Australian households seem to be acknowledging that it was a combination of luck and good management that delivered the remarkable resilience of recent years; if things had broken slightly differently, the aggregate outcome could have been significantly different — and not in a favourable way. That perception has engendered caution and a desire to consolidate: the opposite response to that historically associated with terms of trade upswings.
This has produced a macroeconomic environment that is characterised by unequal parts of hope (the resources boom) and trepidation (the indebted household sector, the businesses that serve them and currency sensitive tradable industries). But observing that Australia is suffering from the antipodean strain of Dutch Disease (aka the Gregory Thesis in Australian parlance) seriously under-estimates the complexity of the situation presently confronting the economy.
Australia’s policy mandarins are attempting to respond to these forces in the face of an increasingly malignant external environment. Three surveys provide a useful insight into the state of economic play in Australia.
The Westpac-Australian Chamber of Commerce and Industry Survey of Industrial Trends, Australia’s longest running business survey, has just celebrated a sombre 50th anniversary. The 200th issue of the survey, describing the September quarter, indicated that the manufacturing sector contracted for a second consecutive quarter. Manufacturers report weak hiring plans, soggy order books, declining exports, diminished profitability, downgraded capital spending plans and a sharp decline in overall business conditions.
In the Westpac-Melbourne Institute Consumer Sentiment Survey, the tone is equally downcast. Consumers report considerable unease about the state of their family finances, a rising tide of job insecurity and a distinct preference for risk-averse investment options. Households have raised their savings rate to more than 10 per cent of their income, from the negligible rates prevailing before the global financial crisis. Mortgage equity withdrawal has become a thing of the past. The appetite for spending on durables has flagged and the desire to pay down debt has increased. Expectations for house price appreciation have come down significantly. And these observations all pre-date the global financial turbulence that has burst into the national consciousness in recent weeks.
The third report, the Australian Bureau of Statistics’ survey of expected private capital expenditure (colloquially known as CAPEX), indicates that the mining industry plans to boost its investment spending by more than 70 per cent in 2011/12, an extraordinary number coming off an already high base. The mining industry is responding to the spectacular price signal that has pushed Australia’s terms of trade to record levels, with their confidence buttressed by the fundamental view that the urbanisation/industrialisation dynamic in emerging Asia has a considerable time yet to run.
The Reserve Bank’s response to date has been to give priority to managing the expansionary impact of the mining boom and the income stimulus imparted by the terms of trade. Historically, mining booms have been an inflationary force in the Australian economy. In this cycle the Reserve Bank has sought to pre-empt that outcome through a prudent interest rate setting that ‘makes room’ for mining by suppressing activity elsewhere. That has led them to pitch their policy interest rate at a level that is exerting a degree of restraint on activity. The correct adjective to place in front of the word ‘degree’ is a robust topic of debate.
With house prices now falling in most major capital cities, credit growth at many decade lows, dwelling approvals falling, a rising unemployment rate and retail sales scraping along at recessionary rates in per capita terms, interest rate sensitive activity seems to imply that the adjective ‘considerable’ is more appropriate than ‘modest’.
The Reserve Bank’s position has been increasingly questioned as the year has aged. The Bank’s view seems to have revolved around an expectation that the economy was close enough to full employment that policy needed to be extra vigilant against upside risks. Yet now that it has become increasingly clear that the income stimulus from the terms of trade is going towards boosting national savings (with households, firms and government all using the opportunity to improve their balance sheets) rather than lifting consumption and non-mining investment, resulting in a record run of trade surpluses, a different framework is required. Put simply, with the unemployment rate now rising rather than falling, a more flexible approach is now likely to gain support. Short term market interest rates indicate that easier monetary policy is expected in the not too distant future.
On fiscal policy, a substantial tightening is underway at the state and federal level. The public balance sheet is a major beneficiary of the resources boom. Unlike in previous booms, in the current period the public sector is seeking to improve its own saving position, and it is thus not recycling the revenue boost from mining back into the household sector. That severely limits the expansionary effect of the rise in national income brought about by the terms of trade. Households and businesses outside the direct sphere of influence of the resources sector are feeling the heat from restrictive financial conditions (including the heroics of the Australian dollar) and they are being accosted by high food and energy prices (both fuel and electricity). Yet fiscal policy still remains on a contractionary bent, with a dramatic improvement in the government’s bottom line anticipated between 2010/11 and 2012/13.
The uneven nature of activity — ebullient miners and crestfallen consumers — is amplified by the stance of both monetary and fiscal policy. This observation lies at the heart of the palpable pessimism (or lack of optimism) that belies the ‘view from the North’ of Australia as a country with robust fundamentals that should exempt it from the deep anxieties that are pervasive in the North Atlantic and Mediterranean economies.
Huw McKay is Senior International Economist at Westpac Banking Corporation and a graduate scholar at the ANU.
The Author would like to apologise to Daniel H. Rosen and Trevor Houser for borrowing their phrase in the title of this piece.