Saturday, April 13, 2013

What's the RBA's Plan A? Hoping something comes up

Seriously. Saturday column

Why are interest rates still more likely to head down than up?

Because it’s the Reserve Bank’s Plan B.

What’s its Plan A? Hoping something turns up.

Seriously. As it happens, the man at the top of the Bank is a man of faith. A parishioner at his local Baptist church, Glenn Stevens believes he works for the bloke upstairs. "I definitely think if you are a Christian, God has given you certain capabilities to do a job, to earn a living and the Bible teaches that you should do that as if you were doing it for him,” he told an Easter breakfast a few years back.

But faith doesn’t always get you what you want. If it did, it wouldn’t be faith. That’s why Stevens is hanging on to Plan B and preparing to use it.

His problem is that the resources construction boom is about to peak. When Chris Richardson of Deloitte Access had the temerity to suggest this a year ago in the midst of mining euphoria (and very bullish budget forecasts) he was rubbished. But then the resources minister started saying the same thing.

Months later BHP postponed indefinitely the $30 billion mega Olympic Dam uranium and coal project, Fortescue scaled backed an iron ore investment program already underway, and on Friday this week Woodside Petroleum shelved its massive $40 billion Browse liquefied natural gas project.

What’s left is almost unimaginably big. The Bureau of Resources and Energy Economics says projects worth $268 billion are already locked in. An astounding $195 billion are gas or petroleum projects. “To put this in perspective, and to show the scale of the pipeline in Australia, the total committed expenditure on Australia’s oil and gas projects is comparable to the total cost of the Apollo Moon Program in 2012 prices,” it says in its latest update.

But new projects aren’t getting ticks. This means that, as big as it is, Australia’s resources construction boom will soon turn down.

In some ways this will be a good thing. It’s been hard to find workers to build the national broadband network. But the boom has made construction a major employer in its own right. In the ten years since the resources boom began the construction industry has taken on 300,000 workers. Manufacturing has lost 123,000. Construction is now a bigger employer than manufacturing, and a much bigger employer than mining...

A downturn in resources investment will very quickly swell unemployment. (Unless a lot of smaller projects come along or a mega project such as a decision to go full throttle on the NBN or build the very fast train.)

It’ll mean an economic slump, something the Reserve Bank is charged with avoiding.

The peak in resources investment is now close,” was how Reserve Bank assistant governor Christopher Kent put his official assessment in an address to the Bloomberg Economic Summit this week.

“Once it has passed, the decline in mining investment – and the effect of the still high level of the exchange rate and ongoing fiscal consolidation – will weigh on economic growth.”

His point is that when mine construction turns down it would be nice if dollar turned down so that manufacturers and others found it worthwhile to expand and take on the displaced workers.

It would be nice too if the government expanded construction (as it did during the global financial crisis).

But the dollar isn’t turning down. International currency wars and the extraordinary popularity of Australia as a place for financial investment kept it high even when resources prices turned down late last year. It is staying high now that resource prices have turned back up.

And far from expanding, government work is vanishing as the Feds try to reign in the deficit and the states find themselves short of funds. (The NBN, off-budget with the connivance of both sides of politics, is the one big exception.)

So it helps to have faith that something will come along - anything - to pick up the slack.

“This provides scope for other sources of demand to pick up,” was how Kent put it in his speech Wednesday.

What are the grounds for faith?

Kent doesn’t identify many.

One is that the peak in mining investment should be more like a plateau than a cliff. “So there’s not as much to fill, if you take that into consideration.”

Planned non mining business investment is, “sort of subdued is how I would characterise it this financial year; but then gradually picks up next financial year”.

Housing investment “picked up over the second half of 2012, with further moderate growth expected” in response to lower interest rates.

This should in time, provide “a measure of support to employment and activity in the non-mining business sector” he says, using words chosen to indicate that while it’ll be something it may not be enough.

Also, lower interest rates have boosted consumer confidence. “This doesn't mean that consumption growth will return to the very strong pace seen prior to the financial crisis, but it is consistent with consumption growing at least in line with incomes and at a stronger pace than was observed towards the end of last year,” Kent says. “Indeed, the stronger retail sales data since the beginning of the year support this outlook.”

In time higher consumer spending should boost business investment. But not straight away. “Firms can respond to a pickup in demand first by making use of spare capacity they may have,” Kent says.

Non-mining businesses certainly have the means to expand. For most the cost of borrowing is low. And while the high dollar makes it hard for them to compete with suppliers overseas, it makes it easy for them to import.

But if you walked away from Kent’s speech thinking the non mining economy is certain to pick up the slack when the resource investment boom peaks you were alone.

That’s why Kent and Stevens need faith, and Plan B.

In today's Sydney Morning Herald and Age

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