ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Can Australia avoid an economic downturn?
, December 8, 2007
What options has the new Rudd Labor Government in a world of dearer money and dearer energy?No doubt Mr Kevin Rudd feels good about Labor's November 24 election win - and so he might. But, compared to the outgoing Howard Government, the incoming Labor Government is unlikely to have it easy.
Thus far we know little about Labor's intentions - except what Mr Rudd says he won't be doing.
But remember we heard the same sort of stuff from Mr Howard in opposition, yet we found that, once in office, he quickly discovered reasons why he could not keep to his promised program. From that was born the notion of core and non-core promises. Don't be surprised if the Labor leader follows suit.
He has of course taken pains to paint himself as a benign Howard look-alike, except on one or two safe but fundamental points. One of these has been workplace relations, in respect of which Mr Rudd confidently assumes his view carries the weight of public opinion.Everlasting bonanza?
Another less-publicised difference is the matter of the mining boom. Mr Howard acted as if this bonanza was to be everlasting. By contrast the Labor leader has assumed it will come to an end. Mr Rudd's caution seems well justified, and having a strategy in place before the minerals boom runs out certainly makes sense.
As far as it is possible to tell, at least part of the Rudd approach appears to be associated with the reconstruction of manufacturing industry. The Labor leader has not told us much about how he intends to achieve this transformation, but it is good that he is looking at such an idea.
An incoming Labor government could feel the heat of economic problems bearing down upon it more quickly than it would like. And they may concern much more than some tidying up of manufacturing industry and workplace relations.
Some of these problems could be coming off the back of the financial market meltdown, which we all noted hit the US last August. Beyond that, Labor just might be called upon to take a new look at the economic fundamentals - which, despite what has happened, all of the experts right up to the governor of the Reserve Bank keep trying to reassure us are okay. But more of that later.
Meanwhile, let's take a look at the ongoing consequences of the failure of US financial markets last August.
When it comes to anticipating the ongoing consequences of that particular crisis, this writer cannot boast the best of track records. Readers will recall his view, confidently put forward (News Weekly
, October 27, 2007), that the US meltdown - even if it drove the US into a recession - would not seriously affect Australia.
This opinion was based on what seemed sound enough reasons. Compared with a decade and a half earlier, the US is no longer the dominant influence on the world economy. How quickly can things change! Moreover, Australia has had minimal direct exposure to the so-called "sub-prime" housing loans problem which triggered the US crisis.
As if in sympathy with these views, the Australian share market seemed to recover more quickly than expected after an initial "me too" reaction to the US's sub-prime problems. The reasons why probably lay in the fundamentals of our share market. There seemed to be good reasons why our share prices should have bounced back quickly, and they did. Our shares weren't (and still aren't) unrealistically overpriced. By global comparisons in developed countries, Australian company profits per share, measured against traded share values, are among the best.
But three months later our share market continues to jump all over the place. It is as if the market cannot decide what to make of the US crisis. This is hardly surprising - the most recent information coming out of the US is certainly discouraging.
At first, it seemed that the adverse consequences of the sub-prime loans losses were being effectively quarantined to certain relatively minor financial institutions.Freeze on funds
The initial response of the market to the sub-prime loans crisis was to stop lending altogether. The system effectively froze. The US Federal Reserve Bank took immediate and uncharacteristic action to unlock the freeze. In a couple of days it pumped a hefty US$320 billion into the system, and more followed soon after. As well, it lowered interest rates in the hope of keeping the economy afloat. For a time that corrective action seemed to be working.
However, it is now obvious that the problem is more serious and enduring than was first thought, and a number of important banks are in serious trouble. US lending institutions seem to have gone cold on the US housing loan market. Money simply wasn't being made available for lending to build new houses. And, since the domestic building industry and all those industries hanging off it are a principal driving factor in the US economy, what began as a financial crisis has spilled over into the real economy.
Serious expert opinion believes the US housing industry downturn will nudge the US economy into recession - hopefully in its mildest form. But experts sometimes get these things seriously wrong. The prestigious London journal The Economist
recently reminded us that, days after the 1929 stock market crash, Harvard University's Economics Society assured its subscribers that "a severe depression is outside the range of probability".
What does all of this mean for Australia? Our finance industry does not have much exposure to defaulting sub-prime loans. But the question is: can we escape the fallout consequences? Australian banks borrow heavily offshore to lend to home purchasers.Future mortgages
Given what is happening in the US, we can assume they will find it harder to follow existing practices and sell down most of these mortgages to outside financial institutions. Instead, they will have to carry more existing and future mortgages on their own lending books.
This means that they will not be free to lend as much for housing as previously - and, of course, a tighter borrowing and lending market will push up interest rates.
The consequence? Less money for housing - and at higher interest rates. From this we must surely see some adverse impact on our own building industry, which - as in the US - is an important driver of our economy.
Labor in office may well have to face the prospect of a slowing economy, perhaps ahead of, and independent of, any slowdown in minerals exports.
That's one side of the equation: a slowdown in growth brought on by the end of the cheap money era as investors rebalance their assessment of risk and return.
A new kind of inflation is another. It is not too much to claim that Western prosperity over the last 50 or so years has essentially been built on the foundation of cheap energy, ably assisted, more recently, with the help of cheap money.
The future prospect is we will have neither. The cost of money has already been discussed. Let us now consider energy.
The onset of climate change - however we might assess its causes - suggests that, in future, we will be denied cheap energy. Oil is now pushing towards US$100 per barrel; five years ago it was only $25.
Some are tempted to assign this increase to the follies of the US's Middle Eastern policies. For the most part that is incorrect.
Neither is it due to any imminent shortage of oil. Latest estimates put known reserves at 1.2 trillion barrels - 40 years' supply at current usage levels. And that is before we tap into expected additional reserves which are generally believed to be at least as much again.
The question is not so much lack of quantity but the cost of commercial extraction of what remains. That, more than any other single factor, is what is driving up oil prices. Companies won't go looking for more oil unless they can expect a reasonable return on their outlays.
Power generation is also facing huge hikes in cost. Whether we go nuclear or stay with coal (it will have to be clean coal), power is going to cost perhaps twice as much as now. And this cost is going to flow into every aspect of the cost structure of our economy - both in food for households and additional costs for manufacturing and mining.
The new inflation will be driven by energy and money costs. And it is quite likely it will, at the same time, induce and even accelerate an economic downturn.
We could be facing a return to the high inflation/ low growth scenario - then called stagflation - that we experienced 30 odd years ago. At the time, a new economic orthodoxy blamed this outcome on the outmoded ideas of John Maynard Keynes. Market deregulation and free trade were trumpeted as the only road to a safe economic future. It now seems these too might soon be judged not up to the job.
In dealing with this economic circumstance, Mr Rudd and his party may well need to demonstrate more than the qualities of mere economic conservatives.
Unless Labor is prepared to go beyond the sources of orthodox economic advice now available to it - inside and beyond the public service - it is unlikely to find the right economic solutions.
In this case it will be said, as the Coalition has maintained all along, that Labor can't run the economy. Labor will be blamed for developments they could not have prevented, and in respect of which the Coalition, in government, would have handled in exactly the same way.
That's politics.- Colin Teese was a former deputy secretary of the Department of Trade.