Mr Banker

Economists have a habit of being ‘right’ about the future until events ‘prove’ the justifications they have to come up with for having got it so wrong.

But it may not happen, Cassandra

Banker of Last Retort

As a formally trained economist I feel qualified to observe the similarities between my long-suffering spouse (LSS) and hangovers on the one hand, and economists and recessions on the other.

However adept LSS is at identifying the fact of a hangover, to date her communications only serve to identify a condition of which your correspondent is already only too well aware. Further, her well-intentioned efforts to assist your correspondent avoid a hangover involve his complete absence from the party – and where’s the fun in that?

With those reservations about economic commentary now clearly explained, I’ll begin the economic commentary that I foreshadowed in my last blog and explain why I see it linked to the change of government.

Most likely the credit squeeze triggered by the US sub-prime crisis will continue, and we will see a further two or three rates increases. This will slow growth, but not by itself stop growth.

The change of government will probably also ease growth. Big business will put some large investments on hold until they are certain about the direction of future policy. Likewise, this will slow growth, but not kill it.

The beast of inflation will start to rattle its cage in 2008, for two reasons.

First, finance and fuel are inputs into almost every business activity, so the higher rates and petrol prices will create a pervasive cost push pressure on prices.

Second, Mrs and Mr Average are very highly geared. The higher petrol prices (which would be significantly higher but for the strong dollar, by the way) and higher interest rates are hitting their household budget hard. The Averages will start to look for payrises to ease the pressure, and their union will believe that a Labor Government will be more accommodating.

So this will be a key issue for 2008 – will the Labor Government be able to contain wages growth?

That accounts for the things that our Government can control – but there’s more to it than that. The big uncertainty is the booming Chinese economy, or more specifically, the end of the boom. Will the bubble deflate slowly or will it burst altogether? This is critical for our economy because our current lop-sided prosperity is founded on a mining boom driven by Chinese demand. If Chinese buyers decide that they need 20% less raw materials, the consequences will be significant for Australia.

Here are the two nasty bubble-bursting scenarios:

  • The Chinese Government is unable to solve its own inflation problem without killing growth altogether.
  • Ecological disaster provokes a severe regulatory response, which kills growth. (This latter is your correspondent’s newest doomsday scenario; he believes that the “Chinese” ecology will snap before the Chinese economy does.)

Of course China may manage its economy and ecology well, and it may be that a US recession helps China by easing demand – this takes us to the happy slowly deflating bubble scenario.

So your correspondent will summarise by saying that in 2008 things will be either good, or bad; and his readers will therefore observe that his advice is as useful as the other economists of whom he is so critical.

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