Have one for Santa…and One for Australia’s Economy

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The ‘income recession’ we had to have? Doesn’t quite have the same ring to it, does it?

But with the deterioration in political discourse these days, no politician would ever admit that a recession was a necessary, inevitable and healthy adjustment for an economy to have. If it suits their purposes, politicians will simply call black white until they’re…errr…blue in the face.

I’m talking about yesterday’s economic growth data, which showed Australia’s economy growing at just 0.8% in the September quarter, or 2.7% year-on-year. That’s not in recession territory thanks to large volume increases in Australia’s exports, namely coal and iron ore.

But the headline economic growth figure only takes into account volume growth. It doesn’t measure the price we actually receive for our exports. For that, there’s another measure…‘real net national disposable income’, which is a proxy for Australia’s ‘national income’.

This takes into account the effect of the terms of trade on our economic performance. So while it might be good that we’re sending more coal and iron ore to foreign markets, it’s not good that we’re now getting much lower prices for these products than we’re used to.

We’d better get used to it. Prices are just reverting to their long term ranges following the historic China credit boom.

When you throw these prices changes into the mix, it shows that Australia’s national income declined 0.3% in the September quarter, which followed a 0.2% decline in the June quarter. That’s two quarters of negative national income growth. It satisfies the media’s definition of a recession… et voila, the ‘income recession’.

With the terms of trade continuing to fall during the current quarter (plus there is a lag effect to the way the terms of trade is calculated) there’s a good chance you’ll see another quarter of negative income growth when the December accounts come in. If that happens, and the 0.7% positive contribution from last year drops out of the calculation, Australia will go very close to generating negative year-on-year national income growth…a very rare event.

If there’s no bounce in iron ore or coal prices (which dominate the terms of trade) during the March 2015 quarter, then you can almost guarantee that we’ll be in a deep income recession. That’s because the March 2014 quarter’s 1.3% growth will drop out, replaced by something much smaller.

And in this environment, earlier this week, there was a consensus amongst bank economists that interest rates would rise? We all get things wrong in this game…no one is perfect. But that is just gross incompetence.

If you’ve got kids or grandkids contemplating a career in ‘economics’, which requires a very expensive education to get ‘qualified’, do everything you can to talk them out of it. It’s completely useless.

The future is inherently unknowable. We are all at the whim of random events. Yet economists think they can ‘model’ people’s behaviour and ‘model’ an economy. As a result, they see black where most others see white.

Nassim Taleb, author of the book Antifragile, explains that banks are amongst the most fragile of institutions. That’s because one random (and extreme) event can wipe them out in an instant, even though they may have been around for 100 years or more. Think Barings…or Lehman Brothers.

And it’s the banks that employ an army of economists to model everything and protect them against risk. But nature is always one step ahead of them. While they’re protecting the ramparts from another frontal assault, the next attack will come from behind, above, to the side, or underneath…anyplace it’s least expected.

So get the kids out of the economics degrees…get them into philosophy, history…or get them to start a business. That’s the best lesson in economics they’ll ever get.

But hang on, maybe don’t start business. Australia’s policies aren’t about fostering an entrepreneurial workforce. It’s about rewarding rent seekers and speculators.

Yes, the fall in the terms of trade is a worry, but that’s because we’ve put all our chips on China. And then we’ve borrowed against those chips to punt on property. There’s not a lot of diversification going on…nor is it encouraged.

And then you get this from Joe Hockey yesterday…

‘We want Christmas to be good for Australia, we want Australians to go out there and spend – not just for Santa Claus but for Australia, because increasing household consumption is good for the economy and that in turn will help create jobs for other Australians.

I’m sorry…but what an idiotic statement. Coming from the country’s Treasurer, it’s absurd. National income growth is going backwards, and he’s telling people to consume more stuff?

And since when is retail employment the backbone of economic growth? Clearly, Joe has completed an economics degree at a prestigious university.

If he were brave, he’d be targeting a reduction in inefficient taxes that block job growth and removing tax lurks on things like superannuation and negative gearing.

But he’s not brave — he’s a two-bit economic cheerleader peddling economic myths, trying to hang onto power for another term. Here’s a tip, Joe, everyone knows you’re talking rubbish, so zip it.

Given the government is unlikely to do anything in the way of long term structural change (because the benefits of such change would accrue into the next term of politics and beyond, which is no good to them) it’s again up to the Reserve Bank to do something.

But expecting lower interest rates to have anything more than a very short term effect is insane. Let me show you why.

The biggest immediate economic impact from lower interest rates is via lower interest expense for the household sector, the largest sector in the economy. The last interest rate cutting cycle, from 2011 to 2013, had a huge impact on the household sector and saw year-on-year declines in interest payable from March 2012 to March 2014.

Effectively, this provided a big income boost from the RBA and helped boost consumption and retail spending, etc.

The other effect of lower interest rates is to encourage more borrowing. This means more debt and if rates stay stable for a while, before long, interest expense starts to rise again, even though interest rates remain low.

That’s exactly what is happening in Australia. In the year to September, household interest expense increased 4.5% — despite record low interest rates. This detracts from final household income and has a flow on effect to spending.

Here are the last four quarters of ‘final consumption expenditure’ growth, which is probably the best measure of underlying demand in the economy.

December 2013: 1.5%
March 2014: 1.2%
June 2014: 1.2%
September 2014: 0.55%

That latest reading is very low in a historical context. And it’s not adjusted for inflation, so in real terms, underlying demand in the economy is virtually non-existent right now.

So while Australia faces serious economic problems, you have Tony Abbott saying the iron ore price collapse is cyclical and will rebound (it’s not and it won’t) and his Treasurer Joe Hockey telling everyone to go out and spend big for Christmas.

The scary thing is, these people are serious.

Regards,

Greg Canavan+
For The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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2 Comments on "Have one for Santa…and One for Australia’s Economy"

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Kyle Amadio
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I think your criticism of Hockey is a little unreasonable. Hockey had made it perfectly clear that the age of entitlement is over, unfortunately we the audience don’t think he is talking to us. The government knows what it has to do and the commission of audit made the recommendations. Unfortunately political parties have to get elected and stay elected to implement policy. With more than half the country dependent upon the state for support and the labour party and greens desperate to destroy Abbott there is zero chance of real reductions in spending. That leaves taking superannuation and yes… Read more »
toenee
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It is not at all unreasonable to poke fun at these jokers like Abbott and Hockey. Especially when telling everyone else that the age of entitlement is over while enjoying massive pay rises and ongoing public purse funded perks etc. getting photographed chomping on fat cigars and expensive wine while chuckling to himself. Get rid of him as Treasurer and but someone else like Morrison or Turnbull in his place so the budget measures can be explained and sold to the public properly without treating us with contempt as though we’re all incompetent minions who have no idea! Hockey may… Read more »
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