Australia's economic outlook - cautions and constraints

Just six months ago, Access Economics' Chris Richardson was all gloom and doom about the Australian economy to the point that his comments triggered a number of posts here and on my personal blog because I just couldn't see it in the numbers. I was far more positive. Now Chris is cautiously optimistic.

Chris' cautious optimism comes at a time of increasing optimism in general reporting in Australia and internationally. Just as the previous gloom and doom led me to check numbers and come to an opposite conclusion, now I am wondering about some of the current reporting. To what degree has the optimism/pessimism effect gone into reverse?

To assess this, I thought that the best way was to look at the reasons why I was more optimistic before, along with my expectations about future developments. I seem to have been pretty right on the first, what about the second?

To begin with, I saw the remarkable change in Australia's trade performance - the switch from deficit to surplus on the current account at just the time we needed it - as central. This, together with an unexpected and in fact unwarranted fall in the value of the Australian dollar, cushioned Australia to some degree and gave the Australian Government far more room to move.

Since then, the value of the Australian dollar has bounced back, while the balance on the current account has turned slightly negative. You can see the latter clearly in the attached chart from the Australian Bureau of Statistics. Remarkable improvement, followed by partial retreat.

I am not too worried by this, I had expected it, but again we need to watch because the current trend means that the balance of trade on good and services has turned from a positive to neutral, potentially negative.

So far as the exchange rate is concerned, I won't comment in this post beyond noting that whereas I had seen the balance of probabilities favouring an appreciation, after the last bounce I think that they are now neutral tending to negative. From my immediate viewpoint, that's not a bad thing.

In terms of my previous analysis, Australia's unexpectedly strong trade position was reinforced by other variables - a budget surplus, no net Australian Government debt - that provided the capacity for the country to manage through the downturn until the global economy recovered.

At the time I did not expect the global stimulus packages to have much immediate impact beyond band-aid until increased Government capital spending kicked in. I also expected capital spend to be far more lagged in Australia and elsewhere than projected by Government because of the nature of intuitional constraints. Overall, I think that the band-aid has been somewhat greater than I expected, the capital spend lags pretty much as expected.

My key concern about Australia and elsewhere lay in rapid increase in liquidity and Government debt. I thought that this was likely to choke growth to some degree as policies went into reverse. This remains my view.

If you look at the chart on the right from Stubborn Mule, you can see how Government gross debt came down and is still at very low levels by global standards. Australia still doesn't have a real problem. The colour bars, by the way, mark periods of Labor Government.

The problem lies in the steady rise in household debt, a lot of which is linked to house purchases.

I have been generally supportive of the Rudd Government's stimulus packages with the notable exception of the First Home Buyers grant for existing houses. This has triggered something of a price boom at the lower price end of the housing marketplace, holding borrowing levels up.

The difficulty with Australia's continuing high levels of household debt lies in the way that interest rate rises create downward economic pressures. Australian interest rates are going to rise over the next two years, and as they do there will be downward pressure on spending in other areas.

I am out of time. I will continue this post a little later.

I said that I expected Australian interest rates to rise over the next two years. At one level, that statement is almost a truism given how low they are now. However, there are still inflationary pressures in the economy.

When I looked at the Australian Producer Price Indexes for June, the thing that stood was the difference between the indices for domestic and imported products. It's quite noticeable that all the major price falls month on month are on the imported side. The year on year position is different, with the rise in price for imported final goods showing a dramatic increase despite recent monthly falls.

My gut judgement, and its not fully supported by the figures, is that price pressures are still there in the more sheltered non or part-import competing sector. On the import side, and excluding exchange rate considerations for the moment, recent price declines are likely to stabilise as the global economy stabilises.

If we now look at the latest CPI figures, the low year on year CPI appears to have been strongly influenced by falls in transportation and insurance and financial services costs. The big increases, all above the Reserve Bank's target inflation band, were education, health, housing, food and alcohol and tobaccos. What can we say about this?

Well, transportation is strongly influenced by fuel costs, so if fuel prices rise as the global economy starts to rise again, we can expect this item to rise. Insurance and financial services costs are strongly influenced by interest rates, and will rise with interest rates.

On the other side of the ledger, the majority of high rise items are in non-import competing sectors and will rise as the Australian economy starts to expand. Rents are already rising. In addition, there are built-in upward factors in education and health. So at least potential CPI and health pressures are still there.

I stand to be corrected on this very simple maths, but it looks to me as though potential inflationary pressures are still present. Should they emerge, then the Reserve Bank will have to think about interest rate rate rise. 

Then we have to factor in Government borrowings. The need to borrow in Australia and overseas to fund stimulus packages will of itself place some pressure on interest rates. So we have a whole set of reasons to expect interest rate rises, with consequent downward pressures on demand.

I now want to bring in a another variable, China.

I have previously expressed concerns about the hope placed on China. Part of this is due to to the relative size of the Chinese economy. It is simply not big enough in absolute terms to have the type of global pull-through effect expected in the absence of growth elsewhere. Part is due to what I see as the vulnerabilities in the Chinese economy itself. Here I am influenced by the writing of Michael Pettis.

I lack the direct knowledge to properly critique Michael's work. But at the very least, it suggests grounds for caution.

This has become quite a long post, so to summarise.

Just as I thought the early gloom about the Australian economy was misplaced, now I am cautious about some of the optimism. Australia is still well placed, that hasn't changed, but I do think that there are some risks and downsides that we now need to factor into our thinking.         

A Stubborn Mule's view of the world

That week I mentioned in my last post proved to be a very long week indeed.

My old friend and colleague Noric Dilanchian kindly pointed me to a Stubborn Mule's Perspective. The writer works in the financial markets in Sydney and is something of a statistical fanatic - a believer in graphs.

I stand somewhat in awe of his statistical skills. Like me, he is interested in patterns. Like me, he likes to test things. However, his statistical skills allow him to do things that I cannot.

Slow posting

My apologies for the absence of posts - other pressures. It will be another week before posting resumes.

Understanding global economic developments - introduction

This has been a remarkable few days.

On Tuesday 2 June the ABS released remarkably good balance of payments statistics suggesting that Australia's March quarter results would add 2.2% to growth for the quarter. The following day ABS released national account figures estimating that Australia's GDP had increased by 0.4% in the March quarter.

It is probably fair to say that the results took people a little by surprise. Coming on top of some other good stats, commentary was very positive. Then today the ABS released stats suggesting that Australia's balance of trade in goods and services in seasonally adjusted terms for April was negative $A91m, a turnaround of $A2,393m on a revised surplus in March 2009. With some other bad data, we had a sharp switch from positive to negative commentary.

Exactly the same thing type of thing happened in the run up to the release of the December national accounts. Some bad news led to negative commentary, then good trade figures reversed this, only to see negativity return when the national accounts showed negative growth. Mood swings have been so swift that positive and negative commentary over-lapped depending on print lags.

I am as prone as anyone else to be affected by changing data and the commentary on that data. I find that it has begun to create a fog in my mind, with the short term crowding out longer term trends and issues.

Looking back over the posts I have written over the last year or so, I don't think that I would vary much of my analysis in light of current events. I certainly wouldn't vary my analysis of underlying changes in management, public policy and public administration, nor my analysis of shifts in global structures that constitute shifts in global economic tectonic plates.

Over the last week or so in gaps in other things, I have been jotting down notes for some posts that might pull together some of this writing. A key aim is, like so much of my writing, to assist me to stand back from the current fog so that I can increase and test my own understanding of events.

I hope to publish the first post tomorrow. 

Turnbull soars then crashes

I have just listened to Australian opposition leader Turnbull's response to the latest Rudd Government budget. I insisted youngest listen with me. She is not a coalition supporter. 

The first half of Mr Turnbull's speech  was frankly magnificent. Sharp, incisive, some new ideas combined with critical analysis. Youngest was saying that this was the best speech by a politician she had seen. She also commented in the growing discomfort in the body language of ALP members. Then he (Mr Turnbull) lost it.

The dividing line came in Mr Turnbull's remarks on the medicare levy.

The proposal to oppose the Government's change in the rebate and instead compensate by increasing taxes on cigarettes may or may be right. After all, I am a smoker. But what was meant to be an example of an alternative view became instead the end of substance. From this point, rhetoric ruled.

What a missed opportunity. If Mr Turnbull had continued with the same analytical approach mixed with human example, he would have carried the day. In some ways, it would not have mattered what he said. If he had announced cuts, explained problems, presented choices, people may have disagreed , but they would have respected him. And in the lead up to the next election, that's really what counts.

Instead, this all vanished. He let the Government off the hook. He became another polly. I have never seen such a clear case of defeat snatched from the mouth of victory.     

Australian Budget 2009

Last night I listened to the Australian Treasurer's budget speech and to the initial commentary. At the end I was not much clearer than I was at the beginning.

When I first started listening to budget speeches they were on radio and ran for several hours. The speech itself contained the information you need to understand the budget. This is no longer the case. The information content is now very low, packaged for TV. You have to wait for the analysis from those in the budget lock-up or those who have time who have time to download and read the full papers. Alternatively, you can try to access the budget papers on-line once the speech is finished.

Those who are interested can find all the budget papers here. So many people wanted to access them last night that it was almost impossible to get through. One just had to sit and wait. I finally gave up and went to bed. 

It is now quite early. Traffic is less. I can get onto the site, but I don't have a lot of time.

The first point to note in the midst of all the hype is that it is projected revenues, not actual revenues, that have declined so sharply. Revenue is projected to decline from 303.7 billion in 07-08 to 290.6 billion in 09-10. That's a substantial decline, but nowhere as scary as the headline numbers based on previously projected revenue.

On the expenditure side, expenditure is projected to rise from 280.1 billion in 07-06 (24.8% of GDP) to $375 billion in 12-13 (27% of GDP), with a fiscal (accrual) deficit in that year of 30.3 billion.  Now this actually is a bit scary. By then, the economy is going to be expanding quite rapidly, so the policy focus will have to shift in the opposite direction towards reducing the budget stimulus effects.

I have written quite often about the difficulties most Governments face in quickly expanding capital spending because of the nature of the lags involved. Because of the nature of those lags, I suggested that capital spend in many countries was likely to be slower than projected and then to bunch together at a time economies had in fact begun to turn up. The risk as I saw it was that this plus washing liquidity might then force contractionary measures including rising interest rates.

From a purely Australian perspective, I have argued that our export mix meant that we were likely to see upturn in advance of a number of developed economies. This needed to be taken into account in planning. In simple terms, the window we had to take advantage of expansionary measures was likely to be less.

I haven't looked yet at the economic assumptions underlying the budget. The reporting I have heard suggests sharp downturn, followed by sharp upturn.

My view all along, and I have had to grit my teeth on this one, is that the Australian downturn was likely to be more moderate than allowed for by the Government and many commentators, including some comments from Access Economics.

This remains my view. If I am in any way right, the big economic policy challenge in the not too far distant future is going to be the management of current spend to accommodate rising capital spend at a time when the economy is once again growing quite rapidly.

I will comment in more detail once I have time to read the budget papers properly.

Economic Outlook - Early May 2009

Another long delay in posting. I have just been too busy, but I do need to post because this blog is partly my journal of record.

In a short post yesterday on my personal blog, Mr Rudd's budget deficit, I expressed some concern about the forecast size of the Australian budget deficit, setting this in the context of some of my previous views. In this post, I want to stand back a little and just muse about future economic directions.

My main reading time - I call it train reading - is travelling to or from work. Just at present much of this has been focused on local history. I am trying to make real progress on my long held dream of writing a full history of Australia's New England.  This has been a personal target for a very long time, and I am beginning to feel that if I don't complete it now I never will.

In the midst of my local history I took a break to read Robert L Heilbroners' The Worldly Philosophers:The Lives, Times and Ideas of Great Economic Thinkers (Touchstone, New York, revised seventh edition, 1999). I enjoyed this book. He really writes well. But it also reminded me how much economics is a creature of its time.

One of my key points in thinking about Australian economic policy is a simple one. Australia is too small to affect the global economy in any real way. We can only mange our response to global changes. I am wondering a little if the Australian Government has this sufficiently in mind.

During the week an Australian economist, I think it was Barry Hughes but only saw the reference in passing, made the very sensible point that we should not conflate output and sales.

The savage downturn in global production means that inventories, stocks, have been falling. This could only go so far before production started to turn up to meet base demand. I think that this is now happening, hence the many references to green shoots. However, this does not mean that sales are or will increase. We may, and this is the link to Helbroner, simply move to a lower equilibrium level.

The various global stimulation measures are intended not just to ease the downturn, but also to prevent the lower equilibrium by increasing sales, thus starting a real recovery. Frankly, I am coming to fear that we would have been better off letting the downturn bite and then inflating. I say this because the size of the stimulus packages is likely to leave many Governments' greatly enfeebled. The risk is a return to the 1970s.

Since September the Australian economy has performed much as I expected, although both the loss of domestic confidence and the size of the global downturn has been greater than I expected.

I said from the beginning that the key thing that I was watching was Australia's international trading position.

Our balance of trade in goods and services went positive at just the time we needed. We needed this, among other things, to give Government greater room to move.

The value of our currency also declined as just the right time. I thought that this was silly and said so because it did not reflect the fundamentals. Still, it did help from a narrow domestic viewpoint. Since then the Oz dollar has appreciated, if more against the US dollar than the Trade Weighted Index. The second is important because it is a broader measure.

The balance of trade in goods and services for March actually showed a further strengthening.

I was trying to explain to a friend why this was important. Like the US, Australia was living above its means. This was reflected in low savings and a deficit on the current account.

You can see this in the attached graph from the Australian Bureau of Statistics. back in 2007 we were in deep deficit. Had this continued, the adjustment impact of the downturn on Australia would have been very harsh.

The change in performance since then has been quite remarkable. Yes, the mineral boom helped, and we are being affected as existing contracts near their end. But we still have a real buffer.

We have in fact done a fair bit better than I expected. One of my concerns was that Government stimulus measures would spin over into deficit on the trade account. So far we have avoided this, in part because of an increase on exports of agricultural products. In global terms, this is a very good performance.

Now look at the next graph. This shows volume retail sales expressed in trend terms on a quarterly basis. Remarkable, isn't it, given the global downturn? You wouldn't know from this graph that Australia was in quite a deep downturn. You can see why I was worried about the trade figures in the context of the stimulus measures.

What is likely to happen now?

I have an absolutely dreadful forecasting. Based on savings rates and asset prices I forecast the latest downturn two years before it happened! Still, what can we say?

My feeling is that the global recession is bottoming because of the production/inventory cycle. So we are then going to see an up-tick in purchases and production. What happens then depends upon other things.

There is a fair bit of surplus capacity around, so this upturn will not immediately translate into sustained growth. However, there is a lot of Government capital spend starting to come on line. This will push demand.

This is where my thinking gets very unclear. I need to think some more!         

Management Perspectives - most popular posts 5

It has been several months since L last looked at the most popular posts on this blog.

Among my last 100 visitors, the most popular posts have been:

• Australian Government's new stimulus package has been by far the most popular post, scoring no less than 44% of visits. This was also the most popular post in November when I did my last check.
• The Importance of Demography and Demographic Change - update again came number two.
• Number three was Common Management Problems Series 1 - managing up. Nice to know that this one is still getting hits.

There was then a considerable gap, followed by five equal posts:

• The Balance of Payments, Australia and the sub-prime crisis
• Recession and the importance of fixed costs
• Economic implications of the Australian Government's Nation Building package
• The economics of the Rudd Government's $A42 billion stimulus package
• On-ground effects of the Australian Government's stimulation packages - March 2009

Interesting that only one of the many management posts I have written has been in the top group.

More Australian economic statistics - home finance, retail sales and employment data

On 8 April the Australian Bureau of Statistics released estimates of Australian housing finance for February 2009. The value of dwelling commitments rose by 1.7% in trend terms, 1.3% seasonally adjusted.

There was a fall in finance for investment properties, but this was more than offset by a solid rise in finance for owner occupied housing.

The influence of the first home buyers grant was clearly evident in the numbers. In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments increased from 26.5% in January 2009 to 26.9% in February 2009, the highest proportion since the series commenced in 1991.

This fits with what I said in On-ground effects of the Australian Government's stimulation packages - March 2009, referring to the mini-boom in house prices at the lower end of the market.

An important feature of the statistics was a solid increase in the number of loans for both new construction and the purchase of newly constructed homes.

The graph from ABS shows the value of new dwelling commitments. The significant decline as the economy turned down in the first part of 2008 has been replaced by a clear upward trend.

This trend is likely to continue until the end of June when the extra home buyers grant comes to an end.

I did not comment on the February retail sales figures. These were released on 1 April and showed a drop of 2% in seasonally adjusted terms. This was to be expected after the big increase flowing from the stimulus package cash payments.

The ABS release included a fascinating graph that drew this out in a rather dramatic way.

The graph on the right shows retail sales. You can clearly see the big increase in December, with the effect then tailing away.

There is still debate in Australia about the value of the stimulus package because so much went into savings. To my mind, that is no bad thing.

Cheques from the next stimulus package are now in the mail, so to speak, with payments appearing in people's bank accounts. I don't expect this to have the same impact, in part because of the constant gloom reporting.

During the week the Australian Reserve Bank reduced the cash rate by a further 25 basis points to 3%. I had hoped that they would not.

Just at present reductions in official rates are not very effective because of a widening gap between the official rates and the banks' cost of funds, so official rate cuts are not necessarily passed on. Further, to my mind there is a strong case for greater stability in policy making. Governments including the Australian Government are a bit all over the place, driven by the latest data.

Finally on the statistics' front, the latest Australian employment statistics were released yesterday. As might have been expected, they showed some deterioration in employment conditions, with the unemployment rate in seasonally adjusted terms increasing from 5.2 to 5.7%. The participation rate remained the same, with a small increase in part time work more than offset by a fall in full time employment. 

I don't pay much attention to the monthly work force statistics because they are a lagging indicator. Certainly we still have some distance to go before we reach the levels set by the 1991 recession when unemployment peaked at over 10%.       

A further meander through recent economic developments April 09 - engineering construction, short term visitor movements

It is remarkably difficult at present to stand aside from the constant stream of comment and ever changing forecasts about the state of the economy. I try to adopt a longer term approach, but its quite hard.

I do wonder about the constantly updated national and international economic forecasts. Apart from anything else, there is always an optimism/pessimism problem. The forecasts have also become a factor in their own right because of the way they feed into expectations.

To start with a somewhat random update on the latest official statistics.

The value of Australian engineering construction activity for the December quarter 08 showed continued strong growth in both trend and seasonally adjusted terms, up more than 5% from the quarter before, well over 20% from the previous December quarter.

However, the value of work commenced in the December quarter at $A18.7 billion was down 17.5% from the September quarter 08.

The attached graph from the ABS shows trend estimates. You can see the way in which the long mining boom drove private sector activity. Now that has gone into reverse.

The thing to watch with these numbers is public sector activity.

Actions by Australian Governments to step up investment spend have still to flow through into increased activity. Government spend is up significantly in year on year terms - +24.3% in trend terms, just a little less than the private sector increase - but most of the measures are still in the final planning stages. There is likely to be a gap between the end of the private sector investment boom and further increases in Government activity.

The February statistics for short term overseas arrivals and departures were interesting. These figures are very variable, but do provide hints as ro activity.

In terms of arrivals, the side graph shows how short term visitor numbers have increased since October 2008 in both seasonally adjusted and trend terms and are now around the level they were in February 08.

Within the aggregate numbers, there have been very large falls in the number of Japanese and Korean visitors, about what you would expect given the economic position in both countries. However, these have been offset by a range of smaller increases including Chinese visitors.

The position is very different if we look at short term departures from Australia. If you look at the ABS graph here, you can see the drop in numbers over the second half of 2008. More Australians have chosen to stay at home.

In combination, there has been a fall in international movements. This is generally attributed to the international downturn. However, the numbers suggest that it is as much Australians' reaction to the downturn, rather than the downturn itself that, that has caused the fall.      

I am out of time this morning. I will continue my meander in my next post.