Hats off to McKibbin

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.


  1. “Australia performed so well during the crisis largely because of reignited Chinese demand for our resource exports rather than Canberra’s wasteful budget stimulus”

    Perhaps Warwick could move to Ireland so he can be closer to the now savagely trounced former national government that sensibly rejected fiscal stimulus in favour of austerity from the start, and immerse himself in the wreckage of a nation that has attempted to re-grow it’s economy by choking it.

    Of course the stimulus prevented a nasty recession from occurring here. Mining went backwards during the GFC and I was here in a resource town watching the job losses mount. In any case, mining is only a small part of the economy, hardly enough to save us from a severe downturn. Warwick might like to ponder why our “saviour” is currently running almost white-hot, yet the rest of the economy is rather tepid.

    “The Fed has employed a second round of “quantitative easing”; essentially printing money.”

    I was under the impression that no “printing money” is involved at all – merely a swap of one kind of financial asset for another – and that there has been no net creation of dollars.

    The hope is that by injecting huge excess reserves into the banking system, the banks will get back to lending full-steam again. The reality is that the banks aren’t going to lend much if prevailing conditions mean that they don’t see an army of credit worthy customers beating a path to their door.

    Something came from someone’s bowels alright, it was Sutchbury’s article.

  2. Lefty,

    I completely agree with your assessment that mining caused the recession, it didn’t prevent it.

    Still, one should acknowledge that the subsequent boom prevented an ongoing current account adjustment.

    On the effects of QE, I agree again. But I think you miss the real import of it.

    The $300 billion or so of asset swaps since December is like pissing into the ocean in terms of global markets that turn over FX alone of $US4 trillion. But still that markets act on it as a signal. A signal that the $US is going to devalue and therefore it does.

    How else do you explain that the inflationary effects of QE began as it was mooted, months before it began?

  3. I remember McKibbin was very early in calling a strong reboud in Asia. This was early 2009 IIRC. I was very skeptical at the time, but in hindsight Warwick was correct. Perhaps the reasons for the rebound (massive Chinese stimulus) will come back to bite us in the long term, but its certainly saved Australia from more serious downturn and a burst housing bubble.

    At least McKibben is talking about future risks for Australia (commodity bubble bursting, stagflation etc). Everyone else at the RBA and Treasury seems to think the only risk is that the resources boom will last forever.

  4. “In Britain, for example, consumer price inflation has risen to 4 per cent even amid the biggest budget crunch in generations.”

    If he thinks Britain is in for more inflation he really is going to be surprised. Once that massive austerity budget starts to bite and the economy start going down faster and faster.

  5. Alex Heyworth

    Rises in inflation in the UK are largely due to increases in government charges and energy prices. Nothing to do with global commodity markets.

  6. Just because someone has something negative to say doesn’t mean he should be congratulated.

    The stimulus was the major reason Australia avoided a recession. China’s stimulus helped, but people really do overrate the importance of the mining sector to Australia’s economy. Net exports contrubution to GDP again zero today. That’s basically 12 months worth of no contribution from net exports. So much for the mining sector driving growth!

    McKibbin also doesn’t understand the monetary system. QE is not printing money.

    I would argue that McKibbin is worse than the growth junkies

    • Can you please explain what QE is if it is not printing money or the market operations of a central bank?

  7. Add in a carbon tax and australia is going to bleed from every oriface. The buerocrats will NEVER cut spending without force, they live on taxes they produce nothing. Instead of cutting alot of government dept’s they will cause a depression instead.

  8. BK let me guess, you get fed from taxes am i right?? BK your going to end up on the bread line.

  9. The stimulus was not the saviour of the Aus economy post GFC. Nor, in fact, was the boom of our export commodity prices, of itself, the saviour of the economy although no doubt it helped.
    Just in numbers how much did the Govt get into the economy in the first 12 months post GFC compared the $100B that came in from overseas? However that is not the main point I want to make.

    We run continuous monstrous out-of-control (depending on how you see debt)CAD’s and have Gross foreign debt of more than 100% of GDP. So of any stimulus, given the structure of the Australian economy and the fact we run zero to negative after-tax real interest rates, a fair proportion will leak into the external account via imports.
    The govt was able to apply a stimulus because,
    1. The RBA was able to do a currency swap with the USA to the tune of some $50 odd Billion dollars. I’m sure someone closer to the stats in their every day job can give an immediate exact figure.
    2. As a result of the fact that we do have massive in-ground resources we are able to BORROW massively from external sources….and we did
    3. Furhter we indulged in, and continue to do so, a massive sell-off of our national assets. We have sold off nearly all secondary industry of any size, we sold off our in-ground mining resources not just the stuff we dug up. All commentators miss this very important point. Stephen Mayne estimates, from a company by company analysis of the shareholdings, foreign interests now own 80% of the listed mining companies on the ASX. This sell-off continues. We continue to sell off extensive areas of farmlands and cattle grazing land. We,long ago, sold off the rest of the food chain

    I remember Wayne Swan on a trip to the US proudly crowing that we had absorbed 10% of the world’s savings in the year post GFC. For a country with about 1.5% of world GDP this is one heck of a lot of borrowing. What a clown!

    Again, in a country running massive CAD’s and large foreign debt, you cannot apply a stimulus without further borrowing in the external account or a sell-off of your national assets, or some combination of both.
    Austrlia is just lucky to have had about the highest natural resources per head of population in the world. The sale of a large proportion of those ASSETS is what saved us from the worst of the GFC.

  10. “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”

    I thought Howard left about 60bn in the future fund (which Labor spent). If the conservatives were still in power surely the 60bn would now be much higher.

    I know this isn’t a political blog but putting Howard and Costello in the same sentence as Gillard/Rudd is just a bit rich.