With the US markets shut down for Thanksgiving and a game of football, there is no Wall Street ‘lead’ for the local bourse to follow today. Just as well then that RBA Governor Glenn Stevens has given investors something to focus on.
In his ‘Opening Statement to House of Representatives Standing Committee on Economics’ Mr Steven’s told the assembled bureaucrats that the price of money in Australia is just about right. The vibe of the speech was that rates would stay where they are for the time being, but further increases down the track were still on the cards.
Stevens is concerned about the cost of labour, which has a major bearing in the cost of money. ‘Growth in labour costs, however, is no longer declining, but rising. The overall pace could not be described as alarming at this stage, but the turning point is behind us.’
Wages are a big deal in the inflation equation. Price rises without compensating wage increases are actually deflationary. If the price of your electricity bill goes up (and it certainly has in NSW lately) for a given disposable income you have less to spend elsewhere. That’s not inflationary.
But if you bargain for a wage increase and do not increase your output, THAT is inflationary. Wages are the biggest expense for businesses so wage pressures are generally followed by price rises. Hence Stevens’ legitimate concerns.
So if the unions, the great protector of the worker, continue to have success in fighting for higher wage claims without offsetting productivity gains, you can expect to see inflationary pressures strengthen, and interest rates to rise again next year.
Speaking of productivity, or lack of it, we should point out that the government is contributing heavily to the upward pressure on wages. The latest figures from the ABS show that full time adult total earnings for the public sector rose a hefty 6% for the 12 months to August 2010 on a trend basis. This compares to private sector growth of 4.3%.
The problem is, government workers to not produce anything of value. The productive part of the economy, the private sector, sustains the public sector via the taxes they pay. The fact that wages are rising faster in the non-productive part of the economy is troubling.
What’s also troubling for Stevens and his mission of guessing the right level for the price of money in Australia is China. What happens there is the wildcard for interest rates.
Credit conditions in Australia are very weak and do not call for interest rate tightening at all. Credit growth is down to an annual rate of 3.3% (all due to housing, by the way) while growth in M3 money supply is 5.8%.
The inflationary impetus is coming from China. While Stevens didn’t mention China directly, he mentioned its proxy, the ‘terms of trade’ on a few occasions. ‘Measured in nominal terms, the rise in GDP is running at about 10% per annum just now, because of the rise in the terms of trade.’
China’s credit boom (where growth in bank lending reached 33% in late 2009 and is still buzzing along at around 18%) is clearly spilling over into Australia via record high iron ore and coal prices.
As Stevens’ points out, this is due to very strong demand for steel.
We all know the emerging economies are growing strongly/industrialising, hence the demand for steel.
But what is really causing it? If the developed economies of the west are struggling to recover from the credit crisis and experiencing below average levels of demand, why are the developing nations growing so fast? After all, isn’t the west meant to be the buyer of the emerging markets’ goods?
In China at least, the answer comes down to the lending binge that kicked off in late 2008. This was an unprecedented attempt to reflate the Chinese economy during the deflationary shock of the credit crisis.
It certainly worked. Get a load of this. In 2009, China’s banks lent out a whopping 9.6 trillion yuan, equivalent to around US$1.44 trillion. The lending target for this year is 7.5 trillion yuan (US$1.13 trillion) but that looks like being exceeded easily.
As the Chinese bureaucrats are now finding out, once a credit boom takes hold it is very hard to stop.
The majority of these loans are going into ‘fixed asset investment’. According to an article in Fortune: ‘Fixed-asset investment accounts for more than 60% of China’s overall GDP. No other major economy even comes close. And of that fixed investment, slightly less than a quarter is attributable to new real estate investment.
Fixed-asset investment means buildings, road, property. Tangible, ‘fixed’, objects. There’s your steel demand right there.
That’s certainly good for Australia now and it is giving Stevens plenty of food for thought when it comes to setting interest rates. But surely he must be wondering what happens when the Chinese lending and fixed asset boom ends, as it surely will. (or is it different, this time, in China?)
One thing is for certain. The bureaucrats in Canberra wont be asking Stevens about Australia’s very heavy reliance on China’s ongoing boom. More than likely they’ll be playing politics (it’s what they do) and asking why banks cant make the price of money for housing cheaper than it should be.
After all, no one wants to see the end of a boom, especially politicians.
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for The Daily Reckoning Australia