Odd disconnects in global economic discussions

Re-reading an earlier post, Australia's fascinating economy, I saw one thing that I need to correct, a case of loose wording. I wrote on 3 March 2009:

I do not have time today to look properly at the numbers. However, nothing that I have seen causes me in any way to switch my previous position (on the economy). To my mind, the real crunch point is still some months away.

I had been discussing the way in which rapidly changing data had affected commentary on almost a daily basis, positive one moment, negative the second.

My core position for many months has been that it was just going to take time for current economic problems to work themselves though, that the effects of the various packages intended to stimulate consumption in different economies were likely to be limited, that on the Government side we had to wait until the capital spend measures kicked in and that this would take time.

I have also generally been more positive than most of the commentary, especially so far as Australia is concerned. In December I summarised my position this way in a magazine article:   

The problem with economic statistics is that, by their nature, they tell us what has happened in the past and with a lag.

It is now clear that the US and international economies were already slowing rapidly at the time the global financial crisis broke. This explains in part why the financial crisis flowed through so quickly and dramatically into contraction in the real economy. However, the scale of the existing slow down was not clear at the time the global financial crisis broke.

All Governments responded to the crisis with action to prop up their banking systems to try to break the credit gridlock that had brought world financial markets to a halt.

As the scale of the crisis in the real economy became clear, Governments then responded through fiscal policy. This took two forms – actions to try to encourage consumption and consumer confidence, followed by stated plans to expand capital investment especially in infrastructure.

From an Australian perspective, several important things should be noted about this global response.

The first is that actions to encourage consumption have not been very successful to this point because they do not address the underlying causes of the problem in the first place. They are best thought of as an asprin to try to ease the immediate symptoms, one that will leave most Governments with high medical bills in the form of increased budget deficits.

Capital spend is different because, sensibly done, it adds to productive capacity and social infrastructure. So there is an immediate economic impact from the spend, followed by a longer term pay-back.

The difficulty is that capital spend takes time to ramp up. The trillions of dollars now committed to capital spend will really begin to affect the world economy about eighteen months out.

The world is now awash with liquidity that nobody wants to use, interest rates are at historic lows, while the global inflation that seemed such an emerging problem only six months ago has vanished.

As global Government capital spending really starts to kick in, the stage is set for quite rapid economic expansion. In the meantime, the economic flue is likely to continue.

Against this background, I wanted to qualify and amplify my use of the words "crunch point". By this I simply meant that it would still be some months before we would know whether the optimists like me or the pessimists were right.

If I am right in my analysis, we will see a growing stream of good news in the midst of the continuing bad leading to a clear bottoming of the downturn and then growth. Here my main expressed concern has been that the liquidity washing round in the global system might then force governments into contractionary action, prematurely curtailing the upswing.

I am not opposed to stimulatory measures. However, I do think that we should be paying more attention to ways of managing the after affects of the combined stimulation measures.    

On-ground effects of the Australian Government's stimulation packages - March 2009

It has taken me much longer than expected to start catching up from the effects of the move. I say start, because I am still running behind. I will continue the series I started on Problems with modern mechanistic management - introduction, but I wanted to do a catch-up post first on the on-ground effects of the Rudd Government's various stimulus packages as I see them working their way through.

As you might expect, the effects have been variable. We talk about the Australian or US economies as though they actually exist. In one sense they do of course, but they are also averages concealing great local or regional variation.

For other reasons, I spend a fair bit of time monitoring the media and especially the press in regional Australia. At this level it is much easier to see specific impacts because they attract reporting in a way not possible in the metropolitan media.

The comments that follow are necessarily impressionistic. There are no statistics to measure the things that I am talking about.

As you might expect to begin with, the effects of the economic downturn itself vary greatly at local level. Some regional centres dependent on mining or with significant local manufacturing have been hit quite hard. In other less trade exposed centres, the recession has had little impact. Whereas at a macro level, people are worried about unemployment, the problem for these centres remains attracting the skilled labour they need.

It is often forgotten in Australia that most of our booms are linked in some way to real estate and construction booms in the major cities. Downturns are actually quite helpful to some other parts of the country because it makes it easier to attract staff.

The higher first home buyers grant on existing homes has created something of a mini-real estate boom in some of the larger regional centres, with quite noticeable increases in sales and in prices at the lower end of the market. Because regional real estate prices are lower than city prices making it easier to buy, demand has spilled over into mid-priced homes.

The direct payments made to pensioners and others just before Christmas had quite a pronounced effect on retail sales.

On-ground effects here were always going to be variable because the proportion of recipients varies between communities. Many regional centres have a higher proportion of people on Family Tax Benefits as well as an older population. Some of these centres saw a very large boost to sales, with clear record trading.

It was always going to be the case that capital spend items would take longer than the Federal Government allowed. The grants to local councils were the first to  have an impact simply because the councils were better geared for action. Local newspapers have been full of stories about small individual projects.

This appears to have cushioned another effect of the global financial crisis that I was insufficiently aware of. Many local councils invested reserve funds in triple A rated instruments such as CDOs that proved to be far from triple A. Armidale City Council, for example, faces a financial loss of up to $A12 million, a very large sum given the council's size.

I haven't seen this much reported, but on a surface skim it appears that the consequent legal class actions - including actions against the ratings agencies -are likely to be quite significant.

One of the most interesting things is the way in which the initiatives in the social housing area have started to feed through.

At least in NSW, the local papers have been full of Housing NSW advertisements seeking, among other things, DA (Development Approved) medium density sites. The intent here is to partner with local developers, including especially those who have been unable to find funding.

I have been meaning to do a macro assessment of this in terms of scale relative to the size of the sector. Looking at the micro-level, I think that one effect will be to empty the existing development pipe-line.

Replicated across the country, this is likely to draw new development planning forward. The key constraint is likely to be - as it was before - the availability of suitable land.

Now add in the initiatives intended to address the maintenance backlog in social housing. This uses the same trade skills as new construction. Again, the local affects are likely to be significant in many regional centres that have significant existing social housing stocks.

Turning again to the macro level, leading indicators such as new dwelling finance commitments (see chart) are now showing a clear upward trend.

All this means that the residential building sector at least is now showing all the signs of a very substantial surge.

This will still take time to feed through into increased construction activity.

I am not absolutely sure of the lags here. On the surface, we are likely to see a steady ramp-up in building activity in the second half of the 2009, with something of a surge in 2010.  

Problems with modern mechanistic management - introduction

The Australian state of Queensland is presently in the middle of an election. Here I heard the leader of the Liberal National Party opposition say that he expected to be able to help pay for his election promises by enforcing a "productivity dividend" on the Queensland public sector.

This is exactly the same approach that Prime Minister Rudd announced before the last Federal election and then enforced. Now the Commonwealth is struggling to deliver on its programs and policies.

NSW, too, has the approach in place, in this case further compounded by a freeze on new appointments. Again, the State is struggling to deliver.

The concept of a productivity or efficiency dividend sounds so sensible.

Competition improves efficiency. The public sector is not subject to competition, therefore use small rolling budget cuts on agencies to provide a proxy for the type of efficiency gains achieved through competition.

The problem is that it does not work in the long term. It is in fact an example of what I call mechanistic management.

As a bit of a break from economics, I plan to explore this issue over coming posts. You will still get some economics, but I feel the need for change.

December quarter 08 - Australia's real net disposable income increases by 1%

I quote from the Reserve Bank of Australia:

A broader measure of change in national economic well-being is Real net national disposable income. This measure adjusts the volume measure of GDP for the Terms of trade effect, Real net incomes from overseas and Consumption of fixed capital (see Glossary for definitions). The graph below provides a comparison of quarterly movements in trend GDP (volume measure) and Real net national disposable income. During the December quarter, trend Real net national disposable income increased by 1.0%, with growth over the past 4 quarters at 6.4% compared to 0.6% for GDP.

So Australians have more money even if GDP as conventionally defined has fallen. My my.

I do not have time tonight to do a proper analysis of the national accounts. I will try to do so tomorrow.

Australia's fascinating economy

What a fascinating beast this Australian economy is just at present. It has also been fun watching commentators twist themselves in all directions as they try to adjust their forecasts to apparently diverging statistics.

Economic data released yesterday (Monday 2 March) led to gloom and doom, with Australian Treasurer Wayne Swan suggesting that last night that the global slowdown would have a “dramatic impact” on the local economy, with commentators downgrading their forecasts. Then today with good data, many commentators hastily revised their forecasts again.

Today also the Australian Reserve Bank decided not to reduce interest rates, suggesting that further monetary stimulus was not necessary. Yet the Government is still talking gloom. As I write, Mr Rudd is revealing his seven principles for fixing the global economy – I lost count around eight at the use of the words “toxic assets”. We appear to have moved from war to medical analogies; the virus of toxic assets must be fixed.

I know that I should not be enjoying this so much, but I cannot help myself. I make no pretence of understanding short term movements. What I have tried to do is to establish a longer term position against which I can test immediate movements.

I do not have time today to look properly at the numbers. However, nothing that I have seen causes me in any way to switch my previous position. To my mind, the real crunch point is still some months away.

On-line problems

I have been effectively off-line because of a house move. Even now, the internet connections are not fully back in the home office. All very frustrating. It will still be a little while before I can post properly again.

In my last post A very odd recession I spoke of the divergences between Australian and international economic performance, of the gap between the negative official commentary and the apparent picture of domestic economic activity revealed by the statistics.

Statistical data released since I wrote including ABS capital expenditure data has continued to surprise commentators with its strength.

This week will be a big one from a data viewpoint, with a whole series of releases including balance of payments data, January retail sales figures and the December national accounts estimates. For the benefit of international readers, the ABS data goes on line at 11.30 am in the morning Australian Eastern Daylight Saving time.

A very odd recession

I have been off-line because of a house move, making it difficult to both write and post.

I find this a very odd recession, both globally and in Australia. Australia may well avoid a “technical” recession, but for all practical purposes at least parts of the country feel as though they are in recession.

Why then do I say odd? Well, the economy is all over the place, with a now somewhat incredible gap between domestic and international economic performance.

At a time of global real-estate declines, the Australian Government’s first home buyer grant in combination with reduced interest rates have triggered something of a mini-real estate boom in at least at the lower end of marketplace. In real estate mad Sydney, real estate investment is again a topic of interminable conversation.

One side effect of this is that rents appear to have risen at the lower end of the market place.

The best data on both rents and sales in NSW is provided by Housing NSW’s Rent and Sales Reports. The latest sale reports are for the June quarter 2008, the latest rent reports the September Quarter.

The sales reports show year on year real estate price declines in most localities. This in combination with lower volume of sales led to a marked drop in State Government revenues from stamp duty. By contrast, rents generally increased.

Since then, house lending has started to move up, with a seasonally adjusted increased for housing finance for owner occupation of 7.1% in December over November. This was associated with a major jump in December for the seasonally adjusted value of dwelling commitments.

The next NSW rent and sales reports may not show this increase because of lag effects – the sales data will be for the September quarter – but should still be interesting.

I had major reservations about the extension of the first home buyers grant on existing properties, a view I still hold. However, one practical economic effect has been the creation of another buffer for financial institutions and for ordinary wage and salary earners owning their own homes.

Australian bank bad debts have increased. However, this has been focused on the commercial side, not housing. This makes it much easier for Australia’s banks to absorb losses without adverse balance sheet effects.
Still on the odd side, only a little while ago Australia’s major banks were seen as global minnows, too small to compete effectively. I find it hard to come to grips with the fact that they now have market capitalisations greater than many major international banks including Citigroup.

Clearly bank shareholders are concerned about the statements from the various major banks that their profits are under pressure and that they may need to reduce dividends. However, there is a major difference between worrying about dividend reduction as compared with worries about sheer survival.

Like US consumers, Australians have clearly been trying to save more and have reduced spend on particular items. Reflecting this, the January figures for motor vehicle sales showed a further small decline in both trend (-0.8%) and seasonally adjusted (-1.1%) terms, continuing a downward trend that began at the start of 2008. December on December sales show a decline of 16.9% in seasonally adjusted terms.

In addition to ordinary shifts in consumer demand, motor vehicle sales have also been pulled down by lower fleet sales. Still, both the December reduction and the year on year numbers are still relatively mild by global standards.

All very interesting.

Crowding out and the Rudd stimulus package - still more economics 101

This post continues the discussion I began in More economics 101 - the economics of Malcolm Turnbull. Since then I have added The Rudd Stimulus Package - Andrew Laming's view to provide a Liberal Party view. This post focuses on the crowding out issue.

As with all these posts, I am trying to think my way through the issues. Feel free to disagree.

Economists use the term crowding out to describe the way in which one set of actions - an increase in Government spend, for example - can reduce other activities, thus crowding them out.

It may seem strange to talk about crowding out at a time the Australian economy has spare capacity. Yet it is an issue to my mind because of the way the package is being funded.

If the Government had funded expansion in the old-fashioned way by issuing Treasury bills thus expanding the money supply, then the increased spend would flow through into increased economic activity. The position is far less clear-cut when the extra spend is funded by increased borrowings from the market.

Increased Government spend pumps one dollar into the economy. The immediate effect is the same regardless of how that dollar is financed.

The Government then borrows one dollar from the market to fund its dollar spend. That dollar is no longer available to do other things. If there is a lot of liquidity around sitting idle as there is just at present, the effect may be small. However, these are very big borrowings.

One potential effect is an increase in market interest rates. Should this happen, then extra funds may be attracted to Australia, leading to appreciation of the currency. In turn, this would encourage imports, discourage exports, placing downward pressure on economic activity.

This is the type of effect that led Harry Clarke to write Pointless fiscal expansions that swamp us with debt but don't reduce unemployment, a post brought on-line in the wee hours of this morning.

However, there is another problem as well.

We presently have a thoroughly constipated financial system with banks still reluctant to lend to business. There is a lot of liquidity around, so Government borrowings may not of themselves shift real interest rates a great deal. Nevertheless, they could well further reduce the availability of loan finance for business.

Still keeping it in simple terms that I can understand, cash has to go somewhere. At present, there is a very high weighting in the market for risk, so available cash flows to the safest investments, reducing cash for perceived riskier investments, and that includes loans to business.

Government borrowings of the type Mr Rudd proposes increases the supply of high quality financial assets, potentially further reducing (crowding out) the cash available for loans to business.

In theory, this might lead to increased interest rates on business loans, widening the interest rate spread until funds are attracted. However, we already have credit rationing. So long as risk assessments remain as they are now, interest rates are unlikely to shift much in the short term.

We can already see some of these types of effects in the housing market place. For a number of reasons, housing is still seen in Australia as a relatively safe longer term investment.

This perception is not clear cut. There is downward pressure on property prices in the more expensive segments of the market place. However, at the lower end house prices have moved up, in part because of Government incentives. This is reflected in the statistics, with loan approvals for housing now increasing.

Banks are lending for housing because they still see it as a relatively safe investment offering a higher yield. Barring unexpected changes, they will continue to do so. So we have credit rationing for business, while housing lending expands.

The Rudd Stimulus Package - Andrew Laming's view

My post More economics 101 - the economics of Malcolm Turnbull drew a thoughtful response from Andrew Laming, the Liberal member for Bowman. I have been remiss in not bringing this up before onto the main blog - it gets lost in the comment section.

The latest Rudd stimulus package has passed. However, Andrew's arguments are still relevant to the longer term.

Andrew wrote:

Dear Jim,
Just a note on your excellent analysis.

This is not a debate between a small Coalition and a large Government stimulus package. It is not about supporting a larger intervention if you are bearish about Australia and smaller if you are optimistic.

This debate is about whether $42 billion spend AS PROPOSED is appropriate in quality and quantity.

Once committed, the $42 billion becomes opportunity cost. That's why Mr Turnbulls's proposed scrutiny of the package in the Senate is so vital.

This debate is not about whether the world will recover from the recession. Of course it will. The real argument is whether the stimuli, as proposed represent cost-effective recession aversion.

Highest level analysis asks - how and when is each stimulus dollar of GDP deployed to pre-empt economic threats and have maximum impact maintaining jobs, and in turn, Australia's GDP growth.

Judge the package not on the social infrastructure it delivers or that people are "paying down home loans and that is no bad thing." This is akin to treating a skin cancer patient with a weight loss program.

We all want nation-building, but in a recession, a specific set of measures are prescribed to maintain economic activity (reduce the length and depth of recession), and to position the economy to achieve the most sustainable growth recovery (so that we are better placed than our competitor economies when we all enter the post-recession phase.

Readers will know of those elements: PREVENTION: high-multiplier expenditure, targeting the most vulnerable domestic sectors to job losses, and ADAPTION: where losses occur, reducing frictional unemployment through rapid retraining and redeployment into economic infrastructure - which reduces costs to business, builds confidence and prevents further job losses.

Finally, with the current fiscal fixation, don’t underestimate the ultimate power of monetary policy. Australia's comparatively higher interest rates allow significant room for stimulus which is not available to other economies, which will restore confidence and entrepreneurialism without sending Australia into generational debt.

As an aside...
Your excellent graph was part of my analysis of ABS retail sales for December. It is irrelevant that December was $700 million more than November. To understand the stimulus, four factors enter the calculations;
1. Temporal factors. Treasury now says they only expected 10% of the stimulus to enter the economy in December (they didnt say that back in December). Most (they hope will turn up in Q1 and Q2 this year).
2.Annual cycles: because every year, Australians spend remarkably close to 11.1% of their annual retail spend in December (as they did in 08, despite stimulus),
3. Year by year comparison: the degree to which December 08 increased from the 4 Decembers before it, relative to the annual growths in each of those years.
4. Monthly trends (your graph), because even with all the pessimism post-Lehmans, it shows that retail sales held up July-November. Too many people grasp at November's slip and infer trends. Remember the stimulus came before we even had the ABS November 08 figures.

My case is that Dec 2008 WAS ALWAYS GOING TO BE SOLID. That position is supported by all four points above, together with the confidence of falling interest rates, particularly cheap fuel and the Christmas effect (where people spend irrationally at Christmas (even at tough times), then compensate, with a rational slump in the first three months of the following year(see Xmas 2007).
It is difficult to argue that the December stimulus saved/supported/created any jobs, because department stores and the household sector (big winners from the stimulus), can and did further discount to maintain sales volumes and retain staff.

In the end, massive discounting plus the stimulus - achieved sales volumes of $300 - 850 million above expectation.

I argue that such a result neither justifies the stimulus, nor assisted much in averting what lies ahead for Australia in 2009.

Andrew Laming
ps: It was the tax cuts announced in May 2007 which "introduced a structural element into the deficit." Bringing those cuts forward is merely a one-off tax expenditure.

End Observation

In posting Andrew's comment in this way, I am treating it as a guest post. For that reason, I am not going to comment on it at this point, but leave it stand as a contribution to discussion.

I left my own post hanging on the issue of crowding out. I will discuss this further in my next post.

February 2008 - so far so good for the Australian economy

I am conscious that I still have to finish More economics 101 - the economics of Malcolm Turnbull. I will do so. However, I wanted to make a comment on the latest economic statistics.

As I write, the Rudd Government's economic stimulus package has been voted down in the Senate through the vote of independent Senator Nick Xenophon. He wanted more Murray Darling water for South Australia and the Government would not budge sufficiently. And a bloody good thing too, although this goes to some of my own biases. I will deal with this later in a separate post.

The latest ABS data that has been released supports my view about the performance of the Australian economy.

On 10 February, the ABS released data on the Value of Principal Agricultural Commodities Produced, Australia, Preliminary, 2007-2008. This suggested the value of agricultural production was up 24% on the previous year.

Yes, this is 2007-2008. Further, the previous year was badly affected by drought. Yet this better performance does feed into our trade stats.

The following day, 11 February, the ABS released housing finance figures for December 2008.

In seasonally adjusted terms, the total value of dwelling finance commitments excluding alterations and additions increased 5.9%. Owner occupied housing commitments increased 7.1%, while investment housing commitments increased 2.9%.

This is not a bad result and shows the effect of the Rudd Government stimulus measures.

If you look at the attached ABS graph, you can see the sharp decline from December 2007 and then the recovery.

The Rudd Government measures are not all good. Home prices at the lower end of the market have started to move up, as have rents.

This is what happened before with this type of measure. Lower income renters were disadvantaged as a consequence.

Now turning to the unemployment numbers released to day.

Employment in January increased by 1,200 to 10,742,100. Full-time employment increased by 33,700 to 7,670,700 and part-time employment decreased by 32,600 to 3,071,400.

The drop in part time employment did not come as a surprise. The rise in full time employment did.

The participation rate, the proportion of the working age population wanting to work, increased. This increased the unemployment rate by 0.3 percentage points to 4.8%.

The attached graph from ABS shows how unemployment has risen. You can see the steady increase since the start of 2008.

Coming on top of the retail sales statistics, none of these statistics show an economy entering serious recession. However, the numbers are lagged and a little misleading.

I have no doubt that the economy is in downturn. My point has always been that the economic fundamentals are pretty good.

I support some variant of the Rudd stimulus package because I see it as important in getting us through to the second half of 2009. By then, some of the longer term measures will be starting to feed through.

As someone who has been watching the economic entrails for quite a long while, I am struck by the apparent disconnect between Australia and apparent global trends.