In assessing economic data, one factor often ignored by media commentators and investors is the ability for human beings (including economists) to defer the acknowledgement of bad news. Despite the data emanating from the United States and Europe continuing to be overwhelmingly negative, many economists and politicians still confidently claim that Australia will avoid recession.
Even as recently as yesterday, a panel of economists noted that there was only a 40% chance that Australia will slip into recession. That sounds like the school student with an assignment due who puts it off until the last minute, perhaps hoping for some act of divine intervention.
It was revealed last week that the US has actually been in recession since December 2007. However, it is only in the last few months, largely after the credit market seized and equity markets tumbled that Main Street has really started to feel the impact. In November, US employers cut 533,000 jobs, the most in 34 years, pushing the unemployment rate to 6.7%. In the last week, phone company, AT&T, announced the loss of 12,000 positions, while Du Pont will cut 2,500 jobs.
Unemployment is a particularly insidious beast, causing a vicious cycle of gloom. When a person is laid off, they suffer an extreme reduction in income. As a result, when a large number of people become unemployed, consumer spending falls — significantly. The problem is, consumer spending is the engine room of Western economies (making up around 70% of GDP). Reduced spending further lowers growth, which causes lower expectations, reduced investment and further decreases employment. As the New York Times noted, US unemployment hit 25% in 1933 but was only 5% in 1929.
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Increased unemployment also curtails the government’s ability to create fiscal stimulus. This is because higher unemployment results in lower income tax receipts and higher welfare payments (lower consumer spending will also decrease GST revenues). Rest assured, Kevin Rudd won’t be mailing any more $1,000 cheques next year.
Despite the growth of the BRICs and EU, the United States remains the world’s growth barometer. If the US slides into depression (which, unlike a “recession” does not have a “technical” trigger), it is inconceivable that the rest of the world, and countries like Australia will avoid an economic downturn, despite the claims of the IMF, the Reserve Bank and Kevin Rudd.
Since the United States stumbled last year, China, previously thought to have “decoupled” from the US has faltered. Chinese growth is expected to fall below 8% next year (China International Capital Corp, a Beijing-based investment bank suggested that Chinese growth could slip to 7.3%), while the Chinese Government has embarked on a desperate US$584 billion spending package. This column predicted as much back in November 2007.
Where does this leave Australia? In recent years, the Australian unemployment rate has remained at near record lows. In October, the ABS reported an unemployment rate of only 4.3% (up from lows of 3.9% in January). However, those figures do not take into account the sudden slump in commodities prices and recent widespread lay-offs in the financial sector. As noted, unemployment feeds on itself, causing GDP to weaken, which then causes further unemployment. Australia, like the US and UK, is also cursed with the presence of a large private debt load. The subsequent de-leveraging of private debt will have further catastrophic consequences on the Australian economy.
Higher unemployment also has a serious impact on property prices — this will be even more evident in Australia due to the record levels of indebtedness. Property buyers have borrowed (and banks have lent) on the basis that the borrower’s income will remain constant (or increase) over the period of the loan. However, when someone is unemployed, their income drops substantially, often making interest payments untenable. Property prices will also be hit by lower economic growth, and reduced immigration. People don’t tend to relocate their family to another country if there are few job prospects.
Few last year wanted to believe that the Australian stock market would fall below 3,500 — but as millions of equity investors found out, hope and reality are two very separate concepts. For some economists still, the delineation is not so clear.