I don’t know what Glenn Stevens is so “quietly confident” about.
The group whose annual dinner the RBA Governor was addressing, Australian Business Economists, said in their annual report published at the same time that there is a 40% chance of a recession. But economists don’t know everything.
The sharemarket thinks the Australian economy is in at least as much strife as the US – our market is down 52%; the Dow Jones is down 47%. And it’s not the just the globally focused resource and energy stocks: the industrials index is down 53% and, more importantly, domestic-focused consumer discretionaries are down 63%. But the market doesn’t know everything either.
And last night the Bank of Canada cut its cash rate by 0.75% to 1.5%, bluntly stating that Canada’s economy “is now entering a recession”. But that’s Canada.
So why is the RBA Governor saying he’s quietly confident? Because he has to say that. It’s like the film where the family is in a raft about to go over a waterfall, and the kids scream “Dad, dad – are we going to die?” And he shouts soothingly above the roar, paddling frantically: “I’m quietly confident we’ll be okay children.”
The Canadian sharemarket has collapsed in the past few months. It peaked in May – about six months after Australia’s – and has since fallen 43%, which is less than both Australia and the US.
The other thing that has happened to Canada is that its terms of trade have collapsed, house prices have started falling and its political stability has started to unravel as a result of a furore over the Government’s recent economic and fiscal statement, which failed to deliver any fiscal stimulus and, if anything, was mildly restrictive.
That statement bore a striking resemblance to a lot of the “talking it up” waffle being spouted in Australia: “Canada has weathered this downturn better than virtually any other industrialised country… domestic demand has continued to grow at a solid pace… employment has continued to expand… Canada is facing this period of uncertainty from a position of relative strength.”
The central bank has now blown the whistle on all that guff with another big rate cut to 1.5% and the admission that, actually, Canada is entering a recession.
Australia’s terms of trade are being held up for the time being by the fact that our bulk commodities – iron ore and coal – are sold on long-term contracts. Spot prices have collapsed however, and contract prices will be cut next year, so it’s only a delay.
There is a debate about whether house prices in Australia are going to fall. I think there is nothing surer, but I recognise that there is a good case that prices will be held up by the shortage of housing in this country (as opposed to the glut in the US and Britain).
And perhaps the fiscal and monetary stimulus will hold consumer demand at above recessionary levels; at least the two arms of policy here are not fighting against each other, as they are in Canada.
But the main reason Australia will follow every other western country into recession is that the business investment boom is over.
In fact in a note this morning, Stephen Koukoulas at TD Securities asks: “Is Australian business investment as big a bubble as US housing?”
Investment in Australia rose from 16% of GDP to 21% in about five years. That’s a similar rise to that of US housing, which went from 4% of GDP to 6% over a much longer period (mid-1990s to 2006). The US housing crash has seen investment fall back to 3.5% of GDP as the inventory of unsold houses needs to be cleared.
Australia does not have an overhang of residential housing – the problem is business capacity.
Says Koukoulas: “Both the private and public sectors have not only addressed what were a series of capacity constraints given the prior under-spending on investment during the 1990s, but with the global economy falling into recession, it seems clear that there is a now quite substantial investment overhang.”
In the 1990s recession investment fell to 6% of GDP in three years, a massive downshift. If that happens again, there will a massive hole in GDP.
Koukoulas adds: “There is absolutely and utterly no doubt that investment in Australia will fall. Virtually every day, there are announcements from the mining and resource companies outlining the postponement or cancellation of a range of investment plans.”
Glenn Stevens did mention that in passing last night: “Businesses are currently in the process of scaling back plans for investment and hiring… so in the period ahead, private demand could look weaker than it has for some years."
Indeed. The hope is that public investment and hiring might replace it. The trouble, as I wrote yesterday, is that the public sector is starting from a long way behind.
This article first appeared on Business Spectator
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