Find below Capt’ Glenn’s speech last night at CEDA. It joins the growing chorus of folks calling for a national productivity push to keep Australia’s prosperity in train. All good on that front. The Stevens RBA can hold its head up and say it’s been on that case from the outset, though its predecessor wasn’t.
The first half of the speech is the conventional line about how the Chinese slowdown isn’t bad. It’s really something the way ever-optimistic commentary seamlessly slides from nothing being a problem in the future to the problem we didn’t have being behind us, but that’s neither here nor there. That’s the RBA’s job.
The most interesting part of the speech is the middle where Stevens speculates about the trajectory of demand:
With the peak in the investment phase of the mining boom now coming into view, the question naturally arises as to how the balance between the various types of demand in the economy will unfold. Mining investment will contribute less to growth in domestic demand in the current fiscal year than it did last year, and less again next year. Working in the other direction, it is likely that export volume growth will begin to strengthen as the capacity being installed in the resource sector is used. That would show up as GDP growth, though it may be predominantly reflected as higher measured productivity rather than generating a large volume of extra employment.
Note he says mining will ‘contribute less growth’ to domestic demand not detract from growth. That is true for this fiscal year but not for 13/14 in my view. So that tells you that the RBA, although recognising the peak in mining investment is ahead, still sees the downside as slow. That’s fair enough at this stage. I’m more bearish because I think iron ore is done and LNG is going to rationalise but the numbers as of this moment don’t fully support that. Then Stevens addresses alternative growth sources:
The question will be whether other areas of domestic demand start to strengthen. Many households have made progress in reducing debt burdens. At some point that might be expected to lead to such households feeling more inclined to spend. But a complex interaction of factors – asset values and expectations about job security to mention two – will be at work in ways that are not amenable to accurate short-term forecasting. Overall, our assumption is that consumption will probably continue to grow at about trend pace, in line with income.
Public demand is scheduled to be subdued as governments seek to return budget positions to surplus. The near-term outlook for business investment spending outside the resources and resource-related sectors is subdued, judging by currently available leading indicators. In most cycles, it takes time for this sort of investment to turn; this episode looks like no exception. The exchange rate may also have some role in helping the needed re-balancing. While it’s not surprising that the Australian dollar has been very strong given the terms of trade event we have had, it is surprising that it has not declined much, at least so far, given that the terms of trade peaked more than a year ago. A lower exchange rate would, of course, need to be accompanied by a pace of growth of domestic unit costs below that seen for much of the past five years, in order to maintain low inflation.
These two paragraphs are critical. Put the following two sentences together:
…our assumption is that consumption will probably continue to grow at about trend pace, in line with income.
And:
A lower exchange rate would, of course, need to be accompanied by a pace of growth of domestic unit costs below that seen for much of the past five years, in order to maintain low inflation.
That does not add up. Trend income growth amid reduced wage costs. Nup.
Although Cap’t Glenn is putting a brave face on it, it’s no wonder the RBA thinks it have to cut interest rates further in the year ahead and that’s based upon an orderly wind down of mining investment:
Will the net effect of these developments mean that aggregate demand rises roughly in line with the economy’s supply potential over the next couple of years, or will a significant gap emerge? That is the question the Reserve Bank Board is trying to answer every month when it sits down to decide the stance of monetary policy.
As of the most recent meeting, as the minutes released earlier today show, the Board felt that further easing might be required over time. The Board was also conscious, though, that a significant easing of policy had already been put in place, the effects of which were still coming through and would be for a while. In addition, the latest inflation data, while not a major problem, were a bit on the high side, and the gloom internationally had lifted just a little. So it seemed prudent to sit still for the moment. Looking ahead, the question we will be asking is whether the current settings will appropriately foster conditions that will be consistent with our objectives – sustainable growth and inflation at 2–3 per cent.
The speech is a tacit admission that Australia’s glass is less full than thought last year. It is an admirable confession of the limitations of knowledge, a lesson we commentators never learn. Full speech below.
Producing Prosperity
Glenn Stevens
GovernorAddress to the Committee for Economic Development of Australia (CEDA) Annual Dinner
Melbourne – 20 November 2012Thank you for the invitation to join you for your Annual Dinner.
Financial markets and policymakers have been living in a more or less continual state of anxiety for over five years. While it was poor-quality lending in the US mortgage market that proved to be a key cause of problems, from quite early on it became apparent that European banks also had serious difficulties, because of their exposure to securities of doubtful quality, their high leverage and their need to fund US dollar portfolios on a short-term basis. It was in August 2007 that those acute funding difficulties first became apparent in European markets.
Five years on, US banks have made a lot of progress in working through their asset quality problems and their capital deficiencies. At times the process was not pretty, but the US system is in better shape today as a result. US taxpayers have earned a positive return on the investments in major banks that were made at the height of the crisis.
In Europe progress has been much slower. There are various reasons for that, not least the sheer complexity of coordinating the process of evaluating and strengthening balance sheets across so many countries, where the national capacities to assist are so different, and within the strictures of a currency union. This exacerbates, and in turn is compounded by, the deterioration in economic conditions in Europe, which feeds back to bank asset quality and sovereign creditworthiness.
It is perhaps no surprise then that the news seems to have been dominated by the ebb and flow of anxiety over things like: whether or not the ‘troika’ will recommend further funding for Greece; whether a national constitutional court will strike down a government’s participation in initiatives that will assist other countries; or whether the populace in a country under pressure will reach the end of its tolerance for ‘austerity’ – and so on. There is ‘event risk’ almost weekly. This is the European drama.
Unfortunately, it is, I suspect, set to continue that way for quite some time. Over recent months financial market sentiment has improved, from despair to mere gloom, as a result of a number of important steps that have been taken and commitments that have been made. It is right that this improvement in sentiment has occurred – it recognises the determination of the Europeans to save the euro, which should not be underestimated. But there is much more to do, and it will take a considerable time. So while good progress is being made, we will not, any time soon, see a point at which the ‘euro problem’ can be seen as past. The world will have to live with euro area anxiety for some years yet as a normal state of affairs.
In the meantime the US economy has continued its slow healing. The US housing sector has, it would appear, finally turned. Now the election is past, the so-called ‘fiscal cliff’ is rapidly coming into focus – a new source of event risk. But if one is prepared to assume that the US political system will not, in the end, preside over an unintentional massive fiscal contraction next year, the risks to the US economy probably look more balanced than they have been for a while. An upside surprise would be as likely as a downside one. It would be fascinating if, in another year, we find ourselves looking back at a US economy that had outperformed expectations. (There is still of course a critical need for the US to craft a measured and credible path back to fiscal sustainability. That particular drama could continue as long as the European one.)
But it is appropriate to turn our gaze to our own part of the world, especially in the current period of discussion about ‘the Asian Century’. Two years ago, when I last spoke to CEDA’s Annual Dinner, a key feature of my presentation was this chart.[1]
Graph 1