What has been obvious to MB readers for two years has finally come home to roost for everyone else. The Australian economic model of running public surpluses while the private sector borrows and consumes is dead. This fact has been hidden by a once in a century mining boom for a couple of years but with its passing the truth will out and finally the media is paying attention. Deputy Governor of the RBA, Phil Lowe, last night administered the last rites:
I want to make it clear that I am not saying that we have to accept inferior economic outcomes from those that we have had on average over the past 20 years. Indeed, Australia is very well placed to continue to benefit from the growth of Asia and we have many advantages, including our skilled workforce. But, on the financial side, we are unlikely to repeat this previous experience, and nor should we aspire to. There was an adjustment to take place and that adjustment has occurred. Whether we can take advantage of the opportunities that lie ahead and continue to enjoy the rate of increase in our living standards that we have become used to depends upon productivity growth.
There it is in plain English. But of course, it’s not so simple. With the passing of the mining boom, it is fast becoming apparent that the long boom in credit distorted the underlying economy such that without more rapid credit growth it cannot grow. The search for a new source of demand is being pursued most keenly by the eminently sensible and always ahead of the curve Warwick McKibbin, who has argued overnight that:
“Using monetary policy to deal with the problems we face, I feel, is not the solution,” Professor McKibbin said. “Particularly when you consider the key effect of monetary policy on stimulating the economy is … you depreciate the exchange rate, but if you have this big portfolio shift going on, you destroy that channel. If you destroy that channel, the idea that you do a fiscal consolidation and then back in the loss of output by cutting interest rates is not the right strategy.
“The thing to do is to actually extend the fiscal consolidation and bring on a lot of infrastructure spending, financed by long-term bonds that foreigners are willing to throw money at us for, and use that to actually manage the demand-side of the economy,” he said.
As MB has argued for the past few years, it’s not quite that simple either . The world is not in recession and China is still growing above 7%. These are not the kind of condions that should necessitate counter-cyclical fiscal stimulus. Rather, the high risk nature of the Australia’s economy is being revealed, including an over-reliance on a remarkably small number of commodities to balance what is a chronic over-spending problem in the external account. In short, what S&P describes as a “one trick pony”.
And it’s S&P that complicates the McKibbin strategy. There is little doubt in my mind that if we give the bird to the public surplus, we will lose the AAA rating sooner rather than later. It’s interesting to speculate on what thet might mean.
In the short term, the answer is may be it’s a good idea. The fact is we are not got going to reach the surplus across the cycle (as S&P puts it) anyway, as Saul Eslake reasons in The Oz:
Bank of America Merrill Lynch Australia chief economist Saul Eslake said the data also showed another fall in Australia’s terms of trade – the value of exports relative to imports – and a drop in gross domestic income (GDI), the purchasing power of the Australian economy.
He said that would make it harder for the federal government to meet its commitment to return the budget to surplus this financial year.
…Mr Eslake said the falls in the terms of trade and GDI – both driven largely by a drop in commodity prices – meant the government may need to find further spending cuts or abandon its surplus commitment for 2012/13 altogether.
Losing the rating would mean an immediate cessation of some material portion of the portfolio flows into government debt, pressuring the currency. In fact, it’s hard to believe, even in the face of post-GFC market scepticism about ratings, that a downgrade would not represent a tipping point for the currency, even it were to transpire in slow motion.
The states and banks would both be hit immediately by higher borrowing costs. Liberal states would likely respond with more cuts. The banks could probably absorb the hit but it would not assist the RBA’s effort to increase borrowing for new houses. Rates may have to fall some more. The overall effect might be a better balance of growth.
But I’m not so sure. Buying of government debt no longer seems to be the big driver of currency appreciation. Rather, it’s holding the currency itself that is now in vogue. That, and the interest rate spread on offer to other jurisdictions. International money that is presumably flowing into bank accounts and corporate bonds.
As well, if the government were to spend to boost growth then pressure to ease interest rates will diminish. Perversly, it could actually boost dollar appeal, even in the face of a rating downgrade.
So the outcome could be more growth but a still overly high currency and more hollowing out for the external sector.
I’m wondering if what we need is a combined monetary and fiscal plan, probably informal, that adopts both of Warwick McKibbin’s recent macro-economic suggestions. If we want to grow, we will have no choice but to run public deficits as the mining boom winds down. But we may still have to do something more active about the dollar and McKibbin’s idea of printing AUD and tossing it to the offshore portfolio flows that can’t get enough of the stuff is the best solution.
Perhaps we need a new council for macroeconomic stability which brings together the key heads of the different levers, much like the Council of Financial Regulators.
