Economics 101 for Treasurer Josh Recessionberg

Today we will see the Recessionberg Stupidity Index at new lows, one way or another:

He appears to have absolutely no idea what’s happening, via News:

“Our economic plan is working,” he declared.

“The fundamentals of the Australian economy are sound, but there are genuine and clear risks emerging both at home and abroad.

“The residential housing market has cooled, credit growth has eased and we are yet to see the full impact of flood and drought on the economy.

“Global trade tensions remain, the Chinese economy has slowed and there has been a loss of momentum in Japan, Europe and other advanced economies.

“Notwithstanding these challenges, it is a testament to the strength of the Australian economy that it is in its 28th year of consecutive economic growth. Our economic plan will see this continue.”

Sounds like a robot stuck on repeat. Unless the plan is to crash the economy then it is clearly not working. Here’s Damian Boey at Credit Suisse to explain where it’s all gone wrong for Treasurer Recessionberg:

The partials point to anaemic real GDP growth in 2Q of around 0.1-0.2% over the quarter, and 1-1.1% in year-ended terms. This is all well below RBA forecasts.

Compositionally, we know that consumer spending growth has been soft, construction activity has fallen and that inventories have been a major drag on growth. But what has contributed to these developments from a causal perspective? Modern monetary theory (MMT) 101 tells us that:

  1. Bank loans create deposits
  2. Fiscal deficit spending by the Federal government (on overdraft-like terms with the RBA) creates deposits.

Also, national accounting identities tell us that the sum of saving across all sectors has to equal zero. For every lender, there is a borrower. Re-arranging this identity, we can say that private sector saving, a proxy for the easiness of financial conditions, must equal the sum of the trade balance and fiscal deficits.

What we have seen in 2019 to date is that private sector saving has risen. This is because the trade balance has surged higher on the back of stronger commodity prices. But the fiscal balance has actually switched to surplus in recent times, exerting a tightening on financial conditions, and offsetting the easing coming through other channels. This tightening has contributed to greater concentration of risk in the domestic space, because at the same time, bank credit growth has slowed sharply.

It is an open debate as to whether the 2Q current account surplus, the first since 1975, is a positive development. Conventional thinkers will argue that it is a very positive, albeit temporary development, because it implies a pause in the growth in Australia foreign liability levels. MMT advocates will argue that a current account surplus implies net accumulation of foreign currency denominated assets as the economy gives up goods and services to trading partners – “a useless exchange”.

Regardless of the merits of this debate, even those in the MMT camp will acknowledge that at this juncture, that trade and current account surpluses are a “second best” positive development for the economy, The “first best” solution would have been to ease financial conditions by running larger fiscal deficits – “good management”. Failing this, the economy has had to rely on “good luck” – foreigners deciding to pay more in foreign currency terms for what we export, and a weaker currency – to do the same thing.

A long story short – fiscal austerity has directly contributed to the sharp slowdown in 2Q GDP growth, because it has reinforced the slowing in bank credit growth. But the trade boom has eased financial conditions, and potentially contributed to future real GDP growth on the condition that miners spend their windfall gains. Failing this, we will be left with concentrated risk in domestic demand that can only be alleviated through larger fiscal deficits, another leg higher in the housing credit bubble, or a resurgence in business credit growth (which seems to be dependent on the first two options anyway). Mathematically, we can start forecasting better growth outcomes for tomorrow, but with wider uncertainty bands than normal. The only question from an investment perspective is whether or not certain asset classes and stocks have confused mean forecasts with the distribution of forecasting errors in pricing in fat tail de-leveraging risks ahead of time.

Recessionberg’s discombobulation was again clear yesterday:

He urged people to “look through” the June numbers to the September quarter which will incorporate the effects of the income tax cuts which came into effect on July 1, as well as the June and July interest rate cuts by the Reserve Bank of Australia.

Except Q3 is almost over and data is deteriorating, via George Theranou at UBS:

While booming net exports & public saved Q2 GDP from the ongoing private demand recession, we still forecast a slump to 0.3% q/q & 1.2% y/y (was 0.2%/1.1%), likely worse than the GFC, & below mkt (0.5%/1.4%) & RBA (~¾%/1.7%). Worryingly, retail & car sales indicate weakness continued into Q3, despite tax cuts & rate cuts. However, Government comments indicate no new fiscal stimulus until at least December.

In short, when the private sector is seized by caution and the desire to save, tax cuts don’t work. Government should step into the breach and stimulate via investment. This will create jobs and drive up wages until such a time as private sector confidence recovers.

It’s called “Keynesian counter-cyclical fiscal policy”, Treasurer.

David Llewellyn-Smith
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