Australia: The Small But Perfectly Placed Economy
By Mike SeccombeFebruary 16, 2012
If you can translate from banker-ese, the outlook for Australia’s economy is very good for a very long time — for many, if not all, of its people.
Central bankers are not, as a rule, much given to public jollity. And true to form Reserve Bank of Australia deputy governor Philip Lowe remained po-faced throughout his address at a conference on the year ahead for the Australian economy.
And, really, he should have been grinning.
It's not that he predicted smooth sailing for the Australian economy, but he forecast fast sailing. Very fast sailing. To continue the metaphor, there would be some chop spraying over the bows, and the sails would need some trimming, but the wind would be strong behind us for the coming year, and probably for decades to come.
Or, to put it in the actual, more restrained words he used when he got up before the crowd of business types at the Committee for Economic Development of Australia in Sydney on Feb. 16, at the end of 2011 Australian economic growth was "around trend … underlying inflation was at the midpoint of the medium-term target range. The unemployment rate remained low … and most lending rates in the economy were around average by end year.
"It is fair to say that very few developed economies could make these same claims," he said. "Looking forward, there are reasonable prospects that these favourable aggregate outcomes can continue for a while yet."
Everyone, of course, already knows what's behind it: the resources boom. But Lowe's numbers and graphs on the magnitude of it were nonetheless staggering. In just the past year, he said, business investment had jumped about 20 per cent, and the Reserve Bank expected "double-digit increases in business investment in each of the next couple of years," he said.
"If this occurs, it would take the ratio of investment to GDP to a record level by a considerable margin. It is not an exaggeration to say this is a once-in-a-century investment boom."
Lowe was clear that the concomitant rise in the Australian dollar to heights not seen in close to 40 years posed problems, particularly in the manufacturing, tourism and education sectors, as well as some business services. This would force some structural changes on the nation and might, in the immediate term, push unemployment up a little.
But he was equally clear that he did not believe the mining boom would cause the economy to lose muscle in other areas and be left less competitive once the boom passed.
When one questioner asked about this prospect, Lowe dismissed it. For a start, he said, the indications were that the boom would not be transitory. He expected Asia's demand for Australian resources to last "many, many, many decades".
And he did not see Australia losing the skills it needed to be competitive in the "medium term".
That was not to say he did not foresee some difficult and unpredictable consequences in the short term — we'll come back to that. Suffice for now to say he conveyed the impression that such problems as Australia faces were, if you will, quality problems.
But let's start where the Lowe did, in Europe, where they don't have quality problems. They have dire problems.
He noted the release overnight of figures showing that the Eurozone economy had contracted in the last quarter of last year. It will take another quarter of negative growth to make it officially a recession, so Lowe carefully said Europe was "seemingly" in recession. He did not, however, hold out much hope of things getting rapidly better there.
Interestingly, Lowe questioned the wisdom of "fiscal consolidation" (read: austerity) as a prescription for recovery.
Both in Europe and the United States governments were attempting get their debts under control, which would likely lead to the largest "aggregate fiscal contraction across the advanced economies seen for many years". What's more, it will be happening "in an environment where output in the affected countries is considerably below potential".
In layman's terms, governments are going to be cutting back at a time when their economies are already weak. Some would suggest it's a bit like bleeding a patient with anaemia.
Lowe couched it more neutrally. "There is … a material risk that fiscal consolidation weakens growth in the short run, which leads to more fiscal consolidation in order to meet previously announced targets and, in turn, yet weaker growth.
"We are currently seeing this dynamic play out in a couple of countries in southern Europe," Lowe said.
He did not mention countries by name, but one he might have had in mind is Portugal. Unlike Greece, Portugal has scrupulously obeyed all the demands from the International Monetary Fund and European Union for swingeing cuts in return for a bailout.
The result is that Portugal has sunk even deeper into debt, not because its debts have grown, but because its economy, and therefore its capacity to address those debts, has shrunk.
The deputy governor expressed concern that the pattern could repeat on a bigger scale as the various North Atlantic governments pursued austerity.
Nonetheless, he said, things in Europe looked a little better than they did a few months ago, and in the United States recent data on jobs and the housing market had been encouraging.
"While undoubtedly the US economy still faces many challenges, it does seem to have emerged from the soft patch in the middle of 2011 with some momentum," he said.
Working his way closer to home, Lowe became more upbeat.
China was still continuing to grow "solidly", he said, and though the pace of that growth had slowed, "it has done so in line with the authorities' intentions." Chinese inflation also had moderated.
Across the Asian region as a whole economic growth would be in line with recent years, but with domestic demand, rather than exports, as the main driver.
And so to Australia, the mining boom and the high dollar, which he called "different sides of the same coin".
First, the up side: the industrialisation and urbanisation of Asia was pushing up commodity prices (and the Australian dollar).
The high dollar, Lowe said, "has meant that the prices Australians pay for many manufactured goods are, on average, no higher than they were a decade ago, despite average household incomes having increased by more than 60 per cent over the past decade."
This resulted in people having more disposable income "to be spent on services in the cities and towns far from where the resources boom is taking place."
Thus, he said, the benefits of the boom were spread in ways not apparent — from the mine sites in Western Australia and Queensland to the cafes and restaurants in Sydney and Melbourne
Then the down side: the high exchange rate was also having a "contractionary effect" on other parts of the economy, by making them less competitive. Some businesses were, as a result, scaling back their operations in Australia and some were closing down.
It was, he said "difficult to assess the net effect" of the combination of an unprecedented investment boom and a very high exchange rate.
"It seems however, that over the past year these forces have balanced out reasonably well."
Looking forward, though, it was hard to predict how the countervailing expansionary and contractionary forces would balance out.
He noted, for example, questions about the inflationary impact of "divergent trends in the prices of internationally traded items and the prices of goods and services that are not internationally traded."
Rendered into English, what this means is that the price of, say, a new imported TV has gone sharply down, while the price of a cup of coffee has gone up. Thus the overall effect on prices has balanced out, meaning the overall measure of inflation has balanced out.
But, Lowe noted, the prices of things like TVs cannot continue to fall indefinitely. The effects of the high dollar will dissipate, and that check on inflation will dissipate with it.
"As a result," said Lowe, "some slowing in the rate of increase in prices of non-tradeables is likely to be required at some point."
Again, in English, this means that wage growth will have to slow and productivity will have to pick up, otherwise inflation could take off.
However, he said the RBA expected both those things to happen, meaning there was not much risk of a problem with inflation, in the near future anyway. "Indeed it is likely the headline rate [of inflation] will fall below two per cent in the middle of 2012, before increasing again to above three per cent," said Lowe.
Some small increase in unemployment also was possible over coming months, but was expected to remain low overall.
All in all, it was a pretty rosy picture.
Being a prudent central banker, though, Lowe conceded 2012 would "no doubt contain its fair share of surprises," and that the parlous state of much of the world economy presented "more than the usual number of pitfalls".
But among the developed economies, none was better placed than Australia's to cope with whatever events unfolded.
And then, right at the end, as he wished his bizoid audience success in navigating the year ahead, he briefly, shyly smiled.