It’s the economy, stupid

The great prize for the next government is a wave of prosperity on the back of a falling dollar and record-low interest rates. For Labor to lose after straddling one of the hardest periods in economic history would be terribly unlucky.

The incoming Australian government is likely to inherit the best economic conditions for a generation: the lowest ever interest rates, a falling exchange rate and a recovering global economy, led by the United States.
The key risk is that Chinese growth falls short because of the credit crunch going on there.
But on balance this looks like being the best election to win since the 2001 Tampa and 9/11 election, when the economy hardly figured in the campaign.
A dozen years later, the boats are still coming and still driving politics, even though both sides are dead against them, but once again it’s “the economy, stupid”, to quote that memorable phrase from Bill Clinton’s 1992 campaign manager James Carville.

As I pointed out last month (The problem is debt, not the election, June 12) domestic demand has been contracting and some analysts have raised the probability of recession, but with rates at all-time lows and likely to be cut again, and the Australian dollar down another 4 per cent since then, conditions are improving daily. It’s now all about the US economy.
If the ALP loses this year it can count itself very unlucky indeed: the Rudd/Gillard/Rudd government will have exactly encompassed the second biggest crash and world recession in history followed by the slowest, most difficult recovery.
Compare that with John Howard, who, after winning that 2001 election, governed during one of the great economic booms in history, escaping into satisfied retirement 24 days after the stock market peaked.
Julia Gillard, in fact, was doubly unlucky because a key part of America’s recovery from the bust that its own credit excesses had caused was the debasement of its currency. When the 2010 election was held on August 21, the Australian dollar exchange rate was US89.38 cents, on its way to parity by the end of that year and $US1.10 by mid 2011.
So by coincidence, Gillard’s leadership more or less exactly encompassed the period of Aussie dollar strength, caused entirely by US dollar weakness. The good news is that it allowed 2 percentage points to come off the official cash rate because of low inflation, but that didn’t help Australia’s first female prime minister.
The US dollar and US long-term interest rates are now rising as America prepares to end the extraordinary monetary stimulus that has been required to stabilise its economy.
The Australian dollar is now closely following the US 10-year bond yield, inversely, which is in turn following US payrolls. So notwithstanding yesterday’s brief blip lower and then back again after the Reserve Bank’s statement came out reaffirming its easing bias, the level of the Australian currency is being determined entirely by the US economy.
Meanwhile global inflation has actually collapsed, not increased with all the money printing, as expected – average G7 CPI growth is down to 1.2 per cent. That means the cash rate in Australia can be cut again in the months ahead, most likely after the election.
The level of US payrolls is not only setting the level of the Australian dollar, but it has also been the key influence on global stock markets since 2009. So this week’s release will have a big bearing on the direction of share prices, as well as the Aussie dollar.
But in general the US economy is gradually improving, which is why there is so much talk about exiting, or “tapering” the Fed’s quantitative easing. As a result, the US dollar is likely to keep rising, and the Australian dollar to keep falling to below US90 cents.
The Japanese and European economies likewise appear to have bottomed, especially Japan, where “Abenomics” have got off to a roaring start. European unemployment remains dismal but some of the forward looking indicators suggest a turnaround may be coming.
China is in for a period of slow growth as the new government sets about controlling the rampant credit growth and housing bubble caused by its own version of the shadow banking that brought down the United States in 2008, and reforming the economy in general.
There seems little doubt that Chinese growth will fall below 7 per cent, but whether it gets to the 3 per cent that some are predicting is another matter. More likely the world’s second biggest economy will continue to grow by very large dollar amounts but diminishing percentages because GDP is now so big.
All in all, it’ll be a good election to win and a bad one to lose. With China slowing, we may not see a boom like the one John Howard enjoyed, but with the cash rate likely to start at 2.5 per cent and the dollar probably back at US88 cents, the Australian economy will prosper … and, of course, the boats will therefore keep coming

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