A GDP booster?

Downturn advocates overlook one of Australia’s key saving attributes.

Summary: Economic pessimists are overlooking Australian consumers’ unusually high Australia’s savings.  If the savings rate halves over the next two years to 5% instead of 10%, that could lift growth by about $30bn this year and $60bn next year, giving us a GDP growth rate of 4.5%.
Key take-out: Australian's high savings rate is an under-rated ray of economic sunshine.
Key beneficiaries: General investors. Category: Economics and strategy.

 I’ve noted before, and I think the macro data backs my case strongly, that there is a clear tug of war going on at the moment between confidence, which is abysmal, and the underlying fundamentals (which seriously could not be better). It was positive to note this week then, the almighty tug we saw in the direction of the fundamentals.  Car sales surged and loan demand picked up quite a bit as well. Two very positive developments reminding us why it is exactly that we shouldn’t write Australia off and why, despite the not so little issue of confidence, we can’t consign this country to the downturn dustbin just yet.  

At this point though I’m more interested in the home loans side of things - the credit numbers - as motor vehicle sales have been very strong for a long time and as I noted in my piece of 5 July: Can Australia avoid a confidence death spiral? The housing market is critical. Home lending up to this point hasn’t been what you’d call strong exactly and in fact it’s been very weak despite the RBA’s aggressive easing.

Graph for A GDP Booster?

Source: Australian Bureau of Statistics.

Loans are picking up though and that 2½% bounce loan numbers we saw in May is very positive following the deterioration in lending we saw in 2012. So far this year, lending growth has averaged 2.5% per month with an especially large 6.5% jump in March - probably brought about by the jobs surge we saw in that month and the RBA’s decision to leave rates steady. Recall that my view is that when rates are already very low, further rate cuts act to destroy confidence, not lift it, and the data supports this non consensus view. It’s part of the reason why lending growth was weak last year despite the RBA’s 125bp worth of rate cuts - it added fuel to global growth fears.

But here’s the rub. Amidst this positive data - record car sales and rising loan growth -there are already alarms being sounded. Moody’s for instance, suggested just recently that the current modest rise in house prices can’t last. It’s unsustainable in their view- already before it’s even picked up - and there is a risk of a correction.  Moreover we hear that this current lift in lending will prove short-lived, weighed down by a rising unemployment rate and the difficulty banks will have funding credit growth - that’s not to forget all the other negative things we hear about.

There are numerous flaws with these views, but the one key flaw I want to highlight today is that the pessimism overlooks one critical fact. The very high savings rate of Australian consumers (savings defined in the national accounts as income less consumption).  

Graph for A GDP booster?

Source: Australian Bureau of Statistics.

This is a key point we can’t forget about when we’re trying to determine the relative health of the Aussie economy.  As you can see from chart 1 above, savings now are at their highest since the mid 1980’s. Most people would probably already know that Australia has a high savings rate at the moment, but I don’t think it’s quite appreciated just how significant this is. How unusual it is in modern times and just why, any changes in savings patterns (highly likely) will have a profound impact on economic growth prospects.

In the 1980’s there were very good grounds for households to have high savings. For a start, recessions had been quite common in past decades up to that point. Roughly about 4 or 5 in the previous 15 years. Moreover, lending and deposit rates were very high - double digit as you can see on the below chart, and credit was much harder to come by for households by comparison. 

Graph for A GDP booster?

Source: Australian Bureau of Statistics.

Then, following the Campbell and Martin committees, the financial sector was deregulated; there were less controls on rates and lending, there was more competition - granting of foreign bank licences etc. Credit growth expanded at rapid clip, inflation came down and interest rates soon followed. Savings rates consequently dropped sharply as you can see if you go back to chart 2.

There were good structural reason back then why savings were so high. There are less so now.  This is why I don’t subscribe to the view that savings rates are permanently higher now. Consider that by policy design, there are substantial disincentives to savings - onerous tax regimes, very low interest rates on deposits. Similarly, there strong incentives to dis-save - record low lending rates, comparatively low loan to value ratios etc.

Against that back drop it seems clear to me that high savings now are temporary and it’s probably not even the case that this reflects overly fearful consumers. I mean to some degree it does, consumer spending dropped sharply from mid-last year -- almost 1-year after the RBA started cutting rates.  But that’s a relatively recent phenomenon and in any case, car sales are at records and consumers are going overseas in record numbers -- neither of which points to a new frugality. Instead it seems to me that savings are higher more as an after-thought. Less stuff to buy and the housing market hasn’t done much so no rush to gear-up. Rising auction clearance rates, strong lending growth and tentative gains in house prices suggest that’s all about to change.

So what could be the impact for growth? Well it could be significant. At the moment, consumers save roughly $34bn per quarter or roughly $136bn per year.  Each one of those billions represents around 1/3 % of GDP.  To see how powerful this is, just five of those billions spent this year instead of saved, that is households save $130bn instead of $136bn, would lift GDP for 2013 from the consensus growth rate of 2½ roughly  (average for the remainder of the year annualised) to 3.2%. For the 11.6 million persons who are currently employed that’s an additional spend of $431 for the year or - about a $143 per quarter.

If the savings rate halves  gradually over the next two years to 5% instead of 10%, that could lift growth by about $30bn this year and $60bn next year.  Assuming a below trend average growth rate of 2.5% as a starting point, this halving of the saving rate would see GDP  growth rise to around 4.5% in each of the next two years - well above trend.  All it would take is each of Australia’s 11.4m employed people to spend, instead of save, an additional $215 per month.

Now I say that tongue in check of course. It’s a little more complicated than everyone just running out and sending an additional $200 - although fair to say that approach did underpin the government’s GFC response I suppose. But it does highlight how very small changes in the economic state of play, savings in this instance, from a position that is entirely unusual, can have a tremendous effect of the nation’s growth - and likely will.

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