First boom, then doom…and finally hope

First boom, then doom…and finally hope

Today, let’s take a break from all that doom and gloom I deliver to your inbox each day.

Oh, don’t get me wrong.

That doom and gloom is useful.

After all, luck favours the prepared.

Understanding overlooked problems in the Aussie economy will make you a better investor.

However, today I want to show what’s past the doom and gloom.

Because even this permabear knows there’s light at the end of the tunnel.

Australia just has to go through the tunnel first…

More takers than makers

Long-time readers of The Daily Reckoning Australia know I am anticipating a recession.

Why? Because I understand the role consumption plays in our economy.

To put it another way, I’m well aware of my role as a consumer rather than a producer.

At the end of the day, there’s more people like me in Australia than, say, dairy farmers and wheat growers.

But there’s a little more to it than that.

Many years ago, I stumbled across the research of a 1980s demographer called David Harvey.

His theory on the three circuits of capitalism transformed my understanding of how our economy works. 

It also helped me to understand that while a recession may come, it won’t be the end of our economy — just a transition to the next phase…

The three circuits of capital

In a paper titled ‘The Urbanization of Capital’, David Harvey analyses how capital flows through an economy. 

According to Harvey, there are three circuits in a capitalist society. The primary circuit, the secondary circuit and the tertiary circuit.

The primary circuit is an economy in the production phase — the ability of a country to produce goods.

In Australia’s case, that was our mining boom. Our spare capacity in both the labour market and available minerals let us exploit the two for a profit to grow the economy.

Or, in simple terms, we had the rocks to sell, the people available, and demanding customers.

For a decade, it worked.

The mining boom provided incredible amounts of growth for the Aussie economy. We dodged the financial crisis because we were able to supply goods to another party.

But according to Harvey’s analysis, too much ‘success’ in the primary circuit results in overaccumulation.

This is something Aussies witnessed firsthand.

Again, in the case of our mining boom, we were supplying far more commodities than the global market demand. 

In the case of China, for example, we supplied more iron ore than China wanted. This saw prices fall and company profits shrink.

In turn, firms reduced staff numbers and scaled back production. This led to higher rates of unemployment, while investors moved elsewhere in search of returns.

As a result, mining town populations dwindled — as did the high-paying jobs. Once the primary circuit ends, the capital flows into the secondary circuit, says Harvey.

This is where an economy shifts from producer to consumer.

The secondary circuit is very much about money flowing into fixed investments that relate to building and consumption.

That’s all your houses, shopping centres and leisure activities. On an individual consumer level, it’s money spent on swimming pools, nights out at the movies, dining out and even new cars.

Throw in some loose credit policies, and before you know it people are buying $200 toasters and overpriced coffee table books.

This phase is often referred to as the ‘built environment’ and the ‘built environment for consumption’.

Essentially, the economy becomes focused on what it can build, rather than what it can produce.

Just like the primary circuit, there can be excess supply in the secondary circuit. Basically, that point comes when we build much, much more than people want to buy.

Harvey’s argument is that once an economy becomes focused on building for growth, the whole system starts to look shaky.

Harvey also points out that too much credit amplifies these circuits. And that if any of the circuits are propped up with debt for too long, they create unsustainable bubbles, which have severe ramifications for the economy in question.

And that’s where Australia finds itself today.

So, what comes next as the Aussie economy slowly unravels? 

Becoming better people

Australia is yet to transition from the secondary circuit.

Our economy is still very much hitched to building apartments, roads and bridges. And judging by the $80 billion in federal infrastructure projects underway, we still have another half-decade for this to play out.[1]

But as a country, we still have one more ‘circuit’ to transition to.

Harvey’s research suggests that following a construction boom, money moves into a sector that benefits society much more in the long run.

That is the tertiary sector.

It’s where we invest in science, technology and other products that have social value.

According to Harvey’s theory, excess supply in construction leads people to invest in science and technology. He also points out that the secondary circuit — that is, using construction as a driver of economic growth — generally results in some form of a crisis.

If there’s no money to be made in production or construction, life-saving medical investments will attract early investors.

This has a twofold effect.

The economy benefits from new jobs, created in new fields of science and high-tech methods of production.

This results in societal benefits, which improve the human condition.

Once gains from the secondary circuit start to decrease, money moves into the tertiary circuit.

Essentially, this final stage is an investment in society.

It’s the part of a capitalist society where lower economic growth is sacrificed for overall population health. 

Think of it more as an investment in society overall.

Money flows into science and technology, ideally creating a healthier population. And innovators looks for more efficient methods of production and building.

Then, we begin the circuits again.

Australia is yet to transition from the secondary circuit.

Let the bust play out. When it does, know that we aren’t too far away from a brighter future.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia