Yesterday’s “don’t worry, be happy” speech by Glenn Stevens (that’s how the ABC described it) has received rave reviews from property interests and a kind of perplexed acceptance from the wider media. That’s no surprise given the RBA bosses’ tone was so out of step with both the community and the developing economic environment, not to mention the bank itself. Stevens can’t be blamed for up-selling the Australian economy as the world lurches through another bout of international economic trouble. And the pointed way in Stevens went through Australia’s economic vulnerabilities rather suggests he had in mind international markets when he described how far Australian imbalances have improved since 2008. I assume too that given the tone of the speech was a near total backflip on the RBA’s two year campaign to suppress borrowing and consumption, that the bank sees all of the risks to the downside in both housing and consumption more generally and feels, therefore, that some confidence building jawboning is now order.
But, as I’ve argued for some time, if you want to make a dent on the skeptisism that plagues the Australian economy, you have to address it openly and honestly, not with rhetorical gestures. On this account the speech fell squarely into the category of Invisopower! That is, it blew smoke, not good argument. This, in the end, only makes informed folks look for the fire. Here’s what I mean:
But some observers – admittedly not the majority – still harbour concerns about the foundations of recent economic performance and question the basis for confidence about the future. There are several themes to these doubts, but the common element is that recent relative success owes a certain amount to things that will not continue – to luck – and that our luck may be about to turn.
Rapid growth in Chinese demand for resources, for example, has been of great benefit to date, but what if the Chinese economy suffers a serious downturn? Another potential concern is dwelling prices. Australia saw a large run up in dwelling prices and household borrowing until a few years ago. Some other countries that saw this subsequently suffered painful corrections and deep recessions, associated with very stressed banking systems. Can Australia escape the same outcome?
A further theme is the focus on the funding position of Australian financial institutions, insofar as they raise significant amounts of money offshore. Could this be a weakness, in the event that market sentiment turns? Actually, this is another version of the old concern about the current account deficit: what will happen if markets suddenly do not want to fund our deficit? It has long been a visceral fear among Australian officials and economists that global investors will suddenly take a dim view of us. The same sorts of concerns of organisations such as the International Monetary Fund and the ratings agencies seem to lie behind a perpetual question mark about Australia and its financial institutions.
It is unlikely we will ever be able to change definitively the views of all the sceptics. And – let us be clear – we should welcome the sceptics. Perhaps some of their concerns are valid. The Reserve Bank gives a lot of thought to these issues; we certainly do not dismiss them. We should always be wary of the conventional wisdom being too easily accepted. We should never, ever, assume that ‘it couldn’t happen here’.
There are a bunch of things going on here and I can’t address them all. But let’s do a point-by-point. On China, the doubts about Australia’s dependence are not about a crisis. Rather, they are associated with the Chinese shift in its economic model from fixed-asset investment driven growth to consumption driven growth, which will be much less commodity intensive. As Michael Pettis argues:
Now for the first time I think maybe the long-awaited Chinese rebalancing may have finally started.
Of course the process will not be easy. Debt levels have risen so quickly that unless many years of overinvestment are quickly reversed China will face debt problems, and maybe even a debt crisis. The sooner China starts the rebalancing process, in other words, the less painful it will be, but one way or the other it is going to be painful and there are many in China who are going to argue that the rebalancing process must be postponed. With China’s consumption share of GDP at barely more than half the global average, and with the highest investment rate in the world, rebalancing will require determined effort.
The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP. This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates.
But these measures will necessarily slow growth. The financial repression tax, especially, is both the major cause of China’s economic imbalance and the major source of China’s spectacular growth, even though in recent years much of this growth has been generated by unnecessary and wasted investment. Forcing up the real interest rate is the most important step Beijing can take to redress the domestic imbalances and to reduce wasteful spending.
I’ve no doubt that China can stimulate again in a crisis and make the reckoning of the imbalances described by Pettis ultimately worse. But until Glenn Stevens addresses the real problem instead of straw men, then I can see no reason at all why Australia should continue to pursue a greater commodity dependence.
On dwelling prices, Stevens’ straw man is straight from the property spruiker’s playbook, that affordability is back to 2002 levels and that median multiples are reasonable. This must come through gritted teeth and requires little exposition to debunk. Even R.P.Data laughs at the 4 x income multiple for house prices deployed by Stevens. And arguing that affordability is back to 2002 is a bit silly when 2002 was close to the plateau peak of unaffordability reached in 2003. Using such arguments only makes an informed audience cross their arms and furrow their brow.
Finally, there is the offshore borrowing vulnerability. On this, Stevens makes more sense. There has been good progress in reducing the banks’ dependence upon offshore borrowing. And again, in a crisis, I agree that renewed guarantees, as well as the RBA cash-for coconuts facility, would see us through. The manner in which Stevens sweeps aside the radical changes needed to keep the banks afloat in 2008 is unsettling but that’s not really his fault.
But the fact is, the same vulnerability remains if any persistent weakness hits the Australian economy. And that is the problem. In a world where persistent weakness is now the norm, Australian banks are still leveraged to the hilt on mortgage debt and the external borrowing will still bite if the economy suffers enduring weakness, especially if interest rates fall and capital outflow follows. The past few years of conservative borrowing and spending have succeeded in pushing us back from being priced for perfection but we’re still chock full’o’debt.
My last point is a simple rhetorical riposte. Stevens’ describes focus on Australia’s imbalances as “skepticism”. This is in itself a straw man. A skeptic is someone sitting outside a consensus view. But the Australian community accepts this “skepticism” now as the norm, in part because of useful skepticism on the part of the RBA. That is why it is saving its arse off in a structural adjustment. As a card carrying “skeptic” I don’t expect to get any kudos for helping bring this about, but I do hope that the RBA respects what has been created.
