All eyes on inflation next week, but not everything is as it seems…
July 23 2016 – 12:15AM
Not everything is as it seems about Jess Irvine. She does reasonably regularly write quite informed and perceptive articles about a range of socio economic phenomena – notably housing. She also, however, regularly gets put in the role (often, as here, in the guise of filling in for the more overtly parallel universalism of Gitto) when she simply does not put what one assumes is a decent mind into gear, and serves up a plate full of exhortation and schlock.
I understand she spent some time working with Uncle Rupert. Maybe she needs to go the whole Uncle and move back to the Rupertarian, or get some form of bullshido identification and removal process happening.
Something quite odd is happening in the economy.
Economic growth is quite robust and the jobless rate is falling.
But price pressures are abating. How can that be?
Usually, when economies heat up, you expect to see price pressures building. More economic activity drives higher employment, higher wages and higher prices at the store.
But inflation figures for the March quarter revealed the shock finding that prices actually fell 0.2 per cent, although prices still rose over the year by 1.3 per cent.
This is consistent with other evidence we have seen of easing wages pressure. Annual wages growth has slowed from 4 to 2 per cent a year.
But the economy grew 3.1 per cent over the year ended March and the jobless rate has fallen below 6 per cent.
So, why aren’t prices rising?
The article itself is essentially an exploration of the Economics 101 mantra: A growing economy + increasing employment = increased inflationary pressure.
The first observation to make is that the piece has us in the position where we can only question the answer side of the equation – we can question inflation, and assume that economic growth and employment are concrete, but we don’t go within cooee of questioning economic growth and employment if we assume the inflation figures are OK.
Let us cast this into another guise and pose the statement ‘something quite odd is happening with business journalism’ and follow it up with the observation that seemingly they have ceased to be able to ask questions about the world around them which involve questioning the relationship between economic growth and employment growth with inflationary pressure.
The piece provides evidence for falling inflation in the March quarter (though still up over the year 1.2%) and backs that statement up with more data about wage growth. But it comes comes back to that irreconcilable GDP growth of 3.1% and unemployment below 6%.
Let us ask ourselves the question for Jessica ‘is there a basis for questioning GDP as a measure of socio economic health?’ and follow that up with the question (more pertinent to the assumption underpinning Jessica’s essential line of questioning) ‘is there a basis for questioning GDP as a contributor to higher inflationary pressure?’
Jessica doesn’t go here, which is a shame, because she may well have found answers to her question about inflation simply by unpacking GDP a little.
From there, of course, anyone with a basic awareness of Australia’s economic predicament circa 2016 would probably point to two or three phenomena – Mining volumes, debt, and immigration – being major GDP contributors which either have major question marks hanging over them, or are delivering no net benefit to per capita GDP.
That GDP growth of 3.1% (which does look quite strong in comparison with almost anywhere in the world right now) reflects:-
The growth in export volumes for mining commodities iron ore, coal, gas (in particular) for which prices have plummeted (and which in the case of gas and coal are essentially being sold as a loss-leader for companies desperate to get whatever return they can – see Michael West’s superb exploration of gas here ( It’s a gas! Australian gas is a bargain … if you’re Japanese) before thinking about the future of coal in a world worried about climate change, and iron ore in a world in which the major consumer is moving away from fixed asset investment).
A brief look at that GDP makeup, and the markets for Australia’s three largest GDP export components, may well have bought the sentient reader into a position where they may question if there has been something of an over investment in resources production over the recent past, and from there the question of what the investment plans of those three sectors actually are over the foreseeable future.
Let us look at some charts.
An RBA chart on bulk commodity prices for Australia’s largest export earners (Page 15 here)
A DFAT chart on Australia’s principal export earners in 2015 (Page 4 here)
And some DFAT data from 6 weeks ago on Australia’s principal export earners in 2015
Now true, exports are only a small part of GDP. There are other parts of the GDP mix which are far larger. The good people at Ibis World have put together a map of GDP by sector for us here
And what we find if we look at that graph, and the charts above, is that apart from mining and agriculture (about 4.7% of GDP) and arguably education related travel and non education related travel (tourism, and possibly some of that hospitality) the other 95% of GDP is highly likely to be ……..
- something which costs us money (as opposed to earning it for us),
- something which would be highly sensitive to the strength of the Australian dollar; and
- something we don’t do very well in comparison with how the rest of the world does it
More observably we can see again from that page at Ibis World that these sectors have been the ones taking in the revenues (notwithstanding the marginal propensity for resources producers to get their marketing done in Singapore in order to reduce their taxes in Australia).
Australia’s Industry Mix – Shares of Revenue 2014-2015
Which sort of brings us back to the possibility that the entire Australian economy is running of a base of about 10-20 % of GDP (if that) which actually happens to earn us a buck, which the rest of the economy leverages well for its bucks. And from there we need to ask if a large chunk of the GDP growth Australia has had for quite some time has been related to the rise of Australian Indebtedness and the Financialisation of the Australian economy.
Some of us owe quite a lot
The second phenomena Jessica didn’t want to go anywhere near. Indeed for the most part the entire Australian mainstream media doesn’t want to go anywhere near, and this is possibly because an exceptionally large section of Australian society probably doesn’t want to think about it. It is debt. But the last latest RBA chart pack had this little ripper
Household debt/disposable income (page 6)
It suggests to us that debt/disposable income has sailed somewhere north of 175% in 2016. Anyone looking at that chart would find themselves wondering ‘how high can it go?’ along with maybe ‘what could get it higher?’
If we look at those charts above we can guess that it isn’t going to be a robustly competitive export sector because the only robustly competitive exporters we have are in markets where the price for their resources have collapsed. Indeed ordinary everyday Australians could easily look at the above and wonder if perhaps now is the time to ease back on the credit.
At this point why don’t we pop over to the good people at PIMCO and a piece they put out last June titled ‘A Look at Rising Household Debt in Australia and the Implications for Policy’ which included a chart on Net Disposable Income and GDP Per capita.
Which suggested that as a nation we have been giving debt a good nudge and included the words
”Should expectations rise for future capital price or income gains and/or should debt-servicing costs fall, households may increase their desired levels of debt. The problem is that expected future capital price gains may become unrealistic when extrapolated from recent history (“irrational exuberance”), leading to excess borrowing, which, when unwound, can lead to large negative externalities.”
Along with the very ominous sounding.
The Population Ponzi
The third GDP related phenomena, which nobody wants to talk about, is all the extra bums on seats. A chart from Leith van Onselen at Macrobusiness tells the story all on its own.
Now it may not be that these migrants have much to do with Australia’s wages outlook, but you could easily run a line that even if they have absolutely nothing to do with Australia’s wages outlook, at a time when a nation in hock to its eyeballs, and reliant on wages growth to service the tab there may well be logic to the idea of easing back a bit on the immigration front. This chart from the Macrobusiness post in June suggests the wages issue is worsening.
Enterprise Agreements imply wage rates are likely to slump even further
Even more so if we assume that Australia’s terms of trade have some way still to fall
And consider the historical relationship between terms of Trade and wages
So from there we can see that for anyone likely to be inclined to open the purse a tad and add to inflationary pressure they need to be.
- Not one of the heavily indebted Australians, or
- Not an Australian concerned about either their pay packet increasing or their jobs durability
Which would mean that in the first instance they would not likely be exposed to the global economy. From there we can observe that anyone in that fortunate position will start asking about those who are globally exposed (and providing the basis on which they earn – after those earning have got the marketing done in Singapore, or bounced contracts between their Panama registered subsidiaries) after which even they may be inclined to start tightening their belt. For those who are free from debt and job worries and have exposure to increasing immigration numbers, possibly there will be some worries about how long the immigration tap can be run at that volume before some form of protest vote style vote starts to happen, or how long before the immigrants start to wonder what they will do for a job.
The inflationary 0 we keep nudging towards possibly has its genesis about there.
But meanwhile, back at the ranch….
There are several possible explanations.
The more pessimistic point of view is that the economy is actually much softer than suggested by the jobs and growth figures. Low price rises mean the economy is somehow much weaker than we realised.
Following this argument to its logical conclusion, lower prices mean interest rates are suddenly much higher than they should be to help stimulate the economy. Lower than expected inflation means rate cuts are inevitable.
Indeed, the most pessimistic argument is that a period of sustained price falls may just be around the corner. An inflation-targeting central bank has a duty therefore to keep cutting rates until inflation resumes.
Generously, Jessica goes first to the more and most pessimistic lines of thinking – which are likely to be the base case for anyone looking at any significant number of the charts above.
She also adds, quite rightly, that rates will go lower. As HnH has noted before the RBA only has one lever to pull, and they will pull it.
This “deflation shock” makes for great headlines, but the reality is more benign.
Sure, prices fell for one quarter. We’ll find out this Wednesday whether that has been sustained when the Bureau of Statistics releases figures for the June quarter.
Most economists are expecting to see prices rising again, ie. that we have not entered a period of falling prices.
Price pressures will, however, likely be shown to remain low.
Then we embark on some form of weird contemplation over whether we will have outright deflation or simply low inflation. How many months has inflation been below the RBA target range?
But there are other possible explanations for this other than that the economy is heading off a cliff.
The first is that lower prices are not the result of weak demand, but of greater competition.
In a note to clients after the last inflation report, Commonwealth Bank chief economist Michael Blythe, went through the components of the consumer price index one by one to assess whether weak price pressure could really be attributed to weak demand.
The consumer price index is, of course, a combination of many price movements, weighted by what proportion the particular consumer item makes up of the typical household’s spending.
At the top of the list, food prices fell 0.2 per cent in the quarter. It’s unlikely that people suddenly stopped wanting as much food. More likely, price falls were driven by increased price competition by existing supermarkets and the entry of new players like Aldi and Costco. This, as Blythe points out, is an example of “good” deflation.
The price of clothing also fell, thanks to heavy post-Christmas discounting, which is usually reversed later in the year. An unseasonably warm summer and autumn may also have led households to hold off on winter purchases. If falling prices are due to better deals for consumers, not weak consumer demand, they are of less concern to the Reserve.
Housing price pressures were also weak, rising just 0.3 per cent. This includes rents, the price of new housing and some utility charges. Rental price growth is low as increased supply of new investment properties comes onto the market. Again, that’s not a sign of weakness in activity levels, but actually of strength. There were some utility price falls too, something the Reserve tends to look through.
The price of furnishing, household equipment and services also fell, which Blythe suggests is also due to post Christmas price discounting, rather than very weak demand.
Elsewhere, petrol prices were lower, reflecting lower oil prices, which have since recovered.
Communication prices fell, again thanks to increasing competition among telecommunications players.
There were also smaller than usual rises in health and education. Seasonal increases in pharmaceutical prices were smaller than usual and education price hikes were also lower than usual, perhaps reflecting the lower wages pressure.
From there we reach into Gitto’s drawer of surrealism pills and try and pin the blame on increased grocery competition – with Aldi and Costco in the firing line. These guys are adding competition for the highest margin grocery retailers in the world (Woolworths and Coles) over the last decade. If that doesn’t fire up your bargain hunting juices then maybe the knowledge that post-Christmas sales and warmer autumnal weather have cruelled clothing sales will (it is July now) Then there are drugs, petrol and mobile blower costs all conspiring to deprive us of inflation too – lets get out the Albinoni to consider that one.
For those not possessed of Gitto’s pills then maybe think about our CPI housing component rising 0.3% when every other real estate agent in Sydney and Melbourne is talking 10% plus per annum – and cogitate over the marvel of numberwang which must be behind that! – while bookended with the strength of the rental market which is limiting rent increases (and that strength presumably plays well with those engaged in constructing new abodes or those heavily leveraged with speculative positions in the investment housing world).
“None of this is to say that inflation is anything but low,” Mr Blythe wrote. But it does say that price weakness is not necessarily indicative of weaker demand, but other factors.
Jessica then quotes Blythe to indicate the latter has some sort of awareness of the real world, before defecating on the piece with a statement of palsied rubbish the like of which would prompt far lesser individuals than the late William of Occam to chant the word ‘bullshit’ in unison.
Lower prices are a global phenomenon in the wake of the GFC. US federal reserve chief Janet Yellen has indicated her concern about falling inflation expectations.
But inflation expectations in Australia remain well grounded, if low.
These have been extraordinary times in the global economy. But there is no reason to believe the ordinary business cycle is dead.
Next up is some reassurance of the ‘we are not in this alone’ type, with a side salad of spurious well-grounded wank and a one line rebuttal of the idea any mortality thoughts on the business cycle. That may be so, but do does Jessica think people should head out and spend if glib business journalists are out there spuriously denying the death of the business cycle? Would she concede that if it isn’t actually dead, then it could do with a good lie down? Or that with all the monetary stimulants coursing through its veins it should look a little more alive than Leonid Brezhnev in his final years? What does she think a buoyant economy looks like?
As long as growth remains robust and the jobs market solid, we can expect to see price pressures return.
It may take a while, however, as the economy continues its slow rebalancing away from mining and towards housing and services.
Australia’s deregulated labour market means it may take longer than previously for wages pressures to ignite. Higher pay packets are a precondition for sustained higher consumer prices.
One finds oneself asking ‘what if the growth is of the robust kind which doesn’t support wages?’ (for all those highly leveraged punters – as we have had for some time) or (at the risk of sounding doom merchantish) ‘What if the jobs market doesn’t remain solid seeing as it is generally profoundly uncompetitive, and largely reliant on heavily indebted people – including those in the jobs market – ramping up their debt spending, and the RBA cannot get the currency down to make them more competitive without sparking further house price increases which don’t show up in national inflation statistics but do generate comment, and destabilise an already debt heavy financial system anchored to exorbitant house prices?’
That slow rebalancing she is on about is towards the most expensive houses on the planet being purchased by amongst the most heavily indebted people on the planet, and the services don’t really cut the as a GDP driver (as opposed to GDP parasite) until such point as other nations want to buy our services – which they won’t while they are globally expensive, except for tourism, where we keep selling off assets allowing global companies to vertically integrate their operations, and staff them with cheaper foreign (457 etc) employees, or education, which is essentially about allowing the private sector to rip off taxpayers while touting residency (see staff for vertically integrated tourism above). That second last line about the deregulated labour market was what the last election was ostensibly about in case anyone was wondering. Maybe Jessica is suggesting the government could strike up an industrial relations stoush with the unions and lose to spark some inflation.
So, how worried is the bank about low inflation?
Weaker demand in the economy has already seen the Reserve Bank slash interest rates to record lows. Another weaker than expected inflation reading could prompt it to cut rates again in August to support demand.
But the Reserve doesn’t make decisions in a knee-jerk way. Whilst the Reserve’s mandate has found expression in an inflation target of 2 to 3 per cent, it is not rigid in the way it applies this.
Inflation has been outside the target band before, and indeed has been outside the bank for a third of the period since 1996, according to Blythe – 14 per cent below the band and 21 per cent above.
Does the RBA come out and say they are worried? Jessica unloads some spurious vim on the RBA decisionmaking style (which is pretty much the same style as central banks of the age) and some hedging factoids so as to build up to a thrilling finale.
The important question for the Bank in reading next Wednesday’s inflation report is how much of low price pressures are due to weaker demand, or other factors.
Should it find evidence that suggests demand is much lower than expected, it has room to cut interest rates again in August.
But it may also decide it has done enough to ensure inflation returns to the band, given enough time.
We’ll know more next Wednesday.
That important question is not for the public or the RBA. It is for the editor who looked at the piece, and needs to be reminded about what it was all about right in the final paragraph. The RBA will likely look at the numbers, see if they fit with a trend of below preferred band inflation expectations and flick the only switch it has. Although I do find myself wondering if maybe they will leave that honour to the incoming RBA governor within weeks (would Glenn like to leave a little something for his successor to play with if he thinks ToT, wages, and uncompetitive economy and massive private debt, are coming home to roost at some point after he departs the scene?)
She really could have just said ‘RBA will know all it needs to about inflation on Wednesday’ in the headline and written up a thousand odd words of bull about the significance of Wednesdays for economic decisionmaking…….it wouldn’t have made less sense. The lack of inflationary pressure is obvious, and its causes are profoundly obvious to far too many people for this piece to be all that credible to very many at all.