Take a chill pill

My kingdom for a rational media. Today’s selection of economic commentary, from interest rates to the Budget and carbon taxes is so full of amphetamines that one is tempted to conclude that everyone is still high from last night’s Logies.

From the top, we have a piece from Alan Kohler that makes no economic sense:

The government’s ‘responsible’ strategy of returning the budget to surplus in 2012-13 is beginning to look irresponsible instead.

Getting from a near $50 billion deficit in 2011-12, which is what the leaks have been preparing us for in next week’s budget, to a surplus a year later would require a huge surge in growth and tax revenue over the next two years, which is not going to happen.

Treasurer Wayne Swan needs to dump the surplus promise as soon as possible; the alternative is either a nonsensical budget strategy or a damaging one, as spending is cut and taxes raised to meet a fabricated political target.

What’s changed is the currency. It is now virtually $US1.10 and there is a clear risk that it will go much higher over the next year or two, albeit with corrections along the way.

This represents a huge difference with the first leg of the mining boom between 2004 and 2007. Then, the average exchange rate was 78 US cents, which underpinned a $300 billion blowout in tax revenues versus budget forecasts.

…The Australian government should be planning for an exchange rate much higher than $US1.10 and that means lower GDP growth and less tax revenue.

In the circumstances, cutting spending and raising taxes to meet an artificial and unnecessary promise to report a surplus in 2012-13 would be incredibly irresponsible, especially at the same time as adding a carbon tax.

Can someone please explain to me how loosening the Budget will help here? All it will do is add to inflationary pressures and raise interest rates and the currency further.

Which brings us to Kohler’s stablemate and master of business hysteria, Robert Gottliebsen, who argues today that:

At the weekend the global chairman of Rio Tinto Jan du Plessis took up my theme in The Australian, declaring “I am not sure it is smart” to damage energy intensive exporters at a time when the rest of the world lead by China and the US does not appear prepared to move.

His declaration that it may not be “smart” was a clear understatement – it’s absolutely stupid. But the Rio chairman restrained his language because annoying the prime minister and her climate change minister may not in the best interests of Rio Tinto given that the company will survive the tax and is powering ahead with expansion. Du Plessis was really reflecting the widespread frustration of business.

… Most of the inefficient Australian manufacturers were swept aside years ago but the combination of a poorly constructed carbon tax, the higher dollar, bad industrial relations laws and the reluctance of young families to spend will prove lethal to many of those that have survived, which is increasing community nervousness in many sectors. And, on top of that, there is a danger of a big rise in minimum pay which will cause many restaurants and the like to axe staff in this environment.

For a start, Gotti led the charge against the RSPT, which would have saved much of the pain that these same manufacturers now face. Second, the carbon tax explicitly exempts trade exposed industries through rebates. Third, there is no danger of Australia getting ahead of the world on this issue. China is leading the world on energy-based carbon mitigation via diminished energy intensity. The US is lagging but is still using a lot of regulatory intervention, especially against dirty energy providers. Coal looks set to give was to gas in a major way. No, it hasn’t embraced a carbon price but so what? If it wants to diminish carbon output through much more expensive regulation, then that’s its choice. We don’t have to be so stupid.

Now, interest rates. Here we have a true surfeit of hysteria. First from Adam Carr:

While the RBA meeting this Tuesday (announcement at 1430) should, on paper a least, yield a rate rise, I suspect it won’t. It’s just too much of a mind shift for the RBA I reckon and even, perhaps, the broader market. I mean people talk as if the Australian economy was bordering on a recession – it’s a ‘two tier economy’, ‘the Australian dollar is crunching exports’ and things are ‘really tough outside of mining’. Even adverts that are run talk about how tough things are. I have never seen anything like it, truly remarkable stuff and totally detached from reality – unfortunately/fortunately there is not a lot of evidence to support these claims. As ridiculous as the debate has become though, it doesn’t mean it won’t weigh on the RBA board – it clearly has been which is why I think their fragile, eggshell minds will need time. Time to process these errors of thought, to slowly adapt and change.

Simply put, this is garbage. Go and read the Minutes on Monetary Policy Meeting. There is much more weakness than strength:

The extreme weather events across Queensland and elsewhere were complicating the interpretation of the economic data for the March quarter. While domestic demand appeared to be expanding at a solid pace, production in the quarter had been significantly affected by the natural disasters. In particular, liaison with the Queensland coal industry suggested that delays in removing water from the coal mines were leading to a slower recovery in coal production than had previously been expected.

The household sector continued to exhibit restraint in spending, with the household net saving ratio remaining around 10 per cent in the December quarter. Retail spending had recorded modest increases in the first two months of 2011, consistent with the staff’s liaison with retailers. Consumer sentiment had declined recently to be only modestly above long-run average levels. While there was considerable optimism among households about prospects for the broader economy, members noted that consumers were less positive about their own finances. Conditions in the housing market remained subdued, with housing prices down slightly over the first two months of the year and auction clearance rates a little below average. Consistent with this, growth in household credit had remained well below the average rate of recent years, and housing loan approvals had fallen in January and February. Residential building approvals had weakened in early 2011, with the fall concentrated in apartments, especially in Victoria, where there had been very strong growth in 2010.

The recent business indicators showed a somewhat mixed picture. Survey-based measures of current conditions were mostly around average, while forward-looking measures had picked up to be above average. Imports of capital goods had been trending up and business credit had risen in February, the first increase in nine months. Overall borrowing conditions remained tight, though liaison with larger businesses indicated that there had been some improvement in the availability of finance.

A strong pick-up in business investment remained the central element in the medium-term outlook. Members again discussed the very strong outlook for investment in the resources sector, particularly in gas. Members noted that a major challenge was whether the economy could accommodate the expected high rate of investment without undue pressure on costs. Outside the resources sector, growth in investment was expected to be relatively modest. The appreciation of the exchange rate was weighing on trade-exposed sectors such as tourism and manufacturing, and subdued consumer spending was affecting prospects for investment in the retail sector. In contrast, with office vacancy rates in the two largest cities projected to fall to quite low levels, a pick-up in commercial property construction was expected over the next couple of years from the current low levels.

Employment growth was estimated to have slowed from the rapid pace seen in the second half of 2010. The unemployment rate had, however, held steady at around 5 per cent, suggesting that the reported slowing in employment could be overstated. Forward-looking indicators pointed to a continuation of employment growth over the months ahead, but at a more moderate pace than seen last year.

There had been little new data on wages and inflation over the past month. Liaison with firms suggested that wage growth was increasing in mining-related industries and some skilled occupations, though pressures in the labour market had not become widespread. Recent data suggested that higher fruit, vegetable and petrol prices would significantly boost the CPI for the March quarter.

Slightly less high pitched analysis is available from Terry McCrann:

Interest rates are going up again. The Reserve Bank will make that very clear in its statement on Tuesday.

The first increase could come as early as next month.

Indeed, but for the surge in the value of the Australian dollar, the first increase could have – would have – come next Tuesday.

The dollar’s rise is like a rate increase as it reduces the price of imports and makes it tougher for local producers to put up prices.

Even so, arguably, the RBA should start raising rates next Tuesday as inflation is already above its target ceiling and we are on the threshold of the mother of all inflation-boosting resources booms.

Even with the impact of the strong dollar – the first “de facto” rate rise – the CPI (consumer price index) numbers showed last week that inflation had started to accelerate beyond the RBA’s comfort.

The “headline” increase in inflation was 1.6 per cent for the March quarter – a thumping 6.4 per cent annual rate and way above the RBA’s 3 per cent ceiling.

The RBA understands that was driven by special factors, especially the floods’ impact on food prices, but even the rise in petrol prices.

It is not going to raise rates to attack what are hopefully only temporary price rises.

It focuses on the “underlying” price rises; and it was those that rose by an higher-than-expected and worrying 0.85 per cent in the quarter. That’s 3.4 per cent annualised.

Again, the RBA could live with a temporary blip above 3 per cent. The trouble is, it is already clear this is more than that.

When you drill even deeper into the CPI numbers, the prices of too many things are starting to accelerate – despite the price-cutting impact of the strong dollar and the fact that consumers are saving more than they have done since the 1970s.

As I showed last week, the movements in the CPI were unsettlingly broad based and the RBA will definitely be tightening its finger on the trigger. However, you should bear in mind that:

…[the] CPI release was about three things. Housing and construction-related inflation. Oil-related inflation. And flood-related inflation. The RBA has said repeatedly that it will look through the last. The construction and utilities components of housing are competing directly with the boom sector for resources. But it is a chronic problem that is keeping the CPI base permanently higher rather than a sudden problem.  On oil, they can’t do much but will nonetheless see it as a generally inflationary force across everything. There is some offset, however, in the fact that because consumption is weak, petrol prices are also going to be deflationary. As we’ve illustrated several times, there is a very strong correlation between consumer confidence and oil prices.

None of these data points cast any further light on the central question of labour costs, which is the one that will be bothering the RBA most.

The Stevens RBA has been clear that it is most closely focussed on managing the medium term commodity boom, so the question you need to ask yourself  is: will they see it as necessary to further deflate the services economy now to offset the inflationary forces, such as they are, before more commodity investment pours in?

I other words, the RBA is not about to panic. It can wait until July for the June quarter CPI reading to see how the flood-related price rises are washing through. In the mean time, it will focus intently on forthcoming labour market releases, in the NAB survey and from the ABS. If it gets any sense of a broadening of wage pressures from these, it will hike earlier.

As for the string of rate rises McCrann sees in the second half, it’s way too early to call. Another rate rise by mid-year will add greater momentum to the housing slide, which is developing into a crash in Queensland and Perth. Without doubt, a series of rises would send the slide national, then employment will flatten out quickly. The RBA will be conscious of 30 year lows in borrowing by consumers.

We’re in an intense rebalancing. There will be winners and losers. Everyone should just calm down.

David Llewellyn-Smith

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.

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  1. Perhaps if people were not in debt up to their eyeballs on over priced houses with so many of our daily necessities rising massively (petrol, utilities, etc) there would be far less emotion & angst about each & every potential rate rise.

  2. Time and again the media, with few exceptions, has proven itself anything but rational.
    MSM today epitomises the ability to present information devoid of any sane critical analysis.
    It manages to do this by passing all its pronouncements through the filter of self-interest (on behalf of its masters – eg. media moghuls, RE lobby, interst-chasing banksters, etc).
    The place is awash with non-factual insights thanks to MSM and the gullible are confident that all is good in the economy.
    They are in for a surprise.

  3. If we’re gonna see 3 or 4 rate rises by Christmas, and a currency at $1.20 – $1.30, then the two-speed economy will go into hyperdrive.

    It will definitely be popcorn time for me. No point fighting this.

  4. Re: Kohler: I think he’s saying…

    a) There’s no way they’re going to get into surplus because of the rampant AUD and depreciation deductions, so they shouldn’t push too hard to reach an unattainable target.

    b) Slashing spending at this point will only hurt the non-mining sectors of the economy that are really hurting already (despite what Adam Carr might believe)

  5. InflatiionGuy

    In order for all the ‘hot’ money that are flowing in market are expecting more higher rate for sure, if they don’t get the higher rates that they are expecting to get wouldn’t they dump the A$ and that in turn will deflate our assets prices and that’s the last thing that RBA wants correct ?

  6. Why people still thing that currency valuations have anything to do with the underlying economy? Forex became the new derivative market and it’s purely based on speculation. Big USA speculators are making the biggest bet ever seen: bet against the rest of the world.

  7. CharlieChaplin

    I don’t understand why there has not been more of an outcry against Quantatative Easing. It’s so obviously fraudulent currency manipulation, I’m surprised that a currency war has not errupted. Why are governments particulalrly our own so docile about it all?

    • Deus Forex Machina

      Baffles me???

      The Japanese, Brazilians and the South Koreans have actually done or said something/anything aggressive about it…

      Martin Wolfw wrote some stuff on it last year as did your humble blogger here and in a previous spot.

      But the reality is that we seem to have a process of benign neglect because the Aussies float has always been a positive contributor when it was necessary. We are now seeing the other side of the coin.

      As for the docility of Governments question…can I say oxymoron 🙂

      • The benefits of floating the dollar are unquestioned in Australia. It has become gospel truth. To suggest intervening in the forex markets is economic heresy.

        Undoubtedly it was beneficial through much of the 1980s and 1990s, but today the AUD has become a plaything of the screen jockeys, with trade in the AUD far outweighing our share of the global economy. All this achieves is wild swings in the currency with overshoots on the upside (2008 and today) and downside (2009) which does nothing but make life extremely difficult for trade-exposed businesses.

        Time for a managed exchange rate anyone?

        • Deus Forex Machina

          Hey Lorax

          mmmmm…the australian in me says yes but the market guy in me says no thanks…the australian wins 🙂

          However – its been my hypothesis that currency systems don’t last forever and the move away from free floats and a hands off government/central bank approach won’t work indefinately…so as we are around 40 years since Bretton Woods broke down and closing in on 30 years since the Aussie floated it is time for that debate…or the building of mechanism to shock absorb the negative impacts of the AUD’s strength.

          The problem is we, our economy, are so wired into the global financial system and our institutions likewise that the difficulty arises in extracating us from the grip of the octopus…

          We don’t get the option of theoretising a solution which essentially requires a closed economic system (or which ignores the fact that some of the private actors, such as banks, that are required to make it work without a recession, won’t just find ways to make money for themselves).

          I think in time global central bankers and politicians might get more sick of currency volatility and then we might get somoething there but I doubt we’d go it alone at present.

          My two bobs worth anyway

          Cheers DFM

        • There’s zero chance of managed exchange rate anytime soon. It will only happen if (when?) there’s a crisis and we look back and think: Why the hell was the Aussie dollar at $1.10? Why did we allow our non-resource exporters to be destroyed because of our adherence to the free floating currency dogma?

          • Lorax

            Floating currencies and globalisation are proverbial dual-edged swords. And you’re right, taboo subjects when in polite discussion with economists and traders!

    • CharlieChaplin,

      “I don’t understand why there has not been more of an outcry against Quantatative Easing. It’s so obviously fraudulent currency manipulation, I’m surprised that a currency war has not errupted”

      There is a currency war going on thanks to China. The majority of this is because of China manipulating their currency.

    • One could argue that a fiat currency is worthless anyway, so what difference does “printing” another trillion really matter?

      I’d like to understand how a fiat currency can possibly dilute/lose value if there is no asset backing (eg. gold) – can anyone explain?

  8. The TD Securities inflation number and confirmation that manufacturing is in recession seems to have calmed people down a bit, but not before the Aussie raced through $1.10 for a while.

  9. Tks Lorax
    I’d vote for a managed float. Those who think the float has been good for Australia have never lived in rural areas. Second they ignore the level of Foreign Debt we have accumulated and third they ignore the degree to which our industries and resources (assets) have been sold off to foreign interests.
    It’s been a total disaster.
    I’d guess others here would have a better idea than I as to what other things have to be ‘managed’ to make it work. The first would be speculative flows and the second foreign purchases of assets through some mechanism. It would be a great topic for discussion.

    • A very good topic for discussion.

      For mind, the only condition that is a prerequisite of a stable economy is no controls on capital flows.

      That does not necessarily mean a free for all, as the concept free markets does not mean a free for all without any regulations (it never has).

      But can we trust the good people at the RBA to determine the market price of the AUD just have they have “managed” the market price of interest rates for the last 30 years?

  10. My wife and I have been travelling around Australia for eight years now. Just this year so far we have spent time in SE Queensland, travelled down through central NSW, spent time in NE Victoria, Albury-Wodonga, and are now back up on the NSW mid-North coast. Along the way, we wander through CBD’s, check out real estate windows (almost a full-time job) and go to local property auctions (we don’t own a house so, like so many on this site, are watching the market with morbid anticipation).
    Over the last two years or so, from Perth to Hervey Bay, we have seen decimated regional shopping centres and main streets full of “For Lease” signs, and been to property auctions at which I almost ended up feeling embarrassed for the auctioneer (this is a big ask, believe me). Additionally, we have observed visibly crumbling infrastructure – parks, footpaths, and public toilets trashed and in disrepair, shopping centres littered with trash and graffiti, public and commercial areas that desperately need new tiles, signs, coat of paint, replaced smashed windows, and the like. Road surfaces are abysmal and downright dangerous, particularly where trucks have either chosen, or been forced, to use regional roads that were never designed for such intensive use. In short, the country looks like a bomb hit it, and there is the appearance that the inhabitants have lost all interest in anything other than basic survival.
    I don’t know what Adam Carrs’ “reality” is, but this is the reality we have been seeing for some time now, and it certainly shows no signs of improving.
    Perhaps Adam should take a holiday around Australia and take a real “reality check”

    • Interesting comments Julius – I recently rode my BMW from Perth to Hervey Bay (albeit in just over a week), and got a similar impression.

      There’s a lot to the country outside of the CBD of the capitals, and where there are no mining industries, regional Australia is doing it tough.

      • In places where there is a mining sector (ie Perth), a lot of people are doing it tough *because* of the mining sector. We effectively have to pay a mining sector tax on every purchase we make, without having the salaries to back it up.

      • I call it the “Kebab Effect” Mr Q.

        i.e the higher cost of a kebab is due to the increased money supply coming from cashed-up miners and associated industries.

          • I was thinking of doing a Sale and Distributions of Chill pills,
            ‘out of a Philippines/[email protected]
            But it if, Australia starts taking 20 million a day..I would think that, unless the dollar rises(Au),I will have to put prices up to meet supply,demand.(next the world)
            This would raise the CPI basket and dictate rise in stress….?
            Come to think of it ,it’s self serving’ …thought I better not..chill instead ….cheers JR

  11. Over-loaded Selling ships,shouldn’t shorten
    the Anchor chain ,too an in-coming tide…
    Only takes a Rogue-Wave and their Adrift..

    cheers JR

  12. Surely Kohler has got it wrong about a $50bil deficit for 2011-12? Hasn’t he got his 10-11 and 11-12 figures mixed up? Everyone knows that the 10-11 deficit is going to be $50bil or more (after a forecast of $41bil). However, the 11-12 forecast in the last budget was a deficit of $13bil. If that is revised to $50bil in this budget, it’s a total outrage. We’d be totally screwed.