Recession won't be found in a mining pit

Predictions that a decrease in mining investment will lead to a recession are flimsy, with plenty of room for a falling dollar and low rates to take up the slack.

To be sure, there is some chance that Australia will fall into recession. There is also some chance that annual GDP growth will surge to 5 per cent. There is also some chance that the ASX will drop 50 per cent in the next year or will rise 50 per cent the year after.

Make any of these projections and you will be sure to grab the headlines.

In terms of the economy, the risks of either a bust (recession) or a boom (5 per cent GDP growth) are very low and the case for either scenario is flimsy, faulty and frankly a little bit mischievous.

It is the recession call or forecast that has gained some traction and headlines in recent days based, it seems, on the obvious assessment that mining investment is set to weaken sharply in the next few years.

Before we get to mining, the recession calls were most vocal after the national accounts were released and they showed GDP growing, yes growing, by 0.6 per cent in the June quarter and 2.5 per cent over the year. For some context, the average quarterly rate of GDP growth over the past decade has been 0.74 per cent with the annual growth rate at 2.97 per cent.

So the head-long plunge towards recession is starting from a point where the quarterly GDP growth was about 0.15 per cent below the long run average and the annual growth rate was about 0.5 per cent below the long run average.

Growth is a touch below trend, but recession?

Looking forward, as a source of the next recession, a fall in mining investment does not compute.

Importantly, mining investment makes up only about 6 per cent of GDP. If it fell 25 per cent in the next year, it would obviously subtract around 1.5 percentage points from GDP. If the other 94 per cent of the economy was growing even at a tepid 2.5 per cent, bottom line GDP would still be 1 per cent – weak for sure, but no recession.

But to think that in a climate of a slump in mining investment nothing else would change is unrealistic. And wrong.

This is because in reaction to the obvious mining investment fall that is underway, the Reserve Bank has be cutting interest rates, the Australian dollar is heading back to realistic levels and the government sector is no longer striving for fiscal settings that will knee-cap economic growth.

These three issues will offset any mining investment fall to the point where we are already seeing the interest rate sensitive sectors of the economy picking up the mining investment slack.

In the March quarter, household consumption growth had its strongest lift since the June quarter last year as clear signs the interest rate cuts are working. While 0.6 per cent growth is hardly shooting the lights out, a recession when over half of GDP is growing at an annualised rate of 2.5 per cent is tough to deliver, even with the bluntest pencil on the back of the biggest envelope.

Also supporting the thesis of interest rate sensitive sectors gaining traction is the 4.3 per cent total rise in dwelling investment in the last three quarters, even if there was no growth in the March quarter due to a temporary dip in alterations and additions. We know that house building approvals jumped over 9 per cent in April so the early signs for June quarter dwelling investment looks particularly rosy.

While it is difficult to parlay the monthly current price data from the monthly international trade data to a net export contribution to real GDP, there has been an unambiguous surge in export growth from the levels in the second half of 2012 while imports are lower over that time. 

The trade deficits averaged around $1.7 billion per month in the second half of 2012. Over the last three months, the average surplus, yes surplus, has been around $250 million a month. The lower Australian dollar will, in time, see these surpluses go up and up and up via exports.

For the recession doom merchants, the trade data also means that the hefty 1 percentage point contribution to GDP in the March quarter from net exports is likely to have a follow up 0.5 percentage point or so contribution in the June quarter when the national accounts are released in early September.

Of course, mining investment might fall 50 per cent next year or the level of inventories may be further depleted and therefore subtract from growth or wages and profit growth might fall precipitously. A new Abbott government may cut spending aggressively in his bid to return to budget surplus which would also subtract from GDP growth. But these speculative musings sit in contrast to the hard data over the past month which has been more or less as the Reserve Bank and Treasury forecasts them so recently (Australia’s stocktake reveals a healthy ledger,  May 22).

Of course, the low Australian dollar could spark a rebound in tourism and other exports while household consumption could rise strongly as consumers use their high savings and deleveraged balance sheets to spend. If exports boom off the back of a stronger global economy towards the end of this year, GDP growth will surge to 4 or even 5 per cent.

In its latest forecasts in the Statement on Monetary Policy, the Reserve Bank includes a scenario where GDP growth hits 4 per cent by mid-2015. The Reserve’s worst case for GDP growth over the next two years is 2 per cent. 

I'll back the Reserve Bank over those musing about a recession, any day. 

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