Will she be right, mate? – Kohler

The only question about monetary policy now is when the first rate cut will be – this year or next year.

The only question about monetary policy now is when the first rate cut will be – this year or next year.

I think it will be this year, because debt has made the economy very touchy indeed. And if the predictions in the Bank for International Settlements (BIS) annual report yesterday turn out to be half right, not only will the RBA be cutting rates this year, it won’t make any difference – the Australian economy will be in deep trouble.

Yesterday’s statement from Reserve Bank Governor Glenn Stevens was the first acknowledgement that the economy is now slowing and that there are “tentative signs” that the labour market is weakening.

But the problem is that the terms of trade have been working in the other direction. This has been going on for years; as the RBA tries to slow the economy, rising commodity prices, house prices and share prices drag up incomes and wealth, with the end result that everybody borrows and spends like crazy.

After several years of tentatively poking at the economy with the pointy stick of an occasional rate hike, the RBA went whack, whack in February and March this year with two in a row, and then stood back to see what would happen.

Oil prices took off, is what happened, and a huge new price rise was announced for iron ore. The broad CRB commodity price index went up 20% in a couple of months – more terms of trade shock for the RBA to push against.

But not many countries are like Australia, and enjoy rising commodity prices. For the rest of the world this commodity price shock is bad news, and comes on top of a collapse of confidence in financial markets and a global credit squeeze.

I had just finished reading the BIS annual report when the RBA statement came out, and it rather changed my view of it.

Here’s what the BIS said about the global economy: “A generalised squeeze in the availability of credit in major advanced industrial economies remains a distinct possibility, with potentially more severe implications for demand than are reflected in the current consensus forecasts… the US downturn could prove to be deeper and more protracted, given the high indebtedness of the household sector. How emerging markets would be affected also remains unclear; indeed, the abrupt weakening of equity prices in emerging markets in early 2008 suggests that a shift in sentiment might already have occurred.”

The BIS is no doubt referring here to the collapse in the Chinese sharemarket.

Meanwhile the Australian economy is entirely geared to an expanding world economy.

Wages growth has been running well ahead of productivity growth for several years and spending has been running ahead of both, thanks to borrowings and people using home equity as an ATM.

With average annual wage increases running at 4%, according to last week’s figures, there look to be no problems. Indeed subdued wages growth would have been an important factor in the RBA’s decision to leave rates on hold.

But productivity growth has fallen from 2.7% to just above 1%. The only reason this has not been a problem is that national income has been boosted by the terms of trade.

The Australian economy is now so highly geared to high commodity prices, that any reversal would be devastating.

The already deeply negative current account would collapse along with the currency, aggregate income and demand would plummet, property and share prices would fall rapidly and the RBA could not cut interest rates fast enough to turn things around because no one would be borrowing anyway.

That’s the sort of scenario that the BIS paints in its annual report, but then, it’s always been a gloomy-guts.

After all, this is Australia. She’ll be right, mate.

This first appeared in Business Spectator.

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