MacroBusiness would like to doff its hat to Warwick McKibbin. The current and soon to be former RBA member has embraced the spirit of the Trickster and thrown a big spanner into the works in Canberra’s bull factory. We don’t agree with everything Dr McKibbin has to say, and on some things he doesn’t say enough. But the general thrust of his critique is right and the spirit in which it has been delivered, the Harvard educated turned rogue, could have come from the bowels of our own conviction.
By coming out, as he has done, against the endless growth mantra that drones from Canberra like some dying bureaucratic foghorn, McKibbin has created a counterweight. He has established a credible benchmark against which Canberra can now be judged. At a stroke, McKibbin has removed the defense that was used by every failed economist after the GFC, that nobody else saw it coming either.
Dr McKibbin, please accept this endorsement from those who operate under the banner of Reynard.
Here, in parsing, is his thesis, courtesy of Michael Stutchbury today:
Australia performed so well during the crisis largely because of reignited Chinese demand for our resource exports rather than Canberra’s wasteful budget stimulus. And now the Reserve Bank’s commodity price index has jumped 54 per cent in the past year to be 12 per cent above its pre-crisis peak.
This includes an 82 per cent surge in prices for bulk mining commodities such as iron ore and coal. This has spread over the summer to rural commodities including wheat (up 81 per cent on the year) and cotton (up 165 per cent). And it has extended to the surge in oil prices to more than $US100 a barrel.
The commodity price surge is mostly traced to strong demand from China and other big emerging markets combined with extreme weather disruptions such as the Australian floods and a Russian drought. The food price spike is blamed for igniting the political revolution in North Africa and the Middle East that, in turn, has pumped up oil prices.
But McKibbin warns there’s more to it than just a sharp jump in the price of the mining, energy and rural commodities we export. Rather than just a “relative price shock” generated by Chinese demand for raw materials, we’re also facing a generalised global inflation shock fed by loose US monetary policy. Commodity prices have responded first because they are more flexible. But they threaten to feed into generalised inflation through higher food, steel and energy prices.
Remember that the US housing price bubble and hence the financial crisis itself was born out of the US Federal Reserve’s low interest rate policy following the bursting of the Wall Street technology bubble in the early 2000s.
Now the US, much of Europe and Japan are running official interest rates close to zero to try to revive their economies out of the financial crisis. The Fed has employed a second round of “quantitative easing”; essentially printing money.
But this cheap liquidity is feeding into emerging markets, attracted in part by their higher interest rates. As part of the Washington-Beijing currency war, China is resisting US pressure to allow its exchange rate to strengthen. By effectively pegging the renminbi to the dollar, China is importing an ultra-loose American monetary policy that is feeding into asset prices such as for Asian property prices, commodity prices and generalised inflation.
“That is why inflation is taking off all over the world,” McKibbin says. “Over the next six months you are going to get so many surprises on the inflation numbers.” In Britain, for example, consumer price inflation has risen to 4 per cent even amid the biggest budget crunch in generations.
The Americans play down the threat because they’re still burdened by excess capacity and 9 per cent unemployment. Until recently they’ve been more worried about deflation or falling prices. But commodity prices are set in strengthening global markets, not in the weak US economy. And the US itself commands a much smaller share of the global economy these days.
McKibbin sees this as “70-72 all over again”, or a re-run of the collapse of the Bretton Woods system of fixed exchange rates when the US ran a loose money policy to help finance its Vietnam war and its “Great Society” welfare spending. The result was the 1970s global stagflation of high inflation and high unemployment that was inflamed in Australia by Whitlam government spending and union wage demands.
Today, some Americans will welcome the return of inflation to monetise away their public debt explosion. Higher prices growth means “real” interest rates can fall even as nominal interest rates are stuck at their zero lower bound.
However, the risk for Australia is that a substantial part of the income gains from our highest terms of trade for at least 140 years could be dissipated in a global resurgence of inflation.
McKibbin warns our export prices are likely to fall as the global expansion of mining capacity catches up with Chinese demand and as the commodity bubble pops. At the same time, rising global inflation would push up import prices, push down the dollar, feed domestic cost-of-living pressures and challenge the Reserve Bank’s 2-3 per cent inflation target amid an ongoing mining investment boom. Our terms of trade could reverse sharply as export prices fall and import prices rise.
And rising global interest rates in response to higher inflation would hit credit-inflated asset prices that are yet to fully correct, perhaps including Australian house prices. “As interest rates go up, a whole bunch of assets and balance sheets get crunched, so I am not optimistic it will work out well,” McKibbin says.
If that happens, Australia will wish that both the Howard-Costello and Rudd-Gillard governments had saved some of our terms of trade bounty into a budget reserve fund, partly invested offshore as a hedge against our terms of trade bubble. Australia similarly will regret Julia Gillard’s job market re-regulation, which will make it harder for the Reserve Bank to keep the new global inflation shock at bay.