Recently, we noticed a trend emerging in the Australian economy- retail discretionary spending seems to be falling off significantly. As this news article reported,

But conditions in the retail sector are savage. Consumers are buying less, despite one of the most ferocious discounting wars in history. With the two department store heavyweights, Myer and David Jones, battling it out for customers, the smaller retailers are caught in the crossfire, forced to match the prices or do better.

The latest Australian Bureau of Statistics figures show the household goods sector posted a sharp fall in prices, down 3.6 per cent, making it the second-biggest quarterly fall over the past 11 years. The first-quarter CPI showed particularly large price falls for furniture and furnishing, down 3.8 per cent, and audio visual and computing down 5.9 per cent. The next figures will be even uglier for retailers, whose margins are being cut to ribbons.

Elsewhere, Virgin Blue suffered a big fall in share price as it warned that

… earnings could plunge as much as 75 per cent due to a ”rapid deterioration” in demand from leisure travellers.

It seems that the retail industry is doing it tough. Sectors of the Australian economy related to consumer spending are in pain. Like the US economy, most of the Australian economy are related to consumer spending (say around 60%). Therefore, this trend, if continued, indicates that a major slowdown in the Australian economy is coming. A recession cannot? be ruled out.

The mainstream media will quote mainstream economists and put the blame on rising interest rates, Greek contagion and China? slowdown and so on. Blame will be laid on these “shocks” to the economy that cause consumers to “lose confidence.” That implies that to reverse this trend, consumers will have to be brainwashed to be ‘confident’ in order to spend their way to economic prosperity.

This is an example of voodoo economics for the masses. If this is the correct diagnoses for the ills of the economy, then we have a better idea for an economic ‘stimulus’ package (that will be much far more effective than the Rudd government’s $900 cash splash during the GFC)- distribute $900 worth of Myers/David Jones vouchers (that? will expire in 3 months time) to the masses. We can guarantee that within 3 months, consumers will regain their ‘confidence’ and spend, spend and spend.

Since consumer ‘confidence’ is the wrong diagnosis, then ‘stimulation’ is the wrong cure.? As we wrote in Will governments be forced to exit from ?stimulus??,

In fact, the word ?stimulus? is the most misleading word in economics lexicon because it conveys the idea of a surgeon ?stimulating? a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch.

What is the root of the problem?

Remember, back in Australia?s credit growth is still falling, we wrote that

… for an economy that is addicted to debt, all it needs to tip it into a recession is for credit growth to slow down- no contraction of credit is required. Also, as Professor Steve Keen explained, at this stage of the debt cycle, the aggregate spending in the economy is made up of income plus change in debt.

To understand why, consider this highly simplified hypothetical situation in the economy:

$80 (income) + $20 (change in debt) = $100 (Aggregate spending)

As you can see, of the $100 of economic activity, $20 is the result of an increase in debt. Assuming that next year, the situation looks like this:

$83 (income) + $15 (change in debt) = $98 (Aggregate spending)

Income goes up, but people decide to borrow less. Note that when there’s less borrowing, it does not mean that the total amount of credit in the economy has declined. Instead, it means that credit is still growing, but it is growing at a slower pace.

As you can see from this example, if income remains stagnant and credit growth slows down, the total amount of aggregate spending in the economy will decline, tipping the economy into recession (unless it is the government which increase the spending to fill the gap).

What if next year, everyone decides to stop borrowing (i.e. total credit remains the same)? The equation will look like this:

$83 (income) + $0 (change in debt) = $83 (Aggregate spending)

If aggregate spending falls from $100 to $83, it will be a depression for the economy. What if everyone decides to save, and thus repay their debts? The equation will then be:

$83 (income) + $ -5 (change in debt) = $78 (Aggregate spending)

The situation is worse!

Thus, you can see that for an debt-addicted economy like Australia, if wage growth is constricted, the only way for the economy to grow well (in nominal terms) is for debt to grow at faster and faster rate. Obviously, this is unsustainable because if debt grow faster and faster than wage growth, it will be only a matter of time before the entire economy becomes sub-prime. When that happens, there will be an almighty crash, which in Australia’s case, is likely to result in a currency crisis (see Serious vulnerability in the Australian banking system).

If the government decides to borrow to supplant the private sector’s decline in borrowing in order to maintain economic growth, then the budget deficit will continue to grow. Again, this cannot go on indefinitely because Australia will end up like the PIIGS countries.

One more point, up till now, all these growth are in nominal terms. But what about in real terms?

As we know, it wasn’t long ago that there were media reports of “skills shortage” in Australia. Also, it is clear that Australia requires more “nation building” due to lack of infrastructure. This means that Australia is at the limits of its productive capacity. That means that even if Australia somehow manages to grow in nominal terms, it will be achieved at the expense of higher price inflation. That will attract more interest rate hikes from the RBA. As we wrote two years ago in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

The Australian economy was already running at full steam. Accelerating price inflation is a sign that there are insufficient resources in the economy to allow for all investment projects to succeed and all consumptions to carry on. If this trend is not arrested, the economy will run out of resources, resulting in a crash. Therefore, in order to put the economy back into a sustainable growth path, consumptions and investments have to slow down in order to allow for the economy to catch a breather for the rebuilding of its capital structure. The rebuilding of capital structure is necessary for the economy to replenish its resources for the future so that growth can continue down the track. Unfortunately, this rebuilding itself requires resources now. Therefore, current wasteful consumptions have to be curtailed and mal-investments have to be dismantled to make way for the rebuilding. The curtailment of consumption involves consumers spending less and saving more, while the dismantling of mal-investments involves retrenching workers, liquidating businesses, e.t.c. These involve pain for the people of Australia.

As we all know, the RBA raised interest rates 6 times already and that is the probable reason consumers are de-leveraging (i.e. borrow less and/or repay debts).

To put it simply, a glass ceiling is blocking the Australian economy. If you can feel that the quality of your life is also hitting the glass ceiling, then you know this is the reason.