Recovery Watch: Short-term rates riddle, long-term China warning

Today’s Entrepreneur Watch blog is a joint posting on the SmartCompany Recovery Watch blog, although it probably raises more questions about the state of the recovery than it provides answers.

Professor Ross Garnaut, a leading government adviser and the man who did all the exploratory work on the way to Labor’s carbon pricing regime, has delivered a blunt warning about the state of the Chinese economy and what it means for Australia.

Garnaut, a noted expert on China for decades, says the “salad days” that the Australian economy has enjoyed thanks to the mining boom are rapidly coming to an end.

“We do have to recognise that we are in for fairly tough times,” he told The Australian Financial Review, arguing that China is being hit by three forces that will all weigh on the Australian economy.

Firstly, the Chinese economy is moving away from its focus on heavy industry and exporting, and looking inwards to domestic consumption – this will weaken demand for Australian commodities. Secondly, China is trying to cut its carbon emissions – this will weaken demand for Australian thermal coal. Finally, China is in the middle of a cyclical downturn – this will weaken demand for our exports generally.

Garnaut has called for Australians to adopt an attitude of “shared sacrifice” to prevent the country slipping into an economic malaise as a result of these changes in China. Cuts to government spending, the removal of tax breaks and restrained wage growth are all part of Garnaut’s prescription for keeping the economy going.

Sounds cheery, doesn’t it? At first blush you would think that this sort of message from one of our most respected economists would have the Reserve Bank rushing to get rates down to give the economy some sort of cushion.

But as we all know, it’s never that simple.

Economists are fairly evenly divided between the RBA cutting and leaving rates on hold today. Most of the big banks are backing a cut, with several – most notably Westpac – expecting another cut before the end of the year.

The case for a cut is pretty simple. Outside of the mining sector, economic conditions remain soft, with business and consumer confidence still relatively weak, retail sales down, manufacturing and services still contracting and commodity prices softer than they have been for a while. Cutting rates could also help take some heat out of the Australian economy. The argument is well summarised here by economist Stephen Koukoulas.

But there is a group of economists who argue the RBA should keep its powder dry. We’ve still got full employment, exports remain strong from a historical point of view, the boom in mining investment continues (despite some projects being delayed or canned) and the RBA has time to wait and see the latest inflation data later this month before making its move. There’s a great summation of the hold case from economist Adam Carr here.

It all comes down to the battle we’ve had all year between the strength in the mining economy and the weakness in the non-mining economy.

Further complicating matters for the RBA is a battle between the short term and the long term.

Does it believe the Garnaut argument about the long-term threat to the economy and act to give the economy some cushion?

Or does it look only at the short-term picture, where the line between glass-half-full and glass-half-empty is hard to see, and sit on its hands?

I’m tipping a cut is on the cards. Just as China has given the RBA the cushion it needed to keep rates higher than most other places in the world over the last few years, now China will put more pressure on the central bank to act.

Garnaut’s long-term prognosis should give us all pause – and give the RBA the spark it needs to cut.

James Thomson is a former editor of BRW’s Rich 200 and the publisher of SmartCompany and LeadingCompany.