The Economic Weekly (week ending 12 April 2019)

Since I spent last week on the road in Queensland, this will be a shorter Weekly than usual. And as I’m just about to head off once more – this time for leave – the Weekly will now be on hiatus for a little while before returning in May.

(As a quick aside: many thanks to the AICD members and guests who gave up their time to come and listen to my presentations – and put up with a lot of PPT slides – over the past week, as well as to the AICD team who pulled the trip together. And, of course, thanks to all of you who have been reading my stuff over the past two months as I’ve been settling in to my new role here and to my AICD colleagues who have been turning my scribblings into publishable content.)

What I’ve been following in Australia . . .

What happened:

According to the ABS, lending to households rose 2.6 per cent in February (seasonally adjusted) over the previous month but was down more than 15 per cent over the year. Lending to households for dwellings (excluding refinancing) rose by 2.7 per cent in February in what was the first monthly increase since July last year, although it was still down more than 18 per cent over February 2018. Lending to both owner-occupiers and investors was up over the month.

Lending to households for dwellings

Why it matters:

While lending for housing was still down sharply over the past year, the small upward bounce in the monthly numbers – together with the declining pace in the fall of house prices noted in the previous Weekly – may indicate that the housing market correction is starting to moderate. Still too soon to tell, of course. But just possibly, some straws in the wind?

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) rose 1.9 per cent to 100.7 in April.

Westpac-Melbourne Consumer Sentiment Index

Why it matters:

April’s survey was conducted over 1 – 5 April and that timing meant that it captured consumer reactions to the Federal Budget. The latter appears to have had a positive impact on confidence: sentiment among those surveyed post-Budget was 7.7 per cent higher than for those surveyed before the budget. According to Westpac, that’s ‘the most positive turnaround since we began tracking pre and post Budget responses in 2011.’

. . . and what I’ve been following in the global economy

What happened:

The IMF released its April 2019 World Economic Outlook (WEO), describing the global economy as at a ‘delicate moment.’

The Fund has trimmed its growth forecast for this year from the 3.5 per cent it had been expecting in January (and the 3.7 per cent forecast last October) to a more modest 3.3 per cent, while leaving the forecast for 2020 unchanged at 3.6 per cent1. Growth in the advanced economies collectively is now expected to run at 1.8 per cent this year (down from a two per cent growth forecast in January) while growth forecasts for emerging and developing economies have been trimmed by 0.1 percentage points in 2019 and 2020. On a more positive note, the Fund thinks that global growth should stabilise over the first half of this year before staging a gradual recovery over the second half of 2019.

Real GDP growth 2000-2024F

For Australia, the IMF now expects our economy to grow by just 2.1 per cent his year before expanding at 2.8 per cent in 2020. That 2019 projection represents a sizable downgrade from the October 2018 WEO, which had expected the Australian economy to grow by 2.8 per cent in 2019.

Elsewhere, notable downgrades for forecast real GDP growth in 2019 across the developed world include Germany (down 0.5 percentage points to 0.8 per cent), Italy (also down 0.5 percentage points to just 0.1 per cent), Canada (down 0.4 percentage points to 1.5 per cent) and the UK (down 0.3 percentage points to 1.2 per cent). The growth forecast for the United States saw a more modest downgrade of 0.2 percentage points to 2.3 per cent growth. In emerging economies, there were sizeable downgrades to growth forecasts for Mexico (down 0.5 percentage points) and Brazil (down 0.4 percentage points).

The Fund also cut its forecast for world trade growth, with trade volumes now expected to grow by 3.3 per cent this year, down 0.6 percentage points from its January forecast.

Why it matters:

IMF forecasts are arguably the closest we come to an ‘official’ view of global economic prospects, and as such are a useful gauge of current conditions. One theme of the Weekly over the past month or so has been the soft start to the year for the global economy, and the downgrades to the Fund’s growth expectations reflect this. While the IMF’s base case is for global growth to improve as 2019 progresses, it is also clear that the Fund reckons that the balance of risks ‘remains skewed to the downside’, highlighting: trade tensions; downside risks in systemic economies; financial vulnerabilities; and medium- and long-term risks including ‘pervasive effects of climate change and a decline in trust with regard to establishment institutions and political parties.’

What happened:

US President Trump warned that he was considering imposing tariffs on US$11 billion of EU products in retaliation for Brussels’ subsidies to Airbus. For its part, Brussels said it was seeking punitive tariffs on US$12 billion of US exports in response to US policy support for Boeing.

Why it matters:

While US-China trade talks tend to get most of the headlines, we’ve noted before in the Weekly that trade tensions between Washington and Brussels are another important feature of the contemporary global trade landscape. The current Airbus-Boeing fracas dates all the way back to disputes in the WTO in 2004, but tensions have been rising more recently after the US administration extended tariffs on steel and aluminium to the EU in June last year, prompting retaliatory measures from Brussels. The US has also threatened to impose tariffs on European automotive imports. One possibility worrying trade analysts is that any resolution of the current dispute between Washington and Beijing could be followed quickly by an intensification of US-EU trade disputes.

What happened:

The US Federal Reserve released the minutes from the March 2019 meeting of the Federal Open Market Committee (FOMC). The report of the discussions noted that ‘With regard to the outlook for monetary policy beyond this meeting, a majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year.’ But there was also something of a warning shot for markets, with the follow up statement that: ‘Several participants noted that their views of the appropriate target range for the federal funds rate could shift in either direction based on incoming data and other developments. Some participants indicated that if the economy evolved as they currently expected, with economic growth above its longer-run trend rate, they would likely judge it appropriate to raise the target range for the federal funds rate modestly later this year.’

Why it matters:

In past issues of the Weekly we’ve discussed the marked swing in the Fed’s stance towards monetary policy since the turn of the year. We’ve also noted that financial markets have been increasingly inclined to anticipate a forthcoming rate cut. While the minutes do little to change the assessment of a Fed that is considerably more cautious in its views of the economy than it was in 2018, they also show that the FOMC is keen to remind markets that they may have been getting slightly ahead of themselves with their expectation of a looming rate cut.

What happened:

The European Central Bank (ECB) promised that it would leave official rates unchanged ‘at least though the end of 2019, and in any case for as long as necessary’. In his press conference, ECB president Mario Draghi gave strong hints that further policy stimulus might be on the way later this year, if the ECB does not see a pick up in euro area activity.

Why it matters:

Europe in general and the euro area in particular has been a prominent contributor to the soft global growth conditions highlighted by the latest IMF forecasts, with sluggish underlying growth exacerbated by what Draghi has previously described as ‘continued weakness and pervasive uncertainty’, with the latter reflecting what might be described as ‘known unknowns’ including Brexit and US trade policy. Mindful of the downside risks, the ECB has previously announced that it would launch new measures (in the form of targeted longer-term refinancing operations, or TLTROs) this September to try and provide additional support to the sagging European economy, and Draghi – who will step down from his current role in October – is keen to emphasise that the central bank remains ready to respond to any further signs of weakness.

What I’ve been reading: articles and essays

RBA Deputy Governor Guy Debelle gave a speech on the state of the economy. Debelle covers some familiar ground, highlighting a couple of key disconnects across the economy. The first of these is the contrast between household consumption growth, which has been much weaker than the RBA had previously anticipated, and the rest of the economy, where things have played out largely as the central bank expected. Debelle reckons that the sharp slowdown in consumption growth in the second half of last year was mainly a product of low growth in household income along with ‘an increasing expectation that it is likely to remain low’. In contrast, the story across the rest of the economy has been more upbeat: non-mining business investment has been ‘growing at a good rate’, the decline in mining investment is ‘about at the end’, and exports have continued to expand. The second disconnect is between ‘surprisingly weak’ growth in real GDP and a ‘surprisingly strong’ labour market, with evidence from business surveys bridging the gap. According to Debelle, the ‘tension highlighted by these different lenses on economic growth is of critical importance.’

The RBA has released its latest Financial Stability Review. The summary judgement is that ‘domestic economic conditions remain broadly supportive of financial stability’ with low unemployment and healthy corporate profits offsetting a (consumption-led) slowdown in growth and weak conditions in the housing market. According to the Review:

  • Measures of financial stress among Australian households are generally low and – despite an increase in housing loans arrears, particularly in Western Australia (but where they are still less than two per cent) – low unemployment and low interest rates mean households ‘remain well placed to service their debt’.
  • While large falls in house prices have left some borrowers facing negative equity, the incidence remains quite low. The RBA estimates that nationally only around 2.75 per cent of securitised loans by value (or just over two per cent of borrowers) are in negative equity, with the highest rates in Western Australia, the Northern Territory and Queensland. Almost 60 per cent of loans in negative equity are in Western Australia or the Northern Territory. Elsewhere, rates of negative equity remain very low. By way of contrast, negative equity peaked at more than 25 per cent of mortgaged properties in the US in 2012 and in Ireland it exceeded 35 per cent. That low Australian result reflects (i) the previous large increase in house prices, (ii) the low share of housing loans with very high loan to valuation ratios; and (iii) the fact that many households are ahead on their loans. Of course, if house prices keep falling, those numbers will keep changing . . .
  • Corporate debt remains moderate compared to income and assets, and businesses too ‘are well placed to meet their debt obligations given the strong profit growth’.
  • The large degree of change required by some financial institutions in response to the Hayne Commission ‘raises the significant challenge of managing the implementation in an effective and timely manner.’
  • Banks ‘now have much higher levels of capital, more liquid assets and more stable funding structures’ than they did around the time of the financial crisis.

The OECD’s new report on the ‘squeezed middle class’. Defined as covering those earning between 75 per cent and 200 per cent of the median national income, the report finds that the middle class has shrunk in most OECD economies, with the share of people in middle income households falling from 64 per cent to 61 per cent between the mid-1980s and the mid-2010s. This group has also ‘grown smaller with each successive generation’: while 70 per cent of the baby boomers were part of the middle class in their twenties, that compares with 60 per cent of millennials. At the same time, in many OECD countries ‘middle incomes have grown less than the average and in some they have not grown at all’. Worth noting: according to the short country summary graphics (pdf), at 58 per cent, the size of the Australian middle class is actually somewhat smaller than the OECD average (61 per cent).

What I’ve been reading: books

Ryan Avent on the Wealth of Nations: Work and its absence in the 21st Century. Avent’s focus is on the implications of the ‘Digital Revolution’ for the future of work. Unlike techno-sceptics such as Robert Gordon, Avent thinks that the Digital Revolution is a big deal2. But unlike some of the techno-optimists, he also worries that the implications for work, for our institutions and for society as a whole could be very negative unless they are well managed, citing current features of the global economic landscape (real wage stagnation, rising income inequality, a falling share of labour in total income, growing political polarisation) as indicators of the potential troubles ahead. Avent’s thesis is that it is scarcity that determines relative economic returns, and that in today’s economy, labour has become abundant thanks to a combination of automation, globalisation, and the extremely high productivity of a subset of the most skilled workers. At the same time, he argues that artificial measures that had been designed to improve the relative bargaining power of workers (for example, controls on migration, unionisation, occupational licensing) have also either been eroded or undermined. As a result, Avent worries about what he describes as an ‘employment trilemma’, whereby there is no easy solution to what is effectively a diagnosis of a global labour glut. According to his trilemma, we can only choose two out of three from jobs that (i) can deliver high productivity and wages, (ii) are resistant to automation and (iii) can employ vast amounts of labour. So, for example, jobs that are well-paid and scalable will tend to be automated away, while jobs that are resistant to automation and can employ large numbers of people will tend to be low productivity, low wage affairs. Avent canvasses a range of potential solutions to the challenges posed by his diagnosis of the threats to work and wages, ranging from institutional changes (higher minimum wages, universal basic income, a revival of unionism) to increased education and increased investment to offsetting demographic shifts (ageing and shrinking working age populations) and the sharing economy. But he doesn’t seem to be particularly convinced by any of them.

1 The IMF’s headline forecasts reflect world output shares based on purchasing power parity (PPP) exchange rates, which give a relatively greater weight to faster-growing emerging and developing economies. At market exchange rates, the Fund thinks that the world economy will grow at 2.7 per cent this year and 2.9 per cent in 2020. Since the bigger growth downgrades this time were for developed economies, the slowdown in this measure of global growth for the current year (0.3 percentage points relative to the January 2019 forecast) is somewhat larger than the slowdown in the headline growth rate reported above.

2 One of Gordon’s famous debating points that seeks to downplay the relative merits of recent innovations vs. previous waves is to ask whether people would be prepared to swap indoor plumbing for their smart phone. Avent’s view is that the trade-off is not at all as clear as Gordon thinks it is. Personally, I’m closer to the Gordon view on this one particular test . . .


Summary (week ending 5 April 2019)

  • Inevitably, for the past week, the focus has been on the budget. Just in case you’ve not already overdosed on the traditional deluge of post-budget coverage, you can find our initial take, written on budget night, here, and you can register to watch a recording of a webinar covering some of the key themes, delivered a few days later, here.
  • The RBA Board met on 2 April.  As expected, there was no change to the cash rate. 
  • Australian house prices fell again in March, and while the pace of decline slowed, the geographic spread of house price declines widened.
  • The NAB monthly business survey showed business conditions rising to above average levels in March.  But on a forward-looking basis, business confidence fell again.
  • Australian retails sales staged a strong comeback in February.
  • February’s trade surplus set a new Australian monthly record.
  • And according to the March 2019 Resources and Energy Quarterly, Australia’s resource and energy exports will reach a record $278 billion in 2018-19.
  • The global composite purchasing managers index (PMI) for March told a similar story to last month’s reading, with ongoing strength in services offsetting continued weakness in manufacturing. Attention focused on China, where the official manufacturing PMI delivered its biggest monthly increase since 2012.  The Caixin China general manufacturing PMI also recorded its first improvement in four months, along with the highest reading since July 2018.

What I’ve been following in Australia . . .

What happened:

The RBA Board met on 2 April.  As widely expected, it decided to leave the cash rate unchanged at 1.5 per cent. 

The accompanying statement gave no indication that the central bank has undergone any major rethink in terms of the future stance of monetary policy, noting only that the ‘low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual . . . the Board judged that it was appropriate to hold the stance of policy unchanged at this meeting.’

Why it matters:

No change in policy had been expected for this meeting and no change was what we got.  On the other hand, those hoping for signs of a shift to a more dovish policy stance in the accompanying statement were likely disappointed: arguably, the best they could point to was the rather anodyne closing comment that the board ‘will continue to monitor developments.’

Perhaps of more interest on the monetary policy front was the financial market response to the budget in terms of how it saw the implications for the RBA’s likely policy stance.  One way of interpreting the short-term tax component of this week’s budget measures is to see it as providing fiscal support to households that could potentially substitute for (or at least act as a complement to) easier monetary policy.  Analysis by CBA economists suggests that the personal income tax cuts included in the budget over 2019-20 and 2020-21 would have about the same impact on disposable income as two 25bp rate cuts, for example.  And with monetary ammunition running low, sharing the burden with fiscal policy would certainly make sense.  A look at the level of implied policy rates from a few days before the budget compared to implied levels the day after, however, suggests that the immediate market judgment was that the budget had done little to change expectations of the need for central bank action.

0804191

What happened:

Australian house prices across the eight capital cities fell by 0.7 per cent in March over the previous month, according to CoreLogic, and were down 8.2 per cent in annual terms.   The steepest falls in prices came in Sydney (down 0.9 per cent) and Melbourne (down 0.8 per cent) with the only two cities not to see a fall in prices Hobart (up 0.6 per cent) and Canberra (no change).

Sydney dwelling values are now down almost 14 per cent from their peak while Melbourne values are down 10.3 per cent.  In Darwin and Perth, where prices have been falling for longer, dwelling values have fallen by a cumulative 27.5 per cent and 18.1 per cent respectively, since peaking in 2014.

0804192

Why it matters:

The March report painted something of a mixed picture of housing market health since, despite another monthly fall, the pace of decline has been easing over recent months, prompting CoreLogic to suggest that the housing downturn is ‘losing steam’.  Set against that, however, price weakness is now spreading geographically.

What happened:

The NAB monthly business survey showed business conditions rising by three points in March, with increases across each of the index components, including the employment index, which is now well above average.  But business confidence fell two points from February.

0804193

Why it matters:

The recovery in business conditions following on from last month’s fall was welcome news, and the strength of the employment component was again consistent with the positive aspects of recent labour market outcomes.  But the continued slide in confidence since last month indicates that businesses continue to view the future with some concern.

What happened:

Australian retail sales in February rose by 0.8 per cent over the month (seasonally adjusted) and by 3.2 per cent over the year, according to the ABS.  That was better than consensus forecasts of a 0.3 per cent monthly increase and marked something of a recovery following two weak monthly results (a 0.4 per cent fall in December and a 0.1 per cent rise in January).

0804194

Why it matters:

It’s only one month’s number, but after disappointing results in December and January, and with a heightened focus on the conjunction of weak income growth and falling house prices and their combined consequences for consumer spending, the bounce back in February provides grounds for hoping that the adverse wealth effect on household spending is not – yet – biting too deeply.

What happened:

Australia’s trade balance reached a record surplus of $4.8 billion in February.  That comfortably exceeded market expectations for a $3.7 billion result and follows on from a chunky $4.4 billion surplus in January.   Export values were up more than 13 per cent over the year, while growth in imports was closer to four per cent over the same period

0804195

Why it matters:

The monthly trade numbers help highlight how much Australia continues to benefit from a strong performance in resource exports, including a dramatic surge in the value of exports of natural gas over the past several years.  The implications of these developments have been apparent in the fiscal position and played an important role in supporting this week’s budget bottom line.  (See also the following section on the March 2019 Resources and Energy Quarterly.

 

What happened:

The Department of Industry, Innovation and Science published the March 2019 edition of Resources and Energy Quarterly (REQ).  According to the REQ, Australia’s resource and energy export earnings are forecast to reach a record of $278 billion in 2018–19 after the prices of some of our major commodity exports hit seven-year highs.  That represents an upgrade of about $13.9 billion to the estimates in the December 2018 REQ.  Moreover, the new forecast for 2019-20 (which sees the expected value of resource and energy exports drop only slightly next year, to $272 billion) is now an impressive $31 billion higher than the projections in last December’s REQ.

0804197

Why it matters:

As already noted in this Weekly, high commodity prices have pushed up resource exports and contributed to a stronger budgetary position.  One key message from the REQ is that a large part of this strength has been driven by supply disruptions (iron ore mine closures in Brazil following the collapse of Vale’s Brumadinho mine tailings dam have had the biggest impact, but there have also been disruptions to global copper and oil producers, as well of course as weather-related disruption here in Australia) that have pushed up US dollar commodity prices.  That, along with weakness in the Australian dollar which boosted local currency returns, helped drive the record result for 2018-19.  As supply problems are overcome, prices will adjust, and export values are forecast to fall back over the next five years, dropping to a still relatively healthy $256.2 billion by 2023-24 (in nominal terms).

 

. . . and what I’ve been following in the global economy

What happened:

The JP Morgan global composite PMI suggested that the pace of global economic expansion accelerated in March (pdf). As was the case in February, a stronger performance by the services sector was enough to offset continuing subdued conditions in manufacturing, as services activity increased for a second successive month, while the global manufacturing PMI was unchanged from February.

0804198

Why it matters:

While the global PMI story triggered only moderate interest, news about developments in China attracted rather more attention.  China’s own official manufacturing PMI rose to 50.5 in March from 49.2 in February.  That was the biggest monthly increase since 2012 and took the index back into expansionary territory.  The measures for new orders and new export orders also staged sharp increases (although note that the latter remained deep in negative territory).

At the same time, the Caixin China general manufacturing PMI also showed the Chinese manufacturing sector finishing the first quarter of this year on a positive note, with operating conditions improving for the first time since last November, and the highest reading since July 2018.

With the Chinese economy having started the year on a relatively rocky footing, the two PMI readings for March provide some early evidence that Beijing’s latest bout of stimulus efforts, including via infrastructure spending, may now be having a positive effect on economic activity.

0804199

 

What I’ve been reading: articles and essays

A smaller offering on the readings section this week (although I suppose I could have included the budget papers to bulk things out a bit).

The Parliamentary Budget Office (PBO) has released a new report on the fiscal impacts of Australia’s ageing population.  The old-age-dependency ratio is the ratio of those people aged 65 and over to the prime working age population (defined as those aged between 15 and 64).  Between 1971 and 2011, this ratio increased from 13 per cent to 21 per cent (that is, by 2011 there were 21 people aged 65 and over for every 100 people of working age).  Since 2011, the rate of increase in the ratio has doubled, and between 2011 and 2031, Australia’s old-age dependency ratio is expected to increase from 21 per cent to 29 per cent, with the next decade representing ‘a unique period of population ageing for Australia’. According to the PBO, that coming decade of demographic change is projected to subtract 0.4 percentage points from annual real growth in budgetary revenues while at the same time adding 0.3 percentage points to annual real growth in spending, resulting in an annual cost to the budget of about $36 billion by 2028-29.  That’s projected to be larger than the cost of any one of Medicare, NDIS, or Commonwealth funding for schools and hospitals in the same year.

Adam Tooze asks, Is this the end of the American century?  Tooze reckons talk of an end to the US world order is – for now – a ‘gross exaggeration.’ The two key pillars of US power – military and financial – are ‘still firmly in place’ and much less has changed than is often claimed, since ‘Republican policy is just Republican policy, American military power is waxing not waning, and the dollar remains at the hub of the global economy.’  The biggest shift is the relationship with China, where he writes, intriguingly, ‘we may find ourselves facing not so much an end of the American-led order, as an inversion of its terms. Where the US previously offered soft-power inducements to offset the threat of communist military power, backed up by hard power as a last resort, in the next phase the US may become the provider of military security against the blandishments offered by China’s growth machine.’  Almost worth reading just for the arresting closing image of President Trump on a golf cart, careening around the flight deck of a nuclear-powered aircraft carrier engaged in ‘dynamic force deployment’ to the South China Sea.  (By the way, if you don’t mind bulky books, Tooze’s Crashed from last year is definitely worth a look, although I preferred The Deluge.)

Adair Turner wonders whether zero interest rates are the new normal, and warns that while in the current environment monetary financing will certainly have its attractions, ‘excessive monetary financing is hugely harmful’ and is far from a costless solution.

Veteran environmentalist and journalist Bill McKibben ponders a future without fossil fuels, proposing that the question ‘At what point does a new technology cause an existing industry to start losing existing value?’ may ‘turn out to be the most important economic and political question of the first half of this century.’ 

The IMF has released the analytical chapters for its April 2019 World Economic Outlook.  Topics covered are the rise of corporate market power, the price of capital goods, and drivers of bilateral trade.  Full disclosure: strictly speaking, these should really be on my ‘yet to read list’, rather than on my ‘currently reading’ one.  But I did have time to read Christine Lagarde’s speech on what she’s describing as a ‘delicate moment for the global economy.’  Key takeaway: while 2017 saw 75 per cent of the global economy enjoy a synchronised upswing, this year the IMF expects 70 per cent of the global economy to undergo a slowdown in growth.

An interesting note from Branko Milanovic contrasting some of the ideas of Francis ‘end of history’ Fukuyama with those of mainstream economics (and Hayek).

The WTO foresees continued headwinds for global trade growth.  It now thinks world trade volumes will only manage to grow at 2.6 per cent this year, down from three per cent last year and much slower than the 4.6 per cent achieved in 2017 (see also the previous Weekly’s piece on slowing momentum in global trade).  Previously, the WTO had been expected trade to grow at 3.9 per cent in 2018 and 3.7 per cent this year.