The case for optimism

The sky is falling, the sky is falling. Australia is in a recession and unemployment is going up. Treasury estimates a contraction of 0.5% for this year and unemployment hitting 8.5%. Many others think this is optimistic and that we are in for a deeper and longer downturn.

Maybe they’re right.

But I’m an optimistic sort of person and I can see reasons for hope. The basis for my hope is that the Australian economy is fundamentally sound. Our monetary policy has been stable and balanced, our fiscal policy has been (until this year) equally good. Our financial system doesn’t have significant distortions and we have a relatively flexible economy.

I have said previously that this recession was imported from America. Not much we could do about that. And given how integrated our economy is with the world economy we were destined to feel some of the impact. Failure to anticipate the consequences of an American recession may have led to an under-estimate of the risk premium in Australia… but that mistake was (I think) relatively small and has already been fixed.

We will see less demand for our exports, including commodities. It may also be harder to raise capital on international markets. Both of these things will hurt Australian businesses, jobs and wages. Some businesses will go broke, some people will lose their jobs and the economy will contract.

And then it will recover.

During this downturn not one tractor has spontaneously combusted, skilled workers have not forgotten their trade, and no land has disappeared. Market economies face creative destruction all of the time and while the destruction makes the news, the creation is just as continuous. Prices will adjust. Resources will shift into productive parts of the economy. New businesses will be started and (as I said earlier this week) new investments made and new jobs created. The AFR today reports that business lending is rebounding, which is exactly what you would expect from a market economy.

The doom scenarios are appropriate for America, where there has been a significant mis-allocation of resources and a dramatic adjustment is necessary. But Australia is well positioned to ride out this storm and then continue growing on the other end (though perhaps not as fast as Treasury predicts). The biggest risk to this, in my opinion, is that current government policy will cause ongoing damage by slowing down private investment and distorting the market.

Sadly, when the economy recovers the government is going to try and take credit. This would be wrong. Our economy recovers naturally despite the government, not because of them.

22 thoughts on “The case for optimism

  1. I think I’m even more optimistic. Everybody I know is flat out. Talk of a revenue slump is mostly a joke. This recession will be a memory quicker than most. Rudd will leave us with a pile of unnecessary debt but we’ll survive and at least we’ll have some shiny new roads. Suboptimal but not the end of the world. I personally doubt the unemployment projections will be realised.

  2. Every time I hear the term “fundamentally sound” I cringe. What the hell does it mean anyway?

    I recently looked at unemployment rates in the two previous recessions, and we are currently about 2pp below the same stage of the economic cycle compared to then. Since unemployment hit over 10% each time, a forecast peak of 8.5% seems reasonable.

    However, one factor that makes this recession different is the high level of household debt. Corporate debt may also be high, don’t know. And of course govt debt is rising rapidly. Don’t you think this might prevent a strong recovery?

  3. “The basis for my hope is that the Australian economy is fundamentally sound. Our monetary policy has been stable and balanced, our fiscal policy has been (until this year) equally good. Our financial system doesn’t have significant distortions and we have a relatively flexible economy.”

    I can’t tell if this is sarcasm or not. I hope it is.

  4. As far as my own business goes, we’ve been saying “what recession?” for quite a while… I wish pollies and media would stop talking it up.

  5. Not sarcasm Damian. I’m not very worried about the Australian economy. The recovery is coming. Rudd’s policies will slow things down a bit, but I don’t think he’ll be able to stop it.

  6. I’m with Schiff, Ron Paul, et al. This is just the beginning.

    Why will things get better? There is no reason to think so, as far as I can see…

    The actions taken by basically every government in the world have been wrong. And we are yet to suffer the consequences.

  7. “Not sarcasm Damian. I’m not very worried about the Australian economy. The recovery is coming. Rudd’s policies will slow things down a bit, but I don’t think he’ll be able to stop it.”

    The current politically engendered spending may temporarily result in more positive looking monthly ‘macro’ statistics and buy some time with regards to debt and liquidation. This has nothing to do with expanding the productive capital structure and the correct alignment of all the complimentary factors of production in synchronization with our ultimate buying preferences which is what economic growth is.

    For this to happen properly, prices need to adjust FREELY, money supply and market valuation of that supply needs to be stable and people need to act (in the economic sense) strictly according to the prices being revealed to them, not Kevin Rudd.

    Rudd can technically temporarily lift employment and GDP type statistics to ‘good’ levels just by deciding to bury Tasmania in paperclips, which metaphorically is exactly what is being done right now in a way imperceptible to those ignorant about the workings of capitalism.

    Ultimately because of these actions interest rates will spike dramatically and consumer prices will rise at politically intolerable levels. At worst a currency crises and various levels of government defaulting on debt.

    A symptom of real economic health (excluding the perverse effects of fake credit and money expansion in the early stages of a ‘boom’) would be a steady long term fall in final goods prices and a steady increase in wages relative to finished goods.

    Government eCONomists don’t share this view and neither do political operatives. Destructive policies will be pursued until the suffering is too great and enough credibility is lost amongst the establishment in order to attempt a change in policies.

  8. I am also saying saying “What recession?”. I am in the agriculture sector and seem nearly unable to keep up with demand, sure the super has taken a bit of a hit, but the problems seem to be very sector specific. I don’t think, at least in Australia, this is going to be very long or deep, and we will recover quite soon. There are some huge opportunities opening up at bargain prices and if you maintain cash-flow, not easy I know, there are some very good times coming. In spite of govt policies trying to prop up inefficient and wasteful business structures that are pretty well doomed to fail anyway, the outlook seems to me that we will have a good shake out of dead wood then go forward looking fairly rosy.

  9. Damian — I’m not basing my assessment on the statements from government economists or confidence in the government’s policy response. As I made very clear in my post, I think the government’s policies will only make things worse, but ultimately I don’t think they will prevent new businesses from growing.

    I think the RBA may have slightly over-shot their monetary expansion, but I am hopeful that they will pull back before any serious inflation pressure builds up.

    I also doubt we will see a major interest rate effect, or a currency crisis, or a debt default. Many of these concerns are appropriate for America… but I think Australia is in a much stronger position.

  10. Michael C — Schiff & Paul are talking about America. The America story is still very much in the air and depends quite a bit on luck and government policy. They are certainly taking a step towards an Argentina-style implosion… but Schiff & friends are often too quick at predicting doom.

    Like neo-cons talking about terrorists or greenies talking about AGW, some Austrian economists see doom around every corner. Predicting 10 out of the last 2 recessions is not a great track record.

    America does face big problems. Australia… much less so.

  11. If Australia’s economy is heavily reliant on commodity exports to China and China in turn is heavily reliant on export of consumer goods to America and Europe then isn’t our economic future to a great extent tied to how things go overseas, particularly in the US?

    For Australia to avoid a recession wouldn’t we have to assume that either demand from US and European consumers will recover quite quickly or that China itself (through internal consumption) or other markets will pick up the slack? I would imagine either scenario would take years to play out.

    With a sound economy and plentiful resources I can understand the case for optimism for Australia in the long term but in the shorter term I can’t see how we are not tied to a large extent indirectly to the US consumer.

    I’m no economist so by all means let me know if this is too simplistic or missing something fundamental.

  12. It’s not just America that’s got a problem. Japan, Germany, the UK, Hong Kong, Singapore, eastern Europe and to some extent China are also in bad shape. Our problems are imported from many of them as well. Japan and China are our two biggest export markets, for example.

    I agree the sky is not falling, but I believe we’ll be looking at quite slow growth for several years.

    Indeed, several might turn into many – the Government debt to GDP ratio will be 20% in Australia in 2010 but the OECD says the worldwide average will be 101.3%. Increased taxes and fiscal austerity, most likely with rising inflation and interest rates, are going to be impossible to avoid. We’ll import the consequences of that to add to Rudd’s neo-socialist medicine.

  13. Inflation is monetary and is trivial to avoid. That does not mean we will avoid it but it certainly is avoidable.

  14. Very true Jaz, and we are already in a per-person recession. We certainly are exposed to the international environment, and the international economy is doing badly. As I say in the original post, this will hurt Australia.

    But the external influences only go so far. More to the point, growth is caused by improvements in knowledge use and productivity advances… and these things won’t stop just because some of our miners make less money. The world caused our recession… but we don’t have to wait for the world before we come out of it.

  15. Jaz,

    Metal prices are up from their lows, our dollar is not near the commodity related highs it was once at. Inflation I am so worried about in the long term has a flipside in the short run: it allows external balances to work and our regulated labour market to clear/operate close to a free market, allowing for adjustments.

    What Rudd needs to do is to rein in the spending and bad taxes and macro policy asap. We need a lot of supply side reform [e.g, abolish payroll tax], an effort to quickly balance the budget [cut the least productive items every year so the Government debt is paid off in 2-3 years] and to moderate excessive monetary growth (even with deflationary forecasts vis a vis the diminishing money multiplier, we still have inflation above the RBA target band) [i.e we need a credible disinflation path that doesn’t shock growth].

    One of the greatest insights the New Keynesians has is that unemployment can become persistently high if enough people become unemployed. Taxing employment, crowding out private sector investment and creating an unsustainable credit boom all risk this in the future and a lower productivity growth rate due to higher public sector borrowing could drag the economy into this situation by keeping growth low until there is another bust.

    I’m optimistic like John, but cautious.

  16. I don’t expect any serious recovery so long as government is bailing out industries and trying to direct investment.

    It prevents the kind of creative destruction that is so badly needed right now.

  17. I think things are really bad. Right now there has been some quantitative easing (money base creation) that makes things seem a little easier. But I think we are at a place we’ve never seen before. Never have we had this level of sustained parasitism. Never had we had before a decades-long campaign to systematically undermine our energy production. And always Australians have been allied to the toughest guys around. First the British, then the Americans. Now the Americans are receding from the picture in an explosion of debt.

    So I think we are in big trouble and we have to take serious action. Mass-sackings in the public sector. All good policy starts there.

  18. As soon as Bernanke announced that he was going to engage in “quantitative easing”, the only policy measure he ought to have taken in the first place (as Humphreys argued at the time) I predicted that the market would recover and that things would feel like we were in an Indian Summer. But this easing up cannot last because of all the capital destruction the Americans are engaging in with their idiotic fiscal policy. And a lot of the rest of us as well.

    The problem with quantitative easing is it works. Its the only thing that works. Fiscal policy does not and cannot stimulate spending. It works so well and in the first instance the money will cause the markets to recover and some producer prices to pick back up again, and business activity to resume near what it was. But as soon as things are back to normal again, what with all this red ink everywhere, the Americans will overuse this. They will have to because the Chinese aren’t going to keep throwing their money away on them.

    So the Americans have already made their choice. Their currency will collapse and gold and silver will soar momentarily. What will happen to the AUD is difficult to know. But the American dollar will collapse. Soetoro has made sure of that.

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