Glenn Stevens macrobated

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.

Comments

  1. I reckon they take Bill evans advice and drop rates by 1%.
    Maybe 2% for good measure.

  2. Funny how this was Treasury’s view on mining – “Treasury secretary Ken Henry has challenged the belief that Australia’s mining industry saved the nation’s economy during the GFC, – from The Australian and others reporting his speech in Canberra”.

    Ken is now Julia’s financial adviser.

  3. The innocent bystanders in all this are the non-mining exporters. Well run businesses that never racked up huge debts and were globally competitive at 70c, but are losing money hand over fist at $1.10.

    In a sense, those who borrowed too heavily pre-GFC are getting what they deserve. I don’t think non-mining exporters deserve to be wiped out, and I don’t think it serves Australia’s long term interests for the tradeable economy to become a one-trick pony.

  4. Well, firstly, I agree with every you have said. Secondly, kudos to all at MB, I have no doubt this is a widely read (and indeed macrobated) site, consistently interesting and informative – and opinionated, which I like. I have noticed the word ‘calamity’ has crept into the popular economic lexicon of late and I am sure I read it here first. Influence can be exponential…

    Perhaps time for an article based on the MB vision of the near to medium term outcome for Australia, given subdued consumers, stagnant asset prices, high debt and strong AUD…oh and mining. Nonetheless, have a drink on me! Great blog.

  5. if households had been undergoing these shifts in saving and spending decisions without the big rise in income that is occurring

    I would argue that the vast majority of households are undergoing these shifts without a big rise in income.

    The big rises in income are very narrowly focused in the mining sector, the income is not flowing through to the wider economy.

    Stevens is pushing the Gittins! argument which is plainly wrong.

    • And to state the bleeding obvious:

      Surely the purpose of economic policy is to raise living standards of households. If the household sector is as depressed as it appears to be then clearly the RBA’s economic policy has failed. Utterly failed.

      Is the new mandate of RBA is to make mining companies rich while crushing households? If so, I would suggest its time for a revolution!

    • “Stevens has basically said that without mining, we’d be stuffed.”

      I read this bit. Smiled. Thought of 3d1k and The Lorax. Smiled again.

  6. Headline on TheAustralian website:

    “Consumer spending may lift soon: RBA”

    Not quite sure that was the main point of the speech…

    • Carbon Bologny

      What a bunch of intellectually bankrupt people in the MSM!!

      Well done again MB – you guys are making a huge difference in this country IMO!!

    • “Glenn Stevens has delivered a perfectly timed spank to the intellectually and morally bare MSM.
      .
      Fixed it. There is more than intellectual deficiency here. Those RE and bank ads certainly paid off a lot of MSM pundits.

  7. “Stevens has basically said that without mining, we’d be stuffed.”

    Would we? Really?

    Is it not inconceivable we might have carried on in our merry way, experiencing slow, broad-based growth, being able to afford our houses, having a competitive exchange rate, manageable debt burdens?

    Perhaps with mining we’ll end up being “royally stuffed”?

    • Thank you Ben. Finally someone else questions the premise that mining saved Australia.

  8. “However, so long as the RBA and others continue to pussy foot around the great credit bubble…”

    I think they are pussy footing because they are worried about a disturbing ticking sound coming from the economy.

    If the mining boom is the main thing preventing the household credit bubble ending in tears don’t expect the RBA to arguing for any moderation in the speed of the new resource project pipeline.

    Dutch disease/Mining Boom is a neat distraction from the credit boom of 1995 – 2005.

  9. Yeah I agree… Stevens’ speech was suprisingly good and completely unlike anything that has come out of the RBA previous to this. But I think you might be giving them too much credit when you say they made a choice to allow the build up of debt.

    As he says, from the early 90’s onward, nominal interests rates were historically low. They were low because inflation expectations were low, which were low because central banks were following a strict regime of low and stable inflation to the exclusion of all else. If you couple that with changes in intermediation which increased the availability of credit, you get a recipe for a credit binge which the central bank was powerless to stop.

    His point about the lack of productivity growth over the last 10-15 years was spot on as well.

  10. Spending at the asx3k household is muted. Saving nearly 50% of our take home pay. That’s the cost of expensive real estate for you.

  11. I re-read the Stevens speech, and now I’m really cranky.

    Glenn says…

    the current divergent trends between income and consumption spending are no more sustainable than the previous trends ultimately were. At some point, the two lines are likely to stop moving apart.

    Glenn goes on to suggest that the divergence will end when people feel comfortable about their level of savings, and spending will return to trend.

    This is complete and utter bullshit.

    People are saving because things are grim, and getting grimmer. They work at businesses where margins have been crunched, many of their co-workers are working part time, and they know layoffs are imminent. Many are carrying huge debts from the pre-GFC days, which they are desperately trying to pay down before their incomes decline or vanish.

    The growth in incomes is illusory because its only happening in mining and related sectors, where incomes are growing very rapidly. In many sectors, incomes are already falling.

    Glenn is right about one thing. The lines will stop moving apart, and that will happen by incomes flat-lining.

    • Pretty much agree with you on most of your points, but the income in mining is probably very good in certain professions, but I chose two open mining positions as I know the salaries for these types of role.

      For (Role 1), 80K was the going rate in Melbourne around 1996.

      Then (Role 2) was a similar rate in 1996 as well.

      So of the small sample of jobs I’m familiar with, the salary/rate is not what I would have expected given it was about 14/15 years ago when I last looked at this type of role.

      This might just show one of the points you raised that salaries are at a standstill or inflation rated are less (that what it says to me).

      I don’t know anyone working who is doing it easy these days, and as I’ve said before I save as much as I can, and I’m trying to cover bills which keep rising in the face of me switching most things off, and living as modestly as I can.

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      • Adrian, sorry but welcome to the real world of big mining projects!

        Driving commuter bus ferrying employees around site, occasionally driving small truck delivery equipment – met a young woman on the weekend – grosses close to $4000 per week.

        Crane drivers on construction rates, major projects, routinely net $3500 per week.

        Riggers and trades generally netting around $2000-3100pw, salary.

        Safety superintendents, usually a package $250,000+ (trust me some of these guys do only have Tafe Certificate quals).

        Those engineering jobs you mention would not inspire a single applicant (poss a first year grad) – no engineer I know is working on a major project at those rates, generally $170,000+ – if it’s gas, fabulous bonuses on first gas, even construction PIP around minimum $25K+ (bonus on top of salary).

        Those salaries would be lucky to entice a PA.

        But this is Perth. And there’s a boom going on.

        • I was reading the comms engineer job spec thinking the same thing – how will they get a degree qualified, 5 year+ experienced comms engineer in Perth for under $100/hour?

        • I really love these anecdotes on ming/construction wages.

          Just to add my own. Saw a recent ad on page 3 of the local paper.Scraper drivers,12 mths experience required,56hr week,$60/hr. Thats 150k + for what is esentially low skilled work and you dont have to live in the pilbera,these jobs are in a major coastal city.

  12. comrade stevens is about 8 years behind the interest rate curve…left rates to low in earlys 2000;s and then dropped them when the economy was cleansing and stopped it, which will lead to a worse cleansing later on or WW3.

    • +1…all this praise for Stevens makes me sick. The guys is clueless on what is occuring…he openly admits to creating a housing bubble by allowing credit growth to boom and then somehow thinks people are gonna start spending again because of our Terms of Trade???

      He is also totally oblvious to the housing affordability crisis and blindly uses Rismarks fudged 4-5 income-house price ratio that has been discredited by UE and Critical Influence Blog

      …just because he speaks with this annoying arrogance doesnt mean he isnt sh!ting himself right now.

  13. What was the RBA doing when the mountain of credit was growing during 1995 – 2005? Telling everyone there was nothing to fear because it was all secured by assets like houses and waxing philosophical about the lack of evidence supporting a policy of leaning against the wind.

    The lesson seems clear now. When inflation is low interest rates should be kept at a higher level than was done by the RBA during 1995 – 2000. Interest rates have a lower limit even in circumstances of low inflation. When inflation is low interest rates should be kept at a level that maintains a degree of balance between levels of credit growth and savings.

    Household debts is now about 160% of gdp – perhaps in future the RBA might have regard to that when setting interest rates rather than waiting until the horse has bolted.

    Hopefully the RBA have learnt at least one lesson from the last 20 years. Slashing interest rates now – even if inflation remains under control – is not the answer.

    It time that we got used to a lower bound on the cost of credit.

  14. A few short years ago, the RBA looked like the world’s smartest, speaking out about how housing supply restrictions needed to be relaxed to take the pressure out of the growing bubble.

    What went wrong?

    Somewhere along the line the RBA succumbed to a relapse of galloping Central Banker Hubris, claiming that they COULD handle the housing bubble with their one tool, the base interest rate.

    This is WRONG, WRONG, WRONG. I hope the world has learned its lesson. OECD Reports are starting to become a bit more definite on this point now.

    Sorry I lack time to provide references for what I say here. But it is the truth.

  15. HnH nails it here…

    “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.”

    For Glenn Stevens to note the rapid price growth in houses and not question whether this was a good thing in terms of sustainable prosperity is typicall of a central bankers.

    Hasnt he seen what Bernanke looks like now…a total stooge who was trying to calm the markets even in the face of economic calamity.

    The RBA has caused this – and Australia is now on the brink of a massive credit hangover.

    For people to suggest GS has done well is insanity…its like saying Greenspan did well in 2006 – now is the time we will see whether Batelino, Ellis and the Guv were talking rubbish for the past 5 years.

    I bet you they are all disgraced by the end of 2012