“Inflation, no longer considered a concern with growth prospects under such a threat, increased by 0.7% in February…”
– Chris Zappone, The Age.
Economic growth, economic growth, economic growth. It’s the financial equivalent of the jungle drums. A constant repetitive beat. It’s sent everyone into a trance. Economic growth must be maintained – at all costs.
Or does it…
Everyone tells us the economy must grow. But they never explain why. Maybe they think if the economy stops growing it would be like if the earth stopped spinning – we’d all start floating in the air.
So we’ll throw our two-cents into the economic growth argument shortly. But the quote above from The Age had two parts: a bit about economic growth, and a bit about inflation “no longer considered a concern.”
Let’s take inflation first. We’ve argued for some time inflation is a concern – when the RBA was cutting interest rates, when the RBA was increasing interest rates, and again as the RBA takes the cash rate ever closer to zero.
During that time conventional wisdom has been the RBA are excellent managers of monetary policy. That they know what they’re doing. If they’re cutting rates it means we shouldn’t worry about inflation. No one, under any circumstances should disagree with the RBA.
Even when inflation was high due to higher costs of food and fuel we were told these are ‘volatile items.’ We should discount them from the CPI. So they did. And inflation kept rising.
As recently as earlier this year it was decreed inflation had been licked. Of course, it hadn’t. Prices were still rising. As if proof was needed, the inflation gauge published recently by TD Securities shows inflation rising by an annualized 3.1%.
So why does the myth of “inflation is beat” persist?
One reason is most commentators don’t understand inflation. They look at the CPI number every quarter and stop there. But taking the official inflation data and price gauge data at face value is asking for trouble.
You need to look for further evidence of inflation. For that we turn to data published by the Reserve Bank of Australia. At the end of February, the RBA data showed exactly why inflation is still a major cause for concern. Only, you wouldn’t have read about it in the mainstream press. They were too excited by the news of rising credit applications.
The info was the stats on money supply. As the table below shows, it has increased during the last twelve months.
Whichever monetary measure you look at, they all indicate the same thing – the money supply is rising. And that means more inflation.
You can get the full spreadsheet from the RBA here. It’s in plain sight, and it isn’t hard to find.
Depending on which measure you use, the increase in money supply over the last 18 months ranges between 10% (M1) and 46% (Money Base). During the same period, prices – according to the ABS – have risen by 4.7%. And that’s just the beginning.
What does this all mean? It means more and more money is being tipped into the economy. This will naturally devalue the money already in circulation. Therefore the greater the amount of money, the higher prices will rise to compensate.
So, what does this have to do with economic growth and whether or not we need it?
The reality is we don’t. There, we said it. Of course, there is a downside to no economic growth. It can lead to a period when consumers buy fewer things, so companies produce fewer things, and therefore employers need less staff.
But after seventeen years of economic growth in Australia, the market is trying not to grow. Unfortunately, the united efforts of the boffins in government, industry and pressure groups are trying to prevent this natural contraction in the market. And that’s a threat to one vital part of the economy – but I’ll get to that in a moment.
You see, the problem isn’t that the economy is moving into recession. That’s just the consequence of an extended period of easy credit. The economy has to go into recession to purge the bad parts of the economy. It has to do this because it will then allow stronger parts of the economy to emerge…
Which brings me to the vital part of the economy I mentioned before. It is the economic engine room of any economy that these stimulus measures are harming. Namely enterprising small businesses.
When government says it is stepping in to save the economy, what they really mean is they are stepping in to prop up big businesses. Because it is those companies that will make it to the TV news and the newspapers if/when people start losing their jobs.
They talk about helping the economy to grow, and about government taking over where the private sector has failed. The trouble is, their actions won’t bring about real economic growth at all. It will just bring on inflation-led growth.
Don’t forget that the cash handouts to taxpayers is only part of the economic stimulus package. Even if every last dollar of those handouts are saved, there will be billions of dollars thrown at unproductive companies, or spent on ‘white elephant’ infrastructure projects.
Because it is ‘free money,’ local and State governments won’t care how it is spent. And maybe the economy will grow because of it. Or maybe it won’t contract by as much. But either way, it doesn’t matter. All that will happen is that a false demand will be created to give a short-term financial windfall to a small part of the economy.
Further, it actually worsens the downturn, because the economy has been falsely raised to a higher level than it should have.
Let’s remember that markets were already artificially high thanks to excess credit, over-production and over-consumption. What this economy needs – dare we say it – is a recession to cure it of the ills of the credit bubble.
Pumping more money into the economy is like giving heroin to a heroin addict who’s trying to go ‘cold turkey.’ The addict is saying it doesn’t want any more, but the doctor is sticking the needle in anyway.
So, that’s the problem, what’s the solution?
There is only one solution. It is for government and its agencies to stop manipulating the market.
The economy needs to contract. In this way, the small and nimble enterprises that survive can take advantage of a depressed economy. Companies that are young or don’t even exist yet can pick up the pieces and bring innovation and real growth to the economy.
Unlike government stimulus programmes, small entrepreneurial companies do actually create jobs. And because they try to run as a profit-making enterprise they can best judge where the demand is and fill the gap.
If they get it wrong, they fail. But because there is no-one to artificially prop-up a failed small business they are quickly swept aside and another takes its place. As one of the world’s most famous entrepreneurs said recently:
“Fortunes are made out of recessions. A lot of entrepreneurs get going in the economic depths because the barriers to entry are lower… There are a lot of Richard Bransons that will come out of the next three or four years.”
That’s one reason why at the Australian Small Cap Investigator, I’ve continued to search for small companies that will not only stay the course during a recession, but will pop out the other side even stronger than before.
In a nutshell, we don’t need economic growth all the time. In fact it is impossible to achieve never-ending growth. All the last seventeen years has done is to keep shaking the bottle – eventually it had to explode.
Sometimes the economy must be allowed to shrink so innovators and entrepreneurs can help it to grow again.
for The Daily Reckoning Australia