Saturday, March 15, 2008

Saturday Forum: Has the economy "snapped"?

There is an evocative moment in John Edwards’ 1996 biography of Paul Keating, the Treasurer who stood by in the late 1980s as the Reserve Bank kept pushing up interest rates until it brought on a recession.

Edwards says a few years later Keating’s principal advisor, the tall completely bald former Treasury official Don Russell confided that he “had heard the economy snap, not a slowdown or a steady decline, but an audible snap, something he heard in his office in Canberra not over a period, but at a certain moment on a certain day towards the end of 1989.”

The economy might have snapped again on Wednesday this week.

Mark the date in your diary just in case, Wednesday March 12, 2008...

Until Wednesday the Australian economy seemed unstoppable. Inflation was roaring skywards notwithstanding a near continual run of interest rate rises, investment was soaring and our spending in shops and on houses had hardly faltered.

Then came the consumer confidence survey conducted just after the most recent interest rate hike – the fourth in eight months, or the fifth counting the hike imposed by the banks themselves in January.

Confidence vanished, in a way that it hadn’t with any of the eleven preceding rate hikes.

The index imploded 9.1 per cent, moving well into negative territory where the number of people worried about the future outnumbered the number optimistic.

Over the three months since December the index was down 21 per cent, a sharper fall than ever happened when the economy “snapped” at the end of the 1980s, and the sharpest such fall since the mid-1970s oil crisis and the financial mismanagement of the Whitlam government in 1975.

Assessment of family finances slid 25 per cent. Assessment of whether now was a good time to buy a major household appliance slid 29 per cent.

Australia’s most canny shopkeeper Gerry Harvey of Harvey Norman heard the snap two weeks before. He told Dow Jones Newswires at the time that his earnings were about to slide.

“It doesn't look like it's going to be as strong as it was because you've got all this media every day on interest rates, stock market crash, the whole environment is being affected,” he said.

“If you feed the public that sort of stuff every day of the week, it has to have some effect. We're seeing signs of it.”

What would a post-snap environment mean? It would mean that the pressure was off inflation, however high the inflation rate was at the time. The Reserve Bank could relax and turn its attention to making sure that the downturn didn’t snowball into a recession.

Interestingly the Reserve Bank Governor himself may think that that is what has happened.

He told a meeting of state, territory and Commonwealth Treasurers this week that Australia was beset by the sort of policy disagreements that “tend to recur each time we reach the top end of the inflation cycle”.

This doesn’t mean that unemployment won’t continue to fall, perhaps for months to come, as it did again, spectacularly, in figures out on Thursday.

Australia’s new unemployment rate of 3.97 per cent (the document put out by the Bureau of Statistics perhaps misleadingly rounded the figure up to 4.0 per cent) has plunged unemployment into new territory.

Not since 1974 has Australia’s unemployment rate been below 4 per cent, and there is every likelihood it will fall further for a while.

The Statistician says it would only take the creation of a further 28,000 jobs (about one months average growth in recent times) to push the unemployment rate down to 3.9 per cent.

But that won’t mean, as a number of commentators have been asserting late in the week, that the Reserve Bank will be under pressure to push up rates once again.

If we are near a turning point the unemployment rate is about the last piece of information the Reserve Bank would look at to get evidence of the direction in which we are moving.

Job offers react to spending and investment with a lag – six months is one estimate. They tell you where you’ve been, not what lies ahead.

It’s a lesson the Macquarie Bank’s Rory Robertson says he learned painfully when he worked for the research department of the Reserve Bank at the time the economy snapped in the late 1980s.

He says once a month on the 14th floor of the Reserve Bank’s headquarters in Martin Place Sydney a gaggle of economists (often including the present Governor Glenn Stevens) would huddle around the single news-screen to read the employment numbers, often marveling at the ongoing strength of full-time employment and still-sliding unemployment.

“Later, it turned out that the economy actually was heading south, not waiting for the jobs data to catch up,” he said this week.

The economic chiefs at both Westpac and the ANZ believe that that economic growth is now heading south.

Neither expects any more interest rate hikes in this cycle and both expect a cut in rates next year in order to moderate the impending slowdown and stop it turning into a recession.

They say it isn’t only the relentless run of rate rises that has finally made the economy snap, it is also the collapse in the share market and the sudden world-wide shortage of capital.

The immediate impact of the capital shortage has been sharper increases in mortgage rates than the Reserve Bank intended and also much sharper increases in fixed rates. The ANZ’s Saul Eslake says as people come off expiring fixed-rate contracts and move onto new ones they are experiencing “sticker shock”.

And the rates charged to business have been soaring, climbing far faster than mortgage rates.

Most importantly as other sources of money dry up, the banks are approaching the limits of their legislated ability to lend.

Saul Eslake says it seems increasingly likely that the Australian economy is approaching or may have reached a “tipping point”, where the impact of tighter finance begins to outweigh the boost from higher commodity prices.

While he is emphatically not forecasting a recession he says he acknowledges “that the risk of one is now greater than at any time since Australia last actually had one in 1990-91”.

No-one wants that to happen. It is widely acknowledged that the Reserve Bank mad a major error at the end of the 1980s by continuing to push up rates for months after the economy had “snapped”.

It won’t make that mistake again. If this past Wednesday March 12 was indeed the day Australia’s longest-ever economic boom snapped, our Reserve Bank won’t be pushing up interest rates again for a very long time.

2 comments:

Andos said...

A very interesting read, Peter.
Your blog is exceptionally informative and a must-read these days. It's hard to find balanced analysis and commentary of this quality anywhere else (especially mainstream media).

Keep up the great work.

Anonymous said...

I find it difficult to believe that the Reserve Bank will not push up the interest rates again.

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