December – $763 million larger than was predicted in the Mid-Year Economic and Fiscal Outlook, which came out only a month ago.

It means there is going to be no let-up in the pressure on Federal Ministers to find savings ahead of the election year Budget released on 10 May.

But, promisingly for the Government, the deterioration in the Budget position was largely due to higher-than-expected cash payments than yet another unexpected revenue write-down.

In fact, there are some small signs that the flood of red ink that has drenched the tax revenue columns of Budget for the past few years may be starting to slow.

Gross income tax receipts ($87.6 billion for the financial year-to-date) were a little weaker than forecast in MYEFO ($88.1 billion), but recent jobs growth will spur hope of a strengthening in that revenue stream.

Even more optimistically, company tax receipts reached $30.82 billion so far this financial year – about $750 million more than anticipated in MYEFO.

Of course, this month’s sharemarket plunge might yet cruel this improvement.

Another cause for optimism is that GST receipts were mareginally stronger than expected, reflecting the increased willingness of consumers to shop and firms to invest.

If this improvement in activity, as reflected in the tax revenue figures, is sustained, then hopes that the country is well advanced in its adjustment to the end of the mining investment boom – – aided by the weakening of the dollar – will appear increasingly well founded.

 

Leave a comment

Filed under Uncategorized

Why the gloomsayers are overdoing it

When national leaders talk up how good things are, it is often taken as a sign that they are about to turn very bad.

So when Barack Obama and Malcolm Turnbull each delivered upbeat speeches in the past week, more than a few pessimists probably took them as vindication of their bleak outlook.

After all, there seems to be plenty to be worried about.

The new year has begun in a flood a red ink on global sharemarkets as China growth fears, weak commodity prices, terrorist attacks and natural disasters have all weighed heavily on investor sentiment.

For those determined in their gloom, the latest update on the Chinese economy suggested additional reason for pessimism. The world’s second largest economy expanded at an annual rate of 6.9 per cent in the last three months of 2015, its the slowest pace in 25 years.

Taken together with the decision by the International Monetary Fund to trim its global growth forecasts for 2016 and 2017 by 0.2 of a percentage point each to 3.4 per cent 3.6 per cent respectively, and the bearish mood would seem to be well founded.

But in striking discordantly upbeat messages about the outlook, Messers Obama and Turnbull are not just handing around warm cups of cocoa.

There are concrete reasons to think the gloom is overblown.

Although a sudden upsurge in economic activity appears as likely as a return by Tony Abbott to the Lodge, there are several pointers – local and international – that suggest optimism is not misplaced.

Most importantly, the US economy – still overwhelmingly the largest in the world – appears well established on a growth path.

If the US Federal Reserve’s much-anticipated interest rate increase late last year did not confirm it, a streak of sustained jobs growth that has seen the unemployment rate halve from 10 to 5 per cent ought to allay doubts.

Yes, many jobs have been part-time or casual, and wage growth is weak. And there are headwinds from the weak oil price, which has kicked the stuffing out of the shale gas industry, and the increasing US dollar, which will weigh on export competitiveness.

But cheaper petrol has also boosted real household income, and the American consumer is back shopping and spending, which in turn is encouraging businesses to hire and invest.

As has been widely recognised for some time now, China is engaged is engaged in a highly challenging phase in its economic and political development.

The investment-led growth model that has powered its expansion for the last 25 years has run its course, and left a massive overhang of excess capacity and troubling debt.

If this was not challenge enough, the central government’s reluctance to loosen its control over the economy is coming back to bite it. As The Economist notes, its current situation of a slowing economy, a semi-fixed currency and increasingly porous capital controls is a volatile combination – if the government loosens monetary policy to boost consumption, it will weaken the currency and encourage even more capital to flow offshore.

Still, the Chinese government has plenty of ammunition if recession threatens – $US3 trillion of foreign exchange reserves and ample room to trim interest rates and devalue the yen.

The gloom about Australia’s prospects is also overstated.

The fall in commodity prices has been steep, but so was their rise. As Rod Sims recently pointed out in The Australian Financial Review, the current dominant market narrative of a “collapse” in commodity prices is underpinned by a short-term view. From a historical perspective, they are more accurately depicted as returning toward their long-term average.

Pessimists also point to soft wages growth and a weakening housing market as causes for concern.

But the country is generating sufficient jobs to edge the unemployment rate lower – it fell to 5.8 per cent in December – setting a firmer base under pay rates and raising the prospect of an eventual consumption-boosting lift in household incomes as spare capacity shrinks.

And although capital gains in housing have slowed as some of the heat has gone out of the property market, sentiment toward buying shows signs of picking up.

On the question of whether now was a good time to buy a dwelling, the Westpac-Melbourne Institute Consumer Sentiment Index found a sharp improvement in mood. The index jumped almost 14 per cent this month to 113 points – the highest reading since May last year and only a little below the level of a year ago.

Westpac chief economist Bill Evans says the reading should be treated with some caution, but nevertheless “ma be signalling some improving optimism in the housing market”.

This interpretation is supported by a jump in house price expectations following a plunge in the second half of 2015.

Late last year, Reserve Bank of Australia Governor Glenn Stevens estimated the economy was “roughly half way” through the decline of resources investment, and a rebalancing in the sources of growth was underway – a process that will be greatly aided by the falling currency.

Economic commentary often exudes an unjustified air of certainty.

But the sharemarket’s current bloodletting, but a focus on this has tended to blot out some of the more positive big picture developments occurring.

This is one of those seemingly rare occasions when it may pay to heed the message of political leaders.

 

Leave a comment

Filed under Uncategorized

Why what happens in Washington matters in Canberra

Among the economic indicators Treasurer Scott Morrison needs to keep an eye on, the US labour market should be toward to the top of the list.

As the US Federal Reserve begins to gradually edge up its funds rate, Chair Janet Yellen has indicated the tightness of America’s market for workers will be an important factor in shaping the central bank’s thinking on how quickly to proceed with tightening monetary policy.

The state of the US labour market matters because as it gets tighter, so the bargaining power of workers is likely to increase and wages rise, helping force inflation up.

The higher inflation goes, the more the Federal Reserve will feel compelled to raise interest rates.

This matters for Australia because the higher official US interest rates rise, the greater the downward pressure on the Australian dollar (though this relationship should not be overstated).

As the Australian economy tries to establish sources of growth outside the boom-and-bust resources sector, a lower dollar helps by making exports and locally-made goods and services more competitive.

In the past year, the $A-$US exchange rate has slipped down more than 10 cents to 71.2 cents, a far cry from the above-parity levels reached earlier this decade, when massive mining investment was sucking in huge amounts of capital.

Given that the US unemployment rate has already dipped to 5 per cent, it might come as a surprise that the Federal Reserve has only just begun to increase interest rates.

But behind the headline number, data shows that many of the jobs created in the last few years have been casual or part-time. This suggests that there is considerably more slack in the labour market than a 5 per cent unemployment rate would ordinarily imply.

Recent soft income growth underlines the point. In the year to September, US wages grew by 3.66 per cent, virtually half the long-term average of 6.33 per cent.

This is being reflected in consumer spending – US retail sales grew by a modest 1.7 per cent in the year to November.

The Federal Reserve held off embarking on a tightening cycle until it was confident that the US recovery from the global financial crisis was well-established, so its decision earlier this week to raise interest rates, even by a meagre amount, is seen as a vote of confidence in the world’s largest economy.

As he contemplates the sea of red in the Commonwealth’s financial accounts, Scott Morrison can only hope that this is the case.

Despite his bizarre denialism on the matter, the Federal Government does indeed have a revenue problem. Collapsing commodity prices and soft income and corporate tax collections account for a lot of the deterioration in the Budget position.

And the government’s own forecasts suggest there is not going to be a quick turnaround. Earlier predictions that the economy would expand by 2.75 per cent this year have now been pared back to 2.5 per cent, and next year it is expected to grow by 2.75 per cent rather than 3.25 per cent.

Estimates of business investment, household spending, the terms of trade and private final demand have all been downgraded.

As Reserve Bank of Australia Governor Glenn Stevens observed last month, a rebalancing in the sources of growth is underway, but it is a little rockier than might have been hoped for.

With the economy poised between the drag caused by tumbling resources investment and support coming from a nascent recovery in non-mining activity – particularly services – now would seem a bad time to be adding to the weight on activity by cutting into government spending.

To his credit, Morrison has so far eschewed the sort of bloodletting Joe Hockey pursued in his first Budget.

But the cuts he has outlined – crackdowns on welfare ‘rorts’ and the axing and reduction of bulk billing incentives for pathology and diagnostic imaging services, in particular – make little economic sense.

Both sets of measures, collectively worth more than $2 billion, will mean consumers have less money to spend.

As the country’s experience through the GFC has shown, this is significant. Arguably the most effective measure taken by the Federal Government when the GFC hit in late 2008 was to deposit money directly into the bank accounts of millions.

While much of this money was saved, enough was spent to keep shop tills ticking over, shielding thousands of retail and services sector jobs.

This was especially the case among lower-income households, where a higher proportion of income has to be spent rather than saved.

The bulk of Morrison’s cuts will fall on just such households.

At a time when retailers and service providers are trying to find their feet after several years of lacklustre conditions, this is hardly helpful.

Such unhelpful tinkering by governments all too common.

Economists often lament that government interference prevents an economy’s ‘automatic stabilisers’ (floating currency, swings in tax collections and welfare payments) from working effectively, making a difficult situation far worse.

But it is totally unrealistic to expect governments in such situations to do nothing – after all, they have usually been elected on a platform to ‘do something’.

As Ross Gittens suggests, they could do much worse than to devote their energies into devising a path to surplus that kicks in once a recovery is established, and to work out how to better handle future prosperity.

 

Leave a comment

Filed under Analysis

For interest rates, the only way is down

People might complain about mixed messages coming from the US Federal Reserve, but the same cannot be said about the Australia’s Reserve Bank at the moment.

The message from RBA Governor Glenn Stevens was about as unambiguous as a central banker can get: if there is to be a change in official interest rates in the next little while, the only direction will be down.

Mr Stevens highlighted the dovish sentiment currently prevailing at the central bank at the moment to the 2015 Economic and Social Outlook Conference in Melbourne today.

“Were a change to monetary policy to be required in the near term, it would almost certainly be an easing, not a tightening,” he said, adding that “an accommodative [monetary policy] stance will be appropriate for some time yet”.

But those hoping the RBA might be inclined to offset recent mortgage rate hikes by the big banks with a rate cut of its own are set to be disappointed.

Mr Stevens said that the recent increases had only partially reversed the decline in mortgage rates enjoyed by owner-occupiers this year, and those most affected were investors – a segment of the market policy makers will be happy to see cooled off a little.

Overall, the increases have been equivalent to half a 0.25 percentage point increase in the official cash, and have taken back just a quarter of the interest easing that has occurred since the start of the year, Mr Stevens said.

The RBA does not seem fussed by such a marginal tightening. The governor pointed out that “this increase is from the lowest rates that any current borrower will have ever seen”.

Change is happening

The central bank has also sought to bring some perspective to discussion about the country’s economic prospects, particularly the short-term growth path.

Mr Stevens said that the country had navigated the after-effects of the biggest terms of trade boom in 150 years reasonably well, managing to continue to grow despite the big plunge in mining-related investment.

Promisingly, he thought the country was about halfway through the decline, and the “headwinds” it was causing were currently about as intense as they were going to get.

The rebalancing of the economy away from resources-led growth toward other drivers of expansion, particularly burgeoning services activity, is, Mr Stevens said, well underway.

Leave a comment

Filed under Uncategorized