Since our last recession 23 years ago, the Aussie economy has gone from strength to strength. Australia frequently ranks among the most liveable nations in the world. That success is a reflection of the rising purchasing power households have enjoyed for decades.
But we appear to be fast approaching the end of this prosperous cycle.
According to new research by Deutsche Bank, household purchasing power is set to decline sharply over the next two years.
Why is this important?
Simply put, purchasing power describes how far your dollar takes you. The higher the purchasing power, the better off households tend to be in general. Imported goods are likely to be cheaper; as are overseas trips.
At the same time, a decline in purchasing power results in falling standards of living.
Using IMF data, Deutsche Bank forecasts that Aussie purchasing power is set for a steep decline over the next two years.
Currently, Australia occupies a lofty fifth position in the global purchasing power rankings. However, the bank sees us slipping to eight by the end of this year.
By 2017, they project that Australia will tumble down the table to 17th place.
This slide is worrisome, but not altogether unexpected.
We’ve already seen clear signs that the economy is on course for a rough couple of years.
Income from commodity exports will remain below expectations for some time to come. On top of this, high unemployment and low wage growth will make it harder to lift household purchasing power.
Most importantly, the Aussie dollar is projected to drop to US$0.60 by 2017.
Collectively, these factors will speed up Australia’s slide down the global rankings. Unfortunately, it means Australian living standards will decline to their worst level since the early 1990s.
Policy makers are responsible for declining purchasing power
Part of the problem affecting our purchasing power is the government’s inability to find new ways to grow the economy.
Policy makers have been overly reliant on exports for too long. And it has come at the expense of a coherent policy for managing the post-mining boom economy.
But that hasn’t stopped them from falling back on what they know best.
We continue to see a blind faith towards propping up flagging mining industries.
How wise it this? You only need to look at the forecasts for iron ore prices to see the lunacy of it.
The effects of the mining bust are already weighing on national incomes, with no end in sight. This week iron ore exports fell below US$50 a tonne for the first time since April. And there’s little to suggest they’ll recover any time soon.
Low cost iron ore supply from Australia and Brazil is only set to increase over the next six months. Depending on how bad China’s slump turns out to be, prices could drop to US$40 by the end of the year.
To put this in context, iron sold for US$180 a ton at the height of the boom in 2012. Some simple arithmetic shows us that exporter revenues have fallen almost five fold. That’s a substantial loss considering the resource sector contributes 15% of total government tax revenues.
Lower interest rates adding to pressure on household purchasing power
In response to the mining bust, the Reserve Bank’s policy has been to lower interest rates. As recently as May, the RBA lowered rates to a historic 2%.
Remember, it wasn’t that long ago that the Australian dollar was at parity with the US dollar. But as recently as yesterday, the AUD reached a six year low against the greenback, trading at $0.74.
The RBA actually welcomes this development, despite its effect on household purchasing power.
The reason why they’re so keen for the AUD to fall is because it boosts export sectors.
The biggest benefactors from this are mining, education and tourism industries. It’s not hard to see why either.
A cheaper dollar makes it more expensive for Australians to take overseas trips. But it also makes it cheaper for tourists to visit our shores. Education benefits from this because it supports the surge of international students living in Australia.
Yet this morbid fascination among central bankers to boost exports has adverse effects too.
We all feel the effects of rising inflation that accompanies the dollar’s decline.
What’s more, monetary easing has given central banks a severe case of tunnel vision. All of their efforts seem directed at supporting the export sector.
But the influence of the resource sector on the economy is declining. That’s why we need a fiscal, not monetary, approach to achieving new growth. The RBA is only good for pumping new money into the economy these days. And even those efforts are failing to have the desired effect.
So we need the government to find ways of lifting productivity and wages. More ideas like the small business package would be welcome.
Whether we’ll see real long term solutions is a matter of debate. I don’t expect we’ll see anything other than the usual responses. By that I mean that the RBA will lower rates again in the next six months.
There have been recent reports claiming they’d only consider raising rates in the future. That seems wildly optimistic to me.
The economy shows no signs of improving. Their best bet is to wait for the US Federal Reserve to hike rates. But the RBA could be waiting until late 2016 for that to happen. The Aussie economy could get much worse in the lead up to a US rate rise.
That makes an RBA rate rise unlikely. It would depend on economic growth rebounding. For that to happen, we’d need to see wages rise. And we’d probably need commodity prices to recover from current levels too. The prospects for either of those taking place are slim in the next 12—18 months.
So where does that leave us?
Well, it’s almost certain that households should expect a decline in living standards. Our dollar is only going to take us less further than it used to. The only hope is that we bottom out at 17 in the rankings.
Contributor, The Daily Reckoning
PS: The fall in purchasing power is another sign that Australia’s economy is hurtling towards recession. As one of Australia’s leading investment analysts, The Daily Reckoning’s Greg Canavan has been warning for months that we’re sleepwalking into a recession.
In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why the other two thirds of Australia could face the same fate. Falling mining revenues will affect government spending for years to come. As a result, rising government and household debt will continue to drag on the economy. Most worryingly, Greg has proof that the RBA know that a recession is imminent.
Download your free report to find out what steps you can take to protect your wealth from the fallout of the recession. To find out how to download the report right now, click here.