Recession Where Short-term Benefits of Consumption Belie Long-term Debt Consequences

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Today’s Daily Reckoning is brought to you by the stupidity and buffoonery of Australia’s politicians and mainstream economists. We thank them for today’s bounty. Seldom in our four years since moving to the Lucky Country have we had such a target rich environment. Today’s papers are filled with flim-flam, idiocy, and good old fashioned economic illiteracy.

But wait! Before you write in accusing us of being perma-bears and running down Australia’s economic good news, just remember this: the economy is not a footy team. It’s not something you cheerlead or barrack for. Of course you want things to be good. But whether they actually are or not is a matter of fact, not national pride.

And the facts? Here they are, in brief, for the March quarter: imports fell 1.6%, exports rose 0.6%, consumer spending rose 0.3%, and “consumption expenditure” fell 1.1%.

“Consumption expenditure,” by the way, is government, household, and business spending. And business spending, as you know, is investment (it creates jobs and incomes). Business investment actually fell 6.1% in the March quarter. That’s an ominous sign for future employment.

All of that added up to 0.4% GDP growth. That means that technically, Australia hasn’t had two consecutive quarters of “negative growth” and isn’t in a recession. That’s if you accept the technical definition of recessions, or if you’re a moron.

The numbers show reduced imports because consumers are scared. They show statistically goosed exports which predict lower commodity prices and therefore higher export volumes. And they show the biggest contraction in business capital and machinery outlays since 1991.

In summary: to celebrate the GDP figure as a triumph of government policy is to shout your economic ignorance from the rooftops of the world. Sure, there are items to be positive about, especially exports. But the idea that government spending has somehow spared Australia from the long-term consequences of debt and leverage is beyond absurd. If this isn’t an old fashion recession, it’s a Diet Chocolate recession, in which the short-term benefits of consumption belie the long-term consequences of debt.

Specifically, there are two errors we’d like to expose, and ridicule if possible. The first is that increased consumption implies healthy growth. For starters, the government’s December cash splash may have boosted consumer spending by 0.2% during the quarter. But the bigger contributions to the GDP figure were the surge in exports and big decline in imports.

Why should that matter? Basic economics. Exports generate income and add to GDP while imports cost money and subtract from GDP (in general terms). Or if you were a business, when you sell more and spend less you generate greater income and profits. That’s positive for growth, obviously. And that’s what led to the positive quarterly figure.

But by boosting consumer spending with borrowed money, the government detracts from Australia’s long-term health for a short-term political benefit. Healthy consumption is financed from production. You make something. You sell it. The income you generate pays for the things you buy.

But in the interests of generating the appearance of activity, the government borrowed money so people would spend it (or spent the surplus accumulated in the boom years). That’s debt-financed consumption, an economic stupidity that has led America into a national nightmare. That is what the Aussie government seems to be encouraging and crowing about today.

Of course it’s said that deficit spending is “temporary and targeted.” But no one has really explained yet how long it’s going to take to pay off a $300 billion deficit. It will take years. And it will mean higher taxes or lower spending on other things.

It reminds you a little of Scarlett O’Hara pinching her cheeks to make them rosy for Rhett Butler in Gone With the Wind. The colour rises, but it’s all artificial. It’s the same with Australia’s GDP figures. The number expanded, but it was completely artificial. It didn’t indicate a blush of health, but a kind of bureaucratic harlotry.

So why go to all the trouble of making a sick economy look pretty? Well, if the first error is believing that you can borrow your way to prosperity without producing something of value and generating surplus income from it, the second error is one a four year old might make. You believe you can have something for nothing. And you want it now or you’ll pitch a fit.

The second error is confusing the temporary benefits of a policy for a small group with long-term benefits for an entire economy. It’s like believing you can eat chocolate without getting fat, or get drunk without getting a hangover. Or, if you’re doing it on purpose-knowing full well what you’re up too-it’s putting your short-term electoral prospects ahead of the national interest (something all politicians everywhere now do as a matter of course.)

To be fair, the journo and politicians who think yesterday’s GDP number is a victory for Keynesian policies are making perhaps the oldest mistake in economics. Bad economists and policy makers have always focused only on the immediate and obvious effects of their decisions. After all, it is easy to show who benefits in the short term.

Pensioners get more money. Who’d argue with that? Who wants to see Nanna starve? Consumer spending rises? What retailer will complain? If you focus only on the short-term and obvious, you see that GDP grows and Australia manages to pull off what only two other industrial countries in the world have? Shouldn’t we all be justly proud?

All these obvious benefits have unseen costs that come later, and hardly anyone in Australia is talking about what those costs are and who doesn’t benefit (the next generation). Chocolate makes you fat. Drinking to excess ruins your liver. And debt financed growth ruins a nation’s economic health and steals a fair go from the future. Don’t take our word for it, though. Just listen to Fed Chairman Ben Bernanke speaking to Congress yesterday in America.

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term,” the Chairman said, “we will have neither financial stability nor healthy economic growth…Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.”

Bernanke knows America has to get its fiscal house in order before investors lose complete confidence in the U.S. dollar and dollar-denominated assets. But judging by the reaction of markets, it might be too late already to restore confidence. America’s debt and deficits are large and getting larger.

Australia’s, by contrast, are merely small and getting larger. But if people begin believing that more borrowing and government spending is good for the economy-based on this first quarter GDP number-then Australia will walk even further down the road that has taken America to a road of national servitude to foreign creditors.

Any government that is proud of a policy with that result is either incompetent or economically illiterate. However, now that we write that, we realise that is what most governments are: incompetent and economically illiterate. So what should investors do now? More on that tomorrow…

Dan Denning
for The Daily Reckoning Australia

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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Comments

  1. Where are the journalists calling the government out? They are asleep at the wheel. Instead of pointing out the obvious, that a slight blip in consumption now has come at the cost of years of interest payments, they are all cheering the government on from the sidelines. It’s like the Iraq invasion all over again : journalists print what they are fed, and don’t even raise a whimper of protest.

    No sane parent would mortgage the house to buy the kids all the toys they wanted. Yet the government does exactly this and everyone is supposed to be happy? They say ‘we’ve borrowed less than the UK and America’ : well, that’s like winning the tallest man compeition at a dwarf conference. How about comparing to Norway, which has net government investment, and actually finances government expenditure on income from other indebted countries?

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  2. Dan. Good article. As you know US Fiscal policy has the turning circle of an old super tanker with a tiny rudder. There are financial commitments, contracts, works-in-progress and public expectations that cannot be simply broken.

    Is Bernanke asking for the impossible (not withstanding the observation that it was he that let the cat out of the bag in the first place)? Well yes …….. although the US could do something really radical like adopt the UK or Canadian or indeed Australian models for the Health sector THEN lighten up on the regulations that stuff up the pharmaceutical industry.

    But even IF radical sector based reform were to occur tomorrow, the ship may not be able to turn markedly for a few years. By then the USD will be toast. Commodities and the AUD will go on a roller coaster ride but will recover when new supply contracts are signed.

    Coffee Addict
    June 4, 2009
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  3. Good on ya Dan. Thats why we like your website and not mainstream media drivel.
    What an age we live in! People are spending their cash splashes on Harvey Norman TV sets and feel like patriots for doing so. Too bad for our kids.

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  4. brc notes: “No sane parent would mortgage the house to buy the kids all the toys they wanted.”
    That’s precisely what a large number of Brits did in the last five years, brc… and the toys were mainly for themselves. While the US property crash was fed by no-doc loans, CDOs and slice-and-dice lunacy, borrowing against the mortgage was all the rage in Britain in the mid-noughties. The UK banks encouraged, even institutionalised this madness. A mate of mine in York pointed out the doomed seeds of this largesse in 2005. At the time I believed he was a little too negative about a practice we both agreed was foolish, but he called the crash years before it happened. He found the overvaluation of his own farm property a cause for great mirth… and was never tempted by what he assured me was a widespread practice.

    Lachlan, I guess you could argue that there’s a few pluses for those who employed in freighting and selling the plasmas, but I agree it’s a very poor use of the stimulus cash…!

    Biker Pete
    June 4, 2009
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  5. ” a road of national servitude to foreign creditors.
    Any government that is proud of a policy with that result is either incompetent or economically illiterate”

    … or traitors gloating.

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  6. who cares about the future? every three years there is an election. politicians must please voters in order to get voted into the office. therefore, politicians must look at their short term benefit at the expense of long term benefit of the whole country. that is their job.

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  7. Actually, although the article was good, there is one factual error, although it is a commonly held belief. Chocolate does not make you fat. Sugar and some ingredients added to many candy chocolates make you fat. The chocolate itself is not fattening, in fact it may even help with weight loss. Read my free ebook at my website to learn about it. It’s one of the myths and lies around chocolate.

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  8. It’s interesting that the ABC is running a series called “the rise of money” at the moment which explores the historical flaws of economics. This weeks episode was showing how the bond market was used to create finacial bubbles over the last century. Amazing stuff. And we are walking headlong into the most artifically constructed bubble in Australia’s history. Watch out!

    beyondtool
    June 6, 2009
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  9. I also saw that episode of “The Ascent of Money”. I had a thought re the bond market and government spending. Basically, I was thinking that the government needs to be held accountable for their spending somehow. Ideally, the people in a country would do this, but considering how easily we are bribed with ‘stimulus payments’ and ‘home buyers grants’, this isn’t going to happen. Now when the public debt was fully paid off, there were no pesky bond traders demanding decent yields for their investment and a low-inflation environment. This enabled the government to start ‘buying’ election victories, with the small price that our savings were being inflated away.

    Now that we will once again have a public debt that needs to be financed, maybe there is finally someone powerful enough to make the government avoid inflationary spending.

    Any thoughts on this analysis? (Have I overlooked anything, admittedly official inflation never got much above 4% in the last few years.. but we know how dodgy inflation measurements are.)

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  10. Chris – My State government has announced that electricity costs will increase by 15% this year (I’m told?), the last time I went to pay my house insurance the cost of a replacement dwelling was up 30% (maybe that was over two years?) and the insurer had awarded themselves a 10% increase for the year which is a 25% pa increase in total if I take the charitable view, and the bloke down the local take away curry shop has awarded himself a 20% increase. Plus pharmacueticals were up 13.0% for the quarter according to the last ABS CPI report and food was up 2.2% for the quarter. A quote from same:

    “The most significant price increases were pharmaceuticals (+13.0%), rents (+1.7%), secondary education fees (+7.6%), vegetables (+6.0%), and electricity (+3.6%).
    The most significant offsetting price falls this quarter were for deposit and loan facilities (-14.1%), automotive fuel (-8.1%), domestic holiday travel and accommodation (-5.1%) and overseas holiday travel and accommodation (-4.0%).”

    Source: http://www.abs.gov.au/ausstats/abs@.nsf/mf/6401.0/

    Sure, holidays, petrol and credit were down. But the cost of credit isn’t going any lower and petrol is going back up and not too many people I know see frequent touristy type holidays as an essential of life. But either way, this “translated” to an official overall rise of 2.5% through the year to March quarter 2009.

    If we don’t have runaway inflation happening, I’ll “eat my hat”. Any self respecting bond vigilante would be saying 12.5% pa on short term stuff please – Or I pull the trigger.

    Reply

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