Houses and holes forever!

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The press is full of condemnation of Wayne Swan’s preliminary Budget speech yesterday. Personally, it didn’t strike me as so awful. In parts, it was a pretty candid take on the conundrum facing the economy:

But this phase of the mining boom, mining boom mark II, will be very different to mining boom mark I, the boom my predecessor presided over in the middle years of last decade. Today I want to explain these differences because they matter greatly for our Budget.

First of all, mining boom mark II carries with it some of the legacies of the GFC. This is a feature of the economic landscape that obviously didn’t apply to mark I. As I touched on earlier, a striking indicator of this is the current caution that consumers are exercising.

Despite strong job creation and incomes growth, consumers are now saving much more of their income and borrowing a lot less. This is not surprising given what the global economy has come through, with the memory of the GFC and stock market falls still in the minds of many households. This is being reinforced by investor caution and what has been fairly subdued recovery in household wealth. This is a dramatic change relative to mark I, where strong consumption growth was accompanied by negative household savings rates, and rising indebtedness fuelled by rapidly rising asset prices. Of course, it’s clear that some of this growth was unsustainable, which explains why we’ve seen such a significant shift in behaviour under mark II.

Just consider trends in personal credit. It rose by almost 60 per cent in the four years preceding the crisis. Since then, it has fallen by more than 5 per cent. Growth in household consumption is expected to be almost a full percentage point lower over the budget forecast horizon than it was during mark I.

On top of this, tighter financial conditions since the crisis are also reducing growth prospects for business. Many small and medium-sized businesses are under pressure from greater borrowing costs and reduced access to credit. Annual growth in business credit has slowed from 14.5 per cent during the first boom, to negative 2.2 per cent so far under the current boom. Part of this also reflects the fact that businesses, like consumers, are taking the opportunity to consolidate their balance sheets. This is a natural response to recent events in the global economy and is not a bad thing – it helps to make our economy more resilient.

The strength of the exchange rate marks another important difference between the two mining booms. During mining boom mark I, the average level of the exchange rate was only 78 cents against the US dollar, compared to an average of 98 cents under the current boom. So the exchange rate, which is now hovering at record highs of around 105 cents, is having a much stronger drag on trade-exposed industries this time around. Sectors like tourism, education and manufacturing are all feeling the threat of international competition far more acutely.

There is now a much larger divergence between the performance of the mining and non-mining sectors of our patchwork economy. While corporate profits outside the resources sector grew solidly during the first boom, they have been very weak in the early stages of this boom. Over 2010, mining sector profits grew 59 per cent, while non‑mining profits fell slightly.

A similar story can be told for business investment. Mining investment intentions for the next year have, for the first time, outstripped private business investment plans for the rest of the economy. Think about that: if realised, it will account for more than half of total private business investment in the economy, despite representing less than one-tenth of total production.

All of these things are true and Swan is right to be cutting spending, even if it further encourages debt revulsion, as Delusional Economics argued yesterday. I agree with various commentators today who argue that the cuts won’t be large enough. We need to get into surplus, and start paying down government debt. It’s not because of politics or the throwaway label of “surplus obsession”, it’s because our private sector banks are implicitly guaranteed by the Budget.

When this cycle ends, probably with a China bust, the health of the Budget will be our number one defense against a gigantic and no-brainer short on the Australian banking system.

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But that, in turn, goes to a larger issue that covers both major Parties. What is lacking from this speech and from Andrew Robb’s reply goes back to what The Economist has observed over and again about Australia: we handle tough times well and good times badly. That is, there’s no overall strategy to manage the mining boom beyond a half-arsed effort to get out of the way. Andrew Robb would be no different, indeed can’t be. Swan butchered and Robb resisted the only policy that makes any sense in this circumstance: a beefed up resource rent tax.

Let me take you back a month or two to the Treasury modeling for the RSPT versus its maimed progeny, the MRRT:

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We have discovered since that this modeling had conservative terms of trade assumptions and the lost revenue is more likely to be in the range of $100 billion.

What effect would it have had?

  • It would have reduced some of the commodity investment at the margins
  • If invested offshore, it would have provided some actual relief to the currency through greater outward flows
  • More importantly, it would have signaled global markets that Australia was set to manage the boom and further deter currency inflows
  • By dampening both the boom and government spending, it would have kept interest rates lower, which in turn would have reduced the currency
  • It would have established a permanent stabilisation mechanism for our financial system

In short, some alternative economic equilibrium would have been struck where the two speeds of Australia’s economy ran closer together, the tradable goods sectors weren’t offered as virgin sacrifices to the mining dragon and, when it all ended, as it most certainly will, we had something left to our economy beyond houses and holes.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.