An Australian Economy at Two Speeds

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The Reserve Bank of Australia has done it again, raising the cash rate for the third time this year to 6.25%. “The global expansion has contributed to high levels of commodity prices, which continue to ad to incomes and spending in Australia,” Bank Governor Glenn Stevens wrote in the Bank’s policy announcement.

Thus we have an Australian economy “at two speeds.” When we lived in France, the French press often referred to “a peloton at two speeds,” a comment on those cyclists who were doping (the fast ones) and those who were not (the slow ones.) The French used the metaphor to explain why French cyclists always lose, and why Lance Armstrong always won. We think they were poor sports. But perhaps there is something to the metaphor after all.

We see the same thing in Australia, an economy at two speeds, although for different reasons. The fast or “winning” economy is the resource economy, driven by surging Asian demand and the “capacity constraints” the RBA referred to. Those constraints are keeping commodity prices high, and driving up wages and house prices in the tight labor markets of Western Australian and the Northern Territories. Business investment—the healthiest kind of consumption spending because it creates jobs and new, income-producing capital—is robust.

The “slow,” dare we say “losing” economy is in the Eastern states of New South Wales in Victoria, which have participated in the resource boom only peripherally. Both states have suffered from China’s emergence as the world’s manufacturing workshop. To compensate, these states have engineered another kind of prosperity through the magic of low interest rates. A housing boom!

But cheap interest rates are a kind of dope, the worst kind really. They boost the appearance of wealth, while adding substantial debt. You feel rich but become a debtor. It’s a sucker’s trade off, or a credit junkie’s trade off, if you prefer. Yet many people have chosen to make just such tradeoff, taking on the appearance of wealth now for the reality of poverty later. And now those people face the consequences of rising interest rates on their variable rate home loans.

“The interest rate rise will punish already stretched household budgets in Sydney and Melbourne as home owners face another increase in repayments.” It isn’t supposed to work this way, dear reader. House prices are supposed to go up, not house payments. Rising prices make existing homeowners rich. Rising repayments, via rising interest rates, make owning a house that much more expensive, or, in some cases, unobtainable.

Some highs are more pleasant to come down from than others. For example, we don’t mind the gentle, fuzzy glow that comes after a nice bottle or two of Chianti or Bordeaux. On the other hand, when your veins are full of Baltimore smack, the come-down is a lot more violent and unpleasant, or so we’ve heard.

“Dream of ownership becomes nightmare,” reads another headline in today’s Australian. Its conclusion was swift and merciless, “First-home buyers would bear the brunt of the interest rate hike, pushing the dream of home ownership further from their grasp.” For the record, although the cash rate stands at 6.25%, the standard, variable interest rate on a home loan, however, is nearly two points higher, at eight percent. “Housing powder keg could be ignited by another interest rate rise,” writes Robert Gottliebsen. We think the fuse is lit and burning already.

On an entirely different note, Americans have seen fit to throw out the Republicans from control of Congress and put the Democrats in charge. We don’t think it will make much difference. The best result would be gridlock, where very little business would get done in Washington. The less Washington does, we believe, the better off America is.

From a fiscal or monetary perspective, will anything really change? The Republicans have hardly been spendthrifts during George Bush’s six years in the White House. The Federal debt has exploded by trillions of dollars. New government liabilities like the Medicare prescription drug benefit have been created with the help of a Republican Congress. And of course there is the global war on terror, including the war in Iraq which has already cost America some $2 trillion, according to some experts.

Will the Democrats do any better? We’d like to say they can’t do much worse. But we know from experience this is not true. It can always get worse. Bill Clinton’s Democrats and George Bush’s Republicans are actually not too far apart on the need for expanded government influence in public and private life. They both agree the government ought to spend more money and have more power.

Where they disagree is where to spend the money and how much of it to spend. Republicans tend to favor spending decisions that help corporations and wealthy individuals, while Democrats favor spending that creates new civil service jobs and bureaucracies. Both are simply appealing to their core constituencies, and both constituencies are interested in preserving and gaining power and wealth.

As a side note, there will probably be one big change. Republicans like to borrow and spend, using the bond market to pay for promises they’ve made. Democrats like to tax and spend, soaking the rich to deliver booty to their favorite special interests. Taxes will go up. The Democrats will steal from the rich, keep some for themselves, and maybe give a little to the poor.

This amoral obsession with power and wealth is what disgusts us about politics. But we try not to take it too seriously or earnestly, like the yahoos who actually get out and vote and think they are making a difference. At least politics provides good political theater. We suspect the next two years will give Democrats in America the chance to show the world they are as stupid, clueless, and corrupt as Republicans. America, still the land of equality and opportunity!

Finally, we noted yesterday that the International Energy Agency increased its estimate of needed spending in global energy infrastructure from $17 trillion to $20 trillion. Who is this good for? Major integrated oil companies like ExxonMobil (NYSE: XOM)? Newly transformed “green energy” companies like General Electric (NYSE: GE)? Or uranium producers like BHP Billiton (ASX: BHP)?

Our guess is it will be good for anybody in the energy business in the short-term. In the long-term, if global oil production declines because the ready supply of global oil declines, then the development of serious, commercially viable sources of industrial and residential power will become big business. They are already small, emerging business.

But we may be on the cusp of a major transition from the large, bulky energy production and transmission systems of the 20th century to a more distributed, localized power generation system. The key firms in this non-centralized “off grid” infrastructure will apply existing technologies in new ways to provide real solutions to every day energy problems. At least we think that’s where things are headed. We’ll have more to say on this next week.

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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