• PD Jonson

Monetary Policy in the Fog of (Economic) War

Updated: May 2, 2020

This is a time of great uncertainty – equivalent in the economic sphere to the fog of war. Interest rates have been cut by 50 basis points to provide a measure of insurance against global recession. Will the Eurozone currency union end badly? Will China’s slowdown be sufficient to put Australia’s prosperity at risk? Will the tepid American recovery keep getting gradually stronger?

Domestic uncertainties are equally perplexing, though the resource boom and strong wage claims are real. Against this background, the Reserve may decide to sit tight for now, which Henry regards as the more prudent course. Or the official rate cutting may continue. Either way, Australia’s banks are nerving themselves to defy the Treasurer’s repeated demands that they pass on any official rate cut in full.

First the good news. The American recovery is proceeding more or less as predicted, slow and steady but with growing confidence. GDP growth in the December quarter was a tad behind expectations, though January’s jobs growth exceeded expectations. US, and therefore global equities were strong in January, despite gloomy economic news, especially real fear about the likely course of the Eurozone crisis.

In recent days, share prices have again surged, sending the major US index to its highest close since May 2008, before the Lehman Bros collapse. Commentary suggests, for example as the Wall Street Journal put it in discussing an even more striking recovery in technology stocks, that ‘hopes [have] spread that global growth would be strong enough to boost demand for technology gear’.

Equity markets famously predict many more economic booms and busts than ever eventuate. What is especially interesting is that this market rally follows dire warnings from the International Monetary Fund and the World Bank about the apparent political gridlock in the political economy of the Eurozone. It is impossible to be on top of precisely what is happening in Europe from here, but it is a fair bet that the longer the currency union holds together, the more likely it is that disaster will be avoided. Indeed, the warnings of the international agencies are best interpreted as attempts to ensure that sensible outcomes are achieved.

The extent of the slowdown of the China boom is equally hard to evaluate. China’s imports from Japan fell by 16 % in December, while imports from Taiwan fell by 6 %. The Shanghai Container Freight Index fell 1.4 % to a record low in November, after sliding relentlessly for several months.

The Baltic Dry Index, an old favourite of this writer, measuring as it does freight rates for ores, grains, and bulk goods, has fallen 44 % over the last year. Weak Chinese demand for iron ore is said to be the key culprit, along with a global glut of shipping capacity.

Electricity usage within China has been flat, with sharp contraction in year on year growth to a (still strong) 7.7 % in November. Residential investment has been contracting sharply, and property prices are now falling in all but two of China’s 70 largest cities. But the pace of price reduction falls short of the bursting of China’s property bubble predicted by some. Ambrose Evans-Pritchard, who provided these figures in a recent article, concluded by expressing scepticism about the estimated 8.9 % annual growth in the year to December.

As with the global picture, there are many cross currents in the domestic economy and overall evaluation is difficult. I hasten to note that, if the Reserve Bank is also finding the situation hard to read, I would defy any other institution to do better.

There is, of course, the much discussed ‘two speed economy’ – mining and related services booming, manufacturing, tourism, education and small business generally struggling. It must be noted that this is exactly what should be expected if the overall economy is not to experience an inflationary outburst that would damage the mining industry considerably, and all other industries greatly.

Household confidence has picked up, but is still low. Business conditions remain tight but confidence has picked up a little in December, according to the NAB survey. Credit growth is low and deleveraging of many corporate and household balance sheets continues.

An important Roy Morgan survey takes a broader look than official (ABS) data on the labor market. It allows for whether people would like to work but are not currently seeking work and people who say they would like to work longer hours if opportunities to do so existed. The relevant numbers are shocking. In January, ‘unemployment’ as measured by Roy Morgan was 10.3 % (up 2.4 % since January 2011) - an estimated 1,278,000 Australians were unemployed and looking for work. This is Australia’s highest ever number of unemployed as reported by Roy Morgan and is also Australia’s highest unemployment rate for a decade - since January 2002 (10.9% - 1,075,000).

A further 7.5 % of the workforce were underemployed - working part-time but looking for more work - 934,000 Australians. In January, a decade-long record 17.8 % of the workforce, or 2.21 million Australians, were unemployed or underemployed. (Here is a link to an article that explains these broader numbers, and here is a link to the latest release.)

These numbers deserve to be taken seriously by Australia’s economists and policy-makers. They help to explain why there has not yet been a general wage surge despite the supposed strength of the ‘miracle economy’. They also perhaps help explain why the government’s popularity is so low. Large numbers of people unemployed or underemployed just cannot take seriously the government’s rhetoric about the strength of the economy.

One of Henry's more reliable sources of opinion comes from the real world of opportunity shops, people working part-time in poorly paid jobs battling to find a half-decent house to rent and to pay the rent when they do. This person said recently: 'There are a lot of people hurting out there'. This is the real situation.

The question, of course, is whether or not further interest rate cuts can fix Australia’s dysfunctional labor market. To ask this question is to answer it. Fixing Australia’s labor market is not a job for Glenn Stevens and the Reserve Bank.

The global situation and the current state of Australia’s economy are both hard to read, but improvement seems more likely than catastrophic meltdown. Another rate cut now would do little harm as Australia’s goods and services inflation is undoubtedly low, and may help to further boost confidence.

If Wayne Swan’s hands were on the levers of monetary policy, cash rates would already be lower, and further cuts would undoubtedly be coming. But wiser heads in Australia’s independent central bank may prevail. The lid must be kept on an economy facing a massive investment boom and pressures on wages from politicians, senior officials and more deserving cases including carers, nurses, police and members of the armed forces. Plus of course, people employed in the mining and related services, where skilled workers are scarce.

Published today in The Australian.

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