Thursday, June 14, 2007

Governor says Australia's growth rate "unsustainable".

I was in Brisbane today to hear the first public speech from Australia's newest Reserve Bank Governor. With a seven-year tenure, he can speak without fear. He will outlast the politicians who appointed him. And as my piece in tomorrow's paper indicates, he does.

Australia's Reserve Bank Governor Glenn Stevens has delivered an apocalyptic wake-up call, declaring our present rate of economic growth “unsustainable”.

He has warned as well that he may need to push up interest rates soon to slow it down, but at a seminar in Brisbane yesterday he said that Australia’s current low rate of inflation had bought him “extra time”.

Market analysts interpreted the Governor’s words as indicating that the Bank was almost certain to push up rates this year, but in August or beyond rather than in July as many had thought.

A rate hike after August would come within months of the federal election expected in October...

But the Governor said that would cause him no problem.

“There's a sort of urban myth that is going around that it's understood that we wouldn't raise rates in the year of an election,” he told the Queensland University of Technology Business Leaders' forum.

“I object to this notion.We are not interpreting our decisions through the prism of the election. Whatever has to be done has to be done.”

Asked whether Australia’s present rate of growth in non-farm GDP of around 4.5 per cent was sustainable Governor Stevens replied “Not forever, no. The economy’s trend capacity to produce output is probably 3 point something. I would consider it to be unlikely that year-in, year-out 4.5 per cent domestic growth is going to be feasible”.

He said that his biggest concern was a dangerous belief among businesspeople that Australia’s 16-year economic boom would continue without end.

“The danger is that people become so confident that nothing can go wrong that they put in place financial structures, in particular higher leverage, and they make all sorts of other decisions which turn out to be very costly on the day when something does go wrong. And something will, sooner or later,” he said.

“The business cycle isn’t dead. It can never be abolished and sooner or later there will be a downturn. I can’t tell you when, but there will be. And structures and strategies that pay no regard to those possibilities will turn out to be damaging to the people who have got them. The longer the prosperity goes the more risk we run of that kind of behaviour occurring.”

Attending his first public seminar as Governor, the former Deputy Governor was careful to stress that he believed that both sides of politics were aware of the importance of long-term fiscal discipline. But he said too much attention was being paid to “boosting demand”.

“Anything that stimulates demand is thought to be ‘good for the economy’, he bemoaned. “But unless additional supply is somehow forthcoming, expanding demand just produces overheating and inflation.”

In particular the Governor warned that productivity appeared to be barely growing. “If you look at it industry by industry, productivity has actually collapsed in the mining industry, which seems odd. You can probably tell stories about short-term disruption in mining, but it isn’t just mining.”

Asked how he determined interest rates Governor Stevens said that there was no set formula but that Australia’s current extremely high rate of economic growth had caused him to ask “whether current settings are restrictive enough”.

He said the low rate of inflation probably gave him “a bit of extra time to assess trends”.

Asked when that time would run out, the Governor replied: “Every month we assess whether time as run out or whether it hasn’t. When it has we will let you know”.


Graeme Harrison said...

Yes, of course the guvna is trying to talk everyone INTO the action that would be the result of his likely actions, without having to take the actions. It's a bit like your GP telling you about the lifestyle changes that could allow you to avoid the otherwise-inevitable operation.

The fundamentals still look good for Australian equity markets AT THIS STAGE, in terms of price / earnings ratios and profit growth..... AND the flood of new super funds into that equity market keeps it growing, even if it stood still...

BUT it is getting a long time since a major stock market correction, so one should not be surprised by a 20-25% drop sometime in the next three years, with half-recovery of that loss within 3-6 months, and full recoupment of that loss within 12-18 months... So the only lesson is to make sure that you are not so leveraged that margin calls might lead you to having to sell down while the prices are low. (In many ways it is better to have an equity line loan against your house than to trade shares on a purely margin-lending basis.) As in all previous equity corrections (since 1935) the only people who will REALLY lose are those who are forced to sell out while prices are low.... so the guvna is right in warning that the real risk is borne by only those with too much leverage.
Graeme (email is prof at-symbol

Post a Comment