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May 19, 2014

The five waves that could wipe out the Australian economy this year

The waves washing over the Australian economy won't wipe us out in themselves. But the convergence of them this year could flood attempts to refloat the economy.

The Australian economy is ploughing into rising swells. There are five waves headed our way that might be rideable in isolation but if they converge would represent a perfect storm.

Consider. The structural backdrop for the economy is the mining investment cliff. Although it began two quarters ago, it is not until the second half of this year, probably Q3, that it begins to hit the employment market proper through the wind down of building and structures investment. It has a long way to fall after that (note the green line):

We’ve all known this for some time and interest rates have been cut to record lows to stimulate consumption to offset it. But that project has been seriously disrupted by the second wave, the federal budget, which has rocked consumer confidence to its lowest point since the GFC:

I’ve been happy to see some component of the the big falls as “sticker shock” that will pass. But the structure of budget cuts and the growing social conflict around them means that the political wrangling is likely to run right through to Q3 and the weight on confidence will be more enduring. There is also the unquantifiable impact of the loss of faith in the government (which was economically material last year) and the possibility that consumers accept that there has been an epochal shift for the worse in Australia’s fortunes. A range of polls over the weekend confirmed that Australians felt much worse off after Treasurer Joe Hockey’s budget than any Wayne Swan or Peter Costello effort, despite it being much less contractionary at the macro level.

The other effect of low interest rates has been to fire up east coast property and the Sydney market has, frankly, entered a parabolic blowoff top thanks to an investor mania (check out the blue line moon shot):

That is not the kind of pattern that deflates slowly. This is why the Reserve Bank is warning first home buyers to keep out of the market. House prices growth usually weakens through winter, but the question is: will they strengthen again in Q3 if consumer confidence remains suppressed? That’s my third wave. Sydney property looks toppy and only needs a shock to send it into sharp reverse.

Such a shock may well be coming from outside as well as inside the economy in Q3. Wave four is the iron ore price and mining equities, which are under intensifying pressure:

The iron ore market is very weak. Chinese steel production is strong but end-user demand is not as Chinese property declines and inventories of steel and iron ore are plentiful in China. That has led to a collapsing steel price which will force Chinese steel mills to destock raw materials at some point this year. The most likely candidate for that is Q3 on typical seasonal weakness which looks like it may converge with China’s gathering property bust.

If so, iron ore will fall to $80 or below in August or September (before rebounding somewhat). That will mean all of the budget’s estimated terms of trade falls for next year will arrive instead in just one quarter. Fortescue Metals, as well as a swag of junior iron ore miners, will face another existential crisis.

All of this is transpiring as the fifth wave is washing over everything already. It is the Australian dollar, which is happily levitating far above fair value on the global chase for yield and preventing tradeable sectors from rebounding. Here is The Australian Financial Review’s David Bassanese’s chart (which is similar to that used by Treasury and Goldman Sachs):

Remember, that’s fair value based upon commodity prices and interest rates overseas. It is still too high for the economy as it goes over a once per century mining investment cliff. In truth we need a much lower than fair value dollar for recovery. The high dollar is exacerbating mining and manufacturing woes, as well as rotting on the vine the low-hanging fruits of recovery like tourism and education.

The possible convergence of these five negative waves in the third quarter would swamp the economy. Consumer confidence leads house prices and, if it remains weak, and the external shock arrives, then Sydney and Melbourne housing could roll over just as mining-related job losses rise in Western Australia and Queensland as the Gorgon and QCLNG projects begin the construction wind down.

That’s an income shock, labour market stall and negative wealth effect plus public austerity. Real activity in the national economy will resemble last year’s second-half domestic demand recession even if measures like net exports hold up, only this time housing will be coming off not rising.

I’m bringing forward my next rate cut to October, with a possible follow-up soon afterwards. And that brings me to the real problem: if these events do converge, why would a lousy 50 basis points make much difference?

*This article was originally published at MacroBusiness

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8 thoughts on “The five waves that could wipe out the Australian economy this year

  1. paddy

    Gawd you’re an optimistic bugger.
    *Buys tinned goods and Hides under doona.

  2. pinkocommierat

    Imagine the pickle we’ll find ourselves in once the fat lady has sung. The horse will have bolted, if not over a cliff, then into the cruel swells of a raging economic sea. Like David L-S, I intend on mixing my metaphors ’til the cows come home. while Rome burns, the dollar happily levitates and the cows come home.

  3. pinkocommierat

    My crappy tablet device submitted my post while I was in the middle of editing it. What a way to learn my lesson about being a smartarse online… Serve me right!!!

  4. Chokyi Nyingpo

    Next weeks ANZ-Morgan survey should prove even more enlightening as to how consumers feel about this government.

    Interestingly, this has shown there to be a consistent downward trajectory since Abbott came to power last September.

    Though it went up for the two months prior to the election and jumped around that same level after it, consumers obviously thought times would get better with a change of gov’t.

    But more significantly than that the trend is Abbott has *never* got consumers to feel as good as they did when Rudd made them feel so much better in 2009/2010.

    Tellingly, Abbott’s consumers are now even unhappier than at any time during Gillard!

  5. David Hand

    I would have thought that the end of the mining investment boom, where resources companies cease buying Australian dollars to build the infrastructure, and the collapse of commodity prices, would put downward pressure on the dollar.

    After all, that’s what drove it upwards on the 2000s.

  6. AR

    During the so-called ‘mining boom’- actually manic building of bigger & bigger holes to glut supply, I was bemused that the $mart money didn’t twig that when supply exceeds demand price drops yet here they were attempting to outdo all previous manias of oversupply.

  7. Bill Gates

    You left out the 6th Wave!
    The bad Discriminating Policies of the Abbot & Costello Liberal Party.
    What directly affects the Performance of any economy is the FIDDLING of Governments with restrictive and penalty type Legislation that takes away Consumer Confidence.
    Not that I believe the Other Mob are any Better!
    Both Labour & Liberal Parties have been extremists in Government…both either too far Right or Left!
    Hope people wake up that Donkey ! or Donkey 2 are no longer worthy of their PRE-SOLD Votes!

  8. Leslie Graham

    And of course the other obvious attempt at economic suicide is Abbotts decision to opt out of the new global industrial revolution.
    His making investment in stranded assets a priority over investment in renewables (the fastest growing industrial sector on Earth by an order of magnitude)would roughly equivalent to Britain investing in water wheels instead of steam turbines back in the mid 19th century.
    We are handing the driver for the 21st century to China, Germany, Brazil and even bloody Mexico on a plate.
    Could he possibly be an more stupid?