Slow growth future dawns on the elite

Over the weekend, demographer Bernard Salt of The Australian put forward:

…a simple, yet powerful proposition: The coming federal election will trigger a shift from the austerity that has dominated consumer behaviour since the global financial crisis. What lies beyond, at some point, is a new era of rising consumer confidence and retail spending.

In the years since the GFC began in 2008, Australian consumers have paid back debt and increased household savings. The national unemployment rate remains below 6 per cent, whereas at the peak of the 1991 recession the rate exceeded 10 per cent in most states. Interest rates remain at historically low levels and the Australian dollar has hovered around parity with the US dollar for close to five years.

…After the recession of 1991 the mind and mood of the Australian population was mightily subdued for some years. Sydney seemed to pull out of the doldrums first, in 1994. The catalyst, I think, was being awarded the 2000 Olympic Games in October 1993. Suddenly large-scale, government-funded urban infrastructure projects were under way. Within two years, Melbourne was starting to kick in, with projects such as CityLink, Crown Casino and what is now known as Etihad Stadium.

…Population growth has continued at historically high rates for the better part of a decade. There is underlying demand for household formation, even if households are delaying the act. It’s time for confidence to return to the market. It’s time to increase the credit card debt, take out a mortgage and bid up property values at auctions.

What’s needed is a trigger – such as the Olympics – so that the national mindset is rebooted. What might serve as the trigger? How about the upcoming federal election?

Fair enough. The man is a demographer so let’s not ask him to be an economist. But this idea that Australia is enduring a cyclical consumer slump is wrong. We are in a cyclical miming slump within a larger structural adjustment to the consumer economy. As I said last week when addressing similar hopeful guff from the Kouk:

First, the ratio of household debt to disposable income has eased a touch but it’s big stretch to conclude deleveraging has passed:

Second, national disposable income per capita is falling. The reason why is because the Terms of Trade (ToT) are grinding lower as the China boom passes. That means that the pay rise Australia has enjoyed over the past decade owing to expensive commodity prices is reversing.

This will continue so long as the ToT falls, which is likely for the next few years. To get some idea of how big the reversal is, Treasury estimates that the ToT pay rise accounted for half of our income growth since the turn of the century:

So we’ll be taking a pay cut for some time to come. This can be offset by increased productivity growth, labour utilisation and other things but they’ll all be working against the ToT headwind. Remember, the dollar does not change the terms of trade. If it falls it will boost Australian dollar income but not purchasing power and any gains will be offset by rising tradable prices.

This is the cyclical change that we are undergoing, a rise and now fall in our terms of trade. But it has transpired within a larger, and largely unrecognised, structural change to our houses and holes economic model. What I have often referred to for the past four years as the slow motion current account squeeze. We are simply unable to fund prior levels of credit and consumption growth.

Consider, there are only three macroeconomic ways in which consumers can spend more. The first is that we lower the savings rate – which has sat uninterrupted at 10% since the GFC – or sustain savings and boost borrowing.

But that will not be sustainable for long. The net result for the banks is the same. Deposit growth will fall relative to credit demand and the banks will find themselves short of money to lend. In the past, they would have gone offshore and borrowed it, increasing the current account deficit, but as we know, ratings agencies will no longer allow it. Nor would APRA want to see them try (the RBA is more reckless).

Here is the chart of our banks offshore borrowing:

Notice the plateau since the GFC. While this stays intact, the private credit cap is in place.

This is also what the advancing changes of Basel III signifies as global regulators question highly leveraged banking models and force higher capital ratios into global financial transactions. In this de-globalising world of stabilising banks, current account deficits and the credit growth they fund have much harder limits.

The second way we can expand consumption is that the government steps in to fund a larger current account deficit via borrowing. That is what Ross Gittins argued for the over the weekend:

In his major speech this week, Bowen noted that the great challenge facing the economy over the next year or two is ”rebalancing” – making the transition from growth led by the mining investment boom to growth led by the rest of the economy.

The question, he said, is whether the transition will be ”smooth or bumpy”.

…Should it slow down much further, the rise in unemployment would quicken and become more worrying. And should mining investment fall off rapidly, before the acceleration in home building and non-mining business investment got going, it’s conceivable the economy could slow to the point of contraction.

Trouble is, Bowen in his speech misdiagnosed the problem. He said the answer was Kevin Rudd’s seven-point plan to get productivity improvement back up to 2 per cent a year.

Wrong. This confuses micro-economic policy (aimed at raising the medium-term trend rate of growth) with macro-economic policy (aimed at keeping the actual rate of growth as close as possible to the existing trend rate, thereby smoothing the business cycle). The point is that our main instrument of macro management, monetary policy (the manipulation of interest rates by the Reserve Bank), may not be enough to ensure we avoid a serious downturn. It may prove necessary to use fiscal policy as an emergency back-up.

I note that RG is slowly making his way towards MB. But he’s still missing the key element. The budget guarantees the banks’ offshore liabilities. It must return to surplus across the cycle to make good on that guarantee or it loses the AAA rating. That would pass straight through to the banks cost of funds and credit is limited again.

That is why he is wrong about the macro and micro being separate. The final option to increase consumption is our only sustainable path in the long term. The cyclical boom in mining has partially hidden credit constraints as the miners funded the current account deficit. But it also shows how our incomes must now grow largely via export production growth (supported by moderate public deficits directed at infrastructure) as we endeavour to become more competitive in everything. That is, the only sustainable way to increase consumption is to increase production and higher productivity is a part of that.

In other Western nations this conundrum has led to slow growth and that future seems to dawning across the MSM this morning. David Uren of The Australian warns today that:

Both the Reserve Bank and Treasury are reviewing the economic forecasts they made in May and considering whether they need to be downgraded.

Treasury’s forecast that growth would average 2.75 per cent this year and 3 per cent next appears too optimistic while the Reserve Bank’s more subdued estimate that the economy was growing at 2.5 per cent may also need to be shaved.

Many of the partial indicators, including employment, retail sales and the business surveys, have been depressed over the past two months while the International Monetary Fund has lowered its estimate of global growth.

The March quarter national accounts — published in June after Treasury and the Reserve Bank had finalised their May forecasts — showed the economy had been growing at an annual rate of only 2.25 per cent for the previous two quarters. If anything, the pace appears to have slowed since then.

…The seasonally adjusted retail sales have fallen since February, although the trend numbers, which iron out the monthly volatility, show there is still some very soft growth.

Treasury and, it is likely, the RBA were counting on household consumption growth of 3 per cent both this year and next, which is broadly in line with the long-term trend. Consumption growth closer to 2 per cent would have a material effect on their forecasts.

It is likely that household consumption is being suppressed by weak income growth.

And Chris Richardson of Deloitte is out making similar warnings. From BS:

“If commodity price falls slow, then national income growth will get a second wind…Given the size of the ‘construction cliff’ that this nation is facing, that implies interest rates will stay lower for longer than many realise,” Mr Richardson said.

…the challenges are “large and lingering” and enough to keep output growth below three per cent, a long term trend through to mid-2015, he said.

Half right. If commodity and coal prices don’t fall further I’ll eat my hat. At least there is some belated recognition that the Australian economy is now hobbled. Government spending is one way we can support it as it heals. But that is not a long term solution either. Only greater output builds wealth in the post-GFC world. We’ve a long, hard road ahead.