We have an inflation problem

I’ve argued for almost two years that there is no cause to worry about inflation preventing rate cuts in Australia. And all things being equal that’s likely to continue.

The problem is that I don’t see things as remaining equal. As we go over the mining investment cliff and the terms of trade continues to slide in the next year, we are going to see lower interest rates, even if property bubbles along.

Sooner or later this is going to make the dollar fall and when it does the inflation problem will present itself. Here is the charts that tells you why, courtesy of ANZ:



ALL of the soft inflationary outcome of the past several years has been recorded in the tradable sectors of the economy, those exposed to the Australian dollar. Non-tradable goods and services inflation is in a gentle up trend breaking above 4%.

When the dollar falls, and it will, inflation will spike in the economy, especially if property prices are still bubbling along and supporting non-tradable activity.

This is why it is SO vital that we begin to discuss and plan new monetary policy options, like macroprudential tools. We’re going to need them. We already do.

Houses and Holes
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  1. So no prospect that non-tradeables can/ will fall in an environment where the AUD is falling?

      • Yep- fair point re a slow melt.
        I guess much depends on what moves first- the currency or the economy… Temporary deflation possible if it’s the economy out of the gates quickest..

      • “So no prospect that non-tradeables can/ will fall in an environment where the AUD is falling?”

        Absolutely not! That’s not how it works as anyone who lived through the last great bout of very high inflation can attest.
        Sorry HnH but your faith in the market here is much misplaced. We don’t have a free market so much as a series of power groups.
        As inflation kicks in the various power groups line up for their inflationary compensation. These include the lawyers inc judges et al, politicians, the public service, the powerful unions like Waterfront etc etc, Teachers being essential, electricity workers, petrol refineries, Tradies…then the government charges will need to keep up…on and on it goes.,

        So the inflation in tradables washes across to non-tradable. This is exactly the reverse of previous years where the deflation from tradables has held the inflation rate in check and thus helped to keep non-tradable inflation down (despite it running consistently at 4 to 5%.)

        What you in fact get is a typical economic feedback loop – tradable and non-tradable inflation reinforce each other. This works going up or coming down.

        Again note the RBA and Government are hiding behind the high dollar. It’s been very convenient as long as we’ve been able to borrow the funds to keep it high. The decline of the dollar will demonstrate what a bloody mess has been made of this economy over decades..

        • P.S. Re power groups…add in all those companies with monopoly or oligopoly pricing power!
          Inflation is a dead set cancer. It is evil. It destroys your society.

  2. We’ve already had the inflation. We’re going to have continued inflation in needs and deflation in wants.

  3. Excellent. There’s never been a better time to work in the property industry. Things are about to boom and when the $AU drops it will be time to buy development sites at crushed prices. We have entered the biggest bull trap the world has ever seen.

  4. Interesting article by Greg Canavan regarding inflation in Australia:


    As not so subtly pointed out in today’s Age, the price of just about everything in Australia is going up, up and up. On an international scale, we are now world class.

    ‘In the past 11 years Australia has become one of the most expensive places to live, costlier than New York, London, Frankfurt and Singapore on everything from five-star hotels, car rentals, public transport, a pint of beer, cigarettes, jeans and an iPhone.’

    How all this happened while inflation apparently remained low just goes to show the official inflation figures are a joke. On the one hand the statistician makes adjustments for products that, while may be increasing in price, deliver more bang for the buck in terms of productivity. This turns price inflation into price deflation. But they completely ignore the effect of shrinkage and lower quality inputs, especially in relation to food.

    • Yep Charles…food is my favourite place to look for hidden (hedonic) inflation.
      I recorder buying some Cottee’s raspberry jam last year. It had been some years since I’d bought it as a result of a general tendency to become rotund.
      It used to be sooo nice! This time i couldn’t eat it. So I washed it out. There were about 10 seeds in the whole jar! It would have been flat having one raspberry in it!
      I told my story on Smarties the other day.
      Supermarkets are just full of great examples…including all tasteless fruit that has been picked green!

    • Agree 100% ! True inflation in Australia would be at least triple the official rate. Trouble is no one in the Media is prepared to rock the boat & inform the sheeple.

  5. That chart says to me that in recession, non-tradeables declined at least as much as tradeables. In 2001, they declined by a larger proportion.

    In 2009, the AUD fell by circa 25% – 40% against other currencies and non-tradeable inflation declined significantly.

    Am I missing something?

    • Well said. Just watched ABC news where Kohler and an unnamed ‘expert’ attributed the low tradables number to the dollar. I’m not buying it… happy for someone to convince me otherwise

  6. I can tell you that the inflation is food at the low range (seasonal food) is more than 100% for the last 5-6 years. I can give a list with vegetables, fruits and other everyday food, which are going up and up and exactly like the chocolate, which went more than 150% up all packed food is getting less in grams and higher in price. Let take the soap. One bar of soap was 100 grams, now is 80grms and they are less in a pack, but the prices is slightly up. The inflation is more than 50%. Transport, electricity, rates etc. are other suckers. Rents are up every year, what is down, can someone tell me?

    The government inflation rate is a joke.

    • Exactly right Lori. Both CPI and GDP are bogus, misleading, “homogenizing” (h/t Kyle Bass) reference measures. Naturally, they are held dear by politicians and banksters for the very reason that they offer infinite wiggle room to hide their continuous perpetuation of evil upon the public.

  7. Ben
    Your time frame is too short. The quick rebound in the dollar to even higher levels truncated the flow through effects.
    Also up to that time China has been a deflationary force. China is now an inflationary force. In the subsequent rise of the dollar to $1.03 my landed costs remained exactly the same as when the A$ dollar was USD 0.85

    The behaviour of the oil market is also relevant. Is the oil price going to drop away faster than the A$ this time?
    I don’t have the answer but it is a relevant question in light of your observation.

    • Fair enough. I agree that the 2014 Australian recession will be ‘out of phase’ with the US this time around.

      • As HnH opines above, and perhaps as per your observation, the inflationary effect will depend, at least to some extent, on the path it all takes.
        My short term predictive abilities are somewhat limited particularly in respect of timing.

        My favourite quote on that is from Yogi Bera “It’s hard to make predictions, especially about the future”

        My problem with it all is that the high dollar and lower import prices has been covering inflation and BAD economic policy for about five decades.

  8. I’ve just charted AUD:USD vs index for tradable, non-tradable and total CPI for period Dec qtr 2007 to June qtr 2012.

    CPI and AUD strongly positively correlated. Tradables has a pretty strong correlation as well as non-tradables, although non-tradables has obviously been stronger.

    Point is, the strongly rising dollar has not reduced tradables prices, so why would a falling dollar increase them? Often our dollar falls in a time of global weakness, meaning global prices of merchandise goods may fall and offset them being more expensive, ceteris paribus.

    A monetary explanation of this phenomena would be useful. Presumably there’ll be less demand for dollars and more supply (= more inflation), but inflation only occurs to those dollars that are actually spent and bid up prices. Will we be spending or saving? Our real incomes will fall, our unemployment will be rising, thus wouldn’t we be saving more? Plus, deleveraging will reduce demand and money supply. This suggests inflation not an issue. And then if domestic goods are now relatively cheaper, we switch to them, meaning tradables need to stay competitive or suffer.

    I can see the point you are making but is it that simple? Yes perhaps there’ll be a temporary spike in inflation but is that an issue? I’m not saying its not, I’m just struggling to get my head around how this works.

    How much of the subdued growth in imported goods is due to productivity in China? That is not deflation, its just productivity. So what about Australia? Has our poor productivity meant our domestic prices go up and therefore there is less to be spent on imported products, ceteris paribus? Interestingly, it seems that much of the non-tradable ‘inflation’ is due to govt policy ie in electricity, health etc which is not really inflation, it is just a change in relative prices. but it takes up more of our income and therefore you need offsets elsewhere in the economy. that said, i do recognise the inflationary effects of credit creation. Money supply growth has been too high for too long.

    • “Point is, the strongly rising dollar has not reduced tradables prices, so why would a falling dollar increase them? ”

      You’ve made the very point right there Jake. The reason tradable prices have not fallen is that the FOB prices for goods has been rising. As stated above our landed costs at $1.03 were exactly the same as at UDSD0.85.
      The Chinese are not going to reduce their prices just because our dollar falls. The process of change in China in terms of demography and prosperity will not alter. Indeed the Chinese Govt policy to reorient the economy will hasten the process.
      So we might get the A$ falling at 10 to 15% per year plus FOB prices rising at 10 % per year.
      What a nicer little mix we’ll have

      • Knew I could count on you flawse.
        So barring any global downturn/deflation, we will need domestic prices to fall to maintain our inflation rate as 2-3%? Seems so because if they don’t do it themselves you’d have to see rate rises to fully kill non-tradable prices whilst tempering tradable prices. But who’s going to raise rates in a downturn? This is bleak. Personally, I think a debt deflation event will be the phenomena we see, where money supply falls/shrinks as our income increasingly goes to repaying debt, and interest rates fall to somewhat offset the burden.

        Btw, having a mindblank, but what’s FOB again?

        • Jake thanks! Your summary may well be correct.
          FOB = Free on Board – our USD price we pay with the goods on Board a ship in a China Port.

          “This is bleak.” Hence my quote ” The answer lies back in time”
          I had a slightly different quote meaning the same thing. An old US discussion mate Finster coined my current more succinct version.

          Jake one more thing…there was a really good post a week or so ago on the proportion of our fuel we produce. It has been declining rapidly and is now down to 10%. So this again will exaggerate the effects of a declining dollar as compared to earlier times.

          Welcome to a Curmudgeon’s world !!!!

        • MontagueCapulet

          If the prices of imported goods rise dramatically won’t people cut back on other things to compensate? I’m thinking of petrol in particular as many people are particularly sensitive to the price at the pump. Those who are locked into a long daily commutes and can’t cut back on driving may be forced to spend less on discretionary items.
          On the other hand, higher petrol prices will raise input costs for a lot of items, which could feed into domestic inflation where producers have pricing power. But it’s more likely that margins will get squeezed.
          I think if a lower dollar results in higher petrol prices people will cut back on entertainment, higher end food purchases, discretionary retail purchases. So retail and hospitality will see sales drop off even as input costs rises, which will squeeze profits and lead to staff having their hours cut back. So I’d expect you will see little inflation in things like the price of a latte, a steak or a movie ticket, because people will be cutting back on these items and the it won’t be possible to pass price rises on to consumers.

      • Flawse
        Do you consider this much hyped Australia-China currency agreement will change that inflation dynamic ?

        • loony I’m probably the wrong man to ask but no i don’t think it will be majorly significant. It’s tweaking at the edges and there will probably be some minor saving in costs like point 2 of a % or some such I guess.

          Our prices ex China may be a little less also as the value of the USD worries the Chinese when they are quoting prices. With trim margins and a three or four month delivery exchange rate movements can be significant so logically they allow a bit for it. A quote in Yuan they only have to worry about their own costs.

          Maybe others can see other things I can’t.

          I will say however it is just another brick knocked out of the wall of the USD as a fiat reserve currency.

          The evidence is everywhere of a slow but sure failure of the USD.
          Gold..the popular rush on Gold when bernanke JP Morgan et al knocked the paper price down last week must have scared the living hell out of these b…..ds!

          If more Oil producers stop using the USD as the trading medium for payment we’ll be getting close to the end.


          P.S. I DO think it is a good thing for relationships between the two countries.
          It’s an expression of trust which means a heck of a lot to the Chinese.

  9. Has our poor productivity meant our domestic prices go up and therefore there is less to be spent on imported products, ceteris paribus?

    Jake again your logic gets screwed. Admittedly we are in feedback loops so things can get a bit hard to discern. However here despite our poor productivity we have been able to both flog off our good fortune in having vast national assets within our borders. Note it’s more we sold the assets not the product so much. Associated with this willingness we have been able to borrow lots! Our ability to consume has not been limited, in any way, by our income or productivity.

    • Right so if you are unconstrained in a ponzi style economy fuelled by capital inflows and a mining boom you don’t face the constraints i mention above. Such a boom is basically, in an Austrian sense, inflation.

      • Jake…essentially yes – that’s my opinion but seek others 🙂

        I forget the author but interest.co.nz opined at one stage that interest rates should be set on the basis of non-tradable inflation. It was a darned good thought!
        As Central Banks want to ‘look through inflation’ so also we ought ‘look through deflation’ It’s too late now.

        Again, just thinking out loud, IF we get tradable inflation resulting in a significant CPI inflation interest rates would have damn all effect on that inflation except for the effect it might have on the exchange rate. If the market conditions are such that the exchange rate isn’t responding to interest rate rises we’re in deep doo-doo…well we are anyway whether the exchange rate rises or not…it will just be the type of doo-doo that changes.

  10. “And then if domestic goods are now relatively cheaper, we switch to them, meaning tradables need to stay competitive or suffer.”

    If domestic goods are cheaper they will be some 40 to 100% or more more expensive than the import prices we are now paying.

  11. Our real incomes will fall, our unemployment will be rising, thus wouldn’t we be saving more?

    Again Jake…a couple of points.
    I believe (FWIW) you, and pretty much everyone else, have been looking in the wrong direction for inflation. All anyone seems to think is of inflation in demand pull terms. That’s not where it is going to come from. Our massive money printing over the years has not resulted in inflation because of the deflationary effect of lower prices out of first Japan, then Taiwan then Korea then china. Our money printing didn’t end up as inflation but as a CAD while we imported more and more cheaper goods. Effectively the more money you printed the less inflation you got! Many therefore put it down to how clever we were. The existence of an external was conveniently put aside in the teaching and practice of economic theory.
    That fifty year trend is now ending.

    You’re right our real incomes will be falling. However as to saving what we’ve done so far is simply replace the saving with Govt deficits. Another way to look at it is that Govt has been providing the money for us to save. The nature of those savings is worth exploring as well. As per posts by Rumples and comments by pfs, Phil, Op8 etc we’ve tended to spend our ‘savings’ on houses and increased share prices which are not real savings. Maybe this will change but current policy is to exacerbate those trends. We are to have bigger Govt deficits, lower interest rates, more restraints on production and higher taxes on business.
    There is nothing in that to encourage saving or production.

    • flawse, that’s great, thanks, and probably the best explanation of your ideas that you’ve been expressing on here for a while now. I think you’re right, I probably think too much along the lines of how I was taught in mainstream economics – which I know to be somewhat a load of crap – but its hard to break away from it. Just as Pete Boettke notes that we need to get away from thinking like Keynesians, maybe we also need to get away from the current mainstream.