Saul Eslake joins the recessionista


The eminently sensible Saul Eslake, Economist at Bank of America Merrill Lynch, is out with a new note weighing into the Australian recession debate and hang onto your hat:

As the ‘resources investment boom’ begins to fade …
The investment phase of the ‘resources boom’ looks to have passed its peak. Although resources investment should remain at a high level for another two years or so (until work on the 7 major LNG projects now under construction is finished), resources investment will now likely be detracting from overall growth, not adding to it.

The risks of a downturn are increasing
With the non-mining sectors of the Australian economy responding less promptly to lower interest rates than in history would suggest, and the A$ still at elevated levels by historical standards, in our view the chances of a smooth ‘baton change’ between growth led by resources investment and growth led by exports and other
components of domestic demand are declining.

At best, growth may slow to less than 2% in 2015 and 2016
We attach a ~75% probability to a scenario in which Australian real GDP growth slows from around 2¾%pa in 2013 and 2014 to just under 2% in 2015 and 1½% in 2016. In this scenario the unemployment rate peaks at 6¾% in early 2016.

BofAML view: ~25% chance Australia could have a recession
We attach a ~25% probability to a scenario in which Australia experiences a recession beginning in the second half of 2015, with real GDP growth averaging 1% in 2015 and -0.1% in 2016, and unemployment reaching 7½% in mid-2016.

Australian economic policy-makers’ armoury is depleted
Adding to the risks of recession are that Australian policy-makers have fewer options for warding it off. The A$ may not play its usual ‘buffering’ role; government finances aren’t as strong as they once were (and the political cycle is swinging further against the idea of government borrowing); and interest rates are already low by historical standards. We expect the RBA to cut further – to as low as 1% in the event of a recession – and it may need to undertake a ‘Down Under QE’.

Implication for rates: lower level with steepening risk
The fair value for 3yr and 10yr ACGB are 2.37% and 3.44%, respectively. We see more value in owning the 3 to 5yr sector.

Implications for FX: the A$ has more to fall
The A$ will likely find it difficult to stay above US$0.90 over the long-term if weak growth in 2015-16 dovetails with deteriorating balance of payments, the end of Fed QE, less commodity-intensive growth in China and less speculative carry demand for the currency. We revise down our long-term (end-2014) forecast to 0.88. In the risk scenario of a recession, it is likely to depreciate to the low 0.80s.

Goodness me, they’re piling into the bear camp now. A few points:

  • growth at an at best sub 2% for 2015/16 is an economy running at stall speed. By that I mean that the economy does not have enough momentum to keep running itself into a virtuous cycle;
  • in an economy with very high asset prices, dependent upon ongoing credit creation, stall speed is a very risky proposition. By that I mean that rising unemployment and flat incomes may not be able sustain current asset values. As they stall, business cycle dynamics can take over and the economy roll into a negative feedback loop. Even on Eslake’s own reasoning then I’d conclude the recession risk is higher than 25%;
  • there is absolutely no way in the world that the Australian dollar will be 80 cents in the event of a recession. It’ll be at 60 cents in a jiffy. If Saul thinks 1% rates  are a possibility (or God forbid Australian QE) the currency will be routed.



  1. GunnamattaMEMBER

    The only quibble I would have with his views is that if the RBA even hints at dropping rates to near 1% then the AUD is utter toast.

    I also find myself wondering increasingly not about 2015-2016, but about late 2013, and through 2014.

  2. reusachtigeMEMBER

    He is just doom saying and talking us into a recession. He needs to be silenced, well at least heavily ridiculed as a lesson to others! We cannot have people blatantly talking us down.

    • Mark Out West

      Like Abbott has been doing for 3 years, nah the rescinding of the carbon tax and Utopia is here again.

    • russellsmith55

      He doesn’t even live here, how could he understand our market?! Clearly its different here… he’s just jealous because he doesn’t have any Australian IPs yet.

  3. migtronixMEMBER

    AusQE? Thats just precious. So we’ve gone from a “boom economy” to a potential Japan style bust in around 18 months? Brilliant stewardship of the economy as usual…

    Let me know when QE is about to start so I can lever-up and start amassing call options

    • “So we’ve gone from a “boom economy” to a potential Japan style bust in around 18 months?”

      No, the tone of reporting has done that in 18 months. Our descent in to a potential Japan style bust has been quietly going on for much longer.

      • yuppers . We tripped over the truth in the recession we had to have and ended up face down on the pavement with bloodied nose and chops.
        So we just picked ourselves up, cast a glance down to the article that brought us to an undignified faceplanting and whinge “who was the useless prick that left that laying there? jeez ya be unlucky can’t ya?”

      • +1 AB

        Its’ quite amazing to see, the boom economy many didn’t have, still claim we did have, or are still having.

        Many looked good while the creditor was patient, even generous.

    • russellsmith55

      I was thinking the same thing when I read that AusQE line. Does anyone think our experience will be the same as the US i.e. asset prices to the moon on cheap credit? Or will we slow bleed like Japan for years until someone gets the political will to gamble on reflation?

  4. If the predicted worldwide demographic decline fully takes hold (as has been fully documented by demographers for years) these guys are still being conservative – it will be alot deeper and alot longer than many appreciate IMO.

    I think a blind spot for economists (not trying to offend in any way, the ones on here are fantastic IMO) can be the tendency to look at the economy as a series of data points at the expense of looking at the people who make up the economy as a whole – and what they want, and what they can realistically be pushed to do (hence if you look at demography you can easily see why low interest rates are not working…)

    Looking at a WORLD demography that has peaked in its consumption capacity in the last couple of years and is now declining in many countries with not much let up for the forseeable future, renders a different environment than one based simply on what happened in the past – in fact when you look at the demographic situation, simply looking at the past will surely lead to incorrect analysis.

    We are in uncharted territory IMO with significant economics risks…

    • migtronixMEMBER

      What if we disgorged all the stolen/amassed wealth in the hands of the tiny elite? Wouldn’t all that wealth making its way back to productive hands give us a path for true growth and innovation. My first step would be to completely overhaul the Patent system to only provide patent protection for a maximum of 5 years not 20, and abolish copyright extensions

  5. P.S. The only way I can see us avoiding a recession here is importing a couple of million rich 30 somethings with good business ideas…

    Can’t see an aging population really providing a strong alternative to the mining boom, when being less risk averse and paying down debt preparing for retirement.

  6. “importing a couple of million rich 30 somethings with good business ideas…”

    Hm Just subject them to all our stupid regulations and industrial relations environment…then they find half the country can’t do simple project would get past the initial concept stage.

    • But flawse, the Govt has a plan for the math challenged- it just costs a little money and voila! numeracy nirvana.

      I don’t believe we “need” a recession, but by jingo, wouldn’t it give a new perspective to a few million Australians who have never experienced one? Might make them sit up and take notice.

      • Oh but GSM we DO need a recession! And the sooner the better! We have been paying ourselves wages and salaries that are simply unsustainable on the back of a resources boom that is now ending. We have made absolutely no provision for a return to ‘normality’. Our politicians are so self-obsessed and short-sighted that it’s a travesty. We have neglected any kind of IR reform, desperately needed infrastructure renewal and expansion, fiscal restraint and tax reform. We still have mindless consumers spending like drunken sailors racking up massive debt. We have one of the highest consumer debt to disposal income ratios in the developed world. And while savings rates have improved, they’re still far short of what is needed to reverse the years of ‘borrow and spend’ and to engender a return to the sane world of Austrian Economics’ creation of productive investment capital.

        Australia needs to be battered around the head and then thoroughly thrashed to bring everyone back to their senses. Only a great big fat recession can do that!

    • Your right about poor basic math skills. I’ve interviewed “computer scientists” who didn’t understand simple high school level integration and differentiation problems.

      At a factory floor level your lucky if they can add and subtract (honestly I’ve interviewed machine operators that needed a calculator to adjust the offset settings on their machines).

      Based on my sampling I cant understand why Australia is as high up on the PISA ratings as it is, but I can definitely understand why it is miles behind Shanghai and Singapore.

  7. nice work Saul. And agree with HnH, never underestimate the negative feedback loop which is far more likely to bite in a society saturated with high debt and related asset bubbles. This is where historical references dont help much, we are in unchartered territory, not sure Aus can keep dodging the bullet

    ….. that said, if things go pear shaped, you can be sure the govt will go all out to spread the cost to those who are prudent via even lower rates, QE etc. It might work for w while, it might not – but I am not betting a housing crash will occur in the next few years for this reason.

  8. The answers lie back in time.

    For example one of the only policies I agreed with in the labour side was the mining tax (the original not the one they did). The only reason why the old one failed is because someone in the party saw it as an attempt to undermine the country in return for becoming the leader of a party (need I say more?)

    The problem with relying on only the investment component on mining is that while we get a share of the investment money all future profits from that investments will probably leave our shores very quickly.

    There’s other blunders we made – mostly for short term politics. The country is too lucky – unfortunately it looks like the luck might run out soon.

  9. SweeperMEMBER

    Wasn’t the mining boom supposed to last decades? Since it now can’t even be relied upon to keep Australia out of recession and potential liquidity trap, could certain people please explain why the most important price in this economy (the exchange rate) was allowed to reflect a gross misperception about future demand for Australian produced goods and services, over such a long period?