The horns of a dilemma


Yesterday’s CPI number sent the Bullhawks (Carr, Joye, Bloxham) into the stratosphere. The leader of the group, Chris Joye, had the following to say on his blog:

Well, as predicted here more consistently and loudly than pretty much anywhere, Australia officially has a major inflation problem. And I mean “major”.

Underlying or core inflation has been running at more than a 3.5 per cent per annum pace over the last six months. That is more than one percentage point above the RBA’s implied 2.5 per cent per annum target, which just happens to be the highest inflation target in the developed world. (Remember, inflation is a tax on your savings).

As I have unwaveringly forecast–and reiterated only a week ago–we will get at least one to two rate hikes this year (in fact, we should in theory get three).

Forget rate cuts absent a total global meltdown. Anyone suggesting such refuses to accept our inflationary (and full employment) reality.

The currency market gets it, which is one reason why the Aussie dollar is currently trading at a near all-time high of 1.1035 US cents. Only a couple of weeks ago I flagged the risk of a surge in the Aussie dollar as foreign central banks seek to diversify into high-yielding Aussie government bonds.

August or September now loom as a near-certainty for the first RBA cash rate increase. And I reckon we will get another one before the year is out following which the RBA can probably sit pat.

This morning as well, Terry McCrann calls a hike, with this to say:


The inflation tiger is out of the bag and running, before we really get to the actual spending of the resources investment boom which is going to add so much stress to demand for skilled labour, and so wages and inflation.

…In his important speech on Tuesday — it’s important to understand, before he had any knowledge of yesterday’s inflation figures — Stevens argued that softening was achieving the necessary ‘making way’ in the non-resources economy for the resources boom.

But the clear inflation pressure means he can’t assume that will continue. China is pouring a tsunami of money into Australia. We could all too easily see inflation kicking up above 1 per cent a quarter as it did in 2008.

That brings us back to Gillard and Swan and their imposition of old-is-new again rigidities in our labour market and work practices; their pouring of billions into wasted or low-return projects like schools halls and the NBN.

I’m one of those that was taken a little by surprise by the vigor of yesterday’s CPI figure. Most surprising to me was how broad based the price rises were.

Nonetheless, it is still quite possible to mount good arguments as to why enough of the rises were temporary, and that the RBA can afford to wait. The banking charges highlighted by Bill Evans are temporary, the food price rises are clearly flood related and the RBA has said it will look through them. And the rises in at least some of the consumer goods such as clothing, shoes and booze can be seen as choppiness resulting from consumer caution and discounting churn.


Moreover, evidence is quickly mounting that the global economy is slowing quickly. To my mind, it is clear that the eurozone crisis is not resolved and that another, bigger bailout is going to be needed for Italy and Spain. Probably soon.

Also, last night the Federal Reserve Beige Book showed further slowing in the US economy, even without a US debt-ceiling debacle of some sort. And a slew of global companies are reporting a global slowdown is underway.

But. Equally, there is now no doubt that we have come to the witching hour for the RBA.


In September quarter 2008, the bank famously found itself behind the inflationary curve with the CPI jumping to 5%. They are on record saying that they will not allow that to happen again.

The RBA still has a bias to tighten and in its minutes last meeting suggested today’s CPI would figure strongly in its thoughts.

Earlier in the week, Glenn Stevens thumbed his nose at suggestions that consumer weakness means economic weakness and showed confidence in recent European developments. By doing so he paved the way for rate rises if needed.


And now, we have another CPI number running above the target band for the second straight quarter.

All things being equal, the RBA would raise rates Tuesday.

But they aren’t equal. As I wrote after the May rates decision, when bullhawks were demanding immediate hikes, the RBA is managing two adjustments, not one:


So, what the hell is this new paradigm anyway? It can be summed as follows.

As the ratings agencies have made abundantly clear, Australia can no longer prudently expand its offshore debt. That means the banking system cannot grow except through internal funding, which also means the mortgage system will struggle to grow. This much is on the record. I would go further. The RBA is engaged in a grand project of attempting to keep household debt from growing in the hope that through disleveraging(lowered credit growth rates) Australia can grow into its enormous debt and housing bubble. This has a long way to run. Based on GDP to March and March credit aggregates, Australia’s debt to GDP is at 153%, down from 170% in 07/08.

The RBA is also attempting to prevent household debt from growing for the other oft-stated reason, to make room for dramatically expanded resources investment.

In short, the RBA is having to manage two historic economic transformations simultaneously. One of them is potentially enormously deflationary, the other is potentially enormously inflationary. Pulled between these poles, the RBA may continue to lurch from one extreme to the other, at least in its jawboning.

The RBA is caught between unusually large forces. The services economy is very weak, a disorderly slide in house prices is a real concern and, as the commentaries of Mssrs Joye and McCrann show, the major concern for inflation at this stage is that we are early into a commodities boom with limited resources to accommodate it. Especially in labour.

I would say, rather, that the global cycle is in trouble, and that unemployment is a full percentage point above its 2008 low. As well, employment growth is now clearly stalled and the dollar is about to put a whole new batch of manufacturers out of business.


However, there is still one big danger. If I’m Joe Worker and I look around at my shitty stock returns, falling house price and rising food prices, I might I think I need a pay rise, and now.

The danger, then, is that inflation expectations rise and we enter a wage price spiral. To me, that makes the mid August Melbourne Institute Inflation Expectations Survey rather important.

As the Melbourne Institute diagnosed earlier in the week, the RBA is on the horns of a stagflationary “policy dilemma”.

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.