Gorging on a surfeit of fiscal virtue
Citigroup's chief economist Willem Buiter says Australia has the ammunition to avoid a recession even if China's economy goes off the rails. The more interesting question is whether or not the political will exists to use it, should the need arise.
It should come naturally to the authorities who hold the fiscal and monetary levers to turn up the heat if an economy slows, Buiter says.
In Europe, the tendency was not controlled. A "fiscal responsibility deficit" sowed the seeds of that region's sovereign debt disaster. Here in Australia, however, there was "a surplus of fiscal virtue", he told a meeting of Citi clients on Wednesday.
Buiter is a former external member of the Bank of England's monetary policy committee, and he has been a particularly influential commentator during and after the global financial crisis and Europe's sovereign debt crisis.
That is not just because he coined the term "Grexit", a word amalgam that referred to the possibility that Greece would dump the euro and re-issue a heavily depreciated version of its old currency, the drachma.
He specialises in cutting to the chase, by highlighting early, for example, that Europe's sovereign debt crisis was an existential one for the euro, and that makes his comments about Australia during his visit to these shores interesting.
Buiter sees China's growth continuing to slow, to an annual rate of less than 7 per cent by the end of this year, and to not much more than 6 per cent next year.
The slowdown is part of (and at the leading edge) of a global phenomenon, he says. Developing countries including China are slowing as their old economic model of exporting to the West hits the wall, and domestic demand does not take up enough of the slack quickly enough to maintain momentum and sustain a significant increase in government and private sector balance sheet gearing in the past decade.
Weak Western world demand in the wake of the global crisis is playing a part in this change, but it's not just a case of waiting for the world to mend. There also appears to have been a non-cyclical downshift in global trade, to the point where it is growing less quickly now than sluggish global GDP.
That upsets a paradigm that has existed since World War II, and Buiter confesses that the reasons for the shift are not yet understood.
It is what it is, however, and Buiter says that while there is talk among China's leaders about creating policies that would assist the economy's transition from the broken manufacturing export model to one that is more reliant on domestic demand and services, so far there is little action.
It could be that expectations are too high. The West chronically overestimates the ability of China's government to control its economy, Buiter says, adding that it is possible that growth in China might settle at close to 6 per cent and stay there for a couple of decades.
The axiom is that growth of 7 per cent or more is required in China to maintain full employment and social stability as massive internal job-seeking migration occurs. A serious recession would be annual growth of around 4 per cent.
On Buiter's scenario, China sits for a long time in between those two poles, and the run of double-digit growth that characterised the peak of the resources boom becomes a distant memory.
Demand in China and the rest of the developing world tapers rather than collapses, however. Commodity prices also decline, but do not collapse, and Australia's own commodity-powered export model is pressured, but does not become totally unhinged over the longer term as our resources investment boom morphs into a commodity production surge that helps compensate for lower commodity prices.
The pace of the decline of the investment boom itself does, however, pose more immediate risks. There is a risk of recession if it is a rapid retreat that outpaces growth in the non resources economy, and Buiter's observation in those circumstances, "recession or not" basically depends on the fiscal and monetary response.
The Reserve Bank's monetary response is likely to continue next Tuesday with a quarter of a percentage cut in the central bank's cash rate to 2.5 per cent.
The potential for a fiscal response if it is needed is constrained by the bipartisan political compact in Canberra for fiscal restraint, and a relatively quick return to budget surpluses.
This is the surplus of fiscal virtue that Buiter is referring to. It has not been upset by Labor's leadership change because new initiatives such as the early introduction of carbon trading are being accompanied by promises of offsetting savings, and Buiter's point is that, depending on how things develop, it might be risky.
Scrooge is not a role model, he warned on Wednesday.
His advice? "Live within your means, but define your means inter-temporarily."
My translation of that? Get the deficit down, but only if the time is right. And if a recession is threatening next year, it won't be.
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