Economy slows though consumers spend

For weeks the Reserve Bank has been telling us the economy is growing at "close to trend", but the indicators we got this week leave little doubt we're travelling at below trend.

Had the Reserve's forecast of growth in real gross domestic product of 2.75 per cent over the year to December been achieved, this would indeed have meant the economy was expanding at close to its medium-term trend rate of growth.

But this week's national accounts showed GDP growing by a weak 0.4 per cent in the December quarter and by just 2.3 per cent over the year to December.

There are always things you can quibble with in the Bureau of Statistics' initial estimate of growth for a particular quarter. It's always rough and ready, subject to revision as more reliable figures come to hand.

But it's hard to quibble this time because the story of weakness the national accounts are telling was confirmed by the independently estimated labour-force figures published the next day.

These February figures showed about 3000 jobs a month were created in the past six months, with the rate of unemployment essentially steady at 5.2 per cent, just a bit above the rate the econocrats regard as the lowest sustainable rate we can achieve.

Something else the Reserve has been saying is that the economy's being hit by two huge, but opposing, external shocks: the expansionary effect of our high export prices and all the spending being undertaken to expand our mining capacity, but also the contractionary effect of the high exchange rate, which has reduced the international price competitiveness of our export and import-competing industries.

The economy's below-trend growth suggests the contractionary force may be gaining an edge over the expansionary force. This increases the likelihood of another cut in the official interest rate before too long.

It's important to recognise, however, just why the reported weakness in the March quarter occurred. The greatest single reason was the utterly unexpected fall of 1 per cent in business investment spending. This is actually good news in the sense it's a blip that won't be repeated this quarter. We know the mining construction boom has a lot further to run.

The greatest (but longstanding) area of weakness in the economy is spending on the construction of new homes. It fell 3.8 per cent in the quarter and 1.8 per cent over the year to December. And doesn't look like recovering any time soon.

If you combine the fall in home building with the (temporary) fall in business investment you find the total fall in private sector investment spending subtracted 0.4 percentage points from the overall growth in GDP for the quarter.

If you listen to the retail industry's propaganda you could be forgiven for thinking weak consumer spending must be a big part of the story. Even the Treasurer, Wayne Swan, is still banging on about the "cautious consumer".

But though it's true the growth in consumer spending of 0.5 per cent is on the weak side, consumption nonetheless contributed 0.3 percentage points to overall growth in the December quarter.

And over the year to December consumption grew by 3.5 per cent - that's definitely "close to trend". If consumers really were being cautious we'd be seeing this in a rising rate of household saving. In truth, the rate dropped a little in the December quarter.

But when you look through the quarter-to-quarter volatility, it's clear the saving rate has essentially been steady at about 9.5 per cent of household disposable income for the past 18 months. That's not cautious, it's prudent.

To say consumers are cautious implies that when their confidence returns they'll start spending more strongly. That's a misreading of the situation. Their spending is already growing at trend. They've got their rate of saving back to a more prudent level after some decades of loading up with debt, and from now on their spending is likely to grow at the same rate as their income grows.

What's wrong with that? Nothing. If it leaves the retailers short of customers, that's their problem. Don't be conned: in a market economy, the producers are meant to serve the consumers, not vice versa. If the retailers are selling stuff people don't want to buy - or at prices people don't want to pay - the retailers have to adjust to fit.

We don't have a problem with weak consumer spending; the retailers, who account for less than a third of all consumer spending, have a problem because consumers have switched their preferences from goods to services.

To bang on about the "cautious consumer" implies the retailers' - and, more particularly, the department stores' - problem is cyclical (it will go away as soon as consumers cheer up) rather than structural (it will last until the businesses involved do something to solve it).

A build-up in business inventories contributed 0.3 percentage points to the overall growth in GDP during the quarter. This is a temporary contribution that could be reversed in the present quarter, but Dr Chris Caton, of BT Funds Management, offers the reassuring calculation that the ratio of non-farm inventory to sales was coming off a record low.

For once, the external sector - exports minus imports - made a positive contribution to overall GDP growth during the quarter, of 0.3 percentage points. That was because the volume of exports rose 2.2 per cent, whereas the volume of imports rose only 0.7 per cent.

If you look at the figures over the full year, however, you see a very different story: export volumes in this December quarter were up only 0.8 per cent on December quarter 2010, whereas import volumes were up 12.8 per cent, causing the external sector to subtract 2.6 percentage points from through-the-year growth.

Finally, a key development that's not directly reflected in the GDP figures, but will have a dampening effect on them in coming quarters: for the first time since the global financial crisis our terms of trade have deteriorated - by 4.7 per cent in the quarter - as import prices rose and, more particularly, export prices fell.

So whereas the volume of the nation's production of goods and services (real GDP) rose 0.4 per cent, our real gross domestic income fell 0.6 per cent.

It's production that generates jobs, but the nation's real income declined because the terms on which we trade with the rest of the world deteriorated.

Read more >>

All hail mighty Aussie dollar, as it's here to stay

This year we'll see more painful evidence of Australian businesses accepting the new reality: our dollar is likely to stay uncomfortably high for years, even decades.

It has suited a lot of people to believe that just as the resources boom would be a relatively brief affair, so the high dollar it has brought about wouldn't last.

If there were no more to the resources boom than the skyrocketing of world prices for coal and iron ore, that might have been a reasonable expectation. But the extraordinary boom in the construction of new mining facilities makes it a very different story.

The construction boom is likely to run until at least the end of this decade, maybe a lot longer. The pipeline of projects isn't likely to be greatly reduced by any major setback in the world economy. That's particularly because so much of the pipeline is accounted for by the expansion of our capacity to export natural gas. The world's demand for gas is unlikely to diminish.

Last time I looked, the dollar was worth US105?, compared with its post-float average of about US75?. But that's not the full extent of its strength. At about 81 euro cents and 67 British pence it's the highest it's been against those currencies for at least the past 20 years.

In the context of the resources boom, the high exchange rate performs three economic functions. First, it helps to make the boom less inflationary, both directly by reducing the prices of imported goods and services and indirectly by lowering the international price competitiveness of our export- and import-competing industries.

Second, by lowering the prices of imports, it spreads some of the benefit from the miners' higher export prices throughout the economy. In effect, it transfers income from the miners to all those consumers and businesses that buy imports, which is all of them. So don't say you haven't had your cut.

Third, by reducing the price competitiveness of our export- and import-competing industries, it creates pressure for resources - capital and labour - to shift from manufacturing and service export industries to the expanding mining sector.

That is, it helps change the industry structure of the economy in response to Australia's changed "comparative advantage" - the things we do best among ourselves compared with the things other countries do best.

As businesses recognise the rise in the dollar is more structural than temporary and start adjusting to it, painful changes occur, including laying off workers. Paradoxically, this adjustment is likely to raise flagging productivity performance.

Economists have long understood that the exchange rate tends to move up or down according to movement in the terms of trade (the prices we receive for exports relative to the prices we pay for imports). This explains why the $A has been so strong, for most of the time, since the boom began in 2003.

But here's an interesting thing. In the December quarter of last year, our terms of trade deteriorated by about 5 per cent as the problems in Europe caused iron ore and other commodity prices to fall. They probably fell further this month.

This being so, you might have expected the $A to fall back a bit, but it's stayed strong and even strengthened a little. Why? Because when the terms of trade weakened, other factors strengthened. The main factor that's changed is the rest of the world's desire to acquire Australian dollars and use them to buy Australian government bonds.

Indeed, the desire to hold Australian bonds was so strong it more than fully financed the deficit on the current account of the balance of payments in the September quarter. It may have done the same in the December quarter. Among the foreigners more desirous of holding our bonds are various central banks.

Remember that, at the most basic level, what causes the value of the $A to rise on any day is that people want to buy more of them than other people want to sell. The price rises until supply increases and demand falls sufficiently to make the two forces equal.

So economists' theories about what drives the value of the $A are just after-the-fact attempts to explain why the currency moved the way it did. We know from long observation that there's a close correlation between our terms of trade and the $A.

But we also know this correlation is far from perfect. There have been times when the two parted company for a while. It's apparent the dollar is driven by different factors at different times.

And it now seems apparent that our relatively superior economic performance and prospects are taking over as the main factor driving the dollar higher (even though our terms of trade would have to deteriorate a mighty lot further before they were back to their long-term average).

There are various reasons why foreign investors (including central banks with currency reserves that have to be parked somewhere) would like to increase their holdings of Australian government bonds.

For a start, we're now one of the few "sovereigns" (national governments) still with a AAA credit rating. For another, the yield (effective interest rate) on Australian 10-year government bonds is almost 4 per cent, compared with about 2 per cent on US Treasury bonds or German bunds.

And the present and prospective state of our economy is a lot healthier than that of the North Atlantic and Japanese economies. Why are our prospects so much brighter and our interest rates higher? In short: the mining construction boom, of course.

It seems clear the world's financial investors are shifting their portfolios in favour of $A-denominated financial assets. And remember, because they're so much bigger than we are, what's only a small shift for them is a big deal for us.

All this suggests the Aussie will stay strong, even as our terms of trade fall back. Remember, too, the huge spending on mining construction over the years will require a lot of foreign financial capital to flow into Australia, helping keep upward pressure on the exchange rate.

This doesn't say the $A has become a safe-haven currency. Were some sudden disaster to occur in Europe it would probably take a dive as frightened investors rushed to the safe haven of US Treasury bonds.

But it probably wouldn't take long for the Aussie to recover - just as it didn't take long after the sudden disaster of the collapse of Lehman Brothers in 2008.

Read more >>

Nice set of figures should shut up the gloomsters

Something strange is happening to the Australian psyche at present. A lot of people are feeling down about the economy. They're convinced it's pretty weak, and any bit of bad news gets a lot of attention.

But most of the objective evidence we get about the state of the economy says it is, under the circumstances, surprisingly strong. Consider the national accounts we got this week.

They show the economy - real gross domestic product - grew by 1 per cent in the September quarter, more than most economists were expecting. And not only that, the Bureau of Statistics went back over recent history, revising up the figures.

Originally we were told the economy grew by a rapid 1.2 per cent in the June quarter, but now we're told it grew by an even faster 1.4 per cent. Originally we were told the economy contracted by 1.2 per cent in the March quarter because of the Queensland floods and cyclone, but now we're told the contraction was only 0.7 per cent.

Those figures hardly fit with all the gloominess. So how fast is the economy travelling, on the latest numbers? We're told it grew by 2.5 per cent over the year to September, but that figure includes the once-off contraction in the March quarter, which is now ancient history.

We could do it the American way and say we grew at an ''annualised rate'' of 4 per cent in the September quarter (roughly, 1 per cent x 4), but that's too high because this quarter (and the previous one) includes a bit of ''payback'' (or, if you like, catch-up) as the Queensland economy got back to normal after its extreme weather.

(There's likely to be more catch-up in the present quarter as the Queensland coalmines finally pump out all the water and resume their normal level of exports, suggesting the Reserve Bank is reasonably safe to achieve its forecast of 2.75 per cent growth over the year to December.)

So the best assessment is that at present the economy is growing at about its ''trend'' (long-term average) rate of 3.25 per cent a year. If so, everything's about normal.

Ah yes, say the gloomsters, but all the growth's coming from the mining boom. Before we check that claim, let's just think about it. If we were viewing our economy in comparison with virtually every other developed economy, we'd be thanking our lucky stars for the mining boom.

But not us; not in our present mood. We're feeling sorry for ourselves because, for most of us, the benefits of the boom come to us only indirectly. (The other thing we ought to be thankful for apart from our luck is 20 years of clearly superior management of our economy. In stark contrast to Europe and the US, we have well-regulated banks and stuff-all public debt.)

It's true the greatest single contributor to growth in the September quarter was the boom in investment in new mines. New engineering construction surged 31 per cent in the quarter and total business investment spending rose by almost 13 per cent.

But though most of that remarkable boost is explained by mining, there was also a healthy increase in manufacturing investment.

And here's a point some people have missed: the second biggest contribution to growth in the September quarter (a contribution of 0.7 percentage points) came from the allegedly cautious consumer.

Consumer spending grew by 1.2 per cent in the quarter and by 3.8 per cent over the year to September. That's actually above its long-term trend. And consumer spending was strong in all the states, ranging from rises of 0.8 per cent in Victoria, 0.9 per cent in Western Australia (note) and 1.1 per cent in NSW, to 1.9 per cent in Queensland (more catch-up).

Although households are now saving about 10 per cent of their disposable incomes, this saving rate has been reasonably steady for the past nine months. So consumer spending is growing quite strongly because household income is growing quite strongly.

It's noteworthy that, according to Treasury, non-mining profits rose by 4.7 per cent in the quarter. And according to Kieran Davies, of the Royal Bank of Scotland, non-mining GDP grew by a solid 0.7 per cent in the quarter, just a fraction below trend.

So the notion that mining (and WA and Queensland) might be doing fine but everything else is as flat as a tack is mistaken. It's true, however, that some industries are doing it tough. Consumers are spending at a normal rate, but their spending has shifted from clothing and footwear and department stores to restaurants, overseas travel and other services.

Home-building activity declined during the quarter - a bad sign. The continuing withdrawal of the earlier budgetary stimulus meant that government spending fell by 2.5 per cent during the quarter. Public spending was a drag on growth in all states bar WA and Queensland (more catch-up).

Our terms of trade - export prices relative to import prices - improved by 2.7 per cent in the quarter (and by 13 per cent over the year to September) to be their best on record. But that's likely to be the peak, with key export prices falling somewhat in the present quarter.

The volume of exports rose by 2 per cent in the quarter, but the volume of imports rose by 4.3 per cent, mainly because of imports of capital equipment. So ''net exports'' (exports minus imports) subtracted 0.6 percentage points from overall growth in real GDP during the quarter.

Ah yes, say the gloomsters, but all this is old news - the September quarter ended more than two months ago. The economy must have slowed since then. After all, look at this week's news of a rise in the unemployment rate to 5.3 per cent in November.

It does seem true the labour market isn't as strong as the strength of economic activity would lead us to expect. This could indicate a degree of caution on the part of employers. But the rise in unemployment is slow and small, and if it's only up to 5.3 per cent we're still doing very well by the standard of the past 20 years.

As for the tempting line that everything's gone bad since the strong growth in the September quarter, just remember: that's what the gloomsters said when they saw the good growth figures for the previous quarter. Turned out to be dead wrong.

Read more >>

Farmers fall silent while food brings home the bacon

Sometimes, as when Sherlock Holmes solved a mystery by noting the dog that didn't bark, the story is not what happened but what didn't happen. If so, don't hold your breath waiting for the media to tell you such a story. Omission is much harder to notice than commission.

But let me ask you - in this year of endless complaint about the supposed two-speed economy - what's been missing? The retailers have been doing it tough and they've let everyone know. The high dollar is great news for consumers - overseas holidays are booming - but bad news for those of our industries that sell on export markets or compete against imports in the local market.

We keep hearing about the difficulties our manufacturers have encountered and, to a lesser extent, the problems facing our tourism industry (see above). Now we're hearing of staff cutbacks in universities because foreign student numbers are down.
Advertisement: Story continues below

But who haven't we heard from?

A clue - which dog usually barks the house down every time the dollar goes up? Another - which industry contributed to our economy's boom and bust in the mid-1970s by virtually forbidding the McMahon government to revalue our currency in response to a world commodity boom?

That's right, the farmers. So, have they been suffering in silence for once in their lives? Have they, unlike other industries, stoically resisted the temptation to blame all their problems on a Labor government?

No, nothing so worthy. We've heard nothing from the farmers because they've been doing quite well for themselves. And we never hear from farmers when times are good. City slickers never get invited to the harvest festival for fear of undermining the media's stereotype that ''the man on the land'' is ALWAYS doing it tough. In any case, who's interested in GOOD news about the economy?

You can find the story in the official statistics and forecasts, of course, but public officials know always to understate good news about the farm sector for fear of bringing the farmers' ire down on their heads. The few parts of farming that are the exceptions to the rule will declare all you say is lies.

Our farmers export about three-quarters of what they produce. With the exception of wool, the stuff they sell abroad is priced in US dollars. So when the Aussie dollar goes up, the money they earn in US dollars isn't worth as much to them back home.

That's just as true of our miners. They, too, have suffered from the rise in the Aussie. But they're not complaining because the prices they're getting in US dollars have risen by far more than the Aussie has gone up.

It's a similar story for the farmers, though on a much smaller scale. Since the start of the resources boom in early 2003, the prices being received by our miners have risen by 380 per cent in US-dollar terms. Thanks to the Aussie dollar's rise against the greenback, they've risen by a smaller 175 per cent in Australian-dollar terms - which is what the miners care about.

Over the same period, the prices being received by our farmers have risen 90 per cent in US-dollar terms and almost 10 per cent in Australian-dollar terms. (The rise in the Aussie isn't just a matter of bad luck for our miners and farmers. Since our dollar's been floating it has always risen, or fallen, roughly in line with world commodity prices. What these comparisons show is that rising rural commodity prices contributed to the higher dollar, along with rising minerals and energy prices.)

If that was all there was to the story we probably WOULD have heard whingeing from the farmers. But what matters to our farmers even more than what's happening to prices is what the weather's doing to the size of their harvests and other kinds of production. Whatever the price, the world will always take however many tonnes our farmers are able to produce.

And the truth is that, despite exceptions (West Australian wheat for one; the effects of flooding and cyclones), the weather's been a lot kinder to our farmers over the past year or two. It's rained when rain has been needed, there's been more water for irrigation and the moisture content of the soil has improved, allowing more dryland plantings.

This year's winter wheat crop is expected to be a near-record high of about 40 million tonnes and this follows a good harvest last year.

This financial year, our agricultural export earnings are expected to be the second-highest since 2002-03, even after allowing for inflation. Last year's earnings were pretty good, too.

Rises in export earnings are expected for wheat, wool, rice, canola, cotton and lamb, though wine exports continue to languish.

After a bad year in 2009-10, real farm income more than doubled last financial year. This year it's expected to be down only a bit from that.

Why are world agricultural prices so strong? Various reasons, but mainly because of the development of Asia and the steady rise in incomes of its many hundreds of millions of people. As low incomes rise, food consumption tends to increase. And the increase is concentrated in the more expensive types of food.

So food prices are rising for much the same reason minerals and energy prices are rising. And that says they've got a long way further to rise over coming years. Whichever way you look, Australia is sitting pretty in the Asian century. The only shadow over the future of farming comes from climate change and our long mismanagement of water.

Read more >>