As we all know, there are a lot of chatters about recessions in the Australian media recently. As always the case, there are two opposing camps of perennial optimists and committed doomsayers on this recession debate. The question is, will there be a recession in Australia?
Our answer is, a recession is not a matter of if but a matter of when. In other words, we still believe that the economy moves in cycles. We do not believe there is such a thing as ever-lasting growth forever and ever till infinity. In fact, we made the first recession call back in February 2007 in Where are we in the business cycle?:
Thus, we believe that Australia (and the US as well) is at the top of the business cycle. For investors, we have to bear in mind that we are now probably at the cyclical top. If we assume that the current trend of companies? profit growth will extend indefinitely into the future, we will be in for a nasty surprise.
Due to some quirk in human nature, it is very easy to fall into turkey thinking as we explained in Failure to understand Black Swan leads to fallacious thinking. Therefore, it is in this context that we wish to refute Michael Pascoe’s punditry on recession, Doomsayers to the fore. We have been hearing his commentary for a couple of years already and know that he had made many wrong calls in the past, including the comments he made last year about the sub-prime crisis being just a “storm in a tea-cup.” Below are our refutations on his “10 reasons for why we won’t suffer a national recession any time soon”:
The Reserve Bank has lots and lots of dry powder if it needs it. As a result of bumping up interest rates, the RBA can easily cut and cut quite dramatically if it thinks the economy is slowing too fast.
This was the same argument made by Shane Oliver, the chief economist of AMP. As we refuted Oliver’s factual error in Aussie household debt not as bad as it seems?,
[Reflation] did not work in Japan! Remember Japan?s infamous zero-interest rate monetary policy as well as massive government spending fiscal policy? Yet, deflation dogged the nation for more than 16 years. There is only one way to fight deflation and that way leads to hyperinflation (see Recipe for hyperinflation).
Central to Michael Pascoe’s idea is the belief that the pushing of the short-term overnight cash-rates levers by the RBA is a kind of do-it-all snake oil that can solve every economic malaise. But as we sarcastically put forth this question in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,
Think about this: if raising interest rates is ?bad? and cutting interest rates is ?good,? then why don?t the RBA set interest rates to zero, thereby putting the economy into a path of eternal boom (plus runaway inflation)? For those who think this is a good idea, then this article will set to let you understand why this is a bad idea.
Also, as we quoted Ludwig von Mises in How will asset-driven ?growth? eventually harm the economy?,
The economists were and are still today confronted with the superstitious belief that the scarcity of factors of production could be brushed away, either entirely or at least to some extent, by increasing the amount of money in circulation and by credit expansion.
To make a final debunking of this idea, consider this present fact: the US Federal Reserve raising interest rates in baby steps from 1% to 5.25% under Alan Greenspan. Then, in reaction to the credit crisis, it began slashing interest rates quickly to 2% today. Did that solve the core of the rot in the US economy? As we explained yesterday in Would the RBA?s rate cut do any good?, a too hasty and massive cuts in interest rates will have a very negative effect on the Australian dollar, which will not be good news for the Australian economy.
Next, Michael Pascoe said,
The RBA is ready to push money at the banks if necessary. Cutting interest rates isn’t the Governor’s only option. He also is set up to lend the banks money in exchange for mortgages if liquidity gets too tight.
Well, take a look at how the US is faring right now. This step may save the banks, but it may not be good for the Australian people. Furthermore, when debt deflation takes hold, shoving money to banks will not be enough to persuade the economy to take on more debt. As we said before in What makes monetary policy ?loose? or ?tight??,
… we have to remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.
Michael Pascoe said,
We’re not the US or the UK. While a couple of our banks have ‘fessed up to big write offs and provisions, they all remain fabulously profitable and their loan book is in much better shape.
We have this to say at How safe are Australian banks?.
Next, he said,
If the unemployment starts to rise uncomfortably, the government has the option of turning off or at least turning down the big immigration inflow it’s presently encouraging. Australia’s gross immigration is running at more than 300,000 people a year.
The problem is not one of over or under employment. Rather, it is the structure (or configuration) of employment. Take a read at Overproduction or mis-configuration of production?. Also, if Australia falls into serious unemployment problems, do you think migrants will still want to come here?
Next, he said,
The Federal Government has surpluses it can turn into spending if it looks like we’re heading for the recession door. Kevin Rudd wants to be Prime Minister for a lot more than one term.
If the government spends too much money too early (by turning the budget surplus into deficit), it will not solve the problems of mal-investments and mis-configuration of production in the economy. Instead, price inflation will be the main effect. Remember, at this point in time, Australia is close to full employment.
Next, he said,
The oil price could well continue to fall, providing some needed psychological relief for consumers feeling battered by prices prices and, what’s worse, the media screaming doom and gloom about oil.
Mere short-term psychological factors will not solve the basic economic problem of scarcity of factors of production and mal-investments. Take a read at our guide, What causes economic booms and busts?.
Next, he said,
The big picture hasn’t changed – Beijing still wants to see about 200 million peasants move into the cities from subsistence existences down on the farm over about 10 years. Think about the infrastructure demands for housing and moving that many people every year and you won’t be panicked into worrying too much about the United States not buying as many Chinese-made shirts and sandshoes.
And therefore demand for our resources remains strong. The surging iron ore and coal prices are yet to fully emerge from the statistical noise and be shown as the great stimulus that the terms of trade are providing.
He got this half-right. Our views on China is summarised in Crisis and the China growth story. Let’s say China’s economic growth slowed down from around 12% to say, 5%. Relative to the ailing US economy, it is still a fantastic growth rate. But relative to itself, it is a major recession. What will this do to commodity prices in the short to medium term?
Next, he said,
Remember where our economy has come from. Yes, there has been a sharp slowdown in retail sales and credit growth – but they’re coming off very high bases. And the economy overall was running at near capacity – the RBA had to make room for the resources boom impetus.
Michael Pascoe forgot that Australia’s debt level had gone too far from the mean by a far margin. The “base” that he mentioned should be the mean, which is somewhere very much lower that where it is today.
Finally, he said,
And, finally, we do learn from our mistakes. The doomsayers tend to be so busy screaming about any potential disaster that they overlook moves buy the government and RBA to counteract them. We have to give the mandarins just a little credit – the RBA certainly doesn’t want a repeat of the last recession when it was arguably a little slow to put up rates and then far to slow in cutting them.
He forgot that Australia is not an isolated economy. It is a relatively small economy that is very much inter-linked to the global financial system and is at the mercy of global macroeconomic forces. There are some factors that is totally beyond the control of the Australian government and the RBA- for example, oil prices, credit crisis, etc.
