Well, so much for being the lunatic fringe.
The Governor of the Reserve Bank of Australia has delivered a seminal speech on the Australain consumer this afternoon and regular readers can pretty much throw it away. They have read it here for the past six months. Glenn Stevens has been “macrobated” (that is, converted to, or agrees with, the views of MB).
That’s not to say that I agree with everything the good Governor had to say this afternoon. No indeed, and we will come to that. But in the broad brushstroke, as well as much of the detail of his description the cautious consumer, the reasons behind changes in consumption, and the general macroeconomic settings that the consumer confronts, Glenn Stevens (and MB) should be congratulated for clarity of thought.
So, onto the speech. Stevens began by exploring where consumer caution may be emanting from:
Yet it seems we are, at the moment, mostly unhappy. Measures of confidence are down and there is an evident sense of caution among households and firms. It seems to have intensified over the past few months.
There are a number of potential factors to which we can appeal for an explanation of these recent trends. The natural disasters in the summer clearly had an effect on confidence, for example. Interest rates, or intense speculation about how they might change, are said to have had an impact on confidence – even after a period of more than a year in which the cash rate has changed only once, the most stable outcome for five years. Increasingly bitter political debates over various issues are said by some to have played a role as well. The global outlook does seem more clouded due to the events in Europe and the United States. We could note, on the other hand, that the Chinese slowdown we have all been anticipating seems to be relatively mild so far – that country has continued to expand at a pretty solid pace as measured by the most recent data. But these days, mention of the Chinese expansion reminds people that the emergence of China is changing the shape of the global economy and of the Australian economy. And structural change is something people rarely find comfortable in the short term, even though a capacity to adapt is a characteristic displayed by the most successful economies.
So the description of consumers as ‘cautious’ has become commonplace. It is not one I disagree with. Indeed the RBA has made such references on numerous occasions over the past couple of years.
Nor do I wish to dismiss any of the concerns that people have. People want to make sense of the disparate information that is coming at them.
I want to suggest that to do that – to make sense of it all – it is worth trying to develop a longer-run perspective, particularly in the area of household income, spending, and saving. That is my task today.
We have here the beginning of my main objection to this speech. Stevens’ list of possible dampening influences upon the consumer is fair enough. But look for moment at his representation of the RBA’s role in current confidence levels. The idea that “interest rates, or intense speculation about how they might change, are said to have had an impact on confidence” is surely deliberately obtuse. This notion is reinforced when Stevens goes on to hint at surprise that consumer remain cautious “even after a period of more than a year in which the cash rate has changed only once, the most stable outcome for five years”. Stevens knows full well that the RBA has been furiously jawboning about regular and imminent rate rises.
The RBA has a habit of discounting its own role in the management and setting of interest rates. It sees itself as the blind, deaf and dumb applicator of its charter. But that is not really true in my view and it leads to a couple of perverse outcomes that I will come back to at the end.
Next, Glenn Stevens moves to explore his version of what is really driving consumer caution:
I would argue that the broad story was as follows. The period from the early 1990s to the mid 2000s was characterised by a drawn-out, but one-time, adjustment to a set of powerful forces. Households started the period with relatively little leverage, in large part a legacy of the effect of very high nominal interest rates in the long period of high inflation. But then, inflation and interest rates came down to generational lows. Financial liberalisation and innovation increased the availability of credit. And reasonably stable economic conditions – part of the so-called ‘great moderation’ internationally – made a certain higher degree of leverage seem safe. The result was a lengthy period of rising household leverage, rising housing prices, high levels of confidence, a strong sense of generally rising prosperity, declining saving from current income and strong growth in consumption.
I was not one of those who felt that this was bound to end in tears. But it was bound to end. Even if one holds a benign view of higher levels of household debt, at a certain point, people will have increased their leverage to its new equilibrium level (or, if you are a pessimist, beyond that point). At that stage, debt growth will slow to be more in line with income, the rate of saving from current income will rise to be more like historical norms, and the financial source of upward pressure on housing values will abate. (There may be other non-financial forces at work of course.)
It is never possible to predict with confidence just when this change will begin to occur, or what events might potentially trigger it. But an international financial crisis that envelops several major countries, which has excessive borrowing by households at its heart, and which is coupled with a major change in the global availability of credit, is an event that would be likely to prompt, if nothing else did, a reassessment by Australian households of the earlier trends. It would also prompt a re-evaluation by financial institutions of lending criteria. This is precisely what has occurred over recent years.
In short, as we’ve argued here at MB for months and months, it’s asset prices that done it. Now that asset prices can no longer rise on a tide of financial largesse, consumption will return to pre leverrage build-up levels of growth. No Dutch disease bogy of online invaders. No carbon tax drivel. Just the fact that houses ain’t going up, won’t be going up and the fact that we all feel that much poorer in consequence.
But note, again, how Stevens couches things. Again it is choices in the private sector – consumers and banks – that are determing the outcome here. Is there no role for the RBA? It’s like it wasn’t there as the great leverage build up transpired. It just arrived after the GFC, to watch and wonder, and make great speeches.
However, Stevens does give away the game a little when he says he was “not one of those who felt that this was bound to end in tears”. That’s a debate he’s referencing and, by extension, a choice that he and others at the bank have made. That choice was to allow the great debt build up, which so far has not ended in tears but still threatens to.
Stevens then turns his attention to the implications of this diagnoses of consumer caution:
What are the implications of these changes?
An important one is that, as I said at a previous Anika Foundation lunch two years ago, the role of the household sector in driving demand forward in the future won’t be the same as in the preceding period. The current economic expansion is, as we all know, characterised by a very large build-up in investment in the resources sector and expansionary flow-on effects of that to some, but not all, other sectors of the economy. It is certainly not characterised by very strong growth in areas like household consumption that had featured prominently in the preceding period.
That is partly because the change in the terms of trade, being a relative price shift, will itself occasion structural change in the economy: some sectors will grow and others will, relatively speaking, get smaller. That is particularly the case if the economy’s starting point is one that is not characterised by large-scale spare capacity.
But those pressures for structural change are also coinciding with changes in household behaviour that are associated with the longer-run financial cycles I have just talked about. Just as some sectors are having to cope with the effects of changes in relative prices – manifest to most of us in the form of a large rise in the exchange rate – some sectors are also seeing the impacts of a shift in household behaviour towards more conservatism after a long period of very confident behaviour.
It would be perfectly reasonable to argue that it is very difficult for everyone to cope with both these sets of changes together – not to mention other challenges that are in focus at the same time. However, if we were to think about how things might have otherwise unfolded – if households had been undergoing these shifts in saving and spending decisions without the big rise in income that is occurring, to which the terms of trade have contributed – it is very likely that we would have had a considerably more difficult period of adjustment.
And here we come to it. About as close as we’ll come to an admission of responsibility. Stevens has basically said that without mining, we’d be stuffed. I agree with this summation. But in couching things this way, Stevens is also acknowledging that the debt build-up might have been a great mistake, likely to culminate in a “difficult period of adjustment”. Economist speak for a calamity.
I don’t want to be harsh here. Glenn Stevens has delivered a perfectly timed spank to the intellectually bare MSM. Within reasonable limits for the number one cheerleader for the economy, has has delivered a bitter message to many parts of the economy that have had it easy for a long time. That’s how markets saw it too, raising the chances of more rate hikes a few basis points following the speech.
However, so long as the RBA and others continue to pussy foot around the great credit bubble, as if it’s some kind of benevolent uncle, as opposed to a huge risk that we me must constantly manage and factor into our macro analysis, then it faces two outcomes. First, we can’t actually get on with finding fair dinkum solutions. And second, ironically, the RBA itself risks the damn thing reinflating every time it pauses for breath.