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Economics Report - September 2011

Few investors will be sorry to see the back of August. They were whipsawed through some extraordinary market volatility. For the month, the ASX200 fell by 2.9%, its fifth successive monthly drop. But it could have been a lot worse. From its intraday low on 9 August, the Australian market recovered by about 14%. The US share market was also down for the month, by 5.7%.

Once again, the market-driving forces were almost solely offshore. For months, we've worried about double-dip recession in the United States and about Eurozone debt issue. In August, there were three more (related) things to worry about. In no particular order, there was the abject disgrace of the US political process as it struggled to achieve what should have been a fairly basis accounting exercise, the raising of the US government's debt ceiling. Second, shortly after the ceiling was raised, the Standard and Poor rating agency downgraded US government debt because it was unimpressed by the medium-term plan to reduce the deficit that accompanied the raising of the debt ceiling. Third, the statisticians revised downwards the last few years of history in the US, telling us that that economy is growing far less rapidly than thought before. To many, this put it very close to stall speed. I continue to think that the US will avoid a return to recession, although its growth will continue to be less than stellar.

On the Eurozone debt issue, the European Central Bank continues to work towards a solution. There is no magic bullet, but the situation now appears less dangerous than it did a month ago.

There were some interesting developments in the Australian economy. We got more evidence that employment growth has slowed sharply from an average of 39,000 per month in the six months to November last year to just 5,000 per months since then. And the unemployment rate rose from 4.9% to 5.1%. This means one of two things. Either it is simply statistical "noise" or else it’s the first step on the way to 5.5% or more, which would be a major concern for policy makers. There were a couple of significant "job cut" announcements made, and retail trade continued to founder.

What's up with Retail Trade?

It's been a tough year. In the year to the June quarter, the volume of retail trade rose by just 0.6%, a figure almost as low as during the GFC. In the year to July, trade in nominal terms rose by just 1.4%, the second-smallest gain in almost six years. Excluding food, sales have fallen by 0.4% in the past year, also the second-weakest in almost six years. Various explanations have been put forward. First, we are told that the consumer has no discretionary income. After he or she has purchased their electricity, petrol and bananas, there simply isn't enough left to hit the shops. While this is undoubtedly true for some people, it is demonstrably untrue for the consumer sector in total. In the month of June, overseas “short-term” departures totaled 650,000, a rise of 13% in the past year, and about double the pace of just eight years earlier. If there were a shortage of discretionary income, would not the overseas holiday be the first thing to go?

Second, we hear more and more about on-line shopping. This has undoubtedly played a role for some retail categories, mainly those where you don't have to try on the article, or feel the fabric. But only about 4% of all purchases are now made online, and some of these come from traditional "bricks and mortar" retailers anyway. The issue with online purchasing is what is going to happen next that figure of 4% will almost certainly be higher a decade from now.

Retail's main problem is that the consumer has become progressively more cautious in recent years. From the mid-80s to the mid-00s, Australian consumers increased their spending significantly faster than their income, with the result that the saving rate fell from 15% to 0. Around 2005--before the GFC--we apparently decided collectively to change our ways, and since then the saving rate has risen from zero to about 11%. What this means is that in recent years spending has thus increased less rapidly than income. And this is retail's problem.

So the question becomes: what happens next? Is the saving rate on its way to 20%, in which case retail has several more years of bad road ahead of it? Or is the saving rate likely to settle close to its current level, which means that spending growth will snap back in line with income growth? I think the latter is more likely after all, the saving rate has never been as high as 20% before. So retail should improve (slowly) from here.

Two Speed or not Two Speed? That is the question.

The travails of retail trade are one manifestation of the two-speed nature of the Australian economy. This dichotomy of velocity is far more evident at the industry level than it is at the State level. There is one State, Western Australia, out-performing the rest, with its unemployment rate currently at 4%. All other States have an unemployment rate between 5.1% and 5.6%, which is a fairly narrow band.

The story is very different at the industry level. It’s mining versus the rest. During the month, Treasury Secretary Martin Parkinson gave a speech in which he acknowledged that Treasury’s budget-time forecast of 4% GDP growth in 2011/12 assumed that the three-quarters of the non-farm economy that is neither mining nor directly affected by mining would grow by just 1%. My arithmetic says that “mining and related” must therefore be expected to grow by somewhere between 10% and 15%.

Whither Interest Rates?

Two speeds don’t make life any easier for the Reserve Bank. It can only set interest rates for the economy as a whole. During the month, it relented on its view that policy would eventually have to be tightened further to keep inflation under control. Financial markets went a big step further, at one stage pricing in an emergency rate cut before next week’s RBA Board meeting. Unless the rest of the world fell apart, this was never going to happen. Markets are still assuming significantly lower rates a year from now. I am more sanguine about world and Australian growth prospects. In my view, the case for a cut has to build from here. The key indicator in the next several months will be the unemployment rate. The rise in the rate from 4.9% in June to 5.1% in August may be nothing more than statistical noise. If, however, it is the first step on the way to 5.5%, then the case to cut rates will grow quickly.

Thanks for the Feedback

Last month’s missive on the carbon tax inspired more feedback than anything else I have written recently. It’s comforting to know that not everyone hits the “delete” button straight away!

Chris Caton
Chief Economist

The views expressed in this article are the author’s alone. They should not be otherwise attributed. The October issue of Caton’s Corner will not appear until 5 October.

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