Gregory, Garnaut forecast doom

Are you sitting down? Here’s the message I’ve been trying to deliver for some time. This time it’s from two Godfathers of Australian economics, Bob Gregory and Ross Garnaut. In opening the ABARE conference today the two have discussed the coming mining investment cliff and falling commodity prices. Via the AFR:

Mr Gregory said interest rates could fall as low as 1.5 per cent because the RBA will try to stimulate to compensate for the end of the resources investment boom and what he expected would be a substantial decline in the prices of raw materials.

“Interest rates will fall. But I don’t think it’s going to work that much.”…Professor Gregory predicted that Australia’s real income could fall by 15 per cent in the next few years and whatever government gained power would have to convince people to accept lower living standards.

“The investment boom is going to peak and I can’t see something filling the whole quickly,” he said.

He went on to say that when the dollar fell, it would only slowly heal the economy (I assume because we’ve been hollowed out).

Professor Garnaut said the RBA had been:

…complacent about the challenge of managing fluctuations in the terms of trade…To have our short-term interest rates 2 or 3 percentage points higher than other developed countries gets in the way of the exchange rate adjustment that we will need to make and which will be a more painful adjustment the longer it is delayed.”

Get yourself a drink.

Houses and Holes
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  1. “… real income could fall by 15 per cent in the next few years and whatever government gained power would have to convince people to accept lower living standards.” And here’s why interest rates should rise, not fall! No populace is going to take a lower standard of living in its stride….it will borrow the daylights out of itself before that happens. The only way to stop that is….yep….put up interest rates to save people from themselves. If lowering them is unlikely to help ( as the quote infers) then raising them is the proper thing to do.

    • And don’t forget the next gen of people that will retire, lower interest rates eats their savings and they will have to down size, sell of property etc…. to keep pace.

        • I am waiting for an end to grossly overpriced land being a dead weight around the neck of the productive capacity of this country.

        • Dollar at USD0.85 means inflation around 7 or 8% before it feeds back into the non-tradables. Who knows what level it will reach after that?
          If you’re going to have IR around 1.5% you are going to be doing one hell of a lot of ‘looking through’ inflation and for a long time.

          • While I don’t dispute that tradable inflation would rise as the as the dollar fell, 7-8% is bit much.

            The kind of domestic retrenchment implied by a dollar at 80 cents is unemployment above 7% and rising. Non-tradable inflation would therefore be tanking.

            A bit of inflation may not be such a bad thing in this scenario anyway, ala UK…

          • HnH
            You don’t have a perfect economy. I’d describe our economy as totally arthritic. Your tradable will feed into non-tradable despite high unemployment.
            You think the power workers are going to put up with declining wages? Wharfies? Govt employees? Govt itself? Lawyers? Doctors? etc etc etc.
            Anyone with power gets compensated which means that most who drive prices get compensated.
            Next your tradie doesn’t suddenly go out and start working for a whole lot less. He just works less.

            There will be further pressure at the retail pricing level. I just question how much more room there is for squeezing this sector. Margins are already so tight. There will, short term, be fire sales as firms go out of business but in the medium to long term this tranlates into market power for those remaining.

            Note I am talking trends not absolutes. However I am arguing that my outcome is more likely than some benign low-inflation outcome where we automatically become more competitive with prices for exports and import competing products rising and costs remaining static.

            “A bit of inflation may not be such a bad thing”
            That’s a topic we should re-visit. There is no such thing at any level as ‘good’ inflation. It is a BAD thing! 🙂

    • Raising rates will only push our dollar even further up and kill us even more.

      Ideally, you’d want rates to come down while government and banks use financial policies/tools to restrict people from borrowing their brains out.

      Interest rates aren’t the only tool in the shed, just the bluntest….

  2. “He went on to say that when the dollar fell, it would only slowly heal the economy, basically because we’ve been hollowed out.”

    I don’t think that is exactly what he said.

    ps just linked to this in comments didn’t see you had it covered but thought it right up your alley 😉

  3. Therefore house prices to the moon within 2 years 😉 (as RBA is never going to implement macroprudential policies)

          • Seriously, its like you have a list of Minerals Council approved answers ready to go at a moments notice.

          • Funnily enough, I’ve long considered the main point of a SWF in Australia’s case would have been to counter the CAD.

          • Funnily enough, I’ve long considered the main point of a SWF in Australia’s case would have been to counter the CAD.

            So make the private sector pick up an even greater tab perhaps?

            For a country to be running a deficit, the external account offers surplus to foreign parties.

            So either the government, or the private sector is accruing debt.

            For a SWF, meaning more funding coming from government or the private sector.

            The proper fashion is to run a cAS, then use that money to pay for a SWF.

            We’ve got it arse about, and it, the CAD, is flawse’s fault.

          • A SWF would help reverse the CAD if managed properly.

            Right from the start, a SWF has been the only and obvious way to manage the mining boom. I can’t believe it’s still being debated.

          • A bit muddled there Rusty, but you’re not far off.

            Firstly, neither the public sector nor the private sector needs to be accruing debt if a country is running a CAD. A CAD can be funded with direct foreign investment into domestic assets, without the need for debt liabilities to be incurred.

            Of course, in Australia’s case the CAD is funded primarily by debt, in large part owing to its sheer size in recent years.

            If you are unhappy about the size of your country’s CAD and the nature of the capital inflows required to fund it, one option is for the government to reduce spending or increase taxation, and use the proceeds to establish an offshore SWF. The capital outflows from the government’s foreign investments act as a counterweight to the capital inflows arising from private sector borrowing and FDI, thus reducing or erasing the capital account surplus. The declining capital account surplus places downward pressure on the currency, making imports less competitive and export more competitive. If the SWF is large enough to drive the capital account into deficit, then in currency must depreciate such that the current account returns to surplus, in order for the balance of payments to be in equilibrium.

          • MJV – you may be interest to know the RBA released a paper that was lukewarm at best on the question of a SWF. From memory raised some fair points in regard to management of SWF particularly in regard to potential political ends.

          • You don’t have a link to the paper do you 3d1k? I’m aware they’re not particularly enthused by the idea; be interested to know if I’ve read the paper you’re referring too though.

            I’m not especially animated by the idea, it seems like an effective option in theory (and I was merely outlining the theory above- wasn’t taking a position on the issue), but of course there’s the political questions to answer. Personally I’d like to see capital allocation undertaken by the private sector wherever possible, but one must always eschew ideology in economics. If you’re endowed with an enormous resources windfall, like Norway, then a SWF is eminently sensible. Australia’s resources endowment is very different to Norway’s, however. And our aim of establishing a SWF would have been to correct an imbalance, rather than a necessary response to massive surplus revenues. I don’t know of a developed country deploying a SWF with the primary aim of redirecting its currency and reducing a CAD (if anyone can enlighten me in this regard, it would be highly appreciated). It would have been an interesting experiment, one that I would have supported had it been attempted.

          • Have you got a link to that paper 3d1k?

            The politics of a SWF may be complicated (independence etc.). But the economics of a SWF is a no brainer.

          • Thanks RP. CAD’s can be right pesky things sometimes.

            You’re exactly right! For a SWF you must have the policy settings that run a CAS. Then you can have an SWF. Otherwise you are just spending money overseas that will (in the long run) be used to buy more of our assets.

            As far as that goes, management issues aside for a moment, it would make more sense to use the SWF to buy some of our own country back. So the SWF probably ought be in the form of a high savings rate so we need higher interest rates.

            So it’s back to the fact that the old ‘Free and Floating Exchange rate is best’ theory being a load of bollocks.

          • Re SWF I was very pro (still am in theory) but on reading the Delusional Economics links above and the MB sectoral balance primers along with the insights of Flawse my understanding has changed considerably.

          • Cheers 3d1k, I have seen that report. It evaluates the use of SWFs as stabilizes over the course of the commodity cycle and as a vehicle for excess savings. As I mentioned, a key purpose of a SWF here would have been to capture and redirect domestic capital offshore, taking pressure off an appreciating currency; quite a different policy. That’s not to say a SWF wouldn’t act as a stabilizer in Australia, but its effectiveness in adjusting the external account is another matter. (Depending where you are, the capital account may be termed the financial account, the ABS calls it the financial account as it has a narrower definition of the capital account; when I mentioned to the capital account previously I was referring to what the ABS calls the financial account.) Part of the source of my ambivalence towards the policy is that I believe there would be more effective ways of managing your external account than running a SWF for that purpose.

            Thanks for the DE links, I missed them. A high quality and concise appraisal of our economic settings. I’m curious as to how reading those pieces altered your outlook on a SWF.

          • MJV I may have linked to the wrong RBA paper, will check later.

            Here is a Macrobusiness Linkfest for your enjoyment – no doubt much you will be familiar with. I may have missed some of the ‘primers’ (thought there was more on sectoral). Re SWF, frankly I had originally thought of it as ‘pennies in piggy bank’ for a rainy day! I now see it as something far more nuanced/complex that potentially presents a range of issues I’d not considered.







            It might be an idea for MB to consider putting together a bunch of primers it considers essential under a sidebar banner. Many would benefit.

          • Thanks for the link 3d1k.

            I don’t actually think that paper is against a SWF.

            My reading of the paper (especially the “Effects of Large Increases in Capital Inflow for Australia” section) is that a SWF probably would be a good idea *if the ToT boom is expected to be short lived*. If it is expected to be permanent, then it probably wouldn’t be a good idea.

            “The appropriate response of policy makers to these potential developments, will depend on the size of capital flows, their expected duration and the amount of adjustment that is required… if the flows associated with a resource boom are large and are not expected to permanent, policy makers may want to limit the resulting exchange rate appreciation to mitigate undesirable distributional effects on the rest of the economy”

            “If the boom is short lived, the consensus in the literature is that the only way of ameliorating the redistributive effects of a sustained real appreciation is tighter fiscal policy, that is, reducing government spending beyond simply offsetting tax receipts”

            This describes how the SWF would work: if the SWF is set up so as to force a structural tightening in fiscal policy whenever prices of commodity exports increase above a reference price, the SWF would act to dampen real appreciation. It also follows from this that the SWF would mean a smaller CAD than would have been the case absent the SWF

            Also, reading between the lines, I think the RBA has been extremely frustrated by the lack of fiscal assistance in managing the mining boom.

          • Fair point Sweeper – perhaps ambivalent is more correct. I’ll re-read later but If I have linked to correct paper I am sure emphasis was placed on SWF being effective in combination with appropriate government fiscal policy, as you say, a level of frustration.

            In the same vein consider the MRRT proceeds, committed before receipt – there seems little imperative from Australian Government’s to forgo revenues in exchange for SWF!

      • Is the income really going to fall that much ? investments could have their growth rate reduced but still going and for what I understand the output will be significantly higher in 2-3 years time.You would need a very significant drop in commodity prices to make that happen.And this drop is not in the book yet, noone knows for sure what the commodity prices in 2015-16 will be at(or if you know, you should change job).

        of course I know shit in mining/commodity but I am not convinced of the inevitability of these projections.

  4. The last thing a challenged economy needs is to increase its net borrowings as it heads into a resources downturn. What worse could we ask for than an increased debt servicing capacity and a lower national income? What happens to replace that lost income? Past investments made abroad are repatriated, and that doesn’t lower the exchange rate!

    • Oh…and here’s what awaits you guys when you lower your interest rates, as we have done, in the absence of ‘real’ business…”One of (New Zealand’s) largest construction firms Mainzeal, has gone into receivership.”

  5. So, lets have some investment ideas, besides property, for the new normal.

    Yes it looks like we are definately in trouble. However, I think Garnaut is far too bearish on commodity prices. In a world awash with money , Govts willing to “stimulate” and CB’s ready to print at a hint of any sign of deflation or stock index weakness, I dont see too much diificulty there. Which means, outside the resources sector Australia will suffer big time.

    Some possible assistance from?;

    – DE regulate this choked anaemic economy of ours.
    – Take a chainsaw to all levels of Govt , ensuring that essential services are enhanced and the rest of the apparatchiks are banished forever. Paving the way for tax reviews on personal income and Business – lower them. Nothing short of wholesale transformation of the nanny state – into nothing.
    – Royal Commission into the construction industry with a view to dramatically reducing all union interference and involvement.
    – Special attention to be paid to green tape so that whatever resources investment has potential is given a leg up to completion.
    – RBA to sell the AUD, by fair means or foul.It needs to be low 90’s. Yes fuel prices may increase but more jobs will be created (or saved) as an offset.

    Time for our leaders to roll their sleeves up and get stuck in.

    • Royal Commission into the construction industry with a view to dramatically reducing all union interference and involvement.

      Willing to extend that to the AMA as well?

    • dumb_non_economistMEMBER

      Yes, if only we could get rid of the unions in construction, there would be 100s of billions in savings!! Don’t worry about construction companies working in cohorts to jack up and fix prices.

      What you really need is a RC into construction full-stop.

      Green tape: yes, lets get rid of all of it for a 10 yr benefit, I hate flora and fauna in general anyway.

      • dumb,

        “Green tape: yes, lets get rid of all of it for a 10 yr benefit, I hate flora and fauna in general anyway”

        You said “all of it”. Not me. Green tape regulatory restraints are largely put in place to provide compliance jobs for those soft enviro degrees Unis churn out (which in turn secure tenure for all those green academics in Universities). Maybe with some restructuring they might obtain gainful employment , other than adding to costs running around counting bugs and destroying real jobs for a handful of relocateable Bilbys. Don’t take that to mean wanton destruction of our environment is acceptable- it is not. But, the *balance* is way skewed. It needs to be back within the realms of commonsense.

        An example of regulatory nanny state madness run amok. What moron would dream this up?;

        • “… for those soft enviro degrees Unis churn out (which in turn secure tenure for all those green academics in Universities…”

          Love it. And ain’t it true.

        • I have a friend who is an architect for the construction of a church. So Govt has ruled they have to process the water off the roof before it enters the storm water drains! Now this is loony enough. However there is no need to do the same for the run-off from the car park.

          If you don’t believe that private industry is not subject to excess stupidity emanating from people in Govt with nothing practical and productive to do then you are part of the Govt problem.

          • Although I agree with you and that’s why I support carbon pricing over direct intervention by Tony Abbott, I must note that in the case of the church the problem of wasted run-off has at least been partly solved by government decree!

          • Re Carbon…yes if you want to attack it it must be a market mechanism. Whether the best mechanism is the one we’ve is the best might be moot however your point is solid.

            Not sure I understand your post re the run-off and I think there is humour there I am not ‘getting’
            Just for clarity…The roof run-off just goes into the storm water drains. It isn’t being stored for later use.

          • I think I need to go and have a wine before my writing turns to TOTAL gibberish not just partial gibberish!!!

        • An example of regulatory nanny state madness run amok. What moron would dream this up?

          Probably the same “moron” who dreamt up the idea of guidelines around, say, food preparation in restaurants or hygiene and sterilisation in hospitals.

      • C’mon now H&H. It is an urban myth that economists have no imagination 😉

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  6. Interesting article however I feel even less certain than the good Prof about the future stability / manageability of the Aussie CAD problem.

    Hopefully our mines ship lots of dirt at great prices for many years to come. But even this so called Chindia result comes complete with its own resources reallocation problems (and I’m not talking shipping or logistics)

    Economists are quick to point out that China needs to re-balance its economy away from the current export focus and towards a domestic consumption model. However these very same economists are slow to understand the unbelievable strain on ALL consumable resources if China follows their advice.

    Sure Aussie mining exports will benefit, but will Australia as a whole? A Chindia outcome implies a supply constrained world with the reallocation of both manufactured and raw materials towards Asia. In such a system it is difficult to avoid significant price inflation for all tradable goods (manufactured, primary and agricultural) (this is something the world has not seen for over 20 years)

    Like it or not, as this reallocation occurs the materialistic life styles in many western countries must decline (I think of the ClubMed/PIIGS as forming the avant garde of this trend)

    So even in the best case, Mining expansion forever, our current Aussie lifestyle comes to a less than rosy end in under 15 years. 15 years is not a lot of time for Australia to develop its own industrial base, so hopefully we never need to….

    • China-Bob Stupid man! 15 years is forever. We don’t worry about that!!!

      I’ve posted this thought before and maybe before your time. You seem to have a pretty good grip on the Asian situation so I’d like your opinion.

      Very brief summary
      The whole western world has been riding a wave of cheap goods from Asia for 50 years. First Japan, then Taiwan, Sth Korea- Thailand, then the big daddy of them all China.
      This has allowed us not only to enjoy cheap goods and the resulting low inflation. We have thus been able to run a reckless financial structure which is now coming home to roost. All our low interest rates from money printing didn’t result in inflation but in CAD’s. In essence, the higher the CAD the lower the inflation. Unusual economics but I believe it is a fact. However there is a massive lag of decades at work. We didn’t eradicate common sense economics just managed to postpone its outcomes.
      The ‘End of Cheap China’ is now here. FOB prices for goods I import increase at about 7 to 8% per year. I know there has been a move up the ‘food chain’ as far as Chinese manufacturing goes so now we get cheap TV’s. Nevertheless, as i understand, the price rises for these more ‘upmarket’ goods are also on the rise.
      Demographics and prosperity in China mean ‘The End of Cheap China’. Everyone calls for a re-balancing in China without realising the effects you describe above. We ought be damned careful what we wish for.
      Further anyone who thinks China can be replaced by somewhere else has never been there and doesn’t realise the scale of what has happened in the last thirty years.

      So it seems we are at the end of a massive 50 YEAR CYCLE. Nobody in the western world seems to be able to grasp this fact. There are odd people. Shaun Rein ‘The End of Cheap China’ being one.
      Everyone, including protagonists in here, base their ideas of the future on the past. There is an assumption we can go on getting cheap goods to satisfy our wants.
      I am arguing the future will be very different to such assumptions.

      I’d appreciate your thoughts if you have the time.

      15 years? For sure but I think we will feel the squeeze long before that

      • I’ve missed all the chewing over today fellas, but on this particular issue Flawse I think there was a World Bank or IMF report about 18 months to 2 years ago highlighting precisely what you say – cheap manufacture producers – key among them China – have been exporting disinflation for about 50 years and that this period is ending. I will have it somewhere on my computer drives and try and find it.

      • Hi Flawse,
        The economic ascension of China is unprecedented!
        There is nothing in recent human history to compare with this ongoing event, in the space of 40 odd years 1200M people have come from unimaginable poverty to achieve wealth beyond their parents imaginations, over 300M of these Chinese today enjoy a western middle class life style.

        The resources constraints we suffer today are largely to support the wealthy 300M Chinese, whats never mentioned is the other 900M that aspire to greater wealth then even these lucky 300M.

        Today China is achieving economic wealth through hard work and education, however within 20 years there will be a very rude surprise for everyone because the world simply cannot support an additional 900M middle class life styles. At each point, along the journey, someone somewhere must give up their material life style so that another Chinese person can adopt this life style. At some point even resource reallocation will fail to work, because of the sheer magnitude of this wealth shift.

        In my mind, logic dictates that the west must suffer a series of local disasters, economic collapses, financial crises, political reforms, Arab-awakenings, civil wars, whatever, to support this reallocation, The exact manifestations of these problems, are side stories, that will run their course to support the macro-economic shift in Chinese life styles.

        In the end we will have two equally pissed-off groups
        – those peoples that have given away everything their parents had and say here but no further…
        – Those Chinese and Indians that feel they have been cheated because the economic train broke down before they got their ride

        Neither of these groups will care how the world got into this situation. They will have no trouble finding a Cause celebre, be it bankster fraud, or historic injustice(eg Japan), so the real problems start when the western world stops being able to deliver what the Asian world demands.

        Now to get back to your question about the end of cheap goods from China:
        China can only ascend economically if it moves further up the ladder for manufactured goods, this will not necessarily mean giving up the low level production that they currently have because through education and automation they are achieving massive productivity improvements. 20 years ago when people talked about industrial automation they talked PLC’s and industrial controllers that cost $5K and were supplied by companies like Honeywell and Siemens. Today we talk about ARM microcontrollers that cost less than $5 and have over 1000 times the computing power of these old PLC’s. This change makes automation a dirt cheap alternative to labor. So the real bottle neck will not be the worlds ability to produce whatever manufactured goods it wants but rather the worlds ability to source the raw materials to support this new level of production (look no further than Iron Ore which went from about $20/tonne in 2004 to $180/tonne in 2012) if this level of raw material inflation occurs in other sectors than flow through inflation is guaranteed. What I’m saying is that Inflation stops being a labor market saturation effect and becomes a direct consequence of a resource constrained world.

        For China to ascend it must develop local equivalents for all the west’s high tech companies. This means Jet aircraft, power stations, operating systems software, web portals, financial services, the list goes on and on. We are already seeing companies like Huawei that are taking over advanced networking from the likes of Cisco, there are several very successful Shanghai based Fx trading companies.

        If the west refuses to surrender any more technology, jobs, islands then they will have at least 1000M well educated Chinese people to deal with, the situation wont be pretty.

        • Thanks China-Bob

          Approximately you mirror my thoughts exactly.
          As you said we need to plan for these changes.

  7. Speak for yourself, I’ve never been into buying a new SUV every six months or going on holidays OS for a week so I can appear eclectic and worldly. It makes me sick actually, and I’m not even a lefty.

  8. HnH, I have received a copy of the paper Bob Gregory’s speech was based on – fascinating read and turns (or at least questions) much conventional wisdom supporting the mining boom, RGDP effect, exchange tradeoff etc inside out. Well worth a look.

    • Potential for an article based on Gregory/Sheehans work. Once it is understood the extraordinary benefit to income (RGDP, import gain etc) brought by the investment boom it may be clearer to understand the impact post.