Consumption's the cure to Australia's mining malady

Recession fears fail to account for the fact that as mining investment drops off, a lower dollar and interest rates should see consumer spending pick up the slack.

Anyone who has forecast a recession in the last 21 years has been wrong. This is because Australia has not had a recession since 1991, at least according to the existing estimates for GDP and the unemployment rate.

There is little, if any, evidence in the current structure of the economy or policy settings that justify the recent escalation in recession forecasts. They are likely to be about as accurate as those that have popped up at various times since the early 1990s.

The forecasts or scenarios that have Australia threatening to fall into recession seemingly focus on only one aspect – the decline in mining investment and the negative impact that will have on total GDP.

To be sure, there is little doubt that some time soon, perhaps even now, mining investment will fall. Having risen more than five fold in the last decade, there is obviously scope for the fall to be extreme. Indeed, it would be reasonable to expect that over the next few years, mining investment will be down by 50 per cent or more.

And if mining investment did fall precipitously and nothing else changed in the economy, you could bet London to a brick that Australia would register its first recession since 1991.

But things in the other 92 per cent of GDP which are not mining are not staying the same. Official interest rates have been cut to record lows and mortgage and business borrowing costs have fallen sharply over the past 18 months or so.

The interest rate sensitive areas of the economy are looking to take advantage of this lower interest rate regime with retail sales, for example, moving up solidly since the end of 2012. The boost to incomes and spending from lower interest rates, rising stock prices and broadly stable house prices will underpin household spending over the short to medium term.

It should be noted that household consumption is around seven to eight times larger than mining investment so ongoing solid growth in consumer spending is important in supporting GDP growth. A recession requires very weak consumer demand.

Home building approvals have also been edging up over the past year, notwithstanding the extreme volatility in the monthly series. The HIA series of new homes sales has jumped by close to 10 per cent in the last two months to be at a 16 month high. This suggests new construction will continue to expand and support GDP growth for the next year or two at least.

These examples alone suggest that household consumption and dwelling investment will take up some or all of the slack as mining investment fades. A recession is impossible if these two parts of the economy continue to grow at a solid pace.

In addition to that, the recent fall in the Australian dollar is huge news. It will cushion the negative impact of softer mining investment. History shows that when economic conditions soften, as they are now, a weaker Australian dollar provides welcome and substantial support to the local economy with a very short lag.

During the 1997-98 Asian economic crisis, the US tech-wreck around 2001 and of course the global financial crisis in 2008 and 2009, a sharp Australian dollar depreciation worked to support exports, replace imports and underpin overall GDP growth. In all these instances, a weaker Australian dollar and easier monetary policy in tandem saw the economy avoid recession.

Which brings us back to here and now.

Just a few weeks ago, the Australian dollar was trading at around $US1.05 and 80 index points on the Reserve Bank estimate of the trade weighted index. This morning, it is trading near $US0.9650 and 74 Trade-Weighted Index, falls of close to 10 per cent.

Even at these levels, there will be a meaningful boost to the economy from a more competitive exchange rate. If the Australian dollar falls much more, as seems likely, it will, along with low interest rates, do a lot to offset the negative effects from the mining investment down turn.

So a recession?

The economy does not have the smell of such a severe downturn that would lead to recession.

There is no policy error from the Reserve Bank and the contractionary effect of fiscal policy is fading. Consumer balance sheets are the best they have looked in over a decade with high savings, debt deleveraging and rising wealth, all of which will work to support growth even if other parts of the economy do it tough.

It is not impossible to imagine Western Australia falling into recession on the back of a mining investment slide, but this will be offset by strong growth in the Eastern states as low interest rates boost housing and consumer spending.