Henry Thornton The Australian November 06, 2012
THE Reserve Bank's major formal task is containing inflation without driving the economy into the ground.
Its daily, weekly and monthly task is severely practical. Today we ask the board of the Reserve to recognise that inflation ("looking through" effects of the carbon tax) is under control and a lot of small businesses have already failed or are headed for a hard landing. This situation demands another rate cut, after which more quality resources should be devoted to further examining the state of the global banking system.
The global situation remains uncertain. The US economy is estimated to be growing at about 2 per cent annually -- about half its usual rate.
Unemployment has fallen but so has the "participation rate", and the prospect is for a long, slow recovery even if there are no further shocks. The US banks have probably done more than most to improve their balance sheets but the overall financial system remains fragile.
The US Fed is flooding the financial system with liquidity, storing up potential problems for future impact. The eurozone leaders are far from united, and we all know that disunity is death.
Germany and other "northern" eurozone nations are preaching austerity but this may change as their own economies begin to sink under the pressure of retrenchment and austerity elsewhere. The "southern" eurozone nations are attempting to impose austerity but finding their people, ie voters, are fighting back. All leaders seem committed to holding the eurozone together, and my hypothesis is that this is because any efficient solution involves changing exchange rates between inefficient southern nations and efficient northern nations, which would create major problems for eurozone banks.
These would be problems that leaders and their advisers cannot understand and whose effects cannot be confidently predicted.
China's economy seems to have stopped falling, and its new leaders will be installed soon, and may begin their reign with a large stimulus program. China is not without serious problems. For this article, I wish to focus on the fact that state-owned enterprises have been operating in a system that values job creation over making profits, and many have racked up debts that have been financed by China's banks. The transition to a world of largely profitable enterprises and banks with only small and predictable bad debts will not be easy.
Rational concern about the lifeblood of the global economy deserves more air than it has received, at least in public. I would feel far more confident if a senior RBA official gave a speech on the subject and felt able to declare my fears unfounded. Silence, of course, might be interpreted as saying this is too hot to share with unwashed members of the public.
Several commentators have echoed this writer's view that last month marked something of a change of tack by the Reserve, whose economy watchers will have devoted a lot of attention to domestic economic conditions in the past month. The main issues for the RBA analysts are:
lHousing. There has been a lot of attempts to talk up the market for houses and units, and evidence of some minor rises of house prices, albeit reversed in the latest data. In fact, however, the Housing Industry Association new home sales data for September fell by another 3.7 per cent after a 5.3 per cent decline in August. Sales of detached homes and units are down 17 per cent over the past year.
lCredit growth remains subdued, in my view a positive indicator as households and firms work off excess leverage created during the unsustainable asset boom of the 2000s.
lThe Westpac Melbourne Institute Index of Consumer Sentiment increased by 1 per cent last month. The index is well below the neutral level, however, pessimists outnumber optimists and "the vast majority of consumers have been expecting and continue to expect unemployment to rise".
lThe National Australia Bank says that its business customers reported that business conditions improved slightly in the September quarter but remain soft. Furthermore, "based on a comparison with monthly survey results, conditions appear to have deteriorated through the quarter".
lInflation remained low in the September quarter, but with large jumps in electricity prices and "gas and other household fuels" prices to raise a warning note. But the overall consumer price inflation rose by only 2 per cent through the year to the September quarter compared with a rise of 1.2 per cent through the year to the June quarter. In "underlying" terms, the rise in the year to September was 2.5 per cent, in my view making no case to hold cash rates in the light of the evidence of weak economic activity.
There are three major structural issues to worry the punters, if not the government.
lThe mid-term budget revised tax receipts down and saved a wafer-thin (projected) surplus only by assuming large firms would be required to pay tax monthly in future, along with several other fanciful changes. Practically no one Henry respects believes the government will deliver a surplus, and the weasel words are beginning to enter the government's lexicon. Memo to Wayne Swan: these word games destroy confidence rather than enhance it.
lThe "official" (ABS) measure of unemployment jumped from 5.1 to 5.4 per cent in September. This is a tiny move in the direction of reality, as revealed for years by Roy Morgan surveys. This is another disconnect ordinary Australians are aware of that destroys confidence rather than improve it.
lProductivity remains low, and there is no plan to improve the situation, and in particular no plan to address features of the Fair Work legislation that hamper productivity. The hard times facing many Australians will enforce productivity improvement, but the real reforms that would help lift productivity more decisively are conspicuously absent.
Last week, the government told us all to lift our game on interaction with Asia. Vast vision, windy rhetoric, but sadly little connection to reality. There is already a lot of private and business connection to Asia, such as the much denigrated mining industry. With widespread recognition the white paper lacks any semblance of a plan, this is another distraction from the task of getting on with making a living in a highly competitive, edgy, global economy.
The RBA needs to do its bit to help stimulate recovery, which it should do today with another cut to official cash rates. It cannot overcome structural weakness, however. That is a matter for the next government.