Commodity Price Free-Fall – Look Out Below!



Everyone knows that the largest part of the Australian business cycle is driven by fluctuations or swings in commodity prices.

Even though the floating Australian dollar cushions some of the impact of the big swings in global commodity prices, it is beyond argument that high commodity prices are good for Australia, while low commodity prices act to dampen activity.

In recent weeks, commodity prices have been caught in the pincers of lower commodity demand due to weaker global economic activity and extra supply as mining capacity around the world explodes.  And it’s not just mining –  prices across the broad commodity prices indices are sharply lower.

The first chart shows moves in the CRB Index of commodity prices in USD terms for the past year.  It points to a disinflationary shock coming through the global economy.

Some would rightly argue that the recent dip in prices comes from a high base – and that is true.  But the second chart (below) shows prices over the past 25 years.  For the sake of some long run context, the broad commodity price index, at 275 points, is back at 2004 levels (when the AUD was coincidently around US$0.75).   Compared to the early to mid 1990s, commodity prices are now only a little higher.  And in the early 1990s, the AUD was generally around US$0.70.

All of which shapes up to deliver very low inflation and a risk of slower economic growth in the period ahead.  It shows also that the RBA needs to be getting on its rate cutting bike – and fast – and delivering substantially lower interest rates.

It also means that the Australian dollar needs to fall and fall sharply.  Point forecasting exchanges rates is impossible to do well, but that aside, we could or perhaps should see a sub $US0.90 AUD before year end and it should drop into the US0.80s during 2013.

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The Economic Story That Needs To Be Told And Sold


People with knowledge of the subject can see that the Australian economy is performing beautifully.  GDP growth is around 3%, the unemployment rate 5%, inflation 2% and the year that the Budget returns to surplus starts in just a few weeks.

For individuals, an unbroken decade of real wages growth, tax cuts, pension rises and now lower interest rates are driving home the progressive rise in living standards and purchasing power for the vast majority of the Australian population.

Having been in power for 4½ years, one could assume this rare yet quite fantastic economic performance would show up in solid support for the Government more generally, and specifically, for the Labor Party.

A run of recent polls shows this is not the case with the Coalition side of politics judged to be the better economic managers by a margin of around 15 points.

Part of this economic undershooting for the Labor Party on economic management is self-inflicted.   While it would be silly to go anywhere near the line that John Howard used when he was Prime Minister that “you’ve never had it so good”, the alarming and negative connotations of the lines used by Government Ministers, especially that “I feel your pain” and “working families are doing it tough” and “difficulties making ends meet”, are political own-goals.   These sorts of comments filter into people’s fears, insecurities and misunderstandings and eventually voting intensions.

They have to stop.

It is any wonder the electorate thinks the Government is a poor economic manager when the Government itself is perpetuating the “tough times” and “pain” mantra?  The electorate is saying, rhetorically at least, “well, you are in government, what are you doing about my financial pain and me doing it tough?”

The “working families are doing it tough” rhetoric is tantamount to talking down the economy, as it adds to consumer (voter) disaffection and creates an impression that the Government is not delivering good economic outcomes.

Can you imagine Paul Keating saying these things at any stage of the political cycle let alone when the economic performance is as stunningly good as it is now?

The low standing of the Government in the electorate on economic management appears linked to the timidity of the Government in taking ownership of the economic prosperity now being enjoyed.  If the Government is to have any hope of winning the next election, it must change is the narrative on the economy.

The beauty of revamping and refining the discussion on the economy is that it can be facts based.  There is no need for spin or cherry-picking the news.  The cold, hard economic and financial facts paint a picture of a wonderful economic performance and a near perfect application of macroeconomic policy settings.

The Government should be dynamic, authoritatively managing the $1.5 trillion economy that is Australia; it is the 13 th biggest country in the World in terms of GDP, although its population is only the 52nd largest.  Australia’s influence in the global economy is much greater than a population of 23 million would suggest.

The Government needs to lead the economic debate that is delivering reforms that are sustaining economic growth into an unrivalled 21st straight year.  The Government should take ownership of the current low interest rate structure.  While interest rate settings are driven by many things, there is no question that the tight fiscal settings have given the RBA room to cut official rates.

The Government needs to be upbeat and eliminate talk of tough budgets, financial hard times and doing it tough.  It needs to start talking the economy up and its role in securing that growth.

Mortgage interest rates are around 150 basis points lower than those left by the Coalition Government in November 2007 meaning that someone with a $300,000 mortgage is saving $3,500 a year in interest payments.

One reason for this lower interest rate environment is that with a tight and prudent budget, the RBA has been aided by the Government in slashing the inflation rate.   Underlying inflation has fallen from a peak of 5% in 2008 – just after Labor took office – to 2% now.  This helps families make “ends-meet in the difficult economic circumstances”.

Then there are interesting little factoids that can be trotted out.  Things like the size of the economy is $400 billion bigger under Labor:  In 2007-08, Australia’s GDP was $1.18 trillion and it will be around $1.57 trillion in 2012-13.   This is the Government of growth.

This bigger economy has helped to generate 800,000 new jobs since November 2007 and by the end of 2013, this figure will be close to 1 million.

The Government can then throw in the fact that average annual full time wages have increased from $57,200 at the end of 2007 to around $70,000 in early 2012.  This rise of $13,000 a year is a big amount and more than covers the rise in cost of some items such as electricity that people put in their basket of economic pain.

The facts show the economy is doing well, but from the Government’s perspective, not many people feel it or give the Government credit for delivering these outcomes.  Unless the perceptions about economic management are changed and changed quickly, the Labor Party will remain at long odds to win the 2013 election.

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Mr Hockey’s Methodology Applied to Unemployment


Shadow Treasurer Joe Hockey issued a press release last week (http://alturl.com/yrb7o) where he chose the look at the average level of interest rates under the 11 and a half years of the Howard Government and he compared that to the average level of interest rates under the 4 and a half years of the Rudd/Gillard Government.

Mr Hockey concluded that mortgage rates were a touch lower under the Howard government than under Rudd and Gillard.   That is indeed a fact using that methodology, although once the lower level of interest rates from May and beyond are included in these averages, it is likely that the average level of interest rates under Labor will move lower than under the Coalition by year end.

In an earlier post, I noted that using Mr Hockey’s methodology for interest rates and applying it to net Government debt, Labor has a lower average level of net government debt than the Coalition (see http://www.marketeconomics.com.au/2032-mr-hockeys-methodology-applied-to-government-debt ).

That got me thinking about more important economic indicators – in this instance, the unemployment rate.  Using Mr Hockey’s methodology and applying it to the unemployment rate, the following facts emerge:

  • Average unemployment rate under the Howard Government was 6.4%;
  • Average unemployment rate under the Rudd and Gillard Governments is 5.0%.

There you have it.


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Accelerating GDP Growth – Near Record Low Interest Rates: What’s Going On?


On 6 June, the March quarter national accounts are likely to confirm annual GDP growth around 3.2% which will be the first time in 4 years (since the March quarter 2008) that GDP growth will have been above 3%.  It will be good news showing the economy picking up nicely.

On 5 June, the day before we see these GDP figures, the RBA is likely to have cut official interest rates to one of the lowest levels in the last 50 years.  If we take out the so-called emergency level for official interest rates during the GFC, even a 25 basis point cut in June will see the cash rate fall to 3.5% – the lowest level for the cash rate since 1965.  (Thanks to my friends at Bloomberg for data base with this long run cash rate history.)

A regular person would be justified asking for a stock take on what is happening here.  If the rate of economic growth is accelerating, yet the central bank is cutting rates to levels rarely seen in a lifetime, what’s cooking?

There are a few explanations – some are a bit glib, others are more serious.

Importantly, the 3%+ growth rate will be an artifact of policies a year or so ago and based on a time when global economic conditions were stronger than now.  To that extent, they don’t matter much for current policy settings.

What is also happening is that in recent times, some of the economic indicators locally have cooled, while globally there are some seriously confronting risks.  At the same time, commodity prices are weakening as global demand falls, a potentially big negative for Australia.  This fall in prices is occurring just as Australia is adding to its capacity to produce these commodities as a massive rate.

At the same time, we have got a good feel that inflation is low and is likely to stay low.  The labour market is a little soft and asset prices are falling which is dampening consumer sentiment.  The Budget earlier this month has confirmed a quite appreciable contraction from fiscal policy in the year ahead.

In cutting interest rates on 5 June, the RBA will be looking to the end of 2012 and into 2013 for an economic impact and the March quarter GDP result, while very important, tells us little about the economic pressures in 2013.

It will, nonetheless, be interesting to juxtapose near record low interest rates with GDP growing at its fastest pace in 4 years.  Adding complexity and a Harry Potter like confusion on events would be another solid employment number the next day, 7 June.

Oh it is good to be an economist – so many facts and even more explanations.

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Mr Hockey’s Methodology Applied to Government Debt


On Tuesday, Shadow Treasurer Joe Hockey put out a press release about interest rates in which he said:

  • “Wayne Swan likes to boast, but he forgets to check his numbers and tell the truth.
  • He claims repayments for home buyers are less under Labor than they were under the Coalition Government.
  • … The Treasurer would know that, on average, interest rates have been higher under Labor than they were under The Coalition.” [My emphasis.]

Mr Hockey concluded:

  • “This Treasurer should stop the spin and get his facts right.”

Mr Hockey used the average level of interest rates for the whole of the Howard Government and compared it to the whole period of the Labor Government since December 2007 (up to April which of course excludes the May 2012 rate cut).

There is something to be said for this methodology, although it is clear that over the next few months with interest rates now well below historical averages, Labor will likely overtake the Coalition as the Party of low interest rates.


But Mr Hockey’s methodology had me thinking about Government debt.

I turned to my favourite budget document, Statement 10, and looked at the history of net government debt over the past 20 years or so.

Using the same methodology that Mr Hockey used for interest rates and applying that to Government debt, this is what I found.


Average Net Govt Debt

(% of GDP)

Howard 1996-97 to 2007-08


Rudd/Gillard 2008-09 to 2011-12


As is obvious, the average level of net Government debt under the Howard Government was 5.2% of GDP; under the Rudd and Gillard Governments it’s been 4.4%.

Enough said.

Mr Hockey’s full press release is in the link below.


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Labor or Liberal Government Debt?


It seems that a day doesn’t go by without someone from the Coalition side of politics recounting the fact that the Howard Government inherited $96 billion of net Government debt when it won the 1996 election and that over the course of the next decade, it “paid it off”.

There is no denying the fact that net debt was $96 billion in 1995-96 and it was eliminated in 2007-08, the year that the Howard Government lost office.

It is useful and enlightening to look at some other facts behind that $96 billion level of debt “inherited” by the Howard Government, given that there is an implication that all of the $96 billion was racked-up under the Hawke and Keating Governments between 1983-84 and 1995-96.

Something that you never hear, until now, is the fact that almost half of the $96 billion of debt was sourced from the Fraser Government, which in its last few years had Mr Howard as Treasurer.

When John Howard was Treasurer, net Government debt rose at a steady pace, hitting 7.5% of GDP when Fraser lost the 1983 election.  In 1996 dollar terms, 7.5% of GDP is around $40 billion which is in fact the real level of net government debt “inherited” by the Hawke Government when it won the 1983 election.

Recall, by way of context, the fact that the Fraser Government “inherited” zero net government debt from the Whitlam Government in 1975-76, so all of the build up in government debt in the Fraser years was self imposed by the Coalition, its policies and the business cycle.

Coming back to the issue of the $96 billion net debt inherited by the Howard Government in 1996, it’s a fact that 42% of it was bequeathed from the Fraser Government and left for Labor to deal with during its term of government.

So next time you hear someone from the Coalition or elsewhere for that matter banging on about the $96 billion of Labor Government debt that was paid off by the Howard Government, remind them of the fact that $40 billion of it or almost half was a hangover of the debt left to Labor by the Fraser Government in 1983.

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Can the RBA cut rates with unemployment below 5%?


The April labour force data were quite shocking – showing that the unemployment rate was back below 5% against expectations that it would be nearer 5¼%.  This saw many, myself included, question whether the RBA can cut interest rates while the unemployment rate is so low.

The bottom line is of course they can cut rates with unemployment below 5% and if you want any context, you only have to go back to 2008.

Right through 2008, the unemployment rate was below 5% – in fact the August 2008 unemployment rate came in at 4.1% and at the next RBA Board meeting, official rates were cut 100 basis points to 6.00%.

When the September 2008 data were released, they showed the unemployment rate at 4.3% yet in November, the RBA slashed rates by 75 basis points to 5.25%.

Come the release of the October 2008 labour force data, which showed the unemployment rate steady at 4.3%, the RBA slashed rates a further 100 basis points to 4.25%.

Now of course, the GFC was unfolding at that time and the threat to the Australian economy was acute as fears of a 1930s Great Depression event raised their head.  I would note also that the most dramtic fiscal stimulus measures were also being put in place for all the obvious reasons.

Which brings me to the end point – Despite the terrific news in the most recent jobs data, highlighted in the 4.9% unemployment rate, global conditions and much of the local data remain problematic.  What’s more, fiscal policy is being tightened.

It is now a line-ball call on whether the RBA will cut in June to 3.5%.  There are still some important data to be released between now and the next RBA meeting on 5 June and if they are flat and global conditions remain dodgy, the RBA can and will cut.

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Debt: Government versus Households


With all of the hyperventilating over the level of government debt in Australia and the plan to raise the debt ceiling, I thought it would be useful to look at two very basic facts:

  • The household sector in Australia spends around 11% of it disposable income on interest or debt servicing.
  • The Commonwealth government in Australia spends around 3% of its income (total government revenue) on interest or debt servicing.

When will the Opposition start bagging the household sector for its “addiction to debt”; “living beyond its means”; “unsustainable borrowing”; “adding to the debt of our children” when the debt of the household sector is more than three times as burdensome as the Governments?

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Gillard Moves to 18 out of 27


Tomorrow, Julia Gillard will become Australia’s 18th longest serving Prime Minister.  She will overtake Harold Holt who was PM for 692 days.  Ms Gillard has been in the job longer than McMahon, Cook, Reid, Watson, Fadden, McEwen, Page and Forde.

Australia has hade 27 Prime Ministers and interestingly 14 of those have served for less than 3 years.  This means that Ms Gillard will continue to climb the ladder quite quickly in the near term with the next former PMs immediately ahead of her being Scullin, Rudd, Barton and Whitlam.  Indeed, on 1 June 2013, Gillard will overtake Gough Whitlam as the 14th longest serving PM and when she does, she will become the 6th longest serving Labor PM (if we exclude Billy Hughes who batted for all sides!).

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Europe avoided recession? What Tripe!


With the Eurozone GDP data overnight showing zero GDP growth in the March quarter following a contraction of 0.3% in the December quarter, many commentators and economists have proclaimed that “the eurozone avoided recession.”

What poppycock.

The commentary surrounding the performance of the Eurozone makes a mockery of the two-consecutive-quarters of negative GDP as the definition of recession given that the unemployment rate is rising to ugly levels and wealth and income are falling rapidly.

It exposes the lazy, cookie-cutter analysis of many who are in or cover financial markets.  They are seemingly stuck to their silly rules of thumb without actually thinking what the data and market moves are telling them.  Glib phrases such as “risk-off”, “profit taking” and “technical recession” should be discounted at every opportunity.

The two consecutive quarters has always been a cheap, easy and soft option in defining recession given that a profile for GDP of -0.5%; +0.2% and -0.5%, for example, shows all too clearly a contracting economy but one that is not in a technical recession.  Only a goose would think an economy with that profile for GDP is not in recession.

While GDP growth is an important benchmark, so too is unemployment.  Try telling the 10.8% of people unemployed in the Eurozone that the economy avoided recession; or those who’s wealth has been smashed with the housing crash and stock price falls.  Tell those with falling real wages that there was no recession.

Make no bones about it, the eurozone is in recession despite what all the lazy analysts looking at zero GDP growth for the March quarter might say.

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