Interest rate discussion over the past week has been fascinating. Behind the media smoke, bullhawkian economists and commentators have capitulated on aggressive interest rate rises. Most have retreated behind the fallback position of a stalled RBA, in which rate rises are still coming, but later than thought. On the other hand, of course, we’ve seen Bill Evans make a great call on rate cuts resulting from a deterioration in Europe.
My position is closer to that of Bill Evans. I don’t know when Europe will implode, but barring some sudden political breakthrough of epic proportion, it will happen.
However, the main reason I support Bill Evans medium term call is different. No other mainstream economist has acknowledged (implicitly in his references to deleveraging) one simple truth, that Australia is experiencing not one, but two major economic adjustments simultaneously.
The first adjustment we all know about. It’s the mining boom. As we’ve been told ad nauseum, economic resources such as labour need to be freed up so that this boom can unfold without becoming inflationary.
The second, however, is our secret shame. It is the adjustment of bringing the value of our private debt load and the bloated house prices that it services, back into some reasonable proportion with the economy.
That this second adjustment is every bit as real as the mining boom is in no doubt. Take a look around you. The world is in the throws of an historic shift away from the public and private debt stocks accumulated by Western economies over the past thirty years. Global markets now seek the assets of debt-conservative nations. The forces that pushed the rise of the debt mountain of the past three decades were global – integrating capital markets, derivative innovation enabling cross-border capital flows, global banks and synchronising national data – are the same that now target short sales in bonds, seek balanced budgets and expect defaults.
The policemen of this system remain the same too. Ratings agencies, horribly flawed, continue to ply their trade, their fast and loose AAA rubber stamps replaced with nasty debt detectors and a quick revolver.
There is no value judegement in this. It just IS.
For Australia this has meant a profound change to the way in which the economy is funded. No longer can or do the major banks endlessly expand lending with cheap and easy funds from offshore:
Yes, that’s sideways since the GFC. Both the RBA and the rating agencies have effectively ruled out further expansion of this borrowing, without downgrade risk
Instead, services sector debt expands only through internal funding:
An impressive transformation, certainly. But, it’s not a one for one swap is it? As impressive as the growth of those deposits has been, that money is drawn out of the economy, not thrown into it, as used to happen with foreign borrowings.
Now, of course, the high investment and incomes from the mining boom are enabling this process to happen. And the deposits are loaned back out, just as the capital borrowed from offshore used to be.
But this is still a profound change and means, surely, that the Australian economic pie cannot grow like it used to.
I acknowledge that this analysis is far from exhaustive, and frankly, it’ll take an economist of greater technical prowess than I to explain how these dynamics work. The point I wish make today, however, is that there are structural forces at work that used to boost Australian’s spending on everything from houses to restaurants. Now, those same structural forces work in reverse and debt can only grow through deposits.
All of the economists of the old economy continue to see a consumer ready to spring back to life and shower retail and housing with largesse. Perhaps it’s possible. But none of these economists acknowledges that in taking that position, they’re effectively arguing for a seamless transition from an externally funded bubble to an internally funded one.
It’s possible. Internally funded bubbles do happen. Look at China.
But right now the evidence is very much the opposite. Instead of a resuming a bubble, we have an economy desperately rebuilding its savings because it sees little choice. Whether it’s the systemic global debt crunch or it’s the RBA, exuberance is so yesterday.
But if that’s true, then it seems to me that the Australian economy in total has only one speed available to it – slow.
