Australian stagflation?

From David Bassanese at the AFR comes an interesting idea I wish I’d thought of (which happens very rarely to me reading Oz media):

It is one of the ugliest words in financial markets, but one that might start to confront Australian investors in the coming year: “stagflation”, the combination of weak economic growth and rising inflation.

…Rising inflation usually pushes up long bond yields, which cuts bond market capital returns. And there’s a double whammy for equities: weak growth hurts corporate profits, while rising interest rates dampen equity price-to-earnings valuations.

…For overall inflation to remain benign, we’ll need to see a decent slowing in domestic or “non-tradeable” inflation to offset the likely upward drift in “tradeable” inflation due to weakness in our dollar…higher inflation cuts the RBA’s ability to help the economy out of its weak patch – which is why it is such a problem for investors. We can’t blame the weaker Australian dollar – we need a cheaper currency to boost external competitiveness, which has largely driven the lift in tradeable prices.

Instead, should stagflation occur we should blame the lack of internal or “domestic” competitiveness, which may well keep non-tradeable-sector inflation high, despite weak demand.

Correct! Rent-seekers, monopolies, poor and weak policy all make this possible.

Though unlikely. Bassanese also notes that tradable inflation will pass as the revaluation passes through prices – pig through the python style – and that should prevent stagflation. As I’ve said, the RBA won’t raise rates in that event. And if housing comes off the boil I think non-tradable inflation will too as employment and incomes weaken (it’s all we’ve got after all). Meaning the RBA can cut again. That’s what’s happened before in the 2003 and 2008 housing slumps:



Though that’ll mean another spurt of tradable inflation.


Houses and Holes
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  1. I’d rate stagflation in the next 5 years as a 1% probability for both Australia and the world as a whole.

    Deflation is the current problem for most of the developed world because of high private debt levels, low population growth, changing demographic profile with 35 to 45 not growing significantly. Australia is about to glide into it as the resource construcion boom runs off over 3 to 5 years and two major car manufacturers cease operations.

    What is Abbott’s plan?

    • Inflation will hit Oz as our dollar slides and imports become more expensive in AUD terms. Most other countries won’t have that problem

    • What is Abbott’s plan?

      Maybe that is his plan — deflate away, encourage savings, put the flame to over-leveraged households and under-performing corporates, watch real incomes rise, and give over-capitalised industries and overpriced assets a good, cold douche.

      Abbott has clearly stated that he’s not a Keynesian, so he must be an Austrian, am I right? He wouldn’t have no plans at all, would he!?


    • Interesting point regarding the 35 to 45 demographic. There is a lot of commentary on the leading edge of the baby boom reaching retirement. But the trailing edge was actually steeper:[email protected]/Products/3301.0~2011~Main+Features~Fertility+rates?OpenDocument

      Even in the depths of WW2 in 1942, fertility was 2.4/woman. And contrary to popular wisdom, the growth in the fertility rate did not start in 1945/46: it had been growing from a depression era nadir of 2.1 in 1934, on a fairly steep curve from as early as 1940 and did not reach its peak (3.4) until 1961, a 27 year climb of 1.3/woman. It then collapsed much more rapidly, falling from 3.4 in 1961, to 2.9 in 1971, to 1.9 in 1978 and remained in a band of 1.8-2 thereafter. A drop of 1.5/woman in 17 years (or an amazing 1/woman in only 7 years from 1971-1978!) – greater and quicker than the earlier increase.

      Obviously retirement is a big financial change. But there is also a big difference in the spending and borrowing power of a 25 year old and a 35-45 year old.

      The 1978 crowd (at only 1.9/woman) is now 35, so excluding migration the growth in the 35+ crowd is all gone for a little bit until the echo boom from the 1961 peak kicks in. A lot is earned & borrowed and spent by people in the 35-50 range, so as that group stagnates, you would expect it would affect the economy and credit growth.

      I think it should particularly affect credit growth. At least some 55 year olds are probably saving and paying off debt and will not initiate much more entirely new debt on average than a 65 year old. But 25 and 35 are chalk and cheese in this regard.

      Population pyramid for completeness:

      • I’m pretty sure ‘excluding migration’ is not the numbers our corporate patsy pollies are working with…

      • @aj. – Fair call. Perhaps the better conclusion is that, in the circumstances, the only certain things in life are death, taxes and increased immigration.

  2. Stagflation in the 1970s was driven by the two oil shocks. It will probably be similar this time around.

    $3/L of petrol will do.

    • I suspect the Yanks going off the gold standard in 1971 and printing money to try and inflate away their Vietnam war debts and moon program didn’t help either

      • …and they could, and did, because..all forms of debt levels were vastly lower than they are today, and society could ‘share the load’ by leveraging up. The debt had to be secured against a tangible asset, so asset prices (property, shares, gold etc) took off, and “Hey, Presto! We’re saved!”. And yes, we were. But this time, what most seem to have overlooked ( or prayed we’d overlook!) is that there is no spare debt capacity to leverage up into. We have done the borrow and spend bit already. Now what? Well, I reckon we are going to have to sell what we bought to pay the debt down before we try the inflation bit again….but time will tell….

  3. “Bassanese also notes that tradable inflation will pass as the revaluation passes through prices – pig through the python style – and that should prevent stagflation.”

    I’ve not yet seen one credible argument to support this theory other than the unknown of robotics. It’s just wishful thinking…a ‘cargo cult’ mentality that no matter what everything will turn out fine because we could not bear the alternative.

    What evidence is there that prices from China will not stop their current approximately 7 to 10% per year rise? Why will the Chinese rebalancing process not result in the reinforcement and, perhaps, exaggeration of this effect? Why will Chinese demographiocs have no effect? Why will the long term rise in prosperity in Asia, on whom we’ve depended for ever-decresasing prices for 50 years, not have any effect on our costs?
    Why, when the great determinant of our long term low non-tradable inflation, has been negaitve to zero tradable inflation for decades, do we now believe that long term rising tradable inflation, from both currency and world factors, will not feed in to non-tradable inflation at all?
    “Correct! Rent-seekers, monopolies, poor and weak policy all make this possible.”
    This is not “possible” it’s a damned certainty.

    P.S. Thanks Dumpling…I forgot about that part of the post!

    • Yes – I am not sure I understand this pig through a python concept.

      Back in the 1980s I was working in a Hi-Fi shop and watched all that lovely well made Japanese gear rise steadily in price as the Yen strengthened.

      The first response was that the really good stuff stopped being imported and what had been middle of the range became top of the range.

      Then when that was not enough to keep people buying, the Japanese gear started arriving with made in Indonesia, made in Korea and made in Indonesia labels.

      Ultimately, all of them were replaced with Made in China at that point and with the benefit of the mining boom we started to get some of the good quality gear back on the shelves at prices people could afford.

      Once the factory of the world with 1.4B people starts going up in price and our income starts dropping who will be the new çheap country to supply us at no higher cost what we have become accustomed to?

      I suppose we could just get used to the bottom of the Chinese product range becoming the top of the range but if China is starting on the Japan trajectory we may find that even the bottom of the range starts getting pricey.

      China as factory of the world was been wonderful for developed nations. All those goodies at such low prices.

      China as growing middle class nation of the world might be a lot more uncomfortable for those countries who have lost the art of making what they want or earning a real income.

      The dudes with the factories might start charging prices that reflect what middle class people expect to get paid when they are working in factories.

      • As my Chinese mate said…”The Chinese want the good life too. Just like you!”
        So why is it that the University professors, RBA, Treasury, even this forum think that all the Chinese want is to make cheap goods for the rest of the world ?

        The second Chinese aircraft carrier ought be whispering SOMETHING that can be heard by even the stupidest ears of the above cohort!
        People who want to know about China need to go over there and drink lots of Moutai with them! Enough of this poncing around in stuffed shirts!

  4. Me, 2011:

    Outcome = stagflation?

    One possible and incrasingly worrying outcome of the current global issues is that Australia could enter a period of stagflation. With the RBA possibly unwilling to raise rates and trigger defaults, but international pressures pushing up the CPI, it is quite possible that we could be stuck with increasing prices and increasing unemployment if the global situation deteriorates.This could occur for a few reasons. One is simple. Our dollar is floating, and can trade rapidly up and down. The major factors that have held it high have been relatively high interest rates bringing foreign investment and speculation, and commodity prices. It is possible that our dollar will be traded even lower than it is currently (96c) due to a global rush to liquidity denominated in their own currencies. It is also possible that worldwide food prices continue to rise, and importantly, oil prices.
    We currently see an emerging and alarming disconnect between the two major oil indexes. The West Texas Intermediate which mostly supplies the US market, and the Brent Crude which is generally exported have diverged by $20 a barrel.
    This could be a critical sign for oil dependent nations like Australia. We could be facing a lower dollar and stable oil prices. This would translate to a marked increase in prices at the pump. If oil does not drop as it did last time, we could be in for a repeat of the 70′s.It is hard to predict, but this outcome is possible. If the RBA drops rates, our dollar drops and inflation rises.
    If it raises rates, defaults could occur.

  5. LNP is following the UK coalition’s model of the last 5 years:
    – deflate your currency
    – keep immigration high
    – negative real interest rates
    – inflation around 4-5%
    – negative real wage growth
    – keep the housing market booming

    Of course none of these solve our (and the UKs) biggest problem. A massively over-leveraged household sector.

    • Exactly scott! What is there to change it in the immediate future? It won’t change until it can’t go on any longer. I see the UK getting heavily into selling big country estates to foreigners now to keep the scheme running!

    • So aj….RE (not Sydney) to buy or not to buy? I guess stagflation comes first then we get the real inflation?

      • Well there is very little point in saving in fiat, and bonds would have to be a risk. Maybe inflation linked bonds if you trust the CPI 😉

        Actually I think RE (ex china bubble areas) will do fine but I like stocks – those PE numbers look peachy if you halve the value of the currency. Just have to manage cash and leverage to look through an Asian Debt shock if it happens. And if it happens, currencies will undergo another wave of devaluation, after a short arbitrage opportunity.

      • aj
        Yep we get currencies going down across the board. What will the RBA do? My bvet would be raise rates but far below the level of inflation. However even that may be enough to crash the RE market?
        I’m currently trying to ‘steal’ a property on the GC at something less than half replacement cost…big house on acreage. (not sure this is a desirable type property for the new generations either!) However it also requires raising my debt levels…which is the aim if we are going to run fiat to zero.
        I’m also thinking the GC would benefit some if A$ gets hammered (hat tip to Peter Fraser for reminding me of that!) although I think Aus cost structure now so totally screwed it makes everything difficult.

        I’d appreciate any thoughts.

        P.S. I have enough stocks that aren’t doing too well (well that’s one way of putting it!) but which might go ok in a big currency fall!!!!!

  6. There must be some tradeables inflation beginning to creep in over there? Petrol prices etc on the up?

  7. Damn gota save posts! far the inflation is in non-tradables. The tradable still largely in the pipeline.

  8. pfh Re interest rates in this light pfh what’s your best take on the likely path. I see you fired a shot at those of us who reckoned the RBA will ‘look through’ inflation. Got any RBA contacts who have opinions? (I’ll consult with an ex employee later)
    My current thinking is that they will ‘follow’ inflation upwards. However rates will get increasingly RAT negative. However will any nominal increase devastate the RE market and, as a result, the Aus economy?

    RBA said over and over again that increased house prices are the centrepiece of their policy. Will they now announce they are going to crash teh housing market to try to crush inflation…I know it won’t be in those words but that would be the essence?

    • Flawse,

      I have no contacts in the RBA nor anywhere else in FIRE for that matter.

      My comments on what the RBA will do if inflation rises are based on currency stability being their core mission and one they have stuck to very publicly.

      If they choose to look through they will need a battalion of sophists to explain the rationale.

      I now get the pig and the python image – one off price jump but no ongoing price rises.

      That sounds like wishful thinking to me. While the currency may bottom out I reckon prices out of China will steadily rise and there will be no large ‘new’ supplier who will be able or willing to undercut them by much.

      For example: Say a Chinese TV goes up by 30% an Indian or African TV is unlikely to appear at 30% less. More likely that if they appear at all they will might be 10% less.

      China blew the competition out of the water with super low prices but I think they will also drag up all prices as they increase their prices.

      You just can’t replace a cheap factory of 1.4B when it starts to raise prices.

      The other reason I don’t think the RBA can ignore inflation, unless it is clearly temporary – ie a pig, is that once people start expecting 3-5% inflation that is what they will expect each year.

      Most employers and employees take a CPI rise as the starting point. Raise that starting point and the cat is out of the bag.

      The other thing to remember is that the RBAs debt engine needs a high exchange rate and certainly not one that is falling if our Banks are going to roll over their borrowings at low cost.

      Our banks might find the cost of wholesale money rising as our currency and terms of trade decline.

      As much as we have convinced ourselves that we deserve low interest rates, someone somewhere has to forgo consumption if we refuse to. People forget we import the savings habit and the price of that imported service tends to rise as the borrower looks a little sickly.

      So could this mean, rising prices and upward pressure on interest rates at the same time as terms of trade are falling, unemployment rising, credit growth /house prices stagnating?

      Just because the economy is slow and employment doesn’t mean people will not ask for CPI. They may have no choice, there is a lot of debt out in householder land.

      Possibly and it may not be very pleasant.

      It will take time to rebuild an economy that can make use of a lower exchange rate for exports and import substitution, so the choice may be imports that are rising in price or nothing at all.

      One reason that while a floating currency is good allowing the currency to gyrate with foreign QE and manipulations and speculations is insane.

      Especially when have issued the world with Billions of IOUs.

      • good post

        I think the RBA has to be seen to be firm on inflation, and particularly inflation expectations. Thats why we can expect those employees on IR agreements to bear the brunt of government posturing on clamping down on them – despite all the talk starting to emerge overseas about increasing wages being the only way out – as a means to address productivity when every man jack of us knows the biggest issue is the currency and the duopoly/monopoly nature of much Australian industry, or its uber indebtedness. The only escape fro that for a lot of little people is to leverage yourself as much as possible, and hope that you can make that part of your existence which is (overly) leveraged (and therfore worthy of government support) larger than that part of your existence which is earning money openly and in a PAYE tax world (and which deserves to be punished to fund government outlays)

        On China there has been plenty of indication for some time that the one off deflationary impact across the world which came from outsourcing manufacturing there has had its peak and the tide is running the other way, increasing inflaton, and there are plenty of quite credible instances of companies in China relocating production capacity outside.

        As PfH rightly points out the banks need a high AUD – for debt rolling over purposes – while the broader economy wants a lower AUD for competitive purposes. If Australian banks competed like the shrinking Australian globally exposed sector we wouldnt face this ludicrous contradiction – or if there was some form of half decent commitment required by government for the banking sector not to impose a net cost on Australian business in exchange for the backstop role the government provides for it. But when it comes to contradictions even that falls below the mega contradiction we face in the economy needing asset price deflation (to make things – particularly RE affordable), while needing labour inflation (to make our insane levels of private debt manageable) and trying to encourage investment (to offset declining consumer spending and more austere government sectors) in the face of that.

        The late Luis Bunuel should have made a film about the Australian economy circa 2014.

        I am doing my own Yves Tanguy painting of it.

      • “Bunuel should have made a film about the Australian economy circa 2014”

        Now there’s a priceless image – all the Australian pollies sitting around the table on their toilets. Who will be the one to ask for food?

      • interested party

        @ Gunna ……. “But when it comes to contradictions even that falls below the mega contradiction we face in the economy needing asset price deflation (to make things – particularly RE affordable), while needing labour inflation (to make our insane levels of private debt manageable) and trying to encourage investment (to offset declining consumer spending and more austere government sectors) in the face of that.”

        Nailed it in that paragraph. The RBA will have to cut one party loose soon, either the banks or joe public. If I was a betting man my cash would be on joe going down.

        Bank bail-ins are coming…through forced super contributions or straight out cash confiscations. It’s time to play defense.

        It is like we are living through the “distribution phase” after a protracted uptrend……and looking/waiting for the downtrend to start in earnest.

      • Thanks pfh and Gunna…my thoughts pretty much exactly….except…sorry Gunna but I think if you have wage inflation and increasingly negative interest rates people just spend more. It’s logical and it’s a simple fact. it’s part of the reason we are where we are. private debt will not decline. on anything other than a short term emergency fear, as long as you rin negative RAT interest rates. Again that’s how we got here.
        Anyway it’s moot, as you well observe, there are all these contradictions we have to fulfill!

        🙂 Still dunno whether to buy RE on Monday!!!!!!! I am, as HnH suggested trying to buy in a very beaten down market anyway which might l;imit my looses and my time is running out for owning a nice home!

      • I’m with you @interested party

        I think the baseline position of the government (and would be no different if it was an ALP government) is that it will be Joe public that gets cut loose.

        The only observation I would make at that point is that Joe is in debt to the tune of 150% of his disposable income, and includes an awful lot of putative property investors, and that at the point of Joe being released there may be an awful lot of downward pressure on real estate prices – and one would imagine the banks would pucker cloacas at that prospect too.

        So the only way out of that is some mechanism to allow the putative property investors who can no longer meet payments to sell their assets to the government who would buy them and release them in such a way as to prevent a collapse of the market. At this point I would have thought there would have been some consternation even within the Torynuffs. Maybe the other alternative would be to run migration not at 300K per year but maybe at 700-800 per year for a few years (in the face of presumably increasing anti migrant sentiment from swelling ranks of former putative property investors now joining those who have long been priced out of the market or who are faced with massively increased competition for the non existent jobs.

        The other alternative – which seems to be the one being followed – is to gum society with as many migrants as possible before the actual meltdown commences with a view to putting a floor under the real estate market, regardless of the implication of the additional migrants in terms of wage rises which would help reduce private debt levels.

        At some point they need to get the houses off the massively indebted – then they need to somehow apportion them to those who will pay the price without creating a collapse of the RE market, and without the general public wising up to what is going on.

        @flawse – I even agree with you – I think leveraging yourself up with as much debt as is humanly possible is actually a fairly logical strategy for much of the punterariat – on the basis that if they have to sort out a bailout of those in hock to their eyeballs, it cannot be too onerous lest we have an RE collapse (to go with a wider economic collapse) at least until such point as the vast levels of private debt held by future generations broadly equal the vast levels of private debt held by the soon to be retired (or cark it) – at which point some form of overt political blame apportionment can be applied, and until that point it is likely that the massively privately indebted will be treated with more respect than ordinary PAYE workers/tax payers.

        I wish you guys were here drinking with me this fine Geelong afternoon, I would rather not type too much when I am soused as a herring.

      • Gunna
        What a good suggestion! I’ve started on my own ‘Red’ programne for the night! We should get together one day that’s for sure.

        Bloody hell our choices are getting ordinary and I find it so depressing! Hell we should be genuinely super rich by now…every last man Jack of us!
        All the best!

      • Red wine therapy!

        Excellent idea.

        I think the most constructive approach to the present situation is to fix the housing market – both the model for financing the servicing of new developments and approving new developments.

        Anyway you cut it we need the fundamental economic input – land – to be a competitive advantage rather than a deadweight.

        While a construction boom may not be sufficient it will make a substantial difference. Certainly houses are not factories but low cost residential, retail, office and industrial space is the raw material.

        The main obstacle is that the banks have done a fine job of convincing everyone that the world will end if ANY pressure is applied to their loan securities. As a result most everyone has hysteria at the thought of any downward movement in the price of existing houses – even if it is only indirect via lower cost new houses coming onto the market.

        That of course is complete bulldust.

        Providing the construction sector is being driven building new lower cost housing, downward pressure on the price of existing houses, either due to higher interest rates or lower cost new houses will not set off a meltdown for the following reasons.

        1. Plenty of people will still have jobs due to the activity in the construction sector.

        2. People will not abandon their homes just because the value has staganted or slid by say 10-20%. They may be pissed off but they will not walk away.

        3. The govt can always provide some support to both the price of existing housing and the newly energised construction industry by allowing more foreign ownership and more migration by wealthy escapees from less pleasant parts of the planet.

        4. If some bank did find problems with bad debts the govt can always help out with some TARP style nonesense and let the public take on the management of slow paying mortgagors.

        When the rental vacancy rate in the capital cities is circa at least 5% we will start to get some sense of what a healthy rental price looks like.

        All of the above is a much more constructive and healthier response than

        1. continuing to choke housing supply (and thus construction)

        2. propping up prices with cheaper debt – if it is available

        3. letting inflation of the leash by ‘looking through it’

        But we are talking about an RBA who buys the banking sector scare stories and pollies like Joe Hockey who reckon the ‘wealth effect’ is a magic pudding.

  9. I thought more like stagdeflation. (thought Nov 2013)

    That said I don’t much understand tradeable and non-tradeable inflation.

    • Non tradeable is pretty much the stuff we cant get away from

      rates, taxes, road charges, levies, health insurance costs, electricity gas and utility bills and the like, all government or semi government charges – is largely (in the first instance) impervious to currency movements. In Australia it has been running at circa 3% for 3-4 years.

      tradeable is everything we can trade. If local onions become expensive we get cheaper ones from New Zealand, cyclone wipes out Australian banan crop and makes them expensive we get cheap imports from Vietnam, cars became expensive from Australia so we euthenase the industry and get cheaper ones from Korea, expensive TVs become cheaper when we get them from China, our hitherto cheap education sector loses students to UK when we become expensive, our people become expensive so companies export jobs to Philippines, India wherever.

      tradeable inflation has been running at – 1-2% for a while as the Australian dollar climbed and we exported jobs and boosted import of products and services.

      The total of tradeable and non tradeable over recent years has looked great [as LVO and DLS have not regularly] at circa 1% or so [sum of the minus -1-2 and the plus 3 or so] but everyone has felt poor because they have to pay the 3% on the non tradable,

      Now the dollar is back adopting the pike position there will be a sudden jump in tradeable inflation – which many believe the govt and RBA will ‘look through’ [assume it is just a one off due to the falling currency] although many [like myself] think they will freak if it becomes embedded in expectations.

      The sum total of the two parts can be expected to climb

      • I’m thinking we might start to get lots of ‘theoretical’ papers, from the RBA and universities, that suggest interest rates should be set based on the non-tradable inflation number….as they should be but we will be cherry picking our time frames. IR’s should have been based on non-tradable inflation all along!!!!! As a way out for the RBA it will prove quite temporary but would probably be enough, together with Chinese money(?) to keep the RE shebang going for a while longer.

  10. Good summary from the ‘truthinsunshine’ comment

    This is the biggest red flag I’ve yet seen, if true, that should raise serious concerns among even the most reserved of people, that there’s massive instability and systemic problems on bank balance sheets.

    HSBC is a massive western bank, and if it’s seriously inquiring of its customers the reasons for their withdrawing ANY denomination of cash, then THAT’S A RED FLAG.

    If any U.S. or U.S. located bank branch of a foreign bank inquired this of me, I’d immediately withdraw all my funds and close my account, and then pursue other legal remedies that may be available under the state and federal civil codes.

    Gotta say i’ll, again, be keeping a store of cash outside the Bank…any damned Bank!

    • interested party

      “If any U.S. or U.S. located bank branch of a foreign bank inquired this of me, I’d immediately withdraw all my funds and close my account, and then pursue other legal remedies that may be available under the state and federal civil codes.”

      Close to being too late if that happens, mate. The legals will back the banks……..for the stability of society, of course;)

    • flawse, would you consider having some of the yellow shiny stuff to stash under the bed?

      The banks world wide are so interdependent that credit may freeze once again but this time there are even more il-liquid obligations that will have to be ‘covered’ by someone?

      Where is the home of HSBC is it HK or China or perhaps British. This may make a difference as to who backstops a bank run.

    • interested party


      Best not to be too concerned at this late stage in the game. I believe that 08/09 was the warning shot and the main event is somewhere in the future……maybe monday….who knows. If you can do cash, then you will pick up a RE bargain when the SHTF so if you can wait, I would be doing this……….in fact that is what I am doing……..waiting. But then I have developed an intense dislike for debt as it represents so much of what is wrong with society. Be nice if we can get an acre per ounce………hmmm.
      Life as we have built it is not designed to run in reverse……..HSBC is just one flag…..if you look at the big picture, flags are flappin all over the place.

    • interested party

      Imagine the pandemonium if someone in front of a well watched camera were to utter the truth. Good grief.
      Mass realization of the fact that RE is not liquid….lol.

      Rum time here in Perth.